Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 60 - 79)



  Q60  Mr Mudie: If you asked a lad in the street he would say one of the areas they worry about is call centres. In my constituency, for example, call centres are a very, very good avenue for white males, for example, who used to go into the tailoring trade immediately they left school. Call centres, with a training beforehand, they fit into very quickly. We saw in India the Prudential's call centre, staffed with graduates doing the job in which we give an avenue for these unskilled youngsters to actually get a decent wage. They are disappearing.

  Mr Wolf: I think that is going to happen. In this case, protecting (we are going to come to protection) an economy against things that go down a `phone line is basically impossible. Your point is linked to a more fundamental point which I think is very important, which is that one of the consequences of the technological revolution is the collapse in the cost of telecommunications. When I went to India first in 1970 you could not call it; it was impossible to call it. Now there is no problem. This has obviously led to much greater tradability of a large part of services than ever before. That is a very big revolution. The point about tradable services, ie things that go down wires, is they are really impossible to protect. I agree your description is a correct description of a genuine problem. These are not businesses that are going to survive unless the people here can add value which people in India cannot add.

  Q61  Mr Mudie: That brings me to—although I was not aware of it but, thanks to the advisers I am now—the law of comparative advantage. Do you think the Indians and the Chinese know about this law? Will they stick to various things and leave a wee bit of trade for us? I was pessimistic about that. The number of graduates they are turning out, they are going very quickly up the skill trail.

  Mr Wolf: I would like to point out that the law of comparative advantage was put forward by a distinguished Member of this House, David Ricardo.

  Q62  Mr Mudie: Was he a Tory?

  Mr Wolf: He would have been a Liberal, although he was in Parliament at the beginning of the 19th Century before the Liberals emerged. I am sure you know the history. He was a stockbroker, I have to say, and he was probably one of the greatest economists who ever lived. Anyway, the theory of comparative advantage suggests, very broadly, that countries export in order to import. That seems pretty logical. I have written one column about this which you can probably dig out somewhere—I cannot remember the exact date—which made the point that countries do export in order to import and as long as they continue to export in order to import, by definition, they are creating opportunities. China, at the moment, is exporting more than it imports. I think this is a very foolish policy but that, really, relates to China's macro-economic and exchange rate policies, which I suspect goes beyond your terms of reference. India imports more than it exports, so there is no doubt that it is generating large net imports. That is true of most developing countries. Of course, whether what they import will be things we produce is a question of whether we are able to compete. Broadly speaking, these countries import and continue to import in enormous quantities relatively skill-intensive goods and services, which is why Germany has re-emerged as the world's largest exporter (it is important to remember that, because it produces so much of the capital goods these countries want) and of course they import raw materials. As long as we are competitive producers in the former category we should be perfectly well positioned to survive. So we have to continue to upgrade very rapidly. Just to stress the point, at the point at which they are cheaper than us in producing everything they will cease to export because there is no point in their exporting.

  Q63  Mr Mudie: What struck us was that only a third of the Indian labour force is used; two-thirds, 650 million, are almost sitting on the sidelines. A lot of it is in rural farming but they are desperately under-employed in terms of productivity. China similarly. Will the law still work if you have those vast reservoirs of labour that will, at some stage, want to work? In India they are flooding into the cities, as you say, and so in China, they want to be part of it. Do you think that would affect the law?

  Mr Wolf: Exactly the same logic will hold in the sense that this will lead to bigger economies; it will certainly lead to more exports, though not as much as you would expect. China exports an extraordinarily large quantity already in relationship to its economic size—rather weirdly so. So I do not expect the growth to be so large. The same property will hold in the sense that the incomes these people earn will be spent; they may try to spend them initially domestically but unless the economy saves a very large part of its income more than it invests (in other words, has a larger income than it spends, which is inconceivable for such poor countries in the long run) the countries will spend what they earn, and as long as they spend what they earn they will import what they export—by definition. So they will be generating import opportunities along with their exports. This is the fundamental proposition of trade. It is always held. However, of course, one of the consequences of what you describe is we will become a smaller part of the world economy and, almost certainly, in the process we will become more specialised, but that is not really that new. You could have made a very similar argument (in fact, I would not be surprised if in 1900 Joseph Chamberlain also was making a protectionist case at this time) about the rise of the United States and Germany, and somehow we survived.

  Q64  Mr Fallon: The Chancellor gave evidence to us in May, very encouraging evidence, that the Government, or he, was determined to try to resist protectionist ideas . How credible do you think that is in practice, for example, on the example that Mr Mudie gave, if Prudential's back office function can be transferred to India? Is it likely that this Chancellor would agree to transferring public service back office function, for example, to India—some of the agencies that are not working very well, like the Child Support Agency or the Rural Payments Agency? Would they allow a significant stake to be taken in aerospace or our energy industries?

  Mr Wolf: You are asking me to make a political judgment, which I am not competent to make. I have no idea whether the Government would contemplate this. In general, if you look at government policies around the world they tend to be, for the very reasons you have indicated, quite consistent left or right, more protectionist than the private sector because they are not subject to the same market pressures and they are subject, as you have pointed out, to very strong political pressures. There is, actually, in the case you indicated—and this is a very important point—possibly reasons why you would limit the extent to which you want to offshore. The fundamental problems we have seen in many of these complicated systems (and, by the way, this is also occurring in the private sector) is there are very complicated and difficult management problems involved in all major processing activities, and the ones you describe are particularly complex and difficult. We have found them almost impossible, if not impossible, to manage domestically where it is much easier to know what is going on and to control what is happening. Controlling these things at great distance for very complicated processes which involve a lot of discretion is extremely difficult, so I think it is important not to exaggerate the extent to which all these activities will go abroad even in the case of the private sector. It is easier to move things which are completely standard; absolutely standard processing activities can be moved offshore. Things that involve a great deal of discretion, judgment and so forth are much more difficult to do, and as we have seen the CSA is obviously a classic example. The general answer I would give to you is governments are reluctant to do this for perfectly obvious reasons, and some of the reasons why they are reluctant to do this are not bad ones; these are really difficult things to do well at all and doing them well at a distance of 8,000 or 9,000 miles with all the communication difficulties can be very hard.

  Q65  Mr Fallon: On ownership? How credible is it for the Government, on the one hand, to say resist protectionist ideas but then, also, resist, for example, a future bid for a part of a British energy company?

  Mr Wolf: My only answer to that is that as far as I can see there are not many countries in the world—I cannot think, offhand, of any—which have been more willing under governments of different persuasion to accept foreign ownership of companies. So I have no particular reason to suppose, given that we have already handed over—to take an obvious example, when the privatisation of electricity and water occurred I think few people expected foreign companies to own as much of these industries as they have ended up owning. We now have a foreign company about to own British Airports. I do not think protectionism in terms of foreign ownership is a huge problem in this country.

  Q66  Mr Fallon: Finally, do you think successive British governments are actually wining the case in the European Union against protectionism? Do you think we are making progress or not?

  Mr Wolf: I think we are neither winning nor losing. I do not really know how the new EU is going to play out because the new 10 are a rather unpredictable element in this. As we have seen very clearly recently in Poland and Slovakia, their politics is still very volatile because they are still very much in this post-transition phase. In the original EU of 15 there has been a balance of forces on protection which has been fairly stable for quite a long time, with a coalition in favour of liberalisation, in my view, roughly equal in weight to the coalition against. The result in the EU has been I would not say paralysis but an inability to do anything decisive in either direction. I am talking about external liberalisation. By and large the Commission remains, in my view, predominantly an instrument of liberalisation internally (we can debate that in detail), but in terms of the external side the balance of forces is very even. There are very important countries which are quite liberal, which are our natural allies and there are very important countries that are not. We have not changed this, but Britain is the biggest and most important liberal country which has been consistently liberal; Germany has oscillated on this and, therefore, if its voice were on the other side that would make a big difference.

  Q67  Kerry McCarthy: The title of today's session is: "Globalisation: its impact on the real economy". What do you understand by the term "the real economy"? Do you think it is a useful definition to use?

  Mr Wolf: It is a very standard economic term. I do not know whether it is useful. I think it is just a label for what is really important about the economy, which is that it is designed to separate it from the purely monetary aspects of the economy. To focus on what do we mean by "the real economy" we mean jobs, we mean incomes, levels of activity and the levels of welfare that the economy provides. Those are the real things—goods, services and jobs. So that does seem to me a very appropriate focus for a discussion of the impact of globalisation.

  Q68  Kerry McCarthy: I just ask because some people use it, I think, particularly within the trade union movement, to refer to manufacturing in particular.

  Mr Wolf: That is based on a fallacy that is about 250 years old. We have had a long debate—actually, Adam Smith himself encouraged this fallacy (not, I think, intentionally)—and there is a long-standing view of the physiocrats (we are not going to go into the history of economics) that the only real things are things that produce things that drop on your foot. For anybody who thinks about this carefully, that amounts to saying that if somebody does a heart operation that saves your life that is not a real economic good. It is a real good but it is quite obviously something of immense value in every respect, and this applies to many other services. So I do not think that "real" does mean physical.

  Q69  Kerry McCarthy: In terms of Britain's future as a country with a manufacturing industrial sector, how do you see globalisation impacting on that? Do you think there are areas in which we can still maintain a comparative advantage, or is the battle lost?

  Mr Wolf: Clearly the manufacturing sector in the UK has undergone staggering structural changes in the last 30 years—many of them incredibly painful. There has been an enormous reduction in the labour force in manufacturing. I cannot remember exact figures but I do not think it is much more than 15 or 16% of the labour force now, and it has more than halved in the last 20 years or so. The output of manufacturing seems to be quite stagnant; it is not shrinking but it is not growing. The interesting thing about this is that, so far as I can see, the dominant impact on our manufacturing sector has not, interestingly, been our trade with developing countries but our trade with other developed countries. We do seem, for reasons which I do not fully understand but there is a long history in this, to have had a rather weak competitiveness comparative advantage in manufacturing vis-a"-vis other important industrial nations. One result of this is a lot of our companies have ended up being owned by companies based in those nations—the car industry is a very good example. Can we change that fundamentally? I would have thought it is going to be, from where we are, very difficult to imagine we will change it fundamentally. I would guess the manufacturing sector (and this is no more than a guess) will continue to grow a little but more slowly than GDP, as it has done now, for a very, very long time. We will specialise in things which do use relatively skilled labour resources which we have combined with foreign capital and technology. That is basically what we have been doing in large part in manufacturing for the last 20 years or so, and I expect that to continue.

  Q70  Kerry McCarthy: At the moment the low-skill, low-tech jobs are going to places like China and India. Will there not come a point when the high skill jobs in those sectors start to go there as well?

  Mr Wolf: Again, it is a question of where the competitors come from. In the case, for instance, of the motor vehicle industry the most obvious threats to us, I would have thought, are the shifts of assembly from here to Central and Eastern Europe rather than to China or India. I find such moves are perfectly plausible. I cannot predict it. It is true by definition, we can only sustain a manufacturing base here (it is a completely open system) if our productivity is sufficiently much higher than that in low-wage countries. As I say, Germany is the world's largest exporter of manufactures; it is true its value-added in manufacturing has declined but its growth in exports has gone up dramatically. This is true even though Germany is the highest wage country, so far as I know, in the world. So it is clearly not a crippling handicap to have very high wages but it only will work if productivity overall, which includes design and all the other things, matches the cost.

  Q71  Mr Love: Can I just pursue the question you have jut answered. Peugeot Citroen are in the process of moving their manufacturing to Hungary from this country. Logically, from what you have just said, most other mass car manufacturers will be attracted towards an Eastern European bid. What would be the things that would stop Honda, Nissan and the other manufacturers moving their production to Eastern Europe?

  Mr Wolf: I think we have to separate (this is not very helpful in a way) the sum cost element from the marginal investment. I actually think it is very unlikely that the next investments made by any of these companies will be in countries like ours; their next investments are going to be in lower wage countries. That is quite different from deciding to close down existing plants and existing production facilities in which they have invested a great deal to establish the plant, which is different I understand (and I am not an expert in this) from the Peugeot Citroen situation. The Japanese transplants in this country are extremely productive enterprises started from scratch with first rate quality output, and as long as that remains the case I would have thought they are very likely to want to maintain those plants and to sustain their investment. I would have thought substantial new investments by any of these companies will not occur in this country, and it seems to me almost inconceivable that the car industry's total employment will not tend to shrink over time.

  Q72  Mr Love: Can I move on to the role of corporate tax. There is a lot of discussion about how we can use the corporate tax regime to attract companies to locate in this country. Many people say well, much more important factors are skill levels, location, language and transport infrastructure. How do you see corporate tax? Has it a role and how important is it?

  Mr Wolf: It is a hugely controversial question. I would certainly agree with the second part of what you said. Particularly for anybody who is coming to the UK in the service sector, which is of course a very big part of our employment and attraction to inward investment, financial services and so forth, people are coming here predominantly for the reasons you outlined. The quality of our people, our infrastructure, the net work effects they have from being with other big firms are all very powerful reasons for being here and I would be more worried about the transport system of London, as it were, than the corporation tax for many of these things. Just on the corporation tax, speaking purely as an economist, it is quite difficult to be clear why the corporation tax should be that important because most analysis of the corporation tax suggests it is not paid by corporations anyway; it has shifted, back or forward, and so it is an indirect sales tax or it is an indirect employment tax, and if that is the case it is not clear why it should worry companies. Even that is slightly too simple, but I take the first approximation. However, companies themselves may not see it that way, and they may think that this matters more than actually it really does because they do not understand the incidence of the tax upon themselves (which is possible), and therefore they may be attracted. The obvious example is given—and it is the most important example open to us—of Ireland; that the low tax regime of Ireland has been an immensely important source of attraction for the massive FDI in Ireland. I cannot say that is obviously wrong; the empirical evidence is not strong enough either way. So it may be the case that a large cut in the corporation tax would lead to very substantial inflows of capital. Of course, it would also leave the Treasury with a fairly sizeable problem and they would have to raise taxes elsewhere. It is only when we know where else they are raising taxes that we would know the overall effect of this on the levels of activity in the economy. Just as a matter of pure theory, the corporation tax does not make much sense, but that is another completely different issue in tax theory, and I will not go into that.

  Q73  Mr Love: There is a confusing picture here because, of course, if you look at transport infrastructure or skills they require taxation—a lot of companies are quite happy with taxation because they think it will improve the other factors that they are interested in. I am interested because we have a whole industry in this country, as you know, that devotes itself to corporate tax competition; that we ought to compete with other, especially European countries but others as well. Recognising that most of international companies are very sophisticated in the way that they play taxation between different countries to minimise or optimise their overall level of taxation they pay, does tax competition really exist?

  Mr Wolf: I have a whole chapter to discuss this issue.

  Q74  Mr Love: I need to read your book!

  Mr Wolf: The first argument is just to stress your point. It is absolutely clear corporations only go to places which are reasonably satisfactory in the sense that they have a range of services provided in those places, many of which are public. As I say, the lowest corporation tax you can possibly imagine is in Somalia, for fairly obvious reasons—it does not have a government and people do not invest there. Second, some very major western corporations have remained based, very successfully, in very high tax regimes, notably the Nordic countries—and Germany, by the way, too. Third, the reason they do this is because it is more difficult than people think for whole, big corporations to move around the world—it is not impossible but it is not that easy—and because of the very point I made that the tax incidence of the corporation tax is really quite obscure and is not clear that in the end the corporation pays it. So I think it is very, very important to avoid being too simple about this. It is, however, true, as a general proposition, which has to be assessed very carefully in particular cases, that in a regime when certain factors of production—capital and labour—are relatively mobile taxing them becomes more difficult. If you like, competition does become relevant to some degree. The way I put it—and there are lots of other issues—is you have to satisfy highly paid people and corporations that the location-specifics—ie the services they get in a particular place—here are adequate to compensate them for whatever tax burden they pay; that the bundle, as a whole, is a satisfactory one from their point of view. Provided it is, the evidence is not consistent with a collapsing tax base or with a massive outflow of corporate capital from major western countries to other countries with slightly lower tax regimes. I think it is often greatly exaggerated.

  Q75  Mr Love: Can I look at the other side of that equation? There has been a whole debate about R&D tax credits. The Government has ramped them up over recent years because of those pressures, but we are still being told that we are not really competitive compared to—the Germans are always mentioned in this regard. What is your view about where we are with R&D tax credits and do they make a specific difference? Does research and development take place that would not take place without them?

  Mr Wolf: There is a logical argument for R&D tax credits; there are externalities involved. Whether the particular structure we have in the UK is desirable I honestly doubt. There are huge problems in making these work because of defining what R&D is and distinguishing it from other activities. By the way, one of the costs of the German system, as they would admit, is that they have got a very leaky, porous and very inefficient corporate tax structure. I tend to think stick with a very simple system with minimal deductions and credits and a low rate. It is as much prejudice as anything else. I do not think there is any strong argument either way on this one. The OECD's latest report on the UK has a lot of discussion of this if you want to look at it.

  Q76  Mr Gauke: Can I return to a couple of the issues that Michael Fallon raised with you? First of all, outsourcing in the public sector. I note what you say about some of the management difficulties, but, as you have heard, we were in India recently and we saw some very impressive businesses and some very impressive employees. These businesses were frequently telling us: "We are getting a lot of work from the private sector in the UK but hardly anything from the public sector". Do you think there is a missed opportunity here for British taxpayers and those to whom public services are being provided?

  Mr Wolf: I have no problem personally with the idea of the British Government outsourcing processes of this kind if it can reduce substantially the costs for the same quality, and lower taxes or spend on something else as a result.

  Q77  Mr Gauke: The reason why it is not happening is presumably the reason you mentioned earlier, market pressures do not exist but political pressures do?

  Mr Wolf: In essence. It is very difficult for governments (it is no way unique to this country) to do things, for exactly the same reason that every country has tried to preserve its own defence industry.

  Q78  Mr Gauke: Do you think it makes it difficult for politicians to lecture the British public and the private sector about the benefits of globalisation when it is reluctant to embrace it in its own management policies?

  Mr Wolf: I do not want to say anything unkind about politicians, but I would not have thought it is difficult in the least. I do not expect perfect consistency from any human beings, including even our political masters.

  Q79  Mr Gauke: Can I return to the second issue that Mr Fallon raised, which was the EU. Last week we heard from Brian Sanderson who is Head of Asia Taskforce for the Government, saying that with regard to India the movement by the EU into entering into trade agreements has been "glacial"—I think was the word he used. Do you think, given the consensus for free trade that exists in this country with regard to countries like India, the EU is substantially holding us back?

  Mr Wolf: Yes. I am a bit interested in what has happened here. There is a history here which is very interesting and ironical. When we went into the EU a set of policies emerged for, essentially, special concessional trade with developing countries which were associated with us through the Commonwealth. As the French had already had, this has gone through a number of forms—Lomé and so forth—and South Asia was very deliberately excluded. It was very deliberately excluded because it was seen as being, potentially, really quite seriously competitive. I think that is the essential reason. So the decision was made at that very early stage to put particularly India (obviously far and away the most important of these countries) outside the preferential trading network. Since then, until recently, India was not a very important trading entity; its trade was very small, it was very closed and nobody devoted much thought to India, really, until the last 10 years or so. Now the EU, as a whole, has to rethink entirely its trade policies towards the sub-continent. I think it would be fair to say that the EU's policies on trade with major new partners outside the WTO framework (where we are, of course, clearly a problem) have been very difficult to understand. We have pushed very hard, for example, for a trade agreement with Mercosaur—I do not really understand why that is so important. We do not seem to be very interested in this with India, I do not think we are doing—I may be wrong on this—anything with China substantial. I think, basically, from a strategic point of view, the EU has no trade policy now.

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