Economics: Low inflation leaves room for progress

THE NEWS on inflation is extremely good. Thursday's figures showed that prices actually fell in October by 0.1 per cent. The unexpected drop meant that the inflation rate - the rise in prices over the year - fell back to 1.4 per cent. The underlying rate, taking out the impact of mortgage interest rates, eased to 2.8 per cent, as low as the lowest rate in the summer. This was in turn the lowest since 1967.

This fall is as significant as the drop that also took the markets by surprise at the beginning of this year. It reduces the risk of any upwards blip in inflation sparking higher wage settlements and thereby embedding itself in future inflation. Indeed, settlements are flat and earnings growth is still slowing. The rise in earnings over the year to September was 3 per cent, compared with a low for the 1979-88 cycle of 7.5 per cent.

There is, though, a question about whether inflation is subdued merely because the economy is failing to recover. The rise in retail sales volume in October was 0.1 per cent, and several retailers report that sales have been flat this month as consumers wait for any bad news in the Budget. But, overall, it seems wrong to depart from the view that consumption is still rising at a respectable rate. Retail sales volume is up 3.2 per cent over the year. Anything stronger would reverse the improving trade balance and abort the recovery.

The manufacturing figures have been poor, reflecting the miserable state of our continental markets. But neither the growth of services - up 2.2 per cent over the year to the third quarter - nor the surprisingly large 49,000 fall in unemployment in October suggest that the recovery is petering out. This drop in the number of jobless is largely due to a shrinking labour force. There are fewer young people, and more of them are staying on at school. But jobs are also up.

The implications for the Budget are that the Chancellor can still afford to take the risk of a modest net tax rise, and that the fall in inflation increases the chances that some of the net rise will come from VAT or excises. Low inflation and some fiscal tightening would also happily justify an interest rate cut by a full percentage point with another in reserve for the beginning of next year.

This in turn is good news for the financial markets, which had become nervous. Low inflation means low interest rates and a continued flow of savings chasing higher returns than those on bank and building society accounts. This will support the price of both government bonds and shares. We may be in for another leg of the bull market.

The recent achievements on inflation also give the Government an opportunity which, sadly, it seems to be fluffing. There could hardly be a better time to give the Bank of England more control over interest rate policy, a reform that would help to ensure that we do not fritter away our low inflation in another ill-judged Barber or Lawson boom that has to be corrected through a painful recession. Central bank independence would remove the risk of politicians using interest rates in the battle for votes rather than the battle against inflation, and would in turn persuade the financial markets to lend money to the British government more cheaply.

The case is eloquently put in last week's report from the eminent committee chaired by Lord Roll, (Centre for Economic Policy Research, pounds 60). The report rightly argues that a Bank of England Governor who had to give evidence on the achievement of the Bank's statutory mandate to stabilise prices would be more accountable to Parliament than the present cabal of the Chancellor and Prime Minister, neither of whom have to explain themselves to Cabinet, let alone the Treasury committee.

The Roll committee thinks the German system would fail to take enough account of British parliamentary traditions, while the New Zealand system would fail to reassure markets that the Government might not simply raise the inflation target which the central bank is contracted to achieve. So it opts for giving the Bank of England complete responsibility for setting interest rates in the pursuit of price stability, but allowing Parliament to override the Bank for defined periods in the case of crises like the 1973-4 or 1979 oil shocks.

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THE PUBLICATION in most national newspapers last week of the Government's school league tables ought to be a matter of rejoicing. This is an area where the consumer - the child and the parent - has rarely been able to exert market pressure for the simple reason that he and she are ignorant of performance.

Information is important to the efficient working of markets, and it becomes crucial when the purchases are long-lasting and large. If you buy bad apples, you can try a different store next week. If you choose a bad school, your child may suffer for a lifetime.

So it is with a sense of dismay that I say that these figures are not merely worthless but downright misleading. This is not because they fail to tell us about pastoral care or the length of the school swimming pool,features that parents can assess for themselves. It is because they do not even tell us anything about academic success.

Some understanding of probabilities, which has clearly not been granted to our eccentric Education Secretary, would show that these figures are being interpreted in a ridiculous manner. Schools with good A-level results are not necessarily schools where pupils stand the best chance of getting good A-level results. This is a paradox, so let me explain.

Imagine two schools. The first is an inner-city comprehensive. Half its children come from high- achieving middle-class homes and the other half from less bookish working-class ones. (I know this is stereotyping, but you cannot understand society without averages and aggregates). The second school is a suburban comprehensive whose pupils are all middle- class. Now assume that middle- class children, taking the national average, have a 25 per cent chance of good A-level results. And assume that working-class children have a 10 per cent chance.

If the two schools are equally effective in delivering A-level results in line with the national average, 17.5 per cent of the pupils at the inner-city school will have good A-levels (quarter of the half who are middle class, plus 10 per cent of the rest) while 25 per cent of the suburban pupils will get good results. According to the league tables, the suburban school is 'better'. But the schools are equally good.

Now assume that the inner city school actually performs a third better than the national average, in the sense that either middle-class or working-class children stand a 33 per cent better chance of getting good A-levels than they do at an average school.

In this case, the inner city school gets good A-level results for 13.3 per cent of its working class children and for 33.3 per cent of its middle class ones: overall, it gets 23.3 per cent of its pupils good A- level results. The suburban school continues to be merely average, so it gets 25 per cent. The league table still shows the inner-city school to be worse, even though in fact it will improve the life chances of any of its pupils by a third.

Exactly the same problem arises if you compare selective and comprehensive schools: a comprehensive may offer able children a better chance of success than a selective school, even though the selective school has better overall results because it has a more able intake. The solution to this problem will come when we have nationwide tests at 11 and 16, and can compare the quality of intake with the quality of results. But such 'value-added' tables are several years off. In the meantime, league tables should at least make some allowance for the social background of the intake in different schools and local authorities.

This misunderstanding of probabilities applies in many other fields. We recently reported that a quarter of the heads of Britain's top companies do not have a university education. The flipside, of course, is that three quarters of top managers are graduates. Since a mere one in ten of the workforce went to university, it follows that your chances of becoming a top manager are improved more than sevenfold by a university degree. School pays, OK?