Select Committee on Treasury Appendices to the Minutes of Evidence


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?

Table 1


Budget 2001
PBR 2001

  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 error.

  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 year—lower 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.

December 2001

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