Select Committee on Treasury Minutes of Evidence


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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