Examination of Witnesses (Questions 140
WEDNESDAY 7 DECEMBER 2005
Q140 Kerry McCarthy: Being outside
the eurozone would not be a major factor in terms of our UK share
of the European market?
Mr Cunliffe: No, I do not think
so. The last work we did on this was in the five tests that we
have updated a bit. It is clear that within the eurozone there
has been an increase in trade between the eurozone countries but
that has not led to a drop in trade levels with non-eurozone countries.
There is some evidence that eurozone economies have started to
enjoy an increase in trade between themselves, which is what optimal
currency theory will tell you should happen. It has not been at
the expense of the UK or other non-euro countries as far as we
can see and it is still quite a small effect. We have to wait
for a number of years to see how big it is. I would not put the
euro down as an issue, I think the small changes in the global
economy are much more marked.
Kerry McCarthy: Can I turn to the US
current account deficit and throw a few quotes back at you. When
you gave evidence to the Committee in December 2004 you referred
to the fact that the trade deficit was over 5% and you said: "all
of the received wisdom has been that when you get over 5% it has
to be corrected". In March of last year you said that you
thought the US current account deficit heading past 5% of GDP
was a concern. With the deficit now heading past 6% and the dollar
strengthening, what do you say today?
Chairman: How apoplectic are you?
Kerry McCarthy: Have you become more
Q141 Chairman: Take your time.
Mr Cunliffe: It is still a risk.
We note it as a risk and I think most economic commentators would
say, and I mentioned before even Alan Greenspan says, this will
have to correct at some point. The US current account deficit
cannot grow to 100% of US GDP. The stock of foreign owned assets
in the US is growing and I think it is now something like a third
of GDP but I will have to check that. It cannot carry on, it does
have to correct at some point but the risk is it corrects abruptly
rather than smoothly. Why has it gone on much longer than the
IMF and others forecast? Again, looking at past relationships,
there is a structural change in the world economy. I think global
savings are much freer now to move around and to go to where returns
are higher, so the rest of the world is prepared to finance the
US current account deficit. It is easier to finance it than it
was. I think we understand it a little better. There was a very
interesting examination in the last IMF World Economic Outlook
which suggested that some of the problems are on the investment
side but because there is a shortage of investment opportunities
in Asia and in Europe, and this comes back to some extent to companies
not investing as much as they would, there are more global savings
around and those global savings go to the US. So it is being driven
not by the US consumer borrowing to consume and the US Government
borrowing, but it is being driven by a surplus of savings. It
is very odd that China is exporting capital to the US where theory
hitherto would say that capital should move to emerging market
economies, not the other way round. That is not to say that investment
in China is not very high, it is just not as high as savings.
I think what has happened over the last two years probably makes
me a little less apoplectic or a little less concerned because
it does seem to me there are a number of forces at work here and
the global economy seems to be dealing with the strain, but it
will have to adjust and the key is that it adjusts by savings
adjusting the US, by investment opportunities in Europe and in
other places increasing and by a more balanced economic growth
and not by some more abrupt currency adjustment. If I may make
just one other quick point. It has been complicated over the last
two years by the oil market. I know that every answer seems to
come back to oil but I think for the Gulf States their oil revenues
have gone up by something like 200% over the past five years.
Saudi Arabia is now running a current account surplus of 20% of
GDP. The current account surpluses of the oil producing countries
are larger than those of Asia, so we had an issue with emerging
Asia building up current account surpluses, exporting into the
US and then lending the money back to the US, if you like, which
was driving this, and now it is complicated by very large surpluses
building up in the oil producers, particularly in the Gulf, and
that is what it has kicked it up above 6%. I am still concerned
but I do not know when it will correct and how.
Q142 Kerry McCarthy: How well-placed
is the UK to benefit from the increased demand from oil producing
Mr Cunliffe: It depends what they
invest their money in. I was in Saudi Arabia a couple of weeks
ago and they were talking about investing in education, in health
and social services. Those are areas where we can play a part,
particularly in education. Some of the new investment, I hope,
will go into oil and creating new oil production capacity where
the UK, with its North Sea oil industry, should be quite well
placed to cope. Some of the monies being spent are on capital
goods, on investment goods, and there Germany has had an advantage
on things like luxury cars and the like in which other countries
have more of an advantage than we do. I think we are relatively
well placed. The big question is how much of it are they going
to spend. The first thing the Saudis have done is to pay off debt
and they have tried not to spend the oil windfall completely and
not to recycle it back quickly. I would have thought if it is
high tech exports, if it is knowledge based exports and services,
if it is oil exploration, we should do quite well.
Q143 Chairman: So you do not subscribe
to the benign view of some economists that in terms of savings
problems it is not much of a problem because there are already
willing savers in China and Asia to buy the dollar and solve the
Mr Cunliffe: I do not know. The
fact that this has continued longer than people thought it would,
on the one hand, would make you more worried but, on the other
hand, the world does seem to be able to adjust to it. My main
judgment, I guess, is that it does have to adjust at some point.
I think we have got longer for it to adjust than perhaps we thought
but, nonetheless, it could adjust messily or cleanly.
Q144 Mr Fallon: Can we turn now to
your forecasting record. I think you have admitted this week that
you were wildly wrong on the growth forecast, but turning to public
finances your record is now pretty consistently shocking, is it
not? The Chief Economic Adviser told us at PBR 2000: "our
assumptions are cautious so that should always mean the outturns
are better than our projections". In each of the five years
since he said that, the difference between outturn and forecast
for both current receipts and surplus on current Budgets has been
wrong negatively. You told us at the time of Budget 2000: "All
of the public finance projections are cautious", so how is
it that over five years you have said all of your projections
are cautious yet they have always turned out to be over-optimistic?
Would you elucidate?
Mr Cunliffe: If I start with your
opening point that it should be easier to forecast the public
finances in the economy; it is actually more difficult. You only
have to look at the standard errors of forecasters generally between
economic forecasting and forecasting public finances to see that.
The reason is quite simple: in order to forecast the public finances
you need to plug in your economic forecast, which is open to error,
and then you have to do fiscal forecasting and a number of other
forecasts on top of that, so the public finance forecast, if you
like, is the coming together of a number of forecasts and that
is why generally you find that whoever is doing it their error
rates are higher. The point I made at the Budget hearing in March
was if you looked at our fiscal forecasting record since the new
framework was introduced, which has two phases of the cycle, an
upswing and a downswing, you would find in terms of its absolute
error, which is how far was it off one year ahead from the outcome,
not whether it was off by being over-forecasting or under-forecasting,
its absolute error was better than before the new framework was
introduced. If you look at the degree of caution which says if
you sum the times we over-forecast borrowing and the times we
under-forecast borrowing, it is more cautious as well, considerably
so. If you look at us against the US Congressional budget office
Q145 Mr Fallon: Let us stick to your
forecasting. You have been wrong five years in a row. You could
excuse being wrong once but you have been consistently over-optimistic
in each of the last five years, both on current receipts and on
surplus on the Budget. Why?
Mr Cunliffe: I think what I am
saying is fiscal forecasting needs to be looked at against the
record of fiscal forecasters. The numbers I just pointed to suggest
that no fiscal forecaster is right all the time, most fiscal forecasters
do not come out with an outturn that is like the Budget. If you
look at our record, the only way to judge us is to benchmark us
against others and if you benchmark us against others we are better
than most countries in the European Union, we are better than
the IMF, we are better than the OECD and we are better than the
position that applied before the new framework was introduced.
The other point I would make, and the OECD brought this out when
they looked at cyclically adjusted forecasts, is that there is
a tendency for forecast errors to be correlated with the economic
cycle, so when you have a positive output gap there is a tendency
for forecast errors to be one way and when you have a negative
output gap there is a tendency for forecast errors to be the other
way. That is why it is quite important that you look at this over
a whole cycle. I do not think I would accept that our forecasting
record is worse than our peers.
Q146 Mr Fallon: It has been wrong
for the last five years, perhaps that is another reason why you
are extending the cycle, so you can finally get it right. Let
us go on to why you are moving the cycle. We had the first fiddle
going back two years adding two years on at the beginning and
now we have got a new fiddle adding three years on at the end.
That will make meeting the golden rule easier through the new
cycle, will it not?
Mr Cunliffe: I will have to think
about whether it has any impact on the new cycle. Because we are
now forecasting the cycle ends two years out and after that the
economy is on trend, I do not think there is a strong issue about
the new cycle because now we are showing
Q147 Mr Fallon: Does it help the
Chancellor or hinder the Chancellor in meeting the rule over the
Mr Cunliffe: I think we were showing
we could meet the rule over the next cycle in the Budget when
we were still estimating the end date of the cycle in 2005-06.
Q148 Mr Fallon: Does it help him?
Does it make it easier?
Mr Cunliffe: I do not think it
makes much difference actually. We are showing roughly ¾%
of GDP surplus by three years into the new cycle and I do not
that is very different from what we were showing
Q149 Mr Fallon: You may be interested
to know that the advisers this morning advised us that it would
Mr Cunliffe: Over the next cycle
I do not think there is a very big material effect.
Q150 Mr Fallon: Do you not think
it is time that we had the assumptions surrounding the cycle properly
and independently audited, or at least set? We took evidence this
morning that showed us how the cycle is a fairly arbitrary concept,
but it is your concept that the rule is based on. Is there not
a case, because there are arguments on fiddling it at either end,
for getting this thing set independently by somebody else, either
the National Audit Office or the Bank of England, somebody authoritative,
to stop you doing these fiddles?
Mr Cunliffe: The dating of the
cycle has been done for 1997 and for 1999, when we thought that
was on trend point, and 2001 in a transparent way. We set out
what we have done and why and we have had it audited by the National
Audit Office. Your point about is there a case for having main
assumptions on the cycle audited, yes, and we do. The National
Audit Office have audited the change in the date of the cycle,
they will audit the date of the next cycle, they audit our trend
rate assumption which is the key assumption that conditions fiscal
policy and they audit the main assumptions that go into fiscal
forecasting. Yes, these assumptions should be audited. The end
date of the cycle is transparent and has been audited. The Comptroller
and Auditor General has come to the conclusion that there are
reasonable grounds for the change we made. We put out an awful
lot of information on this and, as far as I can see, it is transparent
and audited. Should someone else do it is a rather different question.
I think the point I would make there is this is very analogous
to the Bank of England. When we gave the Bank of England responsibility
for operational independence on monetary policy, we gave them
the whole process. We gave them the forecasting process and we
gave them the interesting rate setting process. We did not say,
"We will have the NAO or PricewaterhouseCoopers do the economic
forecast and you, the Bank of England, will do the monetary policy".
That is because the two things are very closely intertwined and
you need to understand how you put the forecast together to understand
what policy action you take. You do not want to be in a position
where the Bank of England, using that example, comes back and
says, "We did not get monetary policy wrong, we took the
right interest rate decisions, it was the economic forecast and
the forecast of the cycle that somebody else did that was wrong".
If you apply that to fiscal policy, I think it is very important
that all the stages of the process, which are interdependent,
stay with the same authority and that one authority remains accountable.
The answer is not that you contract out different parts of the
process, the answer is you make transparent what you do, which
I think we do, and you audit it, which we have done.
Q151 Mr Fallon: Just for clarity,
you did ask the NAO to audit the change to the end of the cycle
as well as the change to the start, did you?
Mr Cunliffe: We asked them to
audit the end of the last cycle, which is the start point.
Q152 Mr Fallon: The end of the last
Mr Cunliffe: We have said that
when we get to the end of this cycle we will ask them to audit
our judgment, and they will.
Q153 Mr Todd: I want to cover a related
topic to the one that has just been touched on, which is the underspend
on investment expenditure where that happens every year, and I
think even longer than the mis-forecasts in other respects. Can
you throw any light on the consistent performance there that public
investment expenditure is always predicted as being rather greater
than it actually turns out to be?
Ms Brivati: I want to say something
about that, if I may. It is the case that we see underspend on
public sector investment year after year. However, it is discernible
also that the extent of the underspend has been smaller over the
last years, particularly since there was a large increase in public
investment around 2000-01 and a very large underspend following
that, and we have seen an increasing convergence between planned
investment and actual investment. The underspend is still there
but it is getting smaller and we believe that means departments
are getting better at actually spending and realising their investment
Q154 Mr Todd: What steps have you
taken to make them more accurate? You were saying that it is becoming
more accurate, you were implying almost by a natural process,
but are there any approaches you are taking to monitor more accurately
what they are doing through a year and also to identify best practice?
Ms Brivati: It is not entirely
a question of getting forecasts right, it may be the right and
best value for money decision on the part of any given department
to delay expenditure from one year to another. Of course, our
system of end-year flexibility applies to capital spending as
well as current spending and permits any capital budget that is
unspent to be carried over into future years. The reason behind
the underspend for any given department in any give year may be
complex. What we are doing, and what is set out in the PBR document,
in the Comprehensive Spending Review, which we will report on
in summer 2007, is we are undertaking a review of capital spending,
a zero-based review, with the objective of maximising the impact
of capital spending and we would expect in the course of that
to review the behaviour of departments' capital spending, planning
and our monitoring of it.
Q155 Mr Todd: To be honest, it is
not that unusual a problem. Most large organisations, and this
is the largest I have dealt with, have got this problem as well,
people will consistently project that they will be able to do
more within a particular year in capital expenditure terms than
they turn out to do. I would have expected by now a greater degree
of accuracy to be imposed either by just making assumptions that
there will be a failure to deliver or by looking at the methodologies
for control that seem to work better.
Ms Brivati: It is not an unusual
problem and the reasons for that are well documented. Capital
spending is very lumpy and, as you say, we are dealing with very
large amounts of it and it is even lumpier than small amounts.
A lot of it is to do with uncertainties over a precise time of
capital spend on different projects.
Q156 Mr Todd: On 2004-05 compared
with 2005-06, you are expecting an acceleration in the second
half of this year that was not reflected in the previous year.
Is there a reason for that?
Mr Ramsden: What we have found
looking at in year trends in spending from one year to the next
is that the profile of spending through the year can change. In
the data up to October that was published in mid-November before
PBR, so that was the data set we had to go on, public spending
was running below what had been set out in the plans for 2005-06
in the first seven months of the year growth rate. That reflects
the fact that the actual amounts of spending are not as high as
in the plans but also the fact that last year the profile in that
earlier part of the year was higher, so the growth rate is depressed.
We are expecting our full year percentage growth rate for DEL
spending to be as in the plans, but then on top of that there
are changes going on in AME. What that all comes back to is saying
there might be some pick-up in spending by the end of the year
but that would be entirely consistent with plans and entirely
consistent with our new set of end-year forecasts. It is just
in the data.
Mr Cunliffe: I think last year
was unusual because spending grew more quickly at the beginning
of the year than the normal profile. I remember at the time that
was one of the issues: was spending growing too fast and would
it reach its end-year total. It did reach its total. This year
the profile seems to be more back loading and, of course, as Dave
has said, last year had a higher base so it shows up more.
Q157 Mr Todd: Ms Brivati mentioned
end-year flexibility and the ability to transfer expenditure between
years. Are you comfortable with the disciplines within departments
on how that is used because in theory, at least, that could widen?
It is very welcome in terms of preventing people wasting money
on end-year projects to simply get it out of the way but it will
also be impossible to catch people out if those all move forward
at the same time with a large surge of expenditure which might
not be predicted. How do you manage that process?
Ms Brivati: We do monitor departments'
ability to use end-year flexibility. We do that for two sorts
of reasons. One is because departments are under an obligation
to present realistic estimates to Parliament and obviously end-year
flexibility is part of that. The other is that we would clearly
wish to be alert to a situation where a department had a large
EYF stockend-year flexibility stockand at the same
time perhaps wish to suggest that we did a reserve claim for some
other form of expenditure. Clearly we need to take into account
the overall financial position that any department is in. There
is an ongoing dialogue between trade you spend in teams and departments
on the financial situation and the EYF stock, the departments'
desire to draw it down as part of that dialogue.
Q158 Mr Todd: Do you audit what has
led to that EYF stock? In other words, why has this been carried
forward and what is it?
Ms Brivati: I cannot give you
the detail department by department but it is usually evident
to any spending team how EYF is building up where it is building
Q159 Mr Todd: It can come from a
variety of sources. There may be some genuine savings, for example,
which people may wish to transfer forward and use for other purposes;
there may be projects which have been slow to get off the ground,
all sorts of reasons.
Ms Brivati: It arises for a variety
of reasons, as you say.