Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 160-179)

MR JON CUNLIFFE, MR DAVE RAMSDEN, MR MARK NEALE, MR JOHN KINGMAN AND MS MRIDUL BRIVATI

12 DECEMBER 2006

  Q160  Mr Gauke: And, for shorthand, if I say "185,000", there or thereabouts, are we talking about EU or non-EU migration? What is the balance?

  Mr Ramsden: As we set out in the supporting document that we published alongside the PBR and it is also set out in the NAO audit of our cautious trend growth assumption, we have done an analysis looking at trends in the Commonwealth, including new Commonwealth, in the rest of the world which included A8 up to 2004 when they joined the EU. We have included migration out of Britain and we have included migration inwards from the EU15 and it is fair to say that in the data the strongest trend is actually from Commonwealth countries. Indeed, if you look at the disaggregated ONS data, the average net inflow of migrants from the new Commonwealth countries was 110,000 a year in 2004 and 2005, so we have taken account, and that trend was established back in the 1990s, but our analysis, and other people's because external forecasters have done this as well, has tried to look not just at the very recent figures for A8, which are difficult obviously to project, but these underlying trends, so those all feed into our migration projection.

  Q161  Mr Gauke: The return to 2.75 for trend growth obviously has an impact on revenue and that is very clear, but the point which was made to us by Martin Weale yesterday, and indeed in his written submission, is that there does not appear to be any evidence that the impact on public expenditure of this population growth is included. Is there anywhere within the document or within your projections for public expenditure that you have explicitly taken into account the increase in population?

  Mr Cunliffe: There is not an explicit reference to expenditure, nor is there any explicit reference to revenue. What happens in the trend growth assumption is that the economy grows as a whole faster and everything else adjusts within the model to that. We have never forecast it, but I think actually Martin Weale did look at forecast it.

  Q162  Mr Gauke: If you are having a growing population in a year, the economy is going to grow, but the demands on public expenditure will also grow. I know, for example, that police forces are spending a lot more on interpreters now than they were three or four years ago, to give you just one small example and there are many. Is that factored into your public expenditure projections?

  Mr Cunliffe: I would make three points. First, I think the studies which have been done, and the National Institute did one, suggest that immigrants contribute more fiscally than they consume, and that is why it is interesting it was Martin Weale because I thought he did that work. The Home Office has also not done that. So you would expect there to be a benefit. Secondly, we have not put into the revenue projections or the expenditure projections the ways in which immigrants might particularly increase one aggregate or the another aggregate. What we have done is increase the trend growth of the economy. That runs through the model generally. Where the economic model generates fiscal costs and where it generates receipts, that is followed through. Within departments' current expenditure plans will be whatever plans they have to deal with the costs of migration, so that will already be within departmental plans. When we get to the CSR, it will be within their plans going forward., but I think you have to distinguish between that from the economic model which looks at the economy as a whole and then the aggregate numbers are fed into the various fiscal forecasting models and they project fiscal costs and receipts accordingly.

  Q163  Mr Gauke: Moving on to now to the golden rule, and of course the reversion of the trend growth assumption is that the economic cycle comes to an end earlier than it was otherwise going to do, we received evidence from Martin Weale yesterday on this issue of the economic cycle, arguing the fact that the economic cycle came to an end in 2003-04 and the new cycle started then. Did you give any consideration to applying the economic cycle in that way?

  Mr Cunliffe: First, can I say that the change in the trend growth rate makes no difference. It has nothing to do with the dating of the economic cycle.

  Q164  Mr Gauke: It was the growth, yes, thank you.

  Mr Cunliffe: What has changed our view of the economic cycle was the ONS revisions in July of this year and the faster growth that we have had than we were forecasting. It is those two things. The ONS revisions also changed the middle a little bit, the pattern of growth. Our view in 2003-04 is that the economy did not move decisively through trend. When the Chancellor came to the Committee in, I think, July 2005, we published a Treasury document on how we decide when the cycle starts and ends and we made clear that what you would want to see is either a decisive move through trend, to what you would normally see, or, conceivably, the economy comes back to trend and stays on the trend level for a long time. But actually 2003-04 did not look to us like a decisive move through trend, particularly when you looked at the other indicators, inflation, earnings and some of the capacity indicators we used to confirm it.

  Q165  Mr Gauke: How much of that is a judgment call or is it very obvious? Are you applying a degree of judgment, and I am not necessarily saying it is a wrong judgment, but it is quite a difficult call to make?

  Mr Cunliffe: You cannot observe the economic cycle directly and you cannot observe the trend rate of the economy directly, therefore, there are judgments in all of this. What you try and do is make judgments openly based on a sort of transparent methodology and allow yourself to be judged against the judgments you have made, which is what we do. But there is an element of judgment in deciding where the cycle is and there is an element of judgment in deciding around determining the trend rate.

  Q166  Mr Gauke: Looking forward to the next economic cycle, we were specifically asked yesterday by the experts to ask you as to when the new cycle will begin and will 2006-07 count as part of the new cycle, as I think has been the case in the past, that the end year, if you like, counts in both the old and the new cycles?

  Mr Cunliffe: I am very happy to answer that, but I should make clear that what we are talking about is our forecast and the actual dating of the cycle has been, and will be, a backwards-looking exercise. You base the dating of the cycle on the economic data. You forecast on what data you have, but then you look to see, and you certainly wait for the end of the year in question. You look at the economic data and then you date it. That is how we have done it in the past and that is how we are doing it.

  Q167  Mr Gauke: So it is a forecast, not a conclusion?

  Mr Cunliffe: Our forecast is early in 2007, which I would expect to be in the fiscal year 2006-07, but we will not have, bearing in mind what happened last year and particularly the revisions from the ONS in July, the final data on that, the first of the first is the yearly view of it, until the ONS blue book in the summer.

  Q168  Mr Gauke: So you will not know for sure until July when—

  Mr Cunliffe: No, we will not know.

  Q169  Mr Gauke: But whenever it does end, whichever year it is, will that year count for both the old cycle and the new cycle?

  Mr Cunliffe: That is what we have done in the past.

  Q170  Mr Gauke: Is that what you are going to do in the future?

  Mr Cunliffe: I do not know what we are going to do in the future.

  Q171  Mr Love: You have revised down your growth forecasts for 2008. Can you go into the reasons why you have decided that.

  Mr Cunliffe: It is very much to do with the point we have just been discussing on the economic cycle and the ONS revisions. Effectively, what the ONS released in July of this year was a picture in which past growth had been 0.25% higher, I think, in 2003, 2004 and 2005 and that we have had economic growth of about 0.5% more in 2006. If you take that together, it means the level of GDP is closer to its trend level. There has been 1.25% more GDP growth in the past or to date and, therefore, the level is closer to its trend level and it is the difference between the level of GDP at present, not the growth rate, but the level at present and its trend level which gives you the output gap, so basically the output gap got smaller because of the ONS revisions, and I think when I came before the Committee at the Budget I said that that might happen. With the output gap smaller, there is less room for future growth because our forecasting model, as set out in the Pre-Budget Report, assumes the economy comes back to trend over two or three years, so, if it is closer to trend now, it has less growth to make up to come back to trend and effectively growth is higher this year than in the past forecast and it is 0.25% lower in 2008 as a result.

  Q172  Mr Love: You have not taken into account any assumptions about business investment, international trade, anything of that nature.

  Mr Cunliffe: Their forecasting up to 2008 is different from forecasting the next year ahead. For the next year ahead you can forecast by looking at manufacturers' surveys, service industry surveys, intentions, and that gives you some idea of, if you like, the momentum in exports, in business investment and in consumption, but, when you are looking more than two years ahead, it is very difficult to project. We anchor our forecasts two years ahead by a view of where the economy's trend level of output is, is it above or below trend, and then the view that the economy will return to that trend level over two or three years. So the 2008 change is really to do with those medium-term issues rather than anything we can see now at the end of 2006 which might then be impacting business investment. We have increased business investment in 2007 and I think the 2008 forecast is very similar to the Budget.

  Q173  Mr Love: Let me just press you finally in relation to questions which were asked earlier on about what is happening to the US economy. The Governor, when he came, said to us, "Oh, don't worry, it is only 20% of our trade and Europe is over 50% of our trade", but taking the assumption, and I think you commented on it, about the stronger link that appears to exist in the United States between house price movements and consumption and the multiplier effect internationally that the recession, if I can call it that, although that is too strong a word, the downturn in overall demand in the United States might have on the euro area as well as on the United Kingdom, tell me what you think the likely risk of that is for the future export performance of the United Kingdom economy.

  Mr Cunliffe: First, if I said that the US had a stronger link between consumption and housing, then I should not have done.

  Q174  Mr Love: No, that is an example. I was obviously trying to lead you!

  Mr Cunliffe: It certainly has a stronger link between housing and residential investment because what happens in the US is that, when the housing market expands, there is a lot more room to build new houses, whereas in the UK, as you can see from the Kate Barker work, the supply response in the housing industry is nowhere near as strong. What has slowed down the US GDP at present is not consumption slowing quickly because the house prices are not growing as fast, but what has slowed down the US GDP is residential investment. People are not building houses and housing construction has gone down. I do not know what the link is yet and I do not know what the link in the UK is and I would not want to say what the link in the US is. If the US economy were to develop a much more broadly based slowdown and instead of slowing down to growth rates, I would go with the mid-2s next year, and I think you said went into recession or whatever, would that have an impact? It would have an impact on our trade. It would have an impact on the eurozone, although the eurozone's exports to the UK, as Jean-Claude Paul Trichet has said on a number of occasions, are larger than their exports to the US, so we are a more important trade partner for the eurozone than the US. The channel, I think, might come much more through general confidence effects, through the Stock Market and the like, but we do not see that. We see that as a risk, but we do not see it as the majority sort of probability that that might happen. And certainly the evidence is not there so far.

  Q175  Mr Newmark: I have two or three technical questions, I am not sure whether they should be for Dave or for Jon, but the first is: how likely is it that the ONS will reclassify more debt, which was previously off balance sheet, as on balance sheet? The reason why I ask this question is because I know the ONS added £1.25 billion of PFI debt in August in 2005 and then £5 billion in February 2006 and then a further £4.95 billion in September 2006.

  Mr Ramsden: Perhaps I might start on that and Mridul might want to come in on the detail. We have taken account of those revisions as they have been made, including, as you have highlighted, the recent revision in September to bring in finance leasing and that has been one of the key factors that has led to our net debt forecast being very slightly higher for the forecast period, but that reflects the upwards revision in the data. The ONS is operationally independent for these purposes, so it is for them to decide as and when, in line with international classifications, to bring these classification issues when they crystallise in the public finances data.

  Ms Brivati: I am not sure I have much to add to that. To the extent that the ONS is an independent body and it determines that specific items are off balance sheet, they do not figure for the purposes of net debt and impact on the Sustainable Investment Rule.

  Q176  Mr Newmark: Is not the purpose of doing stuff off balance sheet the transfer of risk and, if you can transfer risk, you move stuff off balance sheet, but is there not a pattern beginning to build up which shows that some of these public sector projects which have moved off balance sheet, when there is a problem, they ultimately come back to bite the Government in the arse which is why more and more debt, which was previously off balance sheet, seems to be dripping each year on to the balance sheet? Is that not a problem or an issue?

  Ms Brivati: Well, the decisions as to whether a particular project is on or off balance sheet are made on a case-by-case basis and there are very many of those cases, so I am not sure that I could give you chapter and verse on any of them really, but I do not think I would agree that there is a pattern. I am not sure what evidence there is for that so far. Certainly there are cases—

  Q177  Mr Newmark: Well, the evidence is that each year more and more stuff, which was originally off balance sheet, is coming on balance sheet, but, if it gets to a point where a significant reclassification previously off balance sheet suddenly reaches sort of a tipping point and breaks the sustainable investment rule ceiling of 40%, would you have to then change the ceiling or not?

  Ms Brivati: That is a hypothetical question about the sustainable investment rule which Jon might like to answer, but in terms of how we actually operate under the sustainable investment rule, we deal with the rules as they are and with the numbers as they are which ONS determine for us.

  Mr Cunliffe: There is not much to add to that. The rule is clear.

  Q178  Mr Newmark: It is all great government speak, but let me ask my second question. What is your estimate of the present value of the Government's public sector pension liabilities and, when you answer that question, can you tell me what discount rate you are using?

  Ms Brivati: The number I have for that is £530 billion. I am not sure what the discount rate for that is, whether it is the green book discount rate. Yes, the discount rate for that would be the one that is in the green book.

  Mr Newmark: It is higher than a risk-free rate, but that is okay.

  Q179  Mr Love: It is the standard rate.

  Ms Brivati: Yes, the standard rate, thank you.


 
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