Education? It's the economy, stupid

Labour's solution to the underclass is misguided, says Robin Marris. Money management is the key

Last week the Chancellor raised interest rates. Only by a token amount, but enough to pass a "message" to the City. Commentators have given diverse explanations for his action. None has given concrete evidence that actual inflation is accelerating dangerously. Gordon Brown, in his contribution to the debate on the Queen's Speech, implied that he did believe there was now a serious danger of inflation, but that this was the fault of the Government for failing to encourage investment.

My explanation is that both the Chancellor and his Shadow are still under the spell of a restrictionist, macro-economic philosophy which effectively discourages investment. One can daily see the results throughout the media. Isn't it odd how City columns so often report good news/bad news? In July last, The Times reported, "Output rise may stall rate cut"; in the same month, The Independent wrote, "US jobs surge causes Wall Street pandemonium". Only a few weeks ago, again in The Independent, we read, "Clarke boom is bad for the stock market".

Think about it. Something that is good for the unemployed and for the economy causes stock market prices to fall and the Bank Governor to clamour for higher interest rates. Either there is something odd about the system, or market operators have an upside-down view of reality. I think it is the latter. Market operators, and the people who write for them, are suffering from irrational expectations. Journalists believe markets think that governments have come to believe that almost any improvement in the real economy is a danger sign for inflation. It is a vicious circle. Whether governments believe the gloomy scenario or not, they are forced, by fear of the markets, to behave as if they did.

There are many arguments about the cause of this situation. After five years of 3 per cent inflation, we had the late-Eighties outbreak, when, though general OECD inflation never rose above 5 per cent, UK inflation stood at 7 per cent for a short time. The painful part of that experience was the violent decline in employment and production when the "bust" came. That was not a normal reaction: it was because the financial system had become unstable due to deregulation and the loans bonanza. So we got all the horrors of unemployment and negative equity.

Some of the instability is still there, and there is reason to be cautious, though exaggerated caution carries heavy costs. If the productive business sector comes to believe that every time they produce more goods they will be clobbered, then they will be cautious about long-term expansion plans. The economy's long-term capacity for producing goods and employing labour will grow only slowly. It will fail to keep up with the growth of the labour supply caused by productivity gains and increased participation of women in the workforce. The gap between labour supply and demand will grow. New technology and globalisation of trade will cause the effects to fall hardest on those who are least well qualified. There will be an increasing problem of an underclass.

This malign process has been going on in Britain, the US and continental Europe for the past quarter-century. The results take different forms in different countries, but in the UK the features are a stagnation of real earnings among low-earners; a 33 per cent "non-employment" rate among "low-ed" men of working age (ie, with no GCSEs); and an extraordinary increase over the past quarter-century in the proportion of all working- age men who are not employed: this has gone up from one in 20 to almost one in four.

This should surely be the priority problem for policymakers. The public certainly thinks so: opinion polls show an overwhelming concern about the emergence of an underclass. Tony Blair also seems to think so. In his conference speech, he said that 40 per cent of the population were economically struggling. (I think that is exaggerated, but 30 per cent is not far out.) Yet Tony Blair and Gordon Brown said nothing of the relationship between economic growth and job creation. In their comments on the macro-economy, both spoke mainly about inflation.

Instead, they said the solution to the underclass problem is "education, education and more education". But over the period in which the problem has emerged, we have seen a massive increase in the educational level of the working population. To take a single indicator, the proportion of women with no qualifications has fallen from two-thirds to a third. The corresponding change among men is even stronger.

So what, in the minds of Blair and Brown, has gone wrong? They do not really tell us. They hint that the British education system is still too elitist, but are unspecific about details or remedies. More fundamentally, they do not face up to this question: if those who have not participated in the education revolution had had better qualifications, would there in fact have been jobs for them? On my calculations, the answer is "no".

Implied conventional wisdom says otherwise, but gives no argument or calculation. I have a nasty suspicion that part of the reason for the Brown/Blair position lies in two fears. Both are understandable, but no less disturbing for that. The first stems from the realisation that it is indeed difficult for governments to increase the sustainable rate of long-term economic growth. The second is fear of "the markets".

If these and similar fears are so real that nothing can be done, I am pessimistic for the underclass. Without macro-economic success, "supply- side" policies, such as more and better education, however intrinsically desirable, will fail to resolve the problem of jobs and low wages.

If that conclusion were true, it would be a poor reflection on the state of the world economy. Fortunately for my own state of mind, I do not myself believe it, because the long-run growth rate of total demand and capacity that the economy is able to sustain without unacceptable inflation (the so-called "sustainable" growth rate) is flexible. It is susceptible to both supply- and demand-side policy influences.

One policy that is required is a sustained effort by all governments to create a permanent reduction in long-term real interest rates (they are still, by historical standards, much too high). Another is simply a matter of business psychology. The business people who produce goods and services need constant reassurance that the basic aim of government policy is real long-term economic growth - not only of productivity per worker, but of total output and total employment.

The real economy needs to be constantly re-assured that low inflation is a means to an end, not an end in itself. What Kenneth Clarke did last week gave all the wrong signals, and violated every one of these precepts.

Gordon Brown has shown more awareness of the problem, but his spoken contribution is still bedevilled by the City syndrome. He did not address the problem that high interest rates are themselves a hindrance to investment, and therefore also a barrier to growth. I agree this is a chicken-and- egg problem, but at least it must be recognised.

John Redwood MP interrupted the parliamentary discussion of these difficult matters to ask how the Labour Party could expect to be heard on economic questions when it could not handle a 10-year-old child in Nottinghamshire. Unless the national economic debate is raised to a higher level than that, we shall see more and more of the underclass, and, not improbably, yet more rioting children.

Robin Marris is Emeritus Professor of Economics at Birkbeck College, London University. His book `How to Save the Underclass' is published by Macmillan (pounds 40 hardback, pounds 12.99 paperback).