Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 1-19)

MR ROBERT CHOTE, PROFESSOR DAVID MILES, MS BRIDGET ROSEWELL AND DR MARTIN WEALE

11 DECEMBER 2006

  Q1 Chairman: Good afternoon and welcome. Thank you for coming to assist us with the examination of the Pre-Budget Report. We have got two sessions, this session which I hope to finish round about five past five, and then the one on the microeconomics which will finish about 10 to six. When you are asked a question one of you take it and if anybody has got a real pressing need to give us their particular take on it, you can do it but do it briefly. Can you please introduce yourselves for the record?

  Dr Weale: Martin Weale, the Director of the National Institute of Economic and Social Research.

  Mr Chote: Robert Chote, the Institute for Fiscal Studies.

  Professor Miles: David Miles, Morgan Stanley.

  Ms Rosewell: Bridget Rosewell, Volterra Consulting and the Greater London Authority.

  Q2  Chairman: I want to start on the uncertainty issue. We have had evidence from the inflation report hearing with the Governor of the Bank of England about the uncertainties, and he was saying that they are "genuinely uncertain as to how price setting in the economy will respond to large movements in certain costs, such as energy prices". Would you say that the economic outlook, both for inflation and GDP growth, are more uncertain at the moment than at the time of the Budget?

  Dr Weale: I would be reluctant to say that. I think that at the time of the Budget things were happening to fuel prices. Basically, the oil price has gone up and gone down. We have had and still have considerable uncertainty about migration flows, but that is not a new problem. It is very difficult to make a good case that the situation is particularly uncertain at the moment. On the other hand it is a comment you often hear from economic forecasters, so it is probably true.

  Q3  Chairman: Does the Pre-Budget Report adequately reflect the current uncertainty, do you think?

  Ms Rosewell: I was going to say that there is one additional piece of uncertainty which I think probably has increased in importance since the Budget and that is around the international economy and the state of the US economy in particular. At the time of the Budget it looked like the US economy was slowing. I think that the potential for a much stronger downturn in that economy has probably increased since then, although we are still by no means certain about it. It is that international bit that I would want to draw attention to.

  Q4  Chairman: In his response to a question from my colleague Jim Cousins, Charlie Bean said that it is important that "we continue to see a subdued pay growth going forward over next year to avoid, essentially, labour pricing itself out of jobs". The Bank of England has suggested that labour may be pricing itself out of jobs. Do you agree with that and, if so, is there anything the Government can do about it?

  Dr Weale: I would say that no, we are not seeing strong upward pressure, that the mechanism for dealing with labour pricing itself out of jobs is the interest rate mechanism that the Bank of England use so, although in the long term, of course, the Government has very successfully pursued policies to improve the labour supply side, in the short term it is a Bank of England issue and not a Government issue.

  Q5  Chairman: Anyone else on that one?

  Professor Miles: I think the Government's role here is to try to foster productivity growth and there is a whole agenda about education, plus many of the special reports that came out at the time of the Budget, to try and increase labour productivity in the UK. This is one of the ways of stopping labour pricing itself out of jobs. The evidence on the success of that still remains perhaps a little bit patchy. I do not think there is overwhelming evidence that labour productivity growth has increased very much in the UK unfortunately.

  Q6  Angela Eagle: What do you think is going on in the labour market because we have had an increase in unemployment but also an increase in overall levels of employment? Can you comment on how you think that is contributing or not to the stability that we have seen in the economy?

  Ms Rosewell: One of the difficulties is that we do not really know how big the labour force is. It is obviously particularly an issue in London where many of the migrants, first any rate, appear; they may move on to other places afterwards. One of the things that I recently discovered in trying to delve into this is the limited amount of information on which our estimates of migration are based, and indeed the self-assessment that is required. "Are you planning to stay more than a year?", is what we ask people, and on that basis we estimate what the migration numbers are. It seems to me on this basis that assessing the size of the labour force has become increasingly problematic, as indeed the Bank have recognised, and therefore understanding either what is happening to productivity, employment or unemployment is quite difficult. It would not be therefore any surprise that if you have got much larger numbers of new people entering the labour force you might simultaneously get rising employment and rising unemployment, depending on the particular locality that you are looking at.

  Q7  Angela Eagle: Does that have any implications for policy? Should we be trying to get a better handle on the size of the labour market? Clearly, Government policy has been to increase the size of the labour market, including getting people of working age who have been economically inactive back to work, and there are still programmes that are designed to do that, particularly Pathways to Work, to get those that are inactive on incapacity benefit.

  Ms Rosewell: The implication of the conclusion that there are more people entering the labour market than we thought, but that these are not necessarily people who are on benefit, is that it actually makes those programmes probably more difficult to deliver because there are more other people chasing the positions at any individual point in time. It is not a fixed sum, obviously, but at any point in time there will be a given number of vacancies and more people chasing them than was probably thought. Particularly, again, in the London economy, which I monitor most closely, we know that, for example, participating in part-time work, the availability of part-time work is quite limited in London. That is partly because it is not worth commuting to such positions but it is also because there is an awful lot of competition for the sorts of jobs which in the rest of the country are done part-time.

  Q8  Angela Eagle: Does anyone get a sense of what is going on in other parts of the country? Obviously, London is important but there are other policy implications from what is going on in the labour market in other regions.

  Professor Miles: In terms of just how migration fits into this story, my impression from the statistics is that, whereas a few years ago a very large proportion of the flow of net inward migration came to the south east and stayed in the south east, it is spreading out much more widely across the country now.

  Q9  Angela Eagle: But the whole unemployment issue is not only migration, is it? Martin, you wanted to say something.

  Dr Weale: I wanted to say that if you want to measure migration and therefore the labour force much better, you really would have to have a landing card system at airports and ports, and without that we are really stuck with the sort of very poor survey that we have.

  Q10  Angela Eagle: I think in fact the Governor was pointing something similar out when he came before us the other week. In terms of productivity then, it seems to be rising, as does business investment.

  Dr Weale: You would expect business investment to be rising. What happened over the last couple of years was that we had something like 500,000 unexpected people added to the labour force and, of course, if those are to work productively you need capital for them to work with and that is provided by investment, so we are seeing a lagged response to an unexpected surge in the labour force. In terms of productivity, of course, the Pre-Budget Report talks about how rapid increases in employment have typically been associated with falling productivity. That is true on some occasions but on other occasions, if you go back to the 1950s and 1960s, growth in employment was associated with growth in productivity and no one quite understood what that mechanism was, but perhaps we are seeing something a bit more like that process.

  Q11  Angela Eagle: Does that have any implications for the stability of the cycle or any policy implications? Is there anything that you see in the way these trends are working that is worrying you in terms of the Treasury's predictions and assessments?

  Dr Weale: It does make it very hard, of course, to assess the trend growth rate of the economy and the current position in the cycle. The Government is assuming that immigration continues at a fairly high rate, not as high as we had in 2004 but I think at the rate observed in 2005. Now, of course, there is a question whether that will happen because you might think that the people from the recent Member State who wanted to go and work abroad have mostly gone to work abroad now. As far as I understand it, we are not going to have the same open border to Romania and Bulgaria, so it is perfectly possible that immigration will be slower than it has been recently and therefore the Treasury will not realise quite the trend growth that they have been hoping for.

  Q12  Mr Love: Ever since I have come on to this Committee we have been going through whether business investment is going to improve into the future. What is your, as the group of experts, view on that at the present time? We will start with Dr Weale. What is your view on business investment looking forward?

  Dr Weale: My view is that it will do fairly well and maybe for the reason I have given, that so far we have not seen the sort of increase in the capital stock that you would expect, given the increase in the labour force that we have had, so the prospect does look fairly good. However, at the same time I think it is worth pointing out that the overall share of business investment in the economy is rather low at the moment. The Treasury likes to measure it in constant prices, which I regard as misleading. If you look at what people actually spend on business investment, although it has picked up it is not terribly high and, given the profitability of business, I suppose I still find it disappointing.

  Q13  Mr Love: If I am a little sceptical it is because forecasters, and indeed ministers, have come before us in the past and said that the prospects and the forecasts look good for the future and it has not quite arrived. Does anybody have a slightly different view or a slightly more pessimistic view?

  Ms Rosewell: I suppose it depends what you mean by "good" in the sense that are we looking at the prospect for the sort of investment boom that we have seen in previous decades and I think the answer is no. Is investment, however, falling? It is doing better than it has been doing and looks like it will at least continue on a positive path but I would view it as fairly disappointing levels of investment. The only caveat to that is that you could argue that much of what really is investment does not count as investment in the books, as it were, because it is not investment in plant and machinery; it is investment in intellectual property, it is investment in software and various things which do not count as such, at least in the national accounts. To some extent that must be right, that we have moved the mix of investment towards such sorts of asset. Nonetheless, I would still say that the level of investment is disappointing and likely to remain so.

  Q14  Mr Love: If we do not know why it has not increased as the forecasts have suggested, how do we know that it will not decline rather than improve and what are the risks of a decline in business investment rather than a continued modest increase?

  Professor Miles: Yes, there are risks and you are right: we do not understand that well. Investment has picked up a fair bit, I should say, though. We have got three-quarters of this year's numbers in and it looks like fixed investment is about 6% higher than a year ago and that is probably what the Treasury were forecasting at the beginning of the year, so it has not panned out substantially different from what the Treasury themselves were thinking a little while ago. Their own forecasts are fairly conservative in a sense. They have got about 5% growth next year and 3% growth for the couple of years after that, so the Treasury's own predictions are not exactly pessimistic but certainly conservative in an environment where profitability is very high. You would expect more investment; I think the Treasury share your uncertainty about what is going on here.

  Q15  Mr Love: Can I turn to net trade? When I asked the Governor of the Bank of England last week whether, with the dollar at 1.95 to the pound, it is likely that trade with the United States is going to be even more difficult, he suggested that the solution was intra-European trade. What is your view, Dr Weale?

  Dr Weale: Certainly trade with the United States will be harder but, as the Governor of the Bank of England said, that is only 15% of total UK trade. Nevertheless, one area where I do disagree with the Treasury forecast is on the net trade assumption that they show exports and imports growing broadly in line although they have above trend growth for the economy, and when you look at what has happened to sterling and the fact that they have domestic demand growing fairly rapidly, I would be very surprised if imports grow no faster than exports, so I would look to net trade deducting from output next year instead of making the zero contribution that they show.

  Q16  Mr Love: Does anybody vary from that markedly? No? Taking those assumptions, if we then assume that business investment, if it increases, perhaps is not going to increase that much, and if net trade, as you suggest, Dr Weale, may actually be negative rather than positive, is this shift away from consumption into those other aspects of demand going to happen? Are we being too optimistic on the overall level of demand in the economy going forward?

  Dr Weale: Obviously, the forecast can turn out better or worse than the central numbers presented here. My own view is slightly more pessimistic for next year, not enormously more pessimistic but slightly more so. I am expecting something like 2.5% rather than the 3% growth that the Treasury is showing. It could turn out to be worse than 2.5% if the United States gets into a real mess and world trade does not grow very rapidly and at the same time business investment does not take off, so yes, the margins round any forecast are fairly substantial and I think probably more so than the Treasury's quarter point either way range indicates. I am inclined to be on the slightly more pessimistic side.

  Ms Rosewell: I think there is a slightly different way of thinking about that though, which is, if you like, a rebalancing which occurs not because net trade or investment does particularly well but because the consumer turns out to be rather more pessimistic, and that is just as likely in my view. We are seeing at the moment, for example, another Christmas which is looking a bit shaky as far as the retailers are concerned. That, of course, may change. They can be volatile people, these consumers. If you think back a year ago we were quite nervous about the consumer for 2006 and the 2005 Christmas was looking bad and then it all seemed to sort itself out during the year, but I think that nervousness of the consumer is still a particular issue and we could well see 2007 looking weak.

  Q17  Mr Love: My last question, and Dr Weale mentioned it in his last response is, what happens if the American economy dips into recession? People have talked almost as optimistically about the euro economy replacing that as they have talked about business investment increasing. Should we really be confident that other parts of the world economy will replace America if it does tail off into recession?

  Professor Miles: The rest of Europe is something like three times more important to the UK in terms of trade , so it would not take much of an increase in growth in the rest of Europe to offset even quite a significant slowdown in the US. I am fairly optimistic on all that and I do not think one should believe that what happens in the US is the real driver of what happens in Europe in general and in the UK in particular.

  Q18  Mr Gauke: Mr Chote, can I ask about the trend growth rate returning to 2.75%? As I read the PBR essentially it is saying that the revision is purely due to the fact that net inward migration to working age population is greater than it was thought at the time of the Budget. Is that the correct interpretation of what—

  Mr Chote: I think there is also some demographics, but that is the main one, yes, that they refer to.

  Q19  Mr Gauke: And given the concerns and, Dr Weale, you have already mentioned your concerns about the future and whether that is going to continue, what sort of level of immigration are we talking about year-on-year in order to justify this assumption? Is there anyone who knows the answer?

  Professor Miles: I think the answer is very roughly speaking that it is higher than had been forecast back to the time of the Budget by about 0.2 of 1% of the labour force each year and that is somewhere in the region of 60,000 people.


 
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