Pre-Budget Report 2009 - Treasury Contents


Examination of Witnesses (Question Numbers 1-19)

PROFESSOR SHEILA DOW, MS KAREN WARD, MR ROBERT CHOTE AND MR MARTIN WEALE

14 DECEMBER 2009

  Q1 Chairman: Welcome to familiar faces on the Pre-Budget Report discussion. Can you introduce yourselves for the shorthand writer, please, starting at your end, Martin.

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

  Ms Ward: Karen Ward, UK Economist at HSBC.

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

  Professor Dow: Sheila Dow, University of Stirling.

  Chairman: Welcome all of you. What is missing from the PBR?

  Mr Love: Discuss!

  Q2  Mr Breed: Preferably with us!

  Mr Weale: Could I say on that note what is missing is what is normally missing: a sense of what will happen if things turn out a bit worse than the Chancellor's forecast. We do not know whether they will or not but my expectation is that they will and therefore the deficits will end up rather larger than he is projecting, and there is no sense of, if that happens, how it is going to be addressed. Legislation of course will not cure the problem.

  Ms Ward: I think for me it is a clear understanding of how we've got here. You have asked before for more information on an exact breakdown of tax receipts by sector and that still hasn't been provided. So I am still slightly in the dark about exactly how this structural deficit has emerged so quickly, what sectors have contributed to that, and what the projections are going forward. I still do not think we have enough information about this structural deficit to make informed judgments that it is going to close over the forecast horizon.

  Mr Chote: In addition to those items, I would say a clearer picture on what the outlook is for public spending on public services. We have had a lot of talk about targeting resources on particular areas of public services, but the Chancellor has not said what he plans to spend in total on public services, what he thinks he is spending on the areas that he is protecting, and therefore what the consequences are elsewhere.

  Professor Dow: I would agree. I see the main gap on expenditure. It is not clear at all how the structural deficit is to be reduced in terms of the unprotected areas of expenditure.

  Q3  Mr Plaskitt: Could I come back to the question of the structural deficit. When we had the Governor of the Bank of England in front of us on 24 November, I was asking him about the approach to eliminating the structural deficit, the risks of doing it too rapidly and causing double dip, and doing it too slowly and having problems with sustainability and credibility. In his Delphic way, he said the way to reduce the deficit was to do it "at the right time". When I pressed him a bit further on that he said reducing the structural deficit "needs to be contingent on the state of the economy". What is your thought about that? Is there some way that over the next four or five years there could be some sort of gearing mechanism that says if you get economic growth at X you should be doing Y deficit reduction? Is there a way of fleshing that out to make it understandable? Does anyone want to comment on that?

  Mr Chote: You certainly could do it in principle by simply looking, for example, at the profile for economic activity relative to an assessment of the sustainable level of economic activity and say there is already an implicit path in the Treasury's own forecasts and plans showing at what point it thinks it is appropriate to do the amount of tightening it has in the book already. They divide it up by years, but implicit in that is also a path for how they expect the economy to be performing, and you could say well actually we will do this amount of tightening when it is clear the economy has performed in that way rather than linking it to the years that you do it. I think one of the big difficulties with this type of approach is that for it to be credible you would need to have the policy actions linked to a performance benchmark that people had trusted. For example, if you linked it to the Treasury saying, "We will do this when our assessment of the output gap is X or Y", then people will simply say, "We do not trust their assessment of the output gap therefore why should we trust this as being a commitment to tightening at a particular time?" In a sense, they are erring in the opposite direction on the Fiscal Responsibility Bill and the Fiscal Consolidation Act which, as I understand it, is basically setting a commitment for we will halve the deficit over this period even if the cyclical element of that were to turn out to be larger (because we went into a double dip for example) and then you fall back on exactly the problem that Martin mentioned at the beginning and which we have discussed before, how credible is that if you do not say if things do not turn out as we expect here, let us give an idea of how we would do things differently. It is not obvious that if you ended up with borrowing being a lot higher in the next few years because the economy went back into recession that sticking to a plan to halve the deficit in four years makes any sense.

  Q4  Mr Plaskitt: Do you think there is a credibility gap at the moment over what the PBR says about reducing the deficit over the four-year period?

  Mr Chote: There is in a couple of respects, one of which is the issue of whether you trust the forecasts. In a sense we have discussed this issue before and in a way it is fighting not the last war but the one before that, but we had the period from 2002 through to beyond the 2005 election when I think most of us were sitting here saying that we thought that the Treasury's revenue forecasts, for example, were too optimistic. The Chancellor said repeatedly no, they were not, and then eventually adjusted them after the election was out of the way. Clearly there are mechanisms you could use to try to assure people that the forecasts are truly based on evidence and best judgment, albeit with huge uncertainty around it rather than wishful thinking. There is nothing in the Fiscal Responsibility Bill that does that and that inserts a greater degree of independence into the production of the forecasts for example. The other issue on credibility would be, as we both mentioned, it would be more credible if there was more detail of where some of the pain was coming from. I think some external viewers will say if the politicians are not willing to spell out where the pain is, can we really say that they are committed to going through with this adjustment path.

  Mr Weale: I wanted to make the point that the Government does say what is expected to happen to general government consumption, and it is showing a very sharp downward adjustment, but, essentially, the forecast is relying on a very strong recovery of consumption and there is a real question whether that is actually desirable given the roots of the problems that we have been facing.

  Q5  Mr Todd: That is exactly the point I am going to ask about, which if we are seeking to rebalance the economy—and the assumption is we want to both balance it away from the finance sector and away from consumption and towards business investment—the evidence in the PBR suggests that that is not what the Government is entirely expecting itself, so we are seeing, as you have said, a rebound in consumer growth and a slightly surprising picture on business investment which does not tally with history. How does that fit with your own analysis?

  Mr Weale: That is exactly the way in which I see the Pre-Budget Report. If you look at table A4 this shows the contributions to GDP growth and if we look, say, at 2011 when the economy is supposed to be on the recovery path, we can see both there and in 2012 growth in private consumption is expected to be much the largest component of overall growth, and if that growth in private consumption does not happen and the Government cuts spending in the way that it shows then you would not expect to get the growth which is shown. We have to see this in the historical context where the British economy is the lowest saving of all the advanced economies and that is a factor behind our long-term economic difficulties.

  Q6  Mr Todd: One could query one other line there which is business investment where, to be honest, that shows a profile which is way ahead of trend and, indeed, we queried for a long period through the growth of the early part of this decade where business investment had got to and how it was so low. Here we are seeing really a reasonably robust rebound. Is that credible?

  Mr Weale: All I could say is that it is possible but it is not what I am expecting. In 2011 I am not expecting to see any support from GDP growth from gross fixed investment.

  Q7  Mr Todd: So there are no early signs either of policy instruments or in terms of evidence of this rebalancing that we are seeking?

  Mr Weale: I think, to be quite honest, since the projection is for the rebound in 2011 you would not necessarily be expecting to see the green shoots of that emerging already.

  Q8  Mr Todd: No, but I was meaning more the policy instruments that might make it happen. I do not know whether others want to come in.

  Ms Ward: I disagree with Martin on the outlook about business investment. I think that could be a reasonable projection because we have not just got fiscal policy operating, obviously we have precedentedly low interest rates and sterling has fallen a considerable deal. I think it is reasonable that we could see quite a robust improvement in investment having fallen so sharply this year, because the other policy instruments are encouraging that.

  Q9  Mr Todd: Presumably export led?

  Ms Ward: To some extent export led but I think a recovery in private consumption seems reasonable as well. We have seen a very sharp fall back this year and monetary policy is probably set to remain pretty accommodative which would encourage that area of spending as well. Of course, weaker sterling would not just encourage export growth but we should see more import substitution as well. I think a recovery in domestic demand is feasible. I do not think we will be relying purely on export growth.

  Q10  Mr Breed: Just following on from that, to what extent is this net trade bounce that we are getting more to do with a severe decline in imports rather than some significant increase in exports, because we have only got the net figures?

  Ms Ward: Over the recent period?

  Q11  Mr Breed: Yes.

  Ms Ward: Over the last year it has certainly been disappointing in terms of how net trade has performed. I think you are right, imports really have collapsed and given whatever boosts we have seen, I think the last couple of months the car scrappage scheme has led to quite a large increase in imports, considerably more than exports, which has made the trade deficit deteriorate over the last couple of months. I think that will be different over the course of the next year when the global economy is back on its feet.

  Mr Weale: Could I say on that that one of the most worrying things I saw in the papers surrounding the Pre-Budget Report was in the supplementary material that came with the report, chart 1-11, which shows that despite the fall in the exchange rate that we have had since 2007, in terms of labour costs the economy is actually still less competitive than it was when we were in the ERM, and that is indicative, insofar as one trusts those data (they are from the OECD) of the sort of mountain that we have to climb in order to perform well in world markets.

  Q12  Mr Breed: Professor Dow, how worried are you that if the value of sterling starts to rise then this very modest thing might suddenly disappear and is it likely that sterling might in the next year or so begin to rise again?

  Professor Dow: It is not clear how sensitive imports and exports have been to the change in the exchange rate. Clearly there has been a response but it is not clear that there has been a response commensurate with the change in the value of sterling. In a way, what is most likely to drive the future of the sterling, I would suggest, is capital flows and a lot will depend on the gilts market and global developments in government bonds and the perception of foreign investors of the British bond market. If that was positive and there are higher capital inflows the exchange rate should rise.

  Q13  Mr Breed: So the maintenance of AAA is pretty important then?

  Professor Dow: I would say so, yes.

  Q14  Nick Ainger: You were talking earlier with Mark Todd about growth in the business sector. What effect do you think the level of bank lending is having on that likely outcome?

  Ms Ward: I think there is mixed evidence across the various data sources, and here I am talking about the aggregate banking sector, I am not within the retail bank, because certainly some of the business surveys suggest that corporates are still finding it difficult to access credit but then if you look at other surveys of output for example it does not look like small companies are being held back. They are performing just as well as large companies. One of the things I was concerned about was working capital and it does not seem to be coming through in that survey. I think we could do with more data and a more consistent picture to inform us all very well on what exactly is happening in terms of bank lending to companies. To large companies it is quite clear we have seen large amounts of corporate bond issuance which is being used to repay bank debt.

  Q15  Nick Ainger: I am thinking particularly though of the small to medium size which is where generally the growth starts to come from, particularly in employment as well. You are saying that the figures at the moment do not indicate that there is a problem but there seems to be an awful lot of anecdotal evidence from the business sector that there is a problem.

  Ms Ward: There is definitely some evidence but it is just not clear and it is not exactly consistent across all the different data sources, so it is just difficult to make a clear judgment on exactly what the impact is.

  Q16  Nick Ainger: Adam Posen told us basically that if we cannot fix the banking system and ensure that there is credit available to businesses and to individuals, before the fiscal stimulus is turned off by the Government, then we have got a real problem. Do you see it in the same way as Adam Posen sees it?

  Ms Ward: I think he makes very good points about how we need to think about all the different policy tools that are being used. If you look at some research by the IMF about the best way of overcoming the banking crisis and getting back to strong period of growth, that is what has been followed. We have seen very aggressive monetary policy. We have seen large recapitalisations of the banking sector. We have followed the textbook model to try and ensure we return to a flow of credit and return to growth. I think in terms of whether fiscal policy needs to remain accommodative, many of the businesses I have met over the past six months—their main concern that they cite to me is about the lack of clear fiscal consolidation or how it is going to come through, and that is holding them back from investing and holding them back from taking on new staff—considerably more than any other aspects of their business. They are concerned about higher taxes for them personally and then higher taxes for the people that demand their goods as well.

  Q17  Nick Ainger: Does anybody else want to comment on the availability of credit?

  Mr Weale: I suppose I would make the point that you can always find businesses which would like to borrow to do the sorts of things they were doing two or three years ago, and it may be that banks are not lending to them for very good reasons, so my sense is that credit is still rather tight but you are quite likely to find people who regard their businesses as being sounder than the banks do, and that is a perfectly understandable feature of the sort of economic circumstances that we are in.

  Q18  Nick Ainger: Do any of you actually share Adam Posen's concern that unless this matter is fixed then potentially we could be into a double dip, that as the Government's fiscal stimulus is withdrawn and it is not made up by additional lending from the banks then we have got a serious problem? You do not share his view?

  Mr Weale: One can imagine some circumstances in which if there were another credit stoppage of the sort that we saw in 2008 then we would obviously have a very serious problem, but I am not quite sure that the solution to the problems of the household sector is to go on borrowing on the sort of scale that happened in the period before the crisis. Business lending is a different matter and I do think the Bank of England could have done rather more than it has to improve the availability of credit to business.

  Q19  Nick Ainger: I will just move on to the banking bonus issue. Martin, you gave us a memorandum in which you argued that the temporary tax surcharge on bonuses has a strong economic rationale because bonus arrangements as currently in place can be damaging to the sound running of businesses. Do you want to expand on that briefly?

  Mr Weale: Yes, certainly and this is a general point not one specific to the banking sector. If you pay bonuses on a revenue share arrangement, say you paid half of your revenue out in bonuses, then the implication is if you have a profitable investment opportunity you would issue more shares and take on more capital but instead of the revenue from that going to the shareholders half of it would be paid out in bonuses, if you follow the sort of Goldman Sachs rule. The way round that is that people who are providing finance to businesses like that are likely to prefer debt finance to equity finance, so a natural consequence of the sort of bonus arrangements that we see is that the institutions that operate bonuses become very highly geared. It is possible that that can be addressed by means of regulation, and that, I am sure, is what the FSA would say, but we know that the FSA have not always been terribly enthusiastic about enforcing their own regulations, and I should have thought to be on the safe side to have arrangements in place which disencouraged that particular form of remuneration is desirable.



 
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