Select Committee on Treasury Minutes of Evidence

Examination of Witnesses(Questions 1-19)




  1. May I welcome you to this first evidence session on the 2002 Spending Review. In light of the Chancellor's statement on Monday and the subsequent debate on that, would you like to give a brief comment before we start?

  (Mr Walton) From a macro-economic perspective, there was not very much new in the statement from what we learned at Budget time. The overall spending plans remain the same as set out in the Budget, so really the Spending Review just provided the detail of the split between departmental spending and annually managed expenditure, as well

as the split by Department. But we knew that spending was going to grow quite rapidly, we knew that current spending would grow by 3.8 per cent a year in real terms over the planning horizon, and that with public investment, you would have total spending growing by 4.3 per cent per year. What we do know though from the figures is that there was a very big increase in discretionary spending, and on our own estimates, if you strip out debt interest payments and unemployment benefits, discretionary spending during the course of this parliament is actually planned to rise by 5.6 per cent a year in real terms, and that is in marked contrast both to the increase in spending during the first term of this Labour Government and relative to the period of Conservative office in the previous 18 years. That is the very striking thing, that you have this very rapid growth in discretionary spending. Again, from a macro perspective, what this means is that at a time of uncertainty, fiscal policy is continuing to provide quite a lot of support to the overall economy, and that is a factor which I think will probably help the UK economy to continue to out-perform most other economies over the next couple of years. As far as whether this causes any threat to the overall sustainability and whether these plans are affordable, our own forecasts at Goldman Sachs are actually quite similar to the Treasury's. We think it is quite reasonable to take as a central assumption—and I describe it as "central" rather than "cautious"—an estimate of trend growth in the economy of 2.5 per cent. If that is right over the next few years, it looks as though the Government's projections for the public finances look quite reasonable. The Government's fiscal rules will continue to be met quite comfortably[1].

  2. In terms of spending up to 2006, the figures are in the books.
  (Mr Walton) They are. Obviously, you can be blown off course in two ways: either if the economy performs less well than expected, and it is certainly the case that economic activity is almost certainly going to be different from the precise path set out in the Red Book, but as long as growth on average is around 2.5 per cent, the numbers look reasonably OK; and the other area where you can obviously be blown off course is that it is not easy to forecast tax revenues. With the best models in the world, even if you get growth absolutely right, you can still quite easily be blown off course on forecasting tax. But the forecasts that were presented at Budget time do not seem to make any overly optimistic assumptions; essentially, underlying tax revenue is only growing at about the pace of the underlying growth in nominal GDP, and that seems to be a reasonably cautious assumption to make. Obviously things can go wrong. If they do, obviously the Chancellor will have to come back and address that, but, as you look at things at the moment, it is difficult to say that these numbers look imprudent.
  (Professor Talbot) I would not disagree with any of that, but there are a few things I would add. Firstly, I think some of the discussion about the levels of spending over the last few days in the media almost give you the impression that we are moving to Swedish levels of public spending, and I think we need to get it into perspective. If you look at the figures in the back of the CSR report, giving the total managed expenditure as a percentage of GDP, over the whole period of the report from 1963 up until the forecast for 2005-06, the average is about 43 per cent of GDP over that whole 30-year period. It is quite interesting that the forecast figure for 2005-06 is 41.9 per cent of GDP, so it is actually still below the average for the whole of that period, and it is considerably below the average, I must say, for the period of Conservative government from 1979-96, which was about 44 per cent of GDP on the same figures. So we are talking about actually relatively modest levels of public expenditure in historic terms still. Interestingly, the forecast in the specific increases in this Spending Review go from 41.1 per cent of GDP up to 41.9 per cent, which is only an increase of 0.8 per cent, which is modest compared to the previous three years, which was getting on for 2 per cent of growth. We are not talking about huge amounts of public expenditure in historic terms or any massive shift taking place. There are a couple of other issues I would like to mention which I think have not been brought up very much in the discussion so far. The first is the question of under-spending, which we have not had any recent figures on but has been a problem over the last three or four years. There have been considerable levels of under-spending and considerable problems with getting money particularly into investment programmes. As we know, at the time of the last election, when there was a rather heated political debate about whether or not the figures should be £8 billion less or £8 billion more, we were actually under-spending by about £8 billion on the total figures, which is quite ironic. I think there is a real danger that, in the rush to try and get the money out to-front-line services and to get investments made, there may be a problem about mis-spending in the future. A number of commentators have already mentioned that there may be problems in particular areas, and there is obviously a need for vigilance there. The third point I would make on the macro issues is that there has been some discussion about there being a danger of the extra resources being absorbed by staff costs in the public service. As we know, and the figures are quite clear, public sector staff pay has fallen behind private sector pay quite markedly. In my view, in order to get the levels of service that we need in public services, particularly in the labour-intensive services, there will be a need for a rise in staff costs, both in terms of extra staff numbers and extra staff pay, to make sure they are able to recruit the people they need to deliver the services, and to have the level of morale that is necessary to deliver services.

  3. The capital spend has increased a bit, and that is tied to the fact that departments spend money, so there is a bigger urgency about that now given the extra money for capital spend.
  (Professor Talbot) There is. There is evidence beginning to emerge—and last time I gave evidence to the Committee there was not any clear evidence about whether or not PFI was causing some delays in capital expenditure—that it clearly is causing delays in some areas, getting money actually spent.
  (Mr Walton) Also, since the Budget, we have had the outturn for the last financial year, and net investment actually came in at £9.2 billion, which was £2.8 billion below the estimate given in the Budget. So, as Colin says, there is still some evidence that it is taking time for all this investment spending to come through.

Mr Plaskitt

  4. Staying with the macro situation for the moment, a lot of the independent forecasters are pulling their growth estimates down for this year and also for next year. Are you not bringing yours down, did you say?
  (Mr Walton) We are not actually. Clearly, there is a lot of uncertainty about the global economic outlook, and all the volatility that is taking place in the financial markets is adding to that uncertainty. But it does actually look as though the Chancellor's forecast for the current financial year is still quite reasonable. When we get the second quarter GDP numbers, which are out a week this Friday, those are likely to show a very strong rebound, we think, in the second quarter. Industrial production has certainly rebounded very strongly, and consumer spending has remained very strong. So we could easily see a one per cent or more quarter on quarter rise, and if we get that, that is going to give a good start to growth in this current financial year. The main point is, whatever the uncertainties about growth in the very near term, unless you think that trend growth in the economy has suddenly come down, the implication is that if growth this year turns out to be weaker, then inflation will tend to under-shoot the target, and we are already seeing inflation quite considerably below the target. That would mean that there is then scope for growth to be that much faster in future years. So if you are taking a five-year view, it is certainly not unreasonable to think that growth is going to be averaging somewhere round the 2.5 per cent level, which is implied in the Government's projections.

  5. I think we have to look at it across the whole of the three-year run. What do you think about the first year of it though? That could be a year when the economy somewhat under-performs on growth against Treasury expectations, and if I am reading the figures rightly, there is quite a surge in additional spending come through in the first full year, 2003-04. So in the year when the tax revenues might be coming down a bit lower than expected, the spending is going right up. Will you get one year where borrowing looks too high before it corrects in years two and three?
  (Mr Walton) I think there is that element in the profile anyway, in that the tax increases that were announced in the Budget really kick in from next year; they do not kick in at all this year. In fact, there is a net tax cut of £1 billion or so for this year. Clearly, if you were to get shortfalls in growth, that would tend to also dampen tax revenue at a time when, as you say, the spending numbers are growing quite rapidly. On the Government's own projections, they are expecting to see public sector net borrowing of £11 billion this year, versus the outturn we now know of a surplus of £1 billion for last year. That is embodied already in the Government's projections, and clearly it could turn out to be worse than that if growth is lower. But the other point to remember is that the Government's fiscal rules are judged over the entire economic cycle, and so again, to the extent that output is falling a bit below potential, you are allowed on the fiscal rules to actually have borrowing a bit higher than would normally be the case, providing that it comes back down again as the economy moves back to trend.

  6. Borrowing has gone up a lot, has it not? At the time of Budget 2000 the projected cumulative borrowing for the three years of this Spending Review was £11 billion and it is now projected at £43 billion. Is it still consistent with the Golden Rule?
  (Mr Walton) I think so. If you look at what has happened in recent years, the Government has actually more than surpassed achieving the Golden Rule. In 2001 they had a current budget surplus of 2.2 per cent of GDP. Last year they had a surplus of 1 per cent of GDP. The Golden Rule is that over the cycle you should have either balance or a surplus. So when you bear in mind that already you have locked away quite large surpluses, and indeed, over the projections that the Government has, by the end of the forecast horizon you are still running a surplus of three-quarters of a per cent of GDP. Even if you were to get some shortfall in the next year or two, I think that would still leave the Golden Rule being met quite comfortably over the full period. Certainly, on the net debt ratio, where the objective is to keep net debt below 40 per cent of GDP, that is running around 30 per cent at the present time, and you would have to have very substantial over-shoots in public borrowing to get you anywhere close to a 40 per cent of GDP debt ratio.

  7. So on the basis of what you are saying, it does not sound as if there is any gambling going on.
  (Mr Walton) If you are looking at the period covered by the Spending Review, it is almost certain that we are going to see the Government's fiscal rules still being achieved. There may well be some questions as to what happens in the period after, and obviously that is going to depend on what the Government decides it wants to do with spending and taxes, but for the next three years after the current year, certainly on Goldman Sachs's forecast, we would expect the Government to meet their two fiscal rules quite comfortably.
  (Professor Talbot) The only thing I would add on the gambling issue is that I think the gamble is more a political gamble than a fiscal gamble. It is fairly clear that the perception that is being created is that the Government is throwing huge amounts of money at public services and if that does not solve the problems, then all sorts of issues will flow from that. I think that is probably right in terms of the politics of it. In terms of the fiscal issues—and I do not do economic forecasting, so I have to rely on everybody else's forecasts—I certainly have not seen anything that seriously challenges those sorts of central assumptions.
  (Mr Dilnot) The only thing I would add is that I entirely agree with what David has said about the fiscal rules. The sense in which there is any gambling, though, is that forecasts of the public finances, even done by the Treasury, are on average wrong by quite a lot: £11 billion, even for just one year ahead, more than £40 billion for four years ahead. That is not a criticism of the Treasury—IFS and Goldman Sachs, who of course are at least that good, get it wrong on occasions as well—but it does remind you that we do not know with certainty what the public finances will look like even next year, and because the Chancellor is now running with a higher estimate of the trend growth rate of the economy, he is closer to a central forecast, so there is less scope for, if things go wrong, the fiscal rules not to be broken. If, for example, we were to see an unexplained deterioration in tax revenues that matched the unexplained improvement in tax revenues we saw in the first parliament of the Labour Government, then I think there is more chance of a problem. So I think there is more of a gamble than there was in the first parliament, simply because the forecasts for the economy on which the public finances are based are no longer systematically pessimistic, but they are much more central, so if something goes wrong, the risks have become greater, but I do not think we should exaggerate that risk.

Mr Tyrie

  8. I wanted to ask Mr Walton about City analysts' approach to estimating public borrowing. Do City analysts look carefully at contingent liabilities that have come with the massive increase in PFI? Do they tack that on as a rough estimate of what they think the borrowing outcome might be, or are they largely ignoring it?
  (Mr Walton) I cannot speak for all City analysts. The only thing I would say is that there is not a lot of information on the PFI and the liabilities that result from that in the public domain other than that provided by the Treasury, so to a large extent we do have to rely on the kinds of numbers that the Treasury provides in that particular area. It is much easier in a sense to forecast tax revenues because, notwithstanding the errors in forecasting, at least you would expect over time taxes broadly to maintain a reasonable relationship with overall growth in nominal incomes in the economy. You always have to make a judgement as to what the Government says it is planning to do, whether it is actually going to stick to those commitments or whether at some point they are just going to change. As I say, in certain areas, particularly to do with capital spending, there is not really a lot of independent information available that analysts can look at. We are largely beholding to the Treasury.

  9. So on the basis that there is not much information, City analysts are not tacking a little bit extra on to the estimates of borrowing to take account of the possibility—indeed, the likelihood—that there will be some contingent liability flowing from PFI contracts?
  (Mr Walton) My general view at the moment, and given the Government's track record to date, is that it has been quite reasonable to assume that at some point during the course of the spending round you tend to get some upward revisions to spending plans. So to build in some kind of provision for that I think is quite reasonable.

  10. I am asking a very specific question about PFI and PPP, not a general question about whether spending tends to under-shoot or over-shoot.
  (Mr Walton) I think the issue then is largely is this catered for within the various reserves that are set out by the Government? I would have thought, given the overall size of these liabilities, the various reserves would account for that, but obviously if you then had some other big shock on top of that, you could run into difficulties.

  11. I do not want to put you too much on the spot but just to get a feel for, as one of the country's leading analysts, whether you happen to know roughly what the total PFI signed deals or deals at preferred bidder status are, what the value of them is in the public accounts.
  (Mr Walton) Off the top of my head, I do not have that figure.

  12. Do you know what the figure is by order of magnitude?
  (Mr Walton) Certainly we have seen tens of billions of contracts signed. As I understand it, the actual flow expenditure is still in single billions. I do not know whether my colleagues can comment.

  13. The annual flows are in single billions. The cumulative capital value is £50 billion. One last question: if I told you it is a fact that a high proportion of this information is in the public domain, but it is published in individual departmental accounts, not largely in the Red Book—there is a little information in the Red Book—do you think, in the light of the exchange we have just had, awareness may grow about this and this might be something City analysts ought to start to look at?
  (Mr Walton) When I say we have to rely largely on the Treasury, the Treasury Red Book does summarise all of that information contained in the departmental reports. I am taking the Treasury as a proxy for the whole of government here. The information is clearly there about the contracts which have been signed and how much the Government expects to pay in terms of the ongoing servicing of these PFI contracts. I am not sure that there is much further independent information that is available that would enable you to actually say those numbers that the Treasury have put down in the Red Book are not reasonable central estimates. Clearly, in your forecasts you may want to build in a margin of error if you think there are good reasons for thinking that actually spending may be greater, but if we are talking about £5 billion or so of annual expenditure, in terms of the errors that Andrew was talking about in forecasting the public finances, if the error is £1 billion on the amount of spending on servicing PFI contracts, which would be a very large error, clearly, that would still be relatively small in terms of the overall errors that we can make in forecasting.

  14. I think we are talking apples and pears here. There is the cost of servicing the contracts, which is set out in a clear table at the back of the Red Book, which is in the range of £4-5 billion per annum running for about 40 years. That is not what I am talking about. I am talking about whether the estimates of what might happen to long-run borrowing made by City analysts are taking into account the possibility that some of the risks associated with these contracts have not in fact been transferred to the private sector, that they are covered by letters of comfort or by just common sense, that we know some of these projects, once begun, cannot be reversed—the Government cannot leave a half re-done Underground system—and that therefore in practice there are very large contingent liabilities not in the bottom line of the accounts. This constitutes off-balance sheet finance, which City analysts might want to take a look at. The answer to my first question was you are not looking at this.
  (Mr Walton) If you are saying that there are potential liabilities that you may have to pick up in the future, by and large those probably will never figure, actually, in public sector net borrowing, because a lot of these will be financial transactions which will be below the line. They will clearly add to government debt over time, but they are not necessarily ever going to figure in the Golden Rule or indeed in public sector net borrowing. If we still had the old public sector net cash requirement as an objective, then they would have an impact there, but again, given how low the level of public sector debt is, particularly relative to the 40 per cent ceiling that is set out by the Government, and indeed low relative pretty much to any other European country that you look at, if you were talking about the sustainability of the public finances, I would not have thought there was a great deal to be concerned about at the moment about these contingent liabilities suddenly leading to a big explosion of government debt.
  (Mr Dilnot) The only thing I would want to add is that I think in all of this we are often hampered by focusing too much on annual flows of borrowing. If we were thinking about a company, then we would be very concerned about the balance sheet, a balance sheet properly constructed, and this kind of issue is precisely where a national public sector balance sheet really would help. Such a balance sheet certainly ought to take account of what is happening to explicit liabilities in the form of pension promises, and you would expect it to take some note of these kinds of contingent liabilities. As David said, were a disaster to occur, say on the Underground, it is not so much the impact of that on long-run annual borrowing; there would tend to be a big hit on the balance sheet in the year in which it happened. So I think as much as the concern about whether or not this is taken into account in forecasts of the annual flow of borrowing, the real problem is that we do not focus enough on the balance sheet as opposed to the annual flow of borrowing, because as far as the annual flow of borrowing is concerned, that is not really what is at stake in these kinds of contingent liabilities, over which there is a genuine debate to be had about whether they should be classified as public or private sector, not because of what it would do to the annual flow of borrowing but because of what it would do to what we think the net worth of the public sector carried forward is.

  Mr Tyrie: It appears that these numbers have not yet been given the scrutiny they deserve.

Mr Cousins

  15. Mr Talbot, I am really asking this question because you are from Glamorgan, and you might be more interested in these things than most people in London are. How is under-spending and over-spending dealt with in the Barnet formula?
  (Professor Talbot) I do not know.

  16. You said there was beginning to be evidence that the process of PFI was slowing down spending. Mr Walton came in then with a comment that the outturn figures were, if I recollect what he said, £2.8 billion of planned public investment last year failed to occur, which was quite a high proportion of the total. How much of that under-spending on public investment would you attribute to PFI and its delays?
  (Professor Talbot) That is impossible to estimate. The evidence that PFI contracts are causing delays is purely case study-based. It is difficult to translate that into general figures. I could not say.

  17. You also mentioned pay. In the section on the public sector labour market in the Comprehensive Spending Review there is a sentence on page 151 which reads, "The public sector still maintains widespread national pay determination, which can limit the ability of individual employers to respond to local labour market conditions. Local flexibility on pay and non-pay matters offers a targeted solution." Do you think that presages an undermining of the present national pay negotiations on public sector pay to produce great regional disparities?
  (Professor Talbot) The issue of trying to introduce regionalised, localised pay in the public sector has been going on for 25 plus years. The Treasury has always had it dear to its heart, and they have never succeeded yet, and I very much doubt it is going to happen now. One of the areas that I have studied, for example, is executive agencies in the Civil Service. One of the original points in that was that it was going to lead to regionalisation of pay and pay being geared to local labour markets. By and large it has not, even with a major structural reform like that. So it is there as an aspiration, but I suspect that is all it will ever be.

  18. Mr Dilnot, in your own paper to the Committee on page 5 you make a reference to the Government's commitments on child poverty. You seem to imply that, because of the scale of the committed spending, there will be not much left to sort out either pensioners or child poverty, and that a choice might have to be made between them. That is how I read what you are telling us. Is that right?
  (Mr Dilnot) I think what I say is that the Pension Credit, when it comes in in full, will itself have a very significant impact on pensioner poverty, and indeed, there is a good chance that the Minimum Income Guarantee will take pensioners just above the 60 per cent of mean income, so many of the poorest pensioners may just be taken above the poverty line. Our concern as far as the Government's targets is concerned is much more about child poverty, where the Public Service Agreement is still committing the Government to reducing child poverty by a quarter from 1998, and where the latest results show that far from child poverty having fallen by 1.2 million, it has fallen by 500,000, so the Government is some way away from meeting that target. Of course, the Child Tax Credit, the Working Tax Credit, come in next year, but our estimates are that even once that has happened, very significant further increases in spending on benefits targeted on children in low income families will be necessary for the Government to hit its poverty targets, and that is money which does not appear to be visible here. Of course, some of that money will come in AME rather than being part of the Spending Review process, and so one of the ways in which the spending plans that were set out two days ago may well turn out to be flaws is that I think if the Government is to make significant progress on its child poverty target, it simply will have to allocate significantly more money to children in low income families year by year, but that is not cheap. Estimates that we produced at the time of the last poverty figures were that to get towards meeting its target, the Government might well need to allocate an extra £10 billion a year, 1 per cent of GDP, and that money is certainly not evident in these spending plans.

  19. What about pensioners? (I want to declare my interest, as a man of 58!)
  (Mr Dilnot) There is not an explicit target on pensioners. I trust, Mr Cousins, that you are looking forward to enjoying the Winter Fuel Payment. Pensioner poverty, which has already been significantly reduced by measures taken so far, will be significantly reduced again by the introduction of the Pension Credit, and we nearly have a commitment from the Government to increase the Minimum Income Guarantee in line with earnings for the rest of this parliament. So on pensioner poverty, I think the funds allocated are already here, because I think the policies on pensioner poverty that have been described will have a significant impact. I think there is much more of a problem over poverty amongst children than there is poverty amongst pensioners as far as the Government and its policies are concerned.
  (Professor Talbot) To come back on your question about the Barnet formula, I have been thinking about it while we have been talking. As far as I can remember, the formula is entirely based on planned expenditure, so changes in outturn would not have any effect on it at all.

1   See Ev. 22. Back

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