Examination of Witnesses (Questions 20
WEDNESDAY 7 DECEMBER 2005 (Morning)
Q20 Damian Green: Is there any way
that the higher oil price could have had a greater effect on the
British economy than on other G7 economies?
Mr Broadbent: No, I think it is
true that we do not consume any more oil relative to our output
than any of the other G7 countries, so it is not clear why it
should have had a bigger effect. I do not think the fact that
we are a producer makes that much difference, but on the spending
side I think we probably spend less per pound of GDP on oil than,
say, the United States does and some of the European countries
do as well, so I do not see why it should have had a bigger effect
Professor Miles: If I can just
offer a thought on that. I think there is one reason why you would
expect the effect on the UK to be smaller than most other countries
which is that we are more or less, at the moment anyway, self
sufficient in oil and therefore you do not get the hit to national
wealth or in terms of trade that other countries which have to
import oil have. So there is a reason why it should be less of
a story for the UK.
Q21 Damian Green: What about the
long-term effect? The Treasury seems pretty sanguine that the
effect on long-term productivity potential is not very high. What
do you think about that?
Mr Broadbent: Martin addressed
that earlier; it is extremely difficult.
Q22 Damian Green: Do you agree?
Mr Broadbent: Yes, I would not
be precise about the numbers. The Bank of England had a page in
the last Inflation Report without mentioning a single number.
They have been quite wary of doing that. I know that they are
working quite hard on trying to refine those estimates, or in
fact to come up with one, but in most estimates, for example,
relative to the Treasury's Budget forecast, the oil price is around
$15 a barrel higher. That might mean on a standard estimate something
like 0.5% off GDP and I think Martin's numbers had a permanent
effect relative to two years ago of 1% on output. That certainly
does not seem implausible to me.
Q23 Damian Green: That suggests the
Treasury is being a touch complacent?
Mr Broadbent: Possibly. Certainly
it is one of the reasons why I think collectively all of us have
the opinion that the forecasts not necessarily for next year but
for 2007-08 may be on the high side and have not allowed for any
effect of higher energy prices on potential output.
Q24 Kerry McCarthy: Turning now to
exports, recently the Bank of England noted that given the expansion
in world trade UK export performance has been somewhat disappointing.
What factors would you say account for this disappointing performance?
I am not quite sure who to direct it to? Maybe somebody from one
of the banks
Professor Miles: I think a factor
here has been in play for quite a long time in the UK which is
that since sterling appreciated very sharply in the back end of
the 1990s on many estimates it has remained at a level which makes
it very difficult for parts of UK industry to compete in world
markets. I think it is one of the reasons why manufacturing output
has been far weaker than other parts of the economy which are
less open to international competition. I think it is one of the
reasons why the current account deficit in the UK has gradually
moved up and has been very persistent for several years. Our own
estimates at Morgan Stanley would suggest that sterling remains
pretty significantly overvalued on a fundamental long-term basis
against a range of other currencies. Looking to the future, as
interest rates likely move up, and have moved up in the US relative
to the UK and may well be moving up in the euro zone relative
to the UK, it is possible that that will bring sterling back down
to a more sustainable competitive level, so I think there is some
reason to be optimistic that the outlook for exports is somewhat
more positive over the next few years than it has been over the
last four or five years.
Q25 Kerry McCarthy: Does that mean
you think the Treasury's projections of export growth of 5% to
5.5% for 2006 are reasonable?
Professor Miles: That seems a
not unreasonable central forecast. I think there are other areas
where the Treasury might be on the optimistic side. That to my
mind is not one of them.
Mr Broadbent: I agree with what
David has said but it is also true of course that a lot of the
growth in world trade has been between countries where we have
a very small export presence. If two Asian countries start trading
a lot more with each otherand trade between Japan and China
has boomed in the last few yearsthat is not necessarily
going to reduce our share of the total. We have also lost a bit
of ground even when you look at our trade weighted export market
growth, which I agree with David is probably due to an overvalued
Mr Weale: Could I just add to
the point that while I am happy with the numbers, Britain is less
well-placed than, say, Germany for exports to oil producing countries
and that, for obvious reasons, is looking like an area where there
is some growth potential at the moment.
Q26 Kerry McCarthy: That was going
to be my next question. How well-placed is the UK to benefit from
increased demand from oil-producing countries?
Mr Weale: I think better than
the United States, and for that reason one could say that the
United States is likely to be hit more than other countries by
the high oil price but less well-placed than particularly Germany
which has a very efficient export structure, has good links with
the oil producing countries, and is likely to be helped very considerably,
so partly good, partly bad. It is taken into account certainly
our numbers which are similar to the Treasury numbers, but other
people will do better there.
Q27 Kerry McCarthy: On the question
of the US trade deficit in the past people expressed concerns
that it looked as though it was exceeding 5% and now it has gone
past 6% and the dollar is still strengthening. Do you think that
means an increased risk from global economic imbalances?
Mr Weale: Could I say that I see
the US trade deficit as being a sign rather than the fundamental
cause of the imbalance, which is that the United States and also
the United Kingdom are not saving nearly enough. The United States
is going on investing but it is doing its financing from abroad.
We are investing at a rather lower level but financing it from
abroad. Whether that would ever lead to a major financial crisis
I would not like to predict, but you can be quite sure that what
it means is that in the end people will be disappointed that their
incomes are lower than they would like.
Q28 Kerry McCarthy: Do the others
share that view?
Professor Miles: I think there
is a significant chance of these imbalances in the world economy
playing out in a way that might cause abrupt adjustments, in particular
I am thinking about the possibility that at some point in the
near future those investors outside the US who have been willing
to buy more and more US financial assets, particularly US government
bonds, decide they have got enough, and if they stop buying them,
at that point you need something to adjust very quickly, and the
most likely thing is a combination of the US exchange rate falling
sharply and maybe long-term interest rates in the US moving up
very sharply. That will be very painful both for the US and countries
in Europe as well. I would judge that as a real possibility.
Q29 Susan Kramer: If I could talk
to you just a little bit about the Sustainable Investment Rule.
Professor Miles, I notice from your comments that you say the
Sustainable Investment Rule is more likely to be a binding constraint
than the Golden Rule. I think most of us think the Golden Rule
is not much of a rule any more. Could you give us your rationale
for that opinion and also do you think there is any case for targeting
the rule at a broader set of liabilities, for example including
public sector pension liabilities or a greater share of PFI liabilities?
Professor Miles: I think my reason
for thinking they might become more of a constraint on Government
action and Government investment in particular was the following:
if growth turned out to be below the above trend 3% projection
for 2007-08, it would be a plausible response for the Government
or for the Treasury to say precisely because of that although
borrowing will be higher there was therefore more slack in the
economy and that you push forward the date at which you assess
the cycle will end, and that although you are borrowing more it
would not necessarily follow that you were going to miss the first
rule because you just push the cycle further forward, no doubt
to a time when you thought that there would be some surpluses
and therefore everything could still look okay. What you could
not do is say you were deciding to change how you measure net
debt which is, in a sense, a further, harder number and that that
number if you did not see less than 3% growth in 2008-09 would
not be the 38% odd in the forecast, it would be then be very close
to 40% and you would be pretty much up against a binding constraint
at that point on borrowing more. That was my reason for feeling
that it was more of a constraint probably than the first rule.
On the question of whether you should include a much broader range
of liabilities, including future commitments to spending on pensions
or health, one could do that. I think it depends on how firm you
think the commitment is, and there is an argument that the Government
should quite rightly remain flexible on its plans for the future
partly because we do not know much about how demographics will
play out, there is this huge uncertainty, so what is the point
of putting in a firm number for future commitments when there
is so much uncertainty? If you were to decide nonetheless that
you wanted to widen out the range of liabilities then of course
it would make sense to increase very substantially the acceptable
level of those liabilities relative to GDP. It is not entirely
obvious what the advantage of doing that is. I think the key thing
is how much flexibility does the Government have on certain kinds
of commitments down the road to spending? I would argue that on
education and health and particularly on pensions there is or
there should be a lot of flexibility and therefore it does not
make sense to treat them in the same way as you treat the issue
of an index-linked government bond where there is a very firm
promise to pay certain amounts of money.
Q30 Susan Kramer: Do we need an additional
measure? Is there something that is missing because there is so
much more happening off balance sheet and so much more longer-term
commitment to the way that public sector programming is being
developed, are we missing a new measure we might need to try and
pick that up?
Professor Miles: I think it really
comes back to how much is there a very firm liability that lies
with the Government to spend specific amounts of money, and once
you focus on the issue of how firm is the commitment to spend
certain amounts of money, then you are on a spectrum where at
one end there is something which is a very firm commitment (you
issue an index-linked bond which guarantees that you pay certain
real amounts of money for the next 30 or 40 years) and at the
other end there are areas of commitment that are much more flexible.
I think it is difficult to decide where exactly you draw the line
and include this stuff that is a firm liability and this stuff
that is flexible.
Q31 Susan Kramer: Mr Broadbent, you
looked as though you had a comment?
Mr Broadbent: No, Robert is probably
much better placed to answer this than me. I agree with David.
I think you mentioned specifically pensions for public sector
employees which I would regard, excluding bonds, at the firmer
end of commitment, and where probably one could conditional on
some assumptions about the future make reasonable projections
about what the future flow was and therefore what the present
value of those commitments was. It would certainly be helpful.
Whether or not it should be included in another rule or an existing
rule I am not so sure.
Mr Weale: If I could make the
point that the Government does, of course, produce its long-term
fiscal projections in an accompanying paper and the difficulty
that they face is very much what Ben and David have described.
The Treasury is able to produce projections which say if we pay
this much on pensions, this much on health, then the finances
look fine, even given demographic change, but of course the really
interesting question is are the numbers in there credible? Is
it credible to say the pension credit will be linked to prices
and not to wages from 2008 into the indefinite future? So I think
documents of that sort are valuable but they are valuable because
of the scope for discussion they create rather than the hard and
fast rules that they allow you to set. On the other hand, I do
agree with the other witnesses that the issue of public sector
pensions does seem to me rather important and that there are a
number of other off balance sheet numbers associated with the
PFI which seem to me much more like the issue of government debt
than they do the question how much pension credit the Government
is going to pay in 30 years' time.
Q32 Mr Todd: I would like to turn
to public sector investment. I think Mr Miles has commented on
some of the issues potentially constraining that in the future.
If we look particularly to the back end of the forecasts in the
Pre-Budget Report, what conclusion do you draw from those which
suggested a growth in public expenditure of only 1.9% between
2008 and 2011, if one bears in mind that needs to accommodate
both public sector investment and some of the liabilities that
have just been talked about?
Professor Miles: I think the projections
for overall spending are such that after about 2007 or so spending
is predicted to grow less than GDP, which would represent pretty
tight limits on spending in particular areas. I think my concernand
it really comes back to issues about the net debt rule of 40%is
that that rule may come to affect decisions on highly desirable
elements of government investment and spending which might be
curtailed in a way that is undesirable. In other words, projects
that might have a high expected return might not get done because
we were very close to the 40% rule. My own view on that is that
there is an argument for that 40% number actually being higher
and it runs like this: if you are close to 40% on the net debt
Q33 Mr Todd: which we may
well be during that period.
Professor Miles: which
we are likely to be within a few years, if you are very close
to that and you hit the first rule of balancing the budget on
the current account then how much net investment you can do is
limited to 40% of the increase in GDP. If you start out with a
situation where due to under-investment in infrastructure in the
past you may well want to do more than that in terms of investment
to try and catch up from the past, you would be constrained by
that 40% rule. It seemed much less likely when the 40% rule was
put in place several years ago that that would become a binding
constraint, but that is where we are right now and my worry is
that could curtail investment in infrastructure.
Q34 Mr Todd: Bearing in mind all
of your views that the growth forecasts in that period are probably
on the optimistic side, it suggests an even greater likelihood
of a constraint on public sector investment during that period.
Mr Chote: If I could just add,
you made the point about the spending projections at the moment
for the period of the next Spending Review. Within that period,
the Treasury have assumed that net investment remains at 2.25%
of GDP, so it is not squeezed as a share of national income in
the way that the rest of public spending would be at that time.
Q35 Mr Todd: Yes, but that also presents
an issue that if one maintains that as a fixed element it suggests
that other elements of public expenditure will be squeezed rather
tighter, does it not?
Mr Chote: It does. Current expenditure
is now pencilled in to grow by about 1.9% a year in real terms
over that period. If you take into account the fact that the Wanless
Report is implying 4.4% real growth in the NHS, we have a commitment
to raise overseas aid as a share of GDP, and it seems unlikely
that you are going to want to shrink education as a share of national
income, then obviously what is left ends up being squeezed that
Q36 Mr Todd: The other element the
ONS has certainly commented on is the realism of the delivery
of public sector investment targets anyway and they are pretty
consistently underspent each year simply because it seems to be
harder to get the bricks into the ground than people have suggested.
Mr Chote: That has been a conspicuous
pattern which the Committee has pondered before. It is worth putting
in context with David's point that maybe you want to raise the
ceiling on what you can invest. Even getting to the point where
you are investing as much as you want to within the existing ceiling
would be a start. It has got better, but certainly for a long
time the Government said, "We are very happy to be spending
more on investment," but it just was not happening. It may
be bad schemes were not being done in which case it is not a bad
Q37 Mr Todd: Yes, but the other thing
that appears to be happening is consistent carry forward of expenditure
into subsequent years, which in theory at least, if then drawn
down in that year rather than simply knocked on into a subsequent
year (which normally seems to happen) could potentially have quite
a significant impact on the fiscal position. Is that something
that you have any concern about or do you just think this under-performance
will continue ad infinitum?
Mr Weale: Could I say that the
under-performance seems to be as regular a feature of the data
as the upward revisions in the ONS growth estimate and of course
neither of those is a forecast that it will continue ad infinitum.
We always assume that the investment plans in the Budget statements
are going to be delivered, but of course that does not happen.
I really do not know.
Q38 Mr Todd: But that failure to
perform certainly this year has been met by an increased expenditure
in current expenditure and has provided space for that growth
which of course brings many of its own burdens into subsequent
years as well.
Mr Weale: I think in the past
it has been said that investment spending was the easiest thing
to cut and of course people have criticised various governments
because of that. We may get to the point where if some sort of
tighter fiscal position is needed the Government does take the
view that current expenditure has increased quite a lot and may
be that is where the brake should be applied, and in that sense
to have the 40% rule doing that (if it does work like that) could
be quite valuable.
Chairman: Sally, you have a question
about medium-term sustainability.
Q39 Ms Keeble: Earlier you were all
quite critical of the growth forecast and Mark has covered that
as well. How likely do you think that either tax rises or spending
cuts will be needed to ensure sustainable public finances in the
medium term? Also if you are looking at the different areas of
public spending and the implications then for different issues
that arise, for example, productivity problems in the economy
(which Martin you said you saw the biggest single factor as being
education) are there particular areas that you would in effect
want to see ring-fenced or protected, given that you have also
got the problems of pressures for extra spending on pensions and
also on the Health Service, which I think David just referred
Mr Weale: I would be very hesitant
to say that any particular areas of public spending ought to be
protected in a general environment which is likely to be slower
growth in spending rather than actual spending cuts. I think that
each type of public spending needs to be looked at on its merits.
What we have seen really over the last five years or so is a substantial
amount of politically driven spending, for example a Government
commitment to smaller classes in primary schools. Maybe that is
what the voters want and therefore want to pay for. Whether it
delivers better education seems to me a much more doubtful proposition.
One can make the same point about reduced waiting lists for hospital
treatment. That had been a hot political issue for quite a long
time. There are some very extreme cases which do matter but a
slight reduction in the average, one can reasonably question whether
that is a good way of spending money where the fundamental purpose
of the service is to cure people and treat things that are wrong
with them. So I do think the Government has got into a position
where some key items of public spending have been driven by the
political environment rather than necessarily the value that they
deliver and perhaps it would need to assess that rather carefully.