Examination of Witnesses (Questions 1
- 19)
WEDNESDAY 7 DECEMBER 2005 (Morning)
MR BEN
BROADBENT, MR
ROBERT CHOTE,
PROFESSOR DAVID
MILES AND
MR MARTIN
WEALE
Q1 Chairman: Good morning everyone
and welcome to the Committee in preparation for the Chancellor's
visit on the 2005 Pre-Budget Report. You are welcome and we seek
your expert advice this morning. For the shorthand writer can
you introduce yourselves please.
Mr Broadbent: Ben
Broadbent, from Goldman Sachs.
Mr Chote: Robert Chote, from the
Institute for Fiscal Studies.
Mr Miles: David Miles, from Morgan
Stanley.
Mr Weale: Martin Weale, National
Institute of Economic and Social Research.
Q2 Chairman: We have an hour to get
through a lot of questions and so we want them directed to one
of you and we do not want everybody else answering. Can I start
with the first one and refer to the OECD survey of the UK economy
which indicated that over the past eight years the UK had been
the most stable one in the OECD, but that, despite this the UK
still only ranks just above the median in terms of GDP per capita
and has made little progress in closing the income gap with the
best performing countries. What do you think has led us to being
the most stable economy in the OECD, and how can we translate
this stability into improvements in long-term structural performance?
Who wants to answer that one? Martin?
Mr Weale: I think the policy framework
has been very helpful in delivering stability, in particular the
monetary arrangements that we have had have meant that the Bank
of England has been able to react in a way that other countries
have found difficult. I think what was also helpful was that in
the late 1990s there was a surge in tax revenue that gave the
Government quite a lot of room for manoeuvre in terms of producing
what has subsequently been an expansion of fiscal policy. I think
also—and this is part of the monetary policy issue—that
the movements in house prices over the period that the OECD has
been discussing have actually promoted faster growth than one
might have expected but also reasonably stable growth. In terms
of our overall performance, stability is one of the factors that
influences the supply side but it is only one of the factors and
my own view is that Britain's poor productivity performance is
mainly associated with what I believe to be the poor general quality
of education, a long tail of children who have difficulty with
literacy and numeracy, and of course although the Government is
addressing basic skills at an adult level it will be a long process
of putting that right.
Q3 Chairman: So you do not think
the leaked report is enough in itself?
Mr Weale: The leaked report draws
attention to the issues but I think probably we still need to
think more than we have about how to teach children, and what
can we learn from other countries that seem to do it better.
Chairman: Angela?
Q4 Angela Eagle: Martin Weale, the
Treasury have explained their revision down of the growth forecasts
as a result of higher oil and commodity prices internationally,
a stagnation of growth in the EU, which is one of our major export
markets, some statistical revisions, and a downward trend in domestic
demand. What is your view of what has been happening with growth
and how do you see that panning out in the future?
Mr Weale: Well, the Treasury account
is a comprehensive account of why their early forecast has turned
out in hindsight to be wrong but of course at the time it was
higher than almost everyone else's forecasts and everyone else
therefore, faced with the same uncertainties, did better. In terms
of how things are likely to pan out, I do expect some improvement
in growth next year but I do think that into the medium term,
two to three years ahead, the Treasury is being too optimistic,
and the reason I believe this is that they model by identifying
a trend rate of growth in the economy and the economy is expected
to return to that trend. What they do not take account of is the
fact that in the last year we have had substantial shocks to the
trend, most notably associated with oil. For what it is worth,
we estimate that the increase in the price of oil over the last
year/year and a half has taken something like one to one and a
half percentage points off Britain's trend level of output, and
in the Pre-Budget Report there is no discussion of that, no indication
that the Treasury have even thought about it. So I think they
are being too optimistic because they are not paying attention
to the way that the oil price increase has adverse effects for
the supply side.
Q5 Angela Eagle: Did you expect such
an exogenous shock to ratchet down by 1.5% the trend?
Mr Weale: I also think that the
Treasury in the long term has been a bit too optimistic about
the trend. They have talked about 2.75%. Our view is that it is
more like 2.5% but, yes, in terms of the oil shock I do believe
that it was a downward step that we are adjusting to over a period
of two to three years.
Q6 Angela Eagle: In recent evidence
to us the Governor of the Bank of England actually said that he
was expecting more upbeat information that they are gathering
from their business surveys to lead to the ONS revising its statistics
for growth upwards. What is your view of that?
Mr Weale: It may happen. I perhaps
am a bit more of a sceptic than the Governor about the business
surveys. I think there is actually a lot of work that could be
done to study the way they collect information and improve on
it. On the question of whether GDP growth is likely to be revised
upwards, we know that it has been historically, and that point
is also made in the Pre-Budget Report, but I do think that it
would be helpful if people who are concerned about this instead
of talking about this in vague terms, should give estimates of
what upward revision they expect to happen over the next two to
three year period, and then we would have a basis for knowing
exactly what formed their views and with hindsight we would be
able to assess whether forecasting revisions was a useful exercise
or not.
Q7 Angela Eagle: Ben Broadbent, you
are nodding vigorously. Some of the problem with the ONS in this
area seems to be difficulties with measuring output in the services
sector. Is this something you pick up and take account of in your
own analysis and predictions?
Mr Broadbent: Yes, it is very
difficult to measure service sector output accurately anyway and
early estimates are bound to be more uncertain than later ones.
It does seem to be true that some of the business surveys are
in the end a better indication of what the ONS will eventually
say growth has been than its own preliminary numbers, particularly
in services. We think nominal growth has probably been a little
over 2% this year, say, as opposed to a little under 2%. Having
said that, that would of course change necessarily the Treasury's
own view of where we are in the cycle and it would probably mean
they would have to reduce their estimate as to the degree of spare
capacity in the economy and increase therefore their estimates
of the structural deficit, so it is not an unmixed blessing for
the Treasury if it turns out that growth has been underperforming.
Angela Eagle: In my view nothing ever
is in economics; everything is connected to everything else.
Chairman: Sally?
Q8 Ms Keeble: Whilst the Treasury
have revised down its growth in 2005 and 2006, it has revised
up its forecast for 2007 and 2008, and Angela has covered some
of that. I just wondered what your views are as to the whether
medium-term forecasts are reasonable. Martin, you have already
indicated that you do not agree with the Treasury's figures, so
I wonder in particular if David and perhaps Ben would like to
say a bit more about their forecasts and what the implications
are?
Professor Miles: I think I pretty
much come at it from the same point of view as Martin, namely
that whilst the short-term Treasury forecast looks fairly plausible,
of relatively weak growth next year and below trend, the forecast
they have for 2007-08, which is for above trend growth of around
about 3%, looks on the optimistic side. One of the reasons for
saying that is that it is based on the assumption that the household
savings ratio, which is at an unusually low level, does not increase
from year on forward and stays at around 4.5% or so, which is
historically an extremely low level. If that were to happen it
would indeed make the consumer spending profile look more plausible,
but again it is a double-edged sword because really in the UK
we do need to have a higher household savings ratio, and Adair
Turner and the Pension Commission Report is very strong evidence
for that. So I think the projection of consumer spending looks
on the strong side and that is an important factor because it
is such a big part of demand in the economy, so I think 3% looks
like an optimistic view on growth in 2007-08 and it is rather
important for the assessment that the Golden Rule is met by the
cycle that is assumed to end I think by the end of 2008.
Q9 Ms Keeble: And Ben?
Mr Broadbent: I have broadly similar
views. It is worth saying that the MPC's forecast is also for
3%, at least its central forecast, they have this fan chart, but
their central number for 2007 is also just over 3%. Like David's,
ours is somewhat below. There is no published consensus forecast
for that year yet, but I imagine it will be somewhat closer to
the long-term trend 2.5 to 2.75. So it does look a little on the
high side relative to what most forecasters would predict, I imagine.
Q10 Ms Keeble: And the implications?
Mr Broadbent: The implications
for the fiscal side, certainly from what David and Martin have
said, is that the structural position is somewhat less sound than
the Treasury would claim and therefore the prospects for revenue
growth and for the deficit are therefore a bit less rosy than
in the Pre-Budget Report.
Q11 Mr Fallon: Mr Broadbent, the
Governor attributed part of the consumer slow down to the rising
tax burden and in your note to us you refer to a "strong
rise in household income taxes as something that has probably
contributed to the weakness of private consumption of growth."
Can you expand on that?
Mr Broadbent: David mentioned
a few moments ago the household saving ratio and one of the striking
things about the last few years from the UK is that despite big
swings in house prices, the saving rate has been very stable.
It does not seem to have been as influenced by the housing market
as it was, say, in the late 1980s/early 1990s and many of the
movements in consumption growth in the last few years have been
mirrored by movements in income growth. It seems mainly to have
been changes in cash flow, nothing more complicated than that
that has determined movements in private spending growth. In the
last year or so there has been a big increase in household income
taxes, bigger than the increase in pre-tax incomes, and it has
certainly outweighed, for example, the effect of higher energy
prices on real take-home pay of households, so I think it has
probably been quite an important factor in spending slower consumption
growth, yes. That was in the Treasury's forecast. I think income
taxes have come in broadly in line with what the Treasury expected
in the Budget and indeed in the Pre-Budget Report, but I think
it has certainly arithmetically meant quite a big reduction in
take-home pay for the household sector.
Q12 Mr Fallon: Right. The Governor
suggested that that effect was falling away now. Do you see the
increase in household income taxes continuing to have an effect
on consumer spend?
Mr Broadbent: It will but probably
at a more moderate rate. I think the Governor mentioned the figure
of two percentage points, the increase in taxes relative to income
for households. It is unlikely to carry on rising at that rate
and I do not think either that is in the Treasury's forecast.
They have a forecast which has household income taxes continuing
to rise faster than income. That is normal fiscal drag as people
move into higher tax brackets but not at the same rate we have
seen over the last year or so.
Q13 Lorely Burt: I would just like
to ask about international migration, and I suspect it is for
Mr Weale. The Bank of England has flagged up the importance of
migration from the EU accession countries in dampening wage pressures
but Paul Tucker told us that he thought the view was basically
anecdotal. I just wondered what your view was, whether you support
the Bank's assessment of the role of migration, and is there any
research you would draw our attention to support that?
Mr Weale: I agree with the Bank
of England but I am afraid I do not think I am in a position to
be more precise than them, that, yes, there is a lot of anecdotal
evidence, that one of the features that has surprised me for a
long time, but particularly recently, is just how moderate wage
growth has been and so they and I and you are putting two and
two together, but I am afraid I cannot draw attention to anything
more substantial.
Q14 Lorely Burt: Are there any other
factors you can see that are contributing to this moderate wage
growth?
Mr Weale: Other factors that do
contribute are the Government's continuing policies to get more
people of working age out to work and they draw attention to the
way in which the proportion of lone parents going to work is rising.
It is also the case that we have seen recently increases in labour
market participation of people aged 55 and above and potentially
at least one might think that has more scope than plausible migration
as a way of increasing the pool of available labour.
Q15 Lorely Burt: Indeed in terms
of the actual number it is not a significant number, it is 3.7
million, something like that, coming in.
Mr Weale: Immigration is typically
thought to run at about 250,000 people a year as far as I know.
I think that is a gross number so it includes dependants as well
as people going out to work. Some countries are starting—and
I do not know it is true of Britain—to observe that the
ratio of dependants to potential workers among immigrants is rising
and therefore although the gross flows are staying stable, it
is less likely to reduce labour market pressure than it was. I
can send you some work on that.
Q16 Lorely Burt: Okay. Just finally
if you think that it is mainly to do with people coming off benefits
into work is that because the type of jobs that these people are
taking are lower paid jobs than perhaps other people in the economy?
Mr Weale: Here I am afraid I am
having to guess that I think that people who can command high-paid
jobs typically on average do not have much trouble in finding
jobs. It is in the lower paid sector where there has been the
expansion and I think that is probably what we should look to
see continuing. On the other hand, if you look at people who take
early retirement, there are largely two categories there. One
is people going on to disability benefit and they are likely to
have been doing poorly paid jobs before going on to disability
benefit; the other is highly paid people who essentially retire
when they feel they can afford to. The Government again is concerned
about getting people off disability benefit and back into the
labour market so those will be people who are typically doing
low-paid jobs.
Q17 Mr Mudie: Just when you mentioned
wage inflation there the Chancellor this week said something about
the public sector and 2%. Is this normal or is this the first
visible sign of a tightening economy and what used to be referred
to as "pay freezes"? Is this the first sign of it or
is this just a normal move by the Chancellor?
Mr Weale: It depends what you
mean by a normal move by the Chancellor. It is the sort of normal
move from a Chancellor who is concerned about the fiscal position
and who wants to balance the books by keeping down spending. Obviously
at a time when earnings generally are rising by 4% or a bit more,
2% for the public sector will look low but we know that over the
last few years earnings in the public sector have been rising
more rapidly than in the economy as a whole, and for some reason
there seem to be periods of fast growing public pay, so-called
catch-up periods which some people may say are overtaking periods
and then you have spells when it is the other way round. I think
we are likely to see a period when the Government tries to rein
in public sector pay growth because it is concerned about the
overall fiscal position.
Q18 Mr Mudie: Mr Broadbent, you nodded
your head.
Mr Broadbent: It is true, as Martin
said, there are sustained periods where one sector seems to have
received larger pay rises than the other. As to the level, I think
there are estimates of relative levels of pay which the ONS have
which show that the average wage is higher in the public sector
than in the private sector.
Q19 Damian Green: Can I ask about
oil prices. Ben Broadbent, in your submission you make the point
that higher oil prices cannot be the only or even the main explanation
for downgrading growth forecasts, so how important do you think
oil prices are in explaining the downgrading?
Mr Broadbent: I think they have
to have been part of the explanation and they have to have had
an impact on growth everywhere, but what is striking about the
PBR forecast is that the Treasury did not have to downgrade its
forecasted growth in the other G7 countries, collectively at least,
I think they forecast growth of 1.5 in the euro area and we are
going to get something close to that this year, I imagine, with
one quarter's data still to come, and for the G6 as a whole, excluding
the UK, we are going to get possibly slightly higher growth than
the Treasury expected in the Budget, so it is not clear that higher
oil prices should have had any less of an effect on those countries
than it would have had on the UK. It is worth saying that globally
also higher oil prices have probably had less of an effect on
the world economy than people feared earlier this year and late
last year. I think the world economy has coped pretty well on
the whole with the rise in energy prices.
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