Examination of Witnesses (Questions 121-139)|
12 DECEMBER 2006
Q121 Chairman: Mr Cunliffe, good morning
to you and your colleagues, and perhaps you could introduce them.
Mr Cunliffe: Yes, on my left is
John Kingman, who is the Managing Director of Public Services
and the new Public Services and Growth Directorate. I am Jon Cunliffe,
the Managing Director of the International Finance Directorate
of the Treasury. On my right is Dave Ramsden, who is our Director
of Macroeconomics. Next to him is Mark Neale, the Managing Director
for the Budget, Tax and Welfare Directorate and next to him is
Mridul Brivati, who is the Director for Public Spending.
Q122 Chairman: Welcome. On the issue
of uncertainty around the economic outlook, in the Inflation Report
in November this year, the Governor in his opening statement spoke
about uncertainty and in his evidence to our Committee on the
Inflation Report on Thursday 30 November he said, "I think
we are genuinely uncertain as to how price-setting in the economy
will respond to large movements in certain costs, such as energy
prices". What are the main risks both from the upside and
Mr Cunliffe: To the global economy
and the UK?
Q123 Chairman: Just uncertainty around
the economic outlook.
Mr Cunliffe: The main global risks
for us are around inflation which, I think, is the one the Governor
has mentioned, around the US economy and whether the housing market
downturn will broaden into a more widespread slowdown of the US
economy, around protectionism and the Doha Round and the impact
that will have, around oil and energy prices, which are still
a risk, but perhaps less so than at Budget time, and around global
imbalances because that risk is always there. I think, as far
as the UK side is concerned, there is a risk that the effective
labour force is larger than we think and, therefore, there is
more slack in the economy and more room for growth, and on the
demand side I think there are risk around the housing market,
the extent to which the recent increase in the housing market
will lead to an increase in consumption and the extent to which
there is a link between the housing market and household consumption.
There is a risk around savings and whether households will want
to save more. There is an upside risk around business investment,
with profits strong and corporate financing relatively cheap,
whether we could see more business investment than we forecast.
Then I think there is a risk to exports both ways, the US risk
would be a downturn in global growth and world markets, but, on
the other hand, for the eurozone, where most of our exports go,
it has grown more strongly and I think there is an upside risk
Q124 Chairman: In relation to migration,
the figures are cloudy, at best, are they not? The Governor of
the Bank of England, when he was talking about the migration from
Poland to here, mentioned that in 2003 there were 516,000 flights
between the UK and Poland, but over the next two years it went
to 1.8 million, but International Passenger Survey forms were
handed out at Heathrow, Gatwick and Manchester, so that missed
most of the people who were coming into the country because it
was elsewhere. Is there anything that you are going to do to get
a better handle on it?
Mr Cunliffe: Yes, the Governor
made a number of points about migration statistics, first, that
the International Passenger Survey, as he said, was originally
designed to look at tourism and is now having to pick up answers
on migration. There are also points about how you bring together
the information we have from the Workers Registration Scheme,
and for the issue of National Insurance numbers with the information
that is in the International Survey. The ONS have a programme
of work to try and improve migration statistics. They have set
up an inter-departmental workforce working group to try and bring
this together and I think they plan to issue their report before
Christmas, and there is also, within the ONS itself, a number
of projects trying to improve the quality of migration data.
Q125 Chairman: In answer to a question
in a session on the Inflation Report, Charlie Bean of the Bank
of England suggested that labour may be pricing itself out of
jobs. Have you any evidence that that is the case and can this
explain some of the recent rise in unemployment?
Mr Cunliffe: I do not think we
have any evidence for that. As far as migration is concerned,
we have no evidence that migration has affected directly pay rates.
Certainly average earnings have been low for this stage in the
cycle, growth in average earnings has been low, and that might
be an effect from migration, but it might also be an effect from
globalisation because, I think, right across the economy workers
can see that there is much greater global competition than there
used to be. I think we have certainly not picked up anything definite
to suggest that workers are pricing themselves out of business.
I know that one of the points that Charlie Bean has made in the
past is that the increase in energy prices will in the end have
to be absorbed through pay and maybe not all of that has happened
yet and, therefore, there will have to be slower real growth in
earnings going forward than there has been to make that happen,
so that may have been his point, but certainly we have picked
up no direct effects.
Q126 Mr Fallon: This cannot quite
be right, can it, Mr Cunliffe, because in your own report, page
242, you say you are having to spend £½ billion more
on tax credits because of lower earnings growth amongst low income
households. Dr Weale yesterday attributed that almost directly
to immigration from Eastern and Central Europe.
Mr Cunliffe: Well, it is certainly
right that we are having to spend more on tax credits on low income
families than we forecast and it is also true that for this stage
in the cycle average earnings seems low. Whether that is directly
related to migration or not is another point.
Q127 Angela Eagle: Sticking with
the labour market, we have seen an upturn in unemployment, but
we have also seen continuing growth in the number of jobs. What
do you think is happening in the labour market? You did just mention
that perhaps the effective labour market is larger than might
have been thought, so how is this playing through in your policy
recommendations and thoughts?
Mr Cunliffe: On the first question,
we think what has happened in the labour market in the last year
has been a very big increase in the labour supply of about 450,000.
We think half of that has come from an increase in the population
above 16 and some of that is migration, but some of that is actually
natural population growth, but half of that has come from a reduction
in inactivity. These are people of working age who are
Q128 Angela Eagle: Is this the Pathways
to Work issues on the supply side?
Mr Cunliffe: It is partly that.
It is three things. It is Pathways to Work and people who have
been on long-term sickness and incapacity coming back into the
workforce and it is a continuation of a trend that is bringing
more women into the workforce who were staying at home. The other
effect, and this comes back to how we interpret the labour market,
has been from students. The number of students, which who are
people going out of the workforce while they study, has been rising
quite strongly for the last few years. We saw a very large increase
in students, larger than trend, in 2005 and a smaller increase
in 2006 and what may well have happened, with tuition fees coming
in, is a number of people have brought forward the start of their
studies. Averaged over those two years, the increase is about
in line with trend. If that is the case and next year it goes
back to the trend, then we will find that there will be more students
and, if you like, the level of inactivity, because there will
be more people studying, will go up. Our forecast is that claimant
unemployment has already flattened off, I think, by at least 15-16,000
over the last six months and we expect that to continue and probably
reverse and unemployment on the other, side, the labour force
survey measure, we expect to turn around as the demand in the
economy picks up.
Q129 Angela Eagle: Those structural
changes you have described would probably have positive effects
on the economy, would they not, because actually it is people
coming off inactivity where the Government are paying them for
being active, going into work and paying and, like with migrants,
they are working and contributing?
Mr Cunliffe: The reduction in
inactivity, the increase in the participation rate increases the
productive capacity of the economy. The same happens with migration
because it adds to the labour force and of course the increase
in students is an investment for the future which should also
result in a more productive workforce.
Q130 Angela Eagle: In terms of the
regional effects, have you analysed with the rises in employment
whether they are disproportionately impacting in particular areas
and what is your insight into that?
Mr Cunliffe: I do not know of
any particularly pronounced regional spread.
Mr Ramsden: We have not done a
regional forecasting exercise for this PBR and that is consistent,
that we stick to forecasting at the macro level. However, for
the latest data that we have, that has shown that over the last
year employment has increased in most regions.
Q131 Angela Eagle: Might it be possible
that the next structural change will be older people staying on
in the workforce rather than retiring and have you thought about
what effect that might have on structural change?
Mr Cunliffe: We have seen over
the last four or five years quite a strong trend of people who
have retired coming back into the workforce or staying on after
retirement age and that was quite a big factor last year in the
increase in the labour supply. You would expect, particularly
as life expectancy increases and healthy life expectancy increases,
to see more people coming into the working population and indeed
that is what we are seeing.
Q132 Angela Eagle: In terms of the
impact that the structural changes in the labour market are having
in other areas, what is your analysis of what effect this is having
on productivity, for example?
Mr Cunliffe: The expectation from
migration, I think, is that they would add to productivity because,
on the information we have got, migrants tend to be better qualified,
there are higher proportions, in the sectors they are going to
with university degrees and qualifications, so over time you would
expect that to increase productivity. The productivity numbers
we have at present show that productivity has come back now quite
strongly since the last on-trend performance in the cycle to,
I think, about 2.4%, but we have not tried to analyse recent productivity
performance against the changing structure of the labour market.
Overall, you would expect a more educated labour force to be more
Q133 Angela Eagle: Finally, on the
minimum wage, there is a rise in the enforcement spending on that
and also an increase in the minimum wage itself. Is that impacting
in any way on your analysis in terms of costs?
Mr Cunliffe: Well, in the macroeconomic
forecast we do not try and incorporate the effect of announced
policies, so the greater enforcement of the minimum wage which
has now been announced has not been put into the numbers. You
would expect again over time that, if that happens, it could increase
the attractiveness of going back to work for a number of people
who are outside the labour market and that would have an impact,
but we have not put a number in the forecast for that.
Q134 Mr Breed: Could we turn now
to consumer spending which of course has been rather volatile.
What, therefore, are the main risks to your forecasts for household
consumption, do you think?
Mr Cunliffe: I start with the
forecast which is pretty much unchanged from Budget to now which
is that it grows at about 2% this year and about 2.25-2.75% going
forward which is slower than the growth rate of the economy and
it has recovered from the low in 2005. The view on the past is
that the low in 2005 was caused by two things: one, a reduction
in disposable income growth really going back to 2003-04, the
partly due to higher interest rates when we had the five interest
rate increases in those years; and then in around about the middle
of 2005 households began to feel the impact on disposable income
of higher energy prices. Going forward, we think those increases
have come out of the system and actually
Q135 Mr Breed: What, energy is going
to come down?
Mr Cunliffe: Well, in inflationary
terms, energy prices will drop, the rate of inflation will drop.
Energy prices have come down, but, even if they stay stable, the
rate of inflation drops if energy prices stay stable, and we do
not think energy prices are going to continue to increase, although,
as I said at the beginning, that is one of the risks to the global
forecasts, so we see consumption growing just below the rate of
the economy. As to the risks to of consumption, there are a number.
As I said, there is an upside risk that consumption could take
off or grow a bit more strongly because the housing market has
been stronger in 2006 certainly than we forecast and, I think,
anybody else forecast. There, you have to make some assumptions
about whether household consumption in the UK is linked to the
housing market and to what extent there is a link. In the past,
there has been a link, but there have also been periods like the
recent increase in house prices earlier this century where the
link did not seem to be very strong at all. So there is quite
a lot of uncertainty as to whether these two things are directly
linked or whether they are linked to some other factors and it
is only if those other factors grow that consumption will grow.
There is a potential downside risk to consumption on savings.
The savings ratio has gone up over the last year. As we explained
in the PBR, that is partly because employers' contributions to
employees' pension schemes have gone up and that is counted as
saving. In surveys, households seem to be saying that their saving
intentions are greater than their actual saving is.
Q136 Mr Breed: If it works.
Mr Cunliffe: That may just be
human nature, but it may be that they have not taken into account
the higher saving that is being made on their behalf by their
employers and, if they did decide to increase their savings, clearly
that would reduce their consumption going forward. So those are
really the main risks around the consumption forecast.
Q137 Mr Breed: So house prices generally,
do they have an effect, do you believe, after all the sort of
experience you have had of volatility there? Are they actually
having an effect on consumption then?
Mr Cunliffe: I do not think anybody
knows the answer to that. My personal view is that they have had
effects in the past and the effects came through the so-called
"wealth channel", that, as people's wealth grew, they
felt they were more able to spend, and maybe some came through
the liquidity channel, that they had more collateral to put down
and to borrow. However, I think that relationship is not as strong
as it used to be and I think as well that house prices are driven
by individuals' expectations about employment and expectations
of future income, so more fundamental reasons. I think it is also
driven by the costs of purchasing a house and it is not just the
purchase price of the house, but it is the interest
Q138 Mr Breed: The stamp duty.
Mr Cunliffe: Well, there is the
stamp duty, but it is mainly the interest cost on the mortgage
and there is some evidence that, although the Bank of England
has not reduced the bank rate, because more mortgages are now
being financed on two- or three-year fixed terms and because over
the last year the two-year part of the yield curve for international
reasons was very low, the financing of house purchases became
low and that is what stimulated the market. I would not want to
make the prediction as to how strong the link with consumption
is going forward. It is difficult. As I say, my personal view
is that it is not as strong as it was and certainly, although
house prices have come back, we have not seen consumption come
Q139 Mr Breed: Not yet.
Mr Cunliffe: Not yet, no.