Memorandum submitted by The Institute
Thank you for inviting the Institute of Directors
(IoD) to submit written evidence on the Pre-Budget Report. If
it would be helpful to the Treasury Committee, we would welcome
the opportunity to expand on these themes by providing oral evidence.
The Institute of Directors is a non-political
organisation with some 68,000 members world-wide, 55,000 in the
UK, whose aim is to help directors fulfil their leadership responsibilities
in creating wealth for the benefit of business and society as
a whole. To this end the IoD provides an effective voice to represent
the interests of its members to government and opinion formers,
and to bring the experience of business leaders to bear on the
conduct of public affairs.
We wish to make the following comments.
The Pre-Budget Report makes the important point
that for the first time since 1974, there has been a significant
and simultaneous slowdown of growth in the US, Japan and Europe.
For most of the post war-period, cyclical downturns
were driven by excess inflation and a subsequent tightening in
monetary and fiscal policy. The origins of the current downturn
lie elsewhere. In the US, the downturn clearly pre-dated 11 September
and was driven by excess investment and the piercing of an over
inflated stock market bubble. In this sense the new economy is
very much like the old economy of the 19th century.
US stock market valuations remain a matter of
concern. The market seems fairly valued only on the basis of either
a very low risk premium and/or very high future dividend growth.
Any reduction in the risk premium as a result of the collapse
of communism, is now countered by the possibility of an even greater
risk from rogue states and terrorist organisations. Further geo-political
shocks could be very damaging to the world economy.
We would agree with the reduction in G7 GDP
growthas compared with the 2001 FSBRshown in the
Pre-Budget Report (Table A1: The world economy, p 140). However,
we would also point out that whilst the balance of probabilities
suggests a relatively short and shallow downturn, the risk of
a much deeper and longer downturn is greater than at any time
since the 1930s.
The argument for a short and shallow downturn
is based on the stimulus from the swift and sharp reductions in
interest rates implemented by the Federal Reserve. The argument
for a longer and deeper downturn is based on multiple economic
problems, listed below, which may result in the world economy
being less responsive to a monetary stimuluspushing on
Five areas of global weakness can be identified:
Stock market excess in the US
Savings deficiencies in the US
Systemic failure in Japan
Structural weakness the EU
glom concentration of recession in sectors such as airlines.
The IoD remains, optimistic about the world
economic outlook, but against the background of such uncertainty,
does not believe that further large public expenditure commitments
should now be set in stone by the Government.
Further expenditure commitments-over and above
the current CSRwould not provide a counter cyclical stimulus,
because of the long delay before the money is actually spent.
Nonetheless, the risk is that any such increase in expenditure
could become embedded as a "sacred cow". This is problematical
for two reasons:
Increased expenditure for public
sector monopoly provision in health and education is not the best
way to deliver improved public services (see below).
The detrimental long-term impact
of higher public expenditure on GDP growth may be far greater
than generally perceived.
A recent report from Politeia (Public rags or
private riches. High public spending makes us poor, D. Smith,
Politeia January 2001) advances a compelling argument that,
"Public expenditure in the developed world
is too highfar too high in most of Europe, much too high
in the UK and only a little too high in the US. Even putting aside
the philosophical arguments against high public spending, the
economic arguments are conclusive. Public spending at the level
now reached in the UK damages the British economy, and even those
poorer people who are supposed to be the special beneficiaries
of high rates of public spending might well be far better off
in a few years time in the more prosperous and successful economy
which would be brought about by a sharp reduction in public spending".
The Politeia report takes econometric estimates
by Professor Robert Barro (Determinents of Economic Growth: A
cross country empirical study, MIT Press, 1997) showing a negative
coefficient for the public consumption/GDP ratio. Using the change
in the public spending ratio between 1960 and 1998 the Politeia
report then estimates the impact on economic growth of the increase
in public spending over the period. The results show that over
the past 40 years the negative impact of public expenditure on
GDP has been immense. If the share of public expenditure in GDP
in the UK had been held at its 1960 level, national output would
have been 54 per cent higher in 2000.
This studyas does the Barro researchacknowledges
that there are quite high return to increased public spending
when it is starting from a low base, without the imposition of
the rule of law, or adequate health and education. However, in
the advanced economies the situation is entirely different and
is more likely to be characterised by diminishing marginal returns.
The Politeia report argues that increases in public expenditure
produce a smaller rise in GDP ie public expenditure tends to crowd-out
There are sceptics at the IMF as well. A number
of IMF studies have addressed the issue of what is the optimal
size for the state. Tanzi and Schuknecht (The Growth of Government
and the Reform of the State in Industrial Countries, IMF Working
paper 95/130, V Tanzi and L Schuknecht, 1995) argue that the
social indicators improved over the 1870-1960 period when the
welfare state was in its infancy. Over recent decades they state
"The expansion of public expenditure and
of the welfare state during the last three decades has yielded
limited gains in terms of social objectives while possibly damaging
the countries economic performance. Today, countries with small
governments and the newly industrialising countries show similar
levels of social indicators but these are achieved with lower
expenditure, lower taxes and higher growth than countries with
As a result, the IMF paper asserts that drastically
lower levels of public spending could be achieved, with the possibility
that it need not account for more than 30 per cent of GDP.
A NEW THIRD
The IoD has consistently argued for the introduction
of a Third Fiscal Rulea medium/long term commitment to
reduce the tax burden as a proportion of GDP. The IoD believes
that the Chancellor's two fiscal rules are insufficient to restrain
growth in public expenditure in the long term. It is possible
to argue that satisfaction of the Golden Rulewhich requires
balance in the current budget over the course of the economic
cycleshould alleviate this upward pressure, but the IoD
is less confident.
Satisfying the Golden Rule could still mean
that taxation and public expenditure rise significantly. This
propensity for tax and spend is a matter of great concern. There
needs to be a more binding constraint on expenditure if upward
pressures on taxation are to be avoided.
The Third Fiscal Rule can still be reconciled
with improved public services, by providing people with the incentive
to make a greater private contribution towards the cost of health
Over the 1997-2001 period we experienced a significant
rise in the tax burden attributable to "covert" increases
in taxation. We are now faced with the possibility of "overt"
increases further raising the tax burden.
A rising tax burden will undermine economic
incentives and individual effort. Fiscal drag-indexing personal
allowances by inflation and not earnings growth, will draw in
around 200,000 people into the higher rate tax band this yearis
drawing more people into the higher rate tax band.
This threat to incentives could become even
more damaging if the Chancellor were to abolish the upper earnings
limit on national insurance contribution. This could lead to a
marginal tax rate of 50 per cent on higher earnershardly
an encouragement to enterprise. Half of income tax revenue already
comes from the top 10 per cent of earners.
The central focus of political and economic
debate, in the wake of the Pre-Budget Report, has been health
expenditure and the interim Wanless Report.
The IoD disagrees with the "open &
shut case" approach taken by the Chancellor in his Pre-Budget
Report summary of the Wanless Report to the House of Commons.
We are not convinced that the Wanless review has, thus far, considered
all possible models of health care.
In two recent reports (Choice, Choice, Choice,
Graeme Leach, IoD Policy Paper, December 1999 and Healthcare
in the UK: the need for reform, Ruth Lea, IoD Policy Paper,
February 2000) the IoD has examined the funding and provision
of health care and education in the UK. The central message of
these two reports is that whilst there is a case for spending
more of our national (GDP on health and education, any increase
would be best funded by the private and not the public sector.
The IoD argues that the best way to deliver
improved health care is to encourage greater private sector involvementthe
UK alone is attempting to fund health expenditure solely through
The IoD's health passport model would overcome
the "all or nothing" choice people face at present.
If the Government provided as a credit the equivalent cost of
providing these services in the public sector, then people would
be for better able to afford the necessary top-up. Importantly,
the cost of privately insuring for the top-up would be less than
that for meeting the full cost. This could increase the share
of health expenditure in GDP, improve the quality of service and
cap public expenditure at the same time. Comprehensive health
care would remain free at the point of use, for those who wanted
to continue to receive treatment through the NHS.
Whilst the dead-weight cost to the public sector,
in the short term of providing the top-up to people already using
the private sector, needs to be acknowledged, we feel strongly
that such sums would be outweighed in the medium and long term
by the dynamic economic benefits attained by liberalising the
private health sector.
There is a risk in focussing on the efficiency
of health care as measured by expenditure to GDP ratios alone.
Two indicators highlight very serious concerns as to the efficiency
of the NHS:
Health outcomesSince 1960
NHS spendingin real termshas doubled as a proportion
of GDP, over a period when GDP has more than doubled as well.
Can we really claim there has been a fourfold improvement in the
NHS? The WHO ranks the UK 18th in the world on health system performance.
Crude indicators of life expectancy show the UK was ranked 5th
and 8th in terms of life expectancy for females and males in 1960,
but by 1997 its rank had slipped to 16th and 11th. OECD health
outcomes data show the years lost to heart and respiratory disease
in the UK are far higher than in other advanced economies. More
specific indicators, such as the new NHS Trust league tables highlight
huge differences in performance between the best and worst hospitals.
The tables explode the myth that social deprivation excused poor
performance when hospitals with similar catchment areas produced
vastly different scores.
Fraud & mismanagementRecent
press reports (20th November 2001) suggest that up to 20 per cent
of the NHS budget could be "wasted" as a result of poor
management, fraud, blocked beds, hospital related infections and
other areas of mismanagement. This seems an excessive estimate
but surely warrants investigation.
5 December 2001