Examination of Witnesses (Question Numbers
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
Ms Ward: Karen Ward, UK Economist
Mr Chote: Robert Chote of the
Institute for Fiscal Studies.
Professor Dow: Sheila Dow, University
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
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 economyand the assumption is we want to both balance
it away from the finance sector and away from consumption and
towards business investmentthe 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
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
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
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
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
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,
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
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 monthstheir 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 staffconsiderably
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.