Examination of Witnesses (Questions 1-19)|
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,
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
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
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
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
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
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
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