Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 80-99)


28 MARCH 2006

  Q80  Mr Newmark: Kate, what is your own central projection for growth and to what extent does this reflect more caution about the UK consumer?

  Ms Barker: I have already said that my central projection is a little bit weaker, but I would not want to overplay the difference between the Bank and the outside forecasters either given the tremendous range of uncertainty. I am a little bit more cautious about the consumer and that is partly because I am a little bit more cautious about the positive effect of asset prices on the consumer going forward. Charlie has just mentioned the fact that we have had some output data for the early part of the year which, on the whole, favours the case that growth will remain pretty strong and more in line with the forecast. Of course, the early evidence for the consumer, as the Governor has already discussed, is that actually it is a bit on the side of those of us who think consumption could be weak. To that extent the jury is still out on which of these views will prove to be correct. The main point I would make is that they are not very different views of the economy from each other; they differ only at the margin.

  Q81  Mr Newmark: To what extent have you shifted the emphasis towards domestic consumption as the main driver of GDP growth, rather than investment, external demand and net trade? To what extent did the MPC shift the emphasis back towards exports in the March meeting?

  Mr King: I do not think we have shifted it. The projections for consumer spending in the February report, which we have not really changed our views on, are that after a very weak patch at the beginning of 2005 where, if you will remember, the ONS estimated that consumer spending did not grow at all in the first quarter, growth has picked up to their current estimate of 0.7% in the fourth quarter. That is already at historical trend. We do not have any further pick up in consumer spending growth in our central projection, but who knows what it will be. Our view would be that it is much better to average together Q4 last year and Q1 this year. It may well be that Q1 this year is a bit weaker than Q4, but it is the average of the two that really tells you what is going on. We do not expect consumer spending growth to return to the heady rates that we saw from the late 1990s to the early 2000s. In that period, consumer spending was rising at a much faster rate than was likely to be sustainable in the medium term and indeed, that growth did come to an end. We would expect it to be no more than its historical average over the next few years. We would expect there to be some modest pick up in investment—nothing terribly exciting—and, although the economy is growing pretty strongly, a less negative contribution of net trade to growth than we have seen in the past decade when net trade subtracted from growth every single year. And, of course, public spending growth is still pretty robust and implies growth faster than the growth of the economy as a whole. If you put those things together, that is a picture of growth around trend as a whole. That seems to me pretty plausible. In the event lots of unexpected things will come along which will push us off in one direction or another. One other point I would make, and it is true of the MPC as well as other people, is that if you ask what the risks to growth are, it is very easy to identify downside risks. When was the last time you talked to someone who said they had an upside risk to growth? That is not as common. In fact the MPC's own track record is that we probably, on average, under-estimate growth and we have downside risks more easily than we have upside risks. Just as central banks always find it easier to see upside risks to inflation than downside risks because that is the thing we are concerned about, so a lot of commentators find it easier to get headlines or fees for writing articles by pinpointing disastrous outcomes.

  Q82  Mr Newmark: I do not think it is disastrous outcomes. I think if you listen to what people are saying, there is a certain nervousness about the market at the moment. So I think that people being cautious is not necessarily a bad thing, I think that just reflects today.

  Mr King: Our forecast is very much in line with that. We do not have consumer spending growth picking up to anything like the growth rates that we saw in the past. We have a very modest pick up of investment. We take public spending growth from the Government's own stated plans. That is going to grow faster than the economy as a whole.

  Q83  Mr Newmark: On investment, if we look at business investment, what is your take on that as a percentage of GDP and so on?

  Mr King: There is no doubt it has been very weak in the last year or two and weaker than we had expected and weaker than we find it entirely easy to explain.

  Q84  Mr Newmark: It has been very, very weak.

  Mr King: The growth rates have been very weak but the level relative to GDP has not been, it has risen as a share of GDP over the last ten to 15 years and it is still maintaining that level. Looking at it in that context gives a slightly different perspective. This was something which a year or so ago the US and the euro-area were also seeing and they did not really understand why investment looked weak either. There were stories from the US and elsewhere that maybe generalised business caution explained weak investment, but there was no more compelling or explicit explanation than that. In the last year business investment has picked up in the US and the Euro-Area so that puzzle has gone away. The weakness of the growth rate of investment is still evident in the UK. There is no simple or easy explanation for that because cash flow and profitability are high and the cost of capital is at an all time low. So you would expect that to be an environment in which, with the economy growing at around trend, to see a somewhat faster pick up of investment.

  Q85  Mr Newmark: Exactly right. So why not?

  Mr King: I do not think we really understand why not; we do not claim to. Just as the US and the Euro-Area could not understand it a year ago but have now seen investment pick up, I do not think we should rule out the possibility that this is simply a delay in timing and that investment will indeed pick up. We have a very modest central projection for the pick up of the growth rate of investment which does not look implausible at all. We are not projecting particularly rapid growth rates, we are projecting quarterly growth rates very much in line with those that we have seen in the last quarter or so.

  Q86  Mr Newmark: Productivity growth seems to be extraordinarily low. I am just curious as to why you see that happening. What are the drivers behind that problem?

  Mr King: It is certainly true that measured productivity growth has fallen over the last year or so to very weak levels.

  Q87  Mr Newmark: It is at a 15 year low.

  Mr King: It has picked up in the last quarter. We think, though no-one can be at all sure, the most likely explanation is that this reflects the cyclical pattern of labour hoarding. As the labour hoarding that occurred in the first part of last year starts to unwind—Steve referred to the rise in unemployment and employment has grown more slowly—then the measured productivity growth rate starts to pick up. In the late 1990s when people were talking about the likely increase in the underlying productivity growth rate we were very cautious about that. We have seen no sign at all of any pick up in the growth rate of productivity, but, equally, I think I would be rather reluctant to draw strong conclusions about whether there has been a fall in the trend growth of productivity. There is no obvious reason why there should have been, productivity growth can move around from quarter to quarter. Only time will tell and it is not something which it is easy to form a judgment about and we certainly do not have a closed mind on that.

  Q88  Mr Todd: I want to explore the interaction between household spending and taxation. I think it is generally accepted that tax levels have drifted gently up over the last few years. To what extent do you feel that has affected consumer spending decisions?

  Mr King: Clearly it has had some effect because it slows the growth rate of disposable income. We saw in the period from early 2003 to mid/late 2005 that the ratio of taxes to household incomes rose by two percentage points. We saw in the numbers that came out in the Red Book last week that the share of income tax and national insurance contributions to GDP is likely to rise by another percentage point over the next three years. These are, as you say, gentle rises in the ratio of taxes to GDP to ensure that (a) public spending on health and education could rise more rapidly than in the economy as a whole, and (b) that the public finances would remain in a relatively prudent state. It inevitably follows that you need to have a higher level of taxes to GDP and that slows the growth rate of household disposable income. So it has some effect on consumer spending but it is not the only effect. In our Inflation Report last time we pointed to all the other influences, which will be interest rates, asset prices and expectations of how future incomes will pan out.

  Q89  Mr Todd: Does it suggest that to deal with that effect, mild though it may be and complicated by other factors as well, you also have a duty to consider that in your thoughts on how to deal with consumer spending projections into the future on which you have expressed gentle optimism of growth but certainly not an expectation of a return to previous levels?

  Mr King: And that view is embodied into our central projection.

  Q90  Mr Todd: In your opening statement you referred to a downside risk on consumer spending. Was your expectation of increased taxation a contributory factor to that?

  Mr King: No. I think the impact of this gentle rise in the ratio of taxes to GDP is it affects the longer-term growth rate of household disposable income. This is something that people have seen coming and they know it is coming, it has been published in the Government's plan. The downside risks to consumer spending that we identified in the near term have much more to do with uncertainty about consumer sentiment, about how asset prices will affect consumer spending and about the underlying buoyancy of spending given households' expectations about the future.

  Q91  Mr Todd: Weighing up the different contributory factors, to a large extent you think consumers build into their thinking the level of tax they are expected to pay over a period of time and marginal differences make relatively little contribution to their overall spending patterns, do you?

  Mr King: Marginal differences in taxes make marginal differences in consumer spending growth rates. Bigger differences may have bigger effects.

  Q92  Mr Todd: I am sure you recognise that sometimes the way that tax changes are presented in the media imply potential cataclysmic effects on consumer behaviour.

  Mr King: I do not think that is restricted to tax effects but to many other aspects of the economy.

  Q93  Mr Todd: Your own decisions are linked to those as well. We have had some discussion about the retail sales picture. The data over the last few months has perhaps not been particularly clear as it shrouds around Christmas where behaviour is a little bit different from the rest of the year. What picture do you think you are seeing at the moment?

  Mr King: I think that is why I said earlier that we preferred to look at the fourth quarter and the first quarter together. The fourth quarter looks relatively strong and the first quarter looks a little bit weaker. We do not know the first quarter yet. We have had two months of the official retail sales data and they are certainly weaker. The correlation between these retail sales data and the component of the official estimate of consumption that is spent on retail goods is actually remarkably poor and that is a puzzle in itself. I do not think we have much of a guide yet. The reports that we have picked up from others and our own agents have certainly suggested that into the new year the feeling about consumer spending is a bit softer than it was in December last year, but we have to smooth through these things and to get some feel for the underlying picture.

  Mr Bean: The other thing that is worth adding to that is that retail sales, which we have some reasonable information on at a monthly frequency, such as the retail sales data from the ONS, the British Retail Consortium, the CBI distributed trades, only tells you about less than half of consumer spending. There is a great swathe of consumer spending on consumer services which we have much less information on and there we often rely on what the agents are telling us and there the picture looks a bit spottier. There are some parts which are doing okay and some parts which mirror what has happened on the retail spending side.

  Q94  Mr Todd: There is some evidence, is there not, that that proportion of consumer spending attributed to services and other spending decisions as opposed to retail sales which you measure is actually increasing and therefore making perhaps the retail sales picture rather less of a significant factor in your decision making than an overall picture of consumer confidence? Is that reasonable?

  Mr Bean: Indeed. It is quite possible that in the current situation it may typically be younger households who are concerned about the burden of debt they have taken on and a lot of their spending may be on the retail side, whereas older households who have been accumulating financial assets spend a higher proposition of their budget on services than younger households. So there may be subtleties about the distribution of spending across households impacting on the mix of spending.

  Q95  Mr Todd: Do you think there are data gaps in which it would be nice to know rather more about what is happening? In the services sector and as applied to consumer decision making, is that an area where simply relying on your agents, good though they are, is perhaps not sufficient?

  Mr Bean: It would be very nice to have better data on the services sector. It is one priority that we have signalled to the ONS we would like more progress on, ie on developing suitable indicators of services activity.

  Mr King: This is a major issue for us and it is not easy for the ONS to know how to develop this, but they are certainly working on it. The number of establishments in the UK producing service sector output is very large. Manufacturing used to have the attraction that it was composed of large establishments and you could measure and weigh the output. Now it is very difficult to know how to measure the output from many service sector establishments. It is very hard to produce decent monthly data on that and so we do not get monthly figures. Both in terms of estimating what is happening to consumer spending—because so much of spending is now on services—and also in terms of getting a feel for output in the economy, it is the service sector which contains the information. That is where we really do need to try and make an effort over the next five years to develop a better statistical base.

  Q96  Kerry McCarthy: I want to raise the question of business investment. Do you think the fact that it has been constrained is because, although on a macro level things are fairly stable, we are given a fair degree of certainty as to what the future holds, on a micro level there is uncertainty about long-term prospects and particularly the prospect of competition from developing countries?

  Mr King: There are many potential explanations for why investment might be weak and we simply do not know the answer. I think this one about uncertainty at the macro level being lower but possibly uncertainty at the micro level being higher is an interesting one.

  Ms Barker: The Governor talked earlier about the fact that we have had very different experiences of investment in different countries and of course this macro and micro point has not just been a feature of the UK. It has also been a feature of the US, and led us to look at the evidence in the UK. But in the US we have started to see investment picking up, so I think perhaps it is not likely to be quite such an explanation. I was rather surprised to discover that the volatility among individual firms had increased and it is not just through competition from the developing countries, it is also the fact that technology changes much more quickly, products change much more quickly and, of course, the competition regime in the UK, as indeed in other places, has also been tightened. All these things add together to make the outlook for individual firms much more competitive in some ways. From the economist's point of view this is a better thing, this is the economy working better and more flexibly. Business people sometimes talk about a lack of `visibility' and that is perhaps what is driving some of the reluctance to invest. But it has become more surprising over the past couple of quarters, in fact since I gave that speech, because we have seen more indications of investment picking up in other developed countries where you would expect the same phenomenon to be occurring, so it is a bit more surprising perhaps that in the UK we are not seeing investment rising.

  Professor Nickell: One or two other thoughts about business investment. One of the features of business investment which was quite striking a couple of years ago when we did have a mini boomlet was that that was basically driven by retail, in building supermarkets and so on. It is important to remember that quite a big chunk of business investment is in buildings and structures, factories and so on. If you ask a businessman why it is harder to get appropriate buildings built and so on, one of the things they will undoubtedly say is that the planning system at the moment is such as to discourage that sort of activity. That is one possibility. Another thought that occurs is that the booming sector of the economy at the moment is business services, that is where growth is very strong. One of the constraints on the expansion of business services is actually the shortage of business professionals. That ties in with planning incidentally because one of the reasons the planning system is relatively slow at the moment is the big shortage of planning professionals and one of the reasons why is because the planning professionals who used to work for local authorities now work for private sector business services companies because, of course, they pay more and they are in great demand everywhere in order to get things built.

  Q97  Kerry McCarthy: Planning is certainly something that I have been approached about at a local level quite recently. I was at a regional CBI dinner on Friday and it was something that across the board people there said to me. Is that something that the regional agents are bringing to the Bank's attention, the fact that problems with getting large scale development, particularly through the planning process, is holding up this investment?

  Mr King: It is not something which I have heard them report collectively, and we have asked them about impediments to investment. We look at these things from time to time. No doubt we will have another survey of investment before too long and we can certainly go back and ask them how they would compare the importance of these different factors. It is not easy because many of the decisions about investment spending—as opposed to employment—are often taken centrally and not in the regional offices and headquarters, but we will certainly try to explore this.

  Q98  Kerry McCarthy: What things are the regional agents telling you at the moment about how companies feel?

  Mr King: About their explanations for investment?

  Q99  Kerry McCarthy: Yes.

  Ms Lomax: We asked them about this not very long ago. They always answer that the main constraint on investment is uncertainty about demand and I think the answer this time was not particularly unusual in saying that is the main consideration. Then there is a long tail of other factors but none of them really stands out. The thing that I think some of us were expecting to see but did not show up was pension fund deficits because that is the anecdote, when you sit around talking to businessmen when we go on a regional visit, that comes up very frequently and yet I have not managed to find any hard figures to support that.

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