Memorandum from Geoffrey Dicks, Chief
UK Economist, Royal Bank of Scotland Financial Markets
1. The Government has long been planning
significant increases in the volume of current (consumption) spending.
To date these increases have, by and large, not occurred. Why,
despite the obvious intent, has spending lagged behind plan? Will
it continue to do so? If it does, are the Treasury's 2002 growth
forecasts too strong?
FORECASTS FOR GENERAL GOVERNMENT CONSUMPTION
2. The relevant data are contained in Table 1. Note that
transfer payments (such as higher pensions) are not included in
the definition of general government consumption which relates
to spending on goods and services. Note also government consumption
is the sole component of aggregate demand for which the Treasury
makes a point forecast (as opposed to a range) on the grounds
that these are planned increases and not subject to normal forecast
3. The data are in volume terms and abstract from increases
in the cash spending aggregates which may be driven by higher
public sector inflation (wages). Currently, public spending in
cash terms is rising more rapidly, but this reflects an acceleration
in public sector pay, which, unusually, has been rising faster
than pay in the private sector over the last few months.
4. At the time of the Budget full data for calendar 2000
were not yet available. The Treasury's estimate of a 2 per cent
increase in government consumption between the first and second
halves proved too high. On the latest data the rise was less than
1 per cent and the full-year outturn was a full 1 per cent below
the Budget forecast.
5. The Budget projected a volume increase this year in
excess of 4 per cent. Again this is proving way too high. The
increase in Hl (from the 2000H2 low starting point) was 1 per
cent versus 2.3 per cent forecast. Over the first three quarters
for which the ONS has provided data the annual increase is running
at 1.8 per cent, which, unless the data are substantially revised,
makes a full-year outturn of 3 per cent unlikely. The pre-Budget
forecast implies an increase in excess of 4 per cent between the
third and fourth quarters (17.5 per cent annualised in the US
style of reporting data). This is a large increase though since
we are already two-thirds of the way through the quarter, the
Treasury ought to have a good feel for the way spending is going.
6. The PBR forecast is for another big increase in 2002H1
(2.8 per cent) and for growth next year to average 4¾ per
cent. The level of spending would still be below that planned
in the Budget though the increase would be much larger. Where
the Budget showed the major increase occurring in 2001, the PBR
suggests that the big increase in spending is still ahead.
7. Why has spending by central and local government on
goods and services lagged so far behind what was planned? The
obvious explanation is to do with public sector employment, Government
consumption has two major components: goods bought-in from the
private sector and labour services. The first category includes
defence equipment, NHS drugs/medicines, books and equipment for
schools etc; the second category is essentially personnel, the
armed forces, doctors and nurses, teachers etc.
8. For most of 2001 the labour market has been tight.
Unemployment has fallen steadily, vacancies have been high. It
would appear that, in spite of relatively generous pay awards
in April, the public sector has struggled to recruit the key personnel,
particularly in health and education, "that its plans were
based upon. The shortfall in spending is a shortfall in recruiting
(and also retaining) the teachers, nurses, doctors and other health
and education personnel that are key to improving these services.
9. This may change to the advantage of the public sector
since the labour market is showing the first signs of weakness
in the aftermath of 11 September terrorist attacks. Unemployment
rose in October in what most forecasters see as the start of a
trend. There has been a sequence of high-profile job loss and
redundancy announcements. There may be no direct route for former
merchant bankers to enter the public services though at the margin
it will be easier for the public sector to recruit from (say)
this year's cohort of graduates and to retain existing personnel.
If this process is underway, the Treasury forecast for the current
quarter might make sense.
10. The Budget forecast for private consumption was 3¼
per cent-3½ per cent this year, rather less than that for
public consumption. The PBR reverses this: 4 per cent private
versus 3 per cent public, though next year we revert to the Budget
pattern. 2¾-3 per cent private and 4¾ per cent public.
Given the weaker outlook for private sector employment and demand,
the forecast seems intuitively more sensible than before. But
(i) as before the consumer could defy predictions of a slowdown
with the result that once again public sector employment would
be crowded out or (ii) public consumption will still fail to grow
at the planned rate. If this happens, the MPC may have to do what
it did repeatedly this yearlower interest rates to spur
private demand to make up for the shortfall on the public side.
Either way the GDP forecast may not be affected though the composition
of demand between private and public sectors would be different.