Examination of Witnesses (Questions 40
WEDNESDAY 7 DECEMBER 2005 (Morning)
Q40 Ms Keeble: What your argument
is is that the pressures can be contained simply by slowing down
the growth in public spending and that that would not be a bad
thing in terms of the requirement for public services and there
would not be other implications for the economy or that there
would be catastrophic implications for the well-being of society?
In a nutshell, is that your argument? Then I was going to ask
if other people on the panel agree with that.
Mr Weale: No, I could not see
catastrophic implications flowing from having public spending
growth in real terms of something under 2% for a number of years
instead of the 2.5% growth rate. I do think at some stage more
room will have to be made for higher spending on pensions and
there is a question whether that is going to be done by increases
in taxes or by squeezing at the other end. I suppose I am more
inclined to do it by increases in taxes than by substantial cuts
in other areas.
Q41 Ms Keeble: You think that that
growth you have projected is sustainable over the medium term?
Mr Weale: I think looking at the
Government's forecasts up to 2010-11 they are projecting a current
account surplus. My bet would be zero or something less than zero
but not very much less than zero, so I do not think the surplus
is there. I do think that with the slow spending growth that is
now pencilled in and the tax increases that we have had, we are
much closer to something that is sustainable than we were in the
Budget earlier this year.
Ms Keeble: Does anybody disagree and
want to put a different viewpoint, in particular whether any slow
down in the projected increase in public spendingforget
about our political views, some of us are in strong agreementbut
do you think for example it would have a negative effect in terms
of tackling the problems in education which I think are well-known?
Q42 Chairman: Quick answers please.
Professor Miles: I think squeezing
these big areas of spendingeducation and healthso
that growth is less than GDP for a sustained period would pose
a real challenge to significant increases in results. Yes, it
Mr Chote: To put a rough order
of magnitude on it, if total spending is now projected to grow
by 1.8% a year over the next Spending Review period, if you have
a Wanless-style growth in the NHS, you keep the overseas aid budget
rising to the level it needs to do to get to the 2013 target,
and you spend a constant share of GDP on education, that leaves
everything else to grow by about 0.8% a year in real terms over
that period, which is clearly significantly lower than the growth
rate of the economy. On the point about sustainability, I have
argued before you previously that we thought the Treasury's tax
projections were probably overly optimistic and that therefore
some combination of freshly announced tax increases or public
spending restraint would be needed to bring about the improvement
in the public finances they were looking for. Mr Brown has given
us slightly more cautious projections on revenue, a tax increase,
and a tighter squeeze on public spending, so all those things
together clearly move in the direction that we have argued for.
Now whether, given all that, you still get the improvement he
is looking for depends on (i) whether there is enough spare capacity
for the economy to grow as quickly as the Chancellor hopes over
next three to four years, (ii) whether the spending plans are
inked in as well as pencilled in and then delivered, and then
(iii) whether the growth in tax revenues per pound of GDP is still
plausible. The Chancellor is still obviously pencilling in quite
strong corporation tax growth, still relying on fiscal drag to
pull more people into the income tax net, but certainly from the
measures he has announced yesterday he has done a lot of the things
that we have been arguing that he needed to do.
Mr Broadbent: I agree with all
that. Probably, like the others, I would be slightly less optimistic
on the central projections. I do believe whether or not the Government
borrows an extra five or ten billion relative to its forecast
or even relative to its rule is neither here nor there in terms
of the overall economy. These are relatively small numbers. As
to whether the lower spending profile would be difficult, I am
sure it would be. These are not cuts strictly but productivity
growth tends to be lower in services in general and in public
services in particular and so they would be harder. It does help
if you announce them and, as Robert says, pencil them in quite
a long time in advance, which probably means that the next Comprehensive
Spending Review will be quite a challenging one, but once those
are set it helps if departments know quite a long time beforehand
what their resources are going to be.
Q43 Mr Love: In answer to the very
first question that the Chairman put, Martin Weale commented in
relation to the average living standards as between different
countries, naturally enough primarily due to productivity, but
then tied that in more particularly to low skills. I wanted to
ask the other members of the panel whether they agreed about the
low skills being the major issue or whether there are other issues
in relation to productivity.
Professor Miles: I strongly agree
that we have a problem with low skills, with a substantial proportion
of the adult population having real problems with numeracy and
literacy. Those skills are arguably far more important now in
terms of people's productivity than they were 20 or 30 years ago.
They are likely to become even more important. It is one of the
factors that I think will hold back growth of living standards
in this country, so I strongly agree with Martin there is a real
problem with education.
Mr Chote: I would agree with that.
There are obviously other things that matterthe competitive
environment of the country, et ceterabut clearly
the skills point is a very important one. I guess another area
of disappointment in terms of delivering sustained improvements
is that much of the argument that was made for saying we need
arrangements that will deliver macroeconomic stability was that
it would provide an environment conducive to greater private investment.
I think one of the disappointments has been that the Government
has managed to deliverthrough a combination of luck or
judgmentthe stability, but the investment has not improved
to the same degree and there may be other factors.
Q44 Mr Love: I was going to come
on to thatand I will ask Benwe have had very sluggish
business investment yet profits are up, the gearing is moving
in the right direction, the cost of finance is coming down, so
why is business not investing and what contribution does that
make to the productivity problem?
Mr Broadbent: Quite a significant
one over the long term. It takes quite a long time to change the
capital stock of the country but you can only do it by investing
more. The truth is I do not really know, it is a puzzle globally.
Throughout the last three or four years firms at least in the
OECD countries have invested much less than you would have expected
them to have done and it may well be that the hangover from the
boom of the late 1990s/early 2000s is to make them persistently
cautious about increasing their capital spend despite very low
interest rates and despite the fact that profits are, if anything,
above average. So firms are instead accumulating financial assets
and accumulating bank deposits at record rates instead of investing
in physical capital. It is something of a mystery. It is not something
that is sustainable forever but it has been going on for a couple
of years. On the productivity point I would only add one thing,
I fully agree that the main problem would be education. It is
probably also true that our infrastructure, transport in particular,
is worse than that of our competitor countries and that probably
at the margin also has an impact on productivity.
Q45 Mr Love: I am going to come on
to public sector investment but let me just ask Martin that question
about business investment. Why are they failing to invest? Do
you disagree with anything that has been said?
Mr Weale: No, like Ben, I am afraid
I do not know. Profits are high, the economy is stable, demand
has not fluctuated very much, and I do not have an explanation.
Q46 Mr Love: Can I move on to public
sector investment and without wishing to get into the whole issue
about public sector productivity we have got investment currently
at 2.3% yet we have talked in response to earlier questions about
the squeeze that is likely to come upon that. How critical is
that level of public sector investment to increasing productivity
in the economy, Martin?
Mr Weale: I think it depends on
the areas where the public sector investment is taking place.
There are some forms of public sector investment which are obviously
extremely valuable, having clean hospitals and so on, but most
of the people who use hospitals are not thinking of going out
to work, or a disproportionate number of them, and that does not
have a great impact on the overall level of productivity. On the
other hand, if you look at investment in roads, there that can
have quite an impact but at the same time we have to remember
that the pressure groups that are blaming the quality of the roads
for their poor performance are wanting to get better roads without
having to pay for them and in the public sector investment debate
you always have this problem that what one hears from the private
sector is a wish-list of things that it wants and knows it is
not going to have to pay for directly.
Q47 Mr Love: Robert, can I ask you
when Labour first came in in 1997 we followed the path of the
previous government and that took public sector investment down
to 0.5% of GDP. Can we afford to go back to that? Can we squeeze
public sector investment and still hope to improve productivity?
Mr Chote: The Government is clearly
not intending to do that. If it inks in what it has pencilled
in for the next Spending Review figures then it is ring-fencing
the amount of public sector investment at roughly 2.25% of GDP.
One of the justifications for putting the Golden Rule in in the
first place, as either David or Martin said, was to stop investment
being the first thing that gets squeezed. But that can be one
of the problems you get, as David implied, when you leave a 40%
Q48 Mr Love: That is likely to happen.
The ONS is gradually coming towards us on PFI and various other
changes in accounting practice will take us to 40%. Will that
become a real constraint?
Mr Chote: It could do and then
the Government has to reach a judgment about which is more important,
sustaining the level of investment that it is looking for or sticking
with that 40% ceiling. Remember that there is nothing written
in stone about 40%, there is nothing in the economic textbooks
that says 40% is right and that 20% or 60% is not. If you look
at the spectrum of different countries there are some countries,
Scandinavia or Australasia, where the debt burden is much much
lower but there are others where it is higher and that is a judgment
to be reached. At the end of the day it is a question of whether
you are more interested in meeting the letter of the rule or more
interested in delivering the broader objectives, and that is a
political judgment as much as an economic one.
Q49 Damian Green: Can we return to
the Golden Rule which we have touched on briefly. Robert, the
IMF has been moderately scathing about the fact that we have now
had the dates of the cycle changed not only at the beginning but
also in the future as well, conveniently giving another year of
putative surplus. Do you think the rule has much credibility left?
Mr Chote: I have to say I do not
think the fact that since the Budget we have seen a move from
the idea that it is really important to assess performance over
this seven-year period to now arguing that it is really important
to assess performance over this 12-year period has done anything
to help the credibility of the framework. We have argued for some
time that while it might be perfectly reasonable to say in the
way that you are structuring fiscal policy you want to be in a
position where the government can borrow more when the economy
is weak, and therefore you have to take some account of where
you think you are in the cycle, that does not necessarily imply
that the way you should do this is by trying to identify some
fixed period, call it an economic cycle and say that is the period.
You do not have to do it in that way. I think the problem is that
having had such a big shift in the width of the goal that you
are trying to kick the ball into undermines the idea that this
is going to provide people with a clear anchor in terms of knowing
what the Government is likely to do. That is not the same as saying
necessarily that they have done this in a cynical way in order
to make things easier. The problem in practice is that by moving
the beginning of the cycle back it makes the rule easier to meet
over this cycle. By moving the end of it forward it makes the
rule easier to meet over the next one. Inevitably it will raise
suspicions that this has been done to make the rules easier to
meet. An independent body, if you want to stick with this framework,
which I am not suggesting you do, may have come up with exactly
the same judgments about the width of the cycle. At least that
would mean that it was not likely to be interpreted as a politically
Q50 Damian Green: Are you saying
that you think the whole framework is flawed?
Mr Chote: The Golden Rule at best
was only ever a reasonable rule of thumb because it is premised
on the idea that it is worthwhile borrowing for investment because
investment benefits future generations of taxpayers whereas current
spending does not. That is an imperfect judgment anyway. Current
spending on teacher training may well benefit people more than
a velodrome in the Lea Valley. That distinction is not there.
I think you should only treat it as a rule of thumb. The idea
that over a period of seven or 12 years if you beat it by one
billion that is terrific and you miss it by one billion that is
a disaster just is not sustainable on any analytical grounds.
The problem is that more rhetorical capital has been invested
in this than its analytical foundations will bear.
Q51 Chairman: Martin, you said to
us in evidence on the Pre-Budget Report in 2002 that it was quite
likely that the start date for the current economic cycle would
be revised back to 1997 because "It would not take much of
a change to the numbers or to the estimate of the trend line to
say that the economy had been above trend for the whole period
from 1997", but more recently you said in a quote, "The
Treasury has done a good job of discrediting the use of the economic
cycle as a guide to economic policy making." How do you reconcile
those remarks for a simple person like me?
Mr Weale: I think those two remarks
are entirely consistent. I might almost ask why you are asking
Q52 Chairman: You said it. You have
come to give us evidence.
Mr Weale: The cycle between 1997
and 1999 was very poorly defined. The National Audit Office, for
example, said, above paragraph 49, "The cyclical indicator
evidence is consistent with both 1997 and 1999 being on trend
points, although there is considerable uncertainty in making such
judgments." That is what I was forecasting three years ago.
My view is that because we have now all seen that that is the
case, the National Audit Office is saying that, it demonstrates
that the Golden Rule as handled by the Government is inappropriate
as a means for assessing fiscal policy and my view is that it
has been discredited and should be replaced by some assessment
which is superficially perhaps less precise but is forward looking
and does not hinge on small changes in trend lines from the ONS
and all sorts of things happening nearly 10 years ago.
Chairman: Okay. That is your story!
Q53 Angela Eagle: Mr Weale, I am
not sure you would hack it as a politician. The Governor of the
Bank of England, when talking about the cycle, actually said,
"I am not even sure it makes sense to think about a cycle
as if it is a well-defined phenomenon." In other words, it
is a construct that we use to analyse; it is not something that
exists out there that everyone can agree about like a measurable
thing. Do you not think it is time that we think again about the
concept of the cycle and not be so enslaved to an economic construct
and change the way that we actually anchor the Golden Rule?
Mr Weale: Yes I do. Perhaps I
could illustrate that by asking you to turn to Chart A3 on page
189. This is the Treasury's estimate of the output gap and therefore
implicitly what defines the cycle. You can see the sort of small
amount of bouncing around there between 1997 and 1999 that essentially
is why I said what I did three years ago and why I think it is
all very much up in the air. You can also see that around the
start of 2004 there is something that looks very close to being
a cyclical peak or it would be a cyclical peak if the zero line
was tilted only very slightly. In the Treasury write up they say
that it is a bit of a mystery that the economy nearly went to
that peak but did not then burst through into finishing the cycle.
My view is it is not a mystery at all. Like the Governor of the
Bank of England, I think economies have periods of fast growth
and they have slow growth, but what they do not have is a regular
and clearly defined cycle and therefore we should look for alternative
ways of assessing whether fiscal policy is being run on a sound
and sustainable basis.
Q54 Chairman: The Governor was very
clear when he said, "We do not like this sort of fixed dating
and have a different way of thinking about the productive potential
of the economy and how it evolves. So inevitably we have different
views about the cycle and I am not even sure it makes sense to
think about a cycle as if it is a well-defined phenomenon."
In general terms do you all agree or disagree with that?
Mr Broadbent: Clearly it exists
in the sense that there are periods when spending in the economy
is above what one would consider to be the capacity.
Q55 Chairman: What about the fixed
Mr Broadbent: It is very problematic
if only because, as we have seen recently, it just takes a revision
in the data to change your view of that and it is a very odd situation
for that then to change your view of the appropriateness of fiscal
policy today. If only for that reason the fixed dating is difficult.
The notion of the cycle exists but, as Martin said, it may not
be dealt with in the right way in these fiscal rules.
Mr Chote: In a sense the Government
is a bit of a victim of its own success here. If it believes it
has abolished boom and bust then the idea that you have a big,
chunky, well-identified period below potential followed by a big,
chunky, well-identified period above potential will not be the
case. What you will get is a wobbly noise around the trend, which
is clearly what is happening in 1997 to 1999. It is not the same
as saying you should not take account of the short to medium term
growth prospects in assessing how much you expect the fiscal position
to improve, but the idea of judging it over a fixed period, as
the Governor implies, just seems to be not at all sensible.
Professor Miles: I would like
to make two points. Firstly, having a set of rules and drawing
distinctions between current spending and capital spending is
better than where we were before. Before we had the code there
was nothing. I think it would be helpful to focus on the forward
looking questions, which are how soon we will get back to current
balance and when we think there is very little spare capacity
in the economy and therefore you are back at a neutral point and
if we have plans in place for spending and taxes which roughly
give you a balance on the current budget. To focus on those more
forward looking questions seems to me more fruitful than looking
Q56 Chairman: The Governor goes on
to say that it should be forward looking, which is exactly the
point you are making now.
Professor Miles: Having said that,
when you read the documentation and the PBR stuff, there is a
huge amount of focus on the forward looking stuff. It is not just
that there is also a lot of focus on the backward looking issues
of 1997 or 1999. To my mind it would be more helpful if there
was yet more evidence on the forward looking things.
Q57 Mr Mudie: Before Gordon introduced
the Golden Rule there was nothing. The Golden Rule has been a
source of great comment and earnings potential for some of you.
Mr Chote: I wish!
Q58 Mr Mudie: It has been a source
of great fixation by the financial press. Are you arguing that
we should evolve it further, we should keep it and finesse it
or do we go back to what there was before, ie nothing?
Professor Miles: I would not want
to go back to there being nothing. Focusing on the distinction
that is drawn between current budgets and drawing a distinction
between investment spending and current spending in principle
is a good one but difficult to do in practice. To my mind tweaking
it in a sense and making it much more forward looking would be
a good direction to go in. Going back to having no set of rules
or guidance on where the fiscal position was going I think would
be a retrograde step.
Q59 Chairman: I would like to ask
you a final question about the Treasury's fiscal forecasting record
in recent years. I notice from your submission that Ray Barrell
thinks you are the bee's knees and that you have done better than
the Treasury on this particular issue. Is there any reason for
the systematic error in Treasury forecasts of current receipts
and current budgets?
Mr Weale: My guess is that they
have been inherently prone to optimism because they have not wanted
to produce a forecast which shows that the Golden Rule was going
to have to be rescued by a change in the length of the cycle and
in that sense it is very similar to what was happening in the
first half of the 1990s when the budget forecast showed the budget
returning to balance in the not too distant future, because the
fiscal rule then was that the budget should be balanced. I think
the Treasury is highly bound by the fact that it cannot produce
forecasts which show the rule not working, not being met or close
to not being met. My guess is that has been the main influence.
Chairman: Can I thank you for your time
this morning. We will move on now to the microeconomic issues.