Budget 2010 - Treasury Contents


Examination of Witnesses (Question Numbers 1-19)

MR ROBERT CHOTE, MR MARTIN WEALE CBE, MR ALAN CLARKE AND MR SIMON HAYES

29 MARCH 2010

  Q1 Chair: Welcome to the session. We have three sessions and three-quarters of an hour maximum for this session, so we will be asking brief questions and will be looking for the same in response. Can we start with you, Martin, introducing yourself for the shorthand writer.

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

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

  Mr Clarke: Alan Clarke, UK Economist at BNP Paribas.

  Mr Hayes: Simon Hayes, Chief UK Economist at Barclays Capital.

  Q2  Chair: Welcome. Martin, a double-dip recession: discuss.

  Mr Weale: Obviously the risk of it, no-one would say that another recession cannot happen. I think the problem the economy faces is that the fiscal position is starting to tighten fairly sharply. The cyclically adjusted borrowing requirement is set to fall and for a recession to be avoided that means demand has to recover elsewhere in the economy. The Treasury is hoping that consumer demand will be fairly buoyant. The National Institute is taking an optimistic view about the export position. No-one perhaps is expecting a great deal from investment. If none of these get going and the fiscal retrenchment happens as set out in the Budget Statement then we may well see a double-dip.

  Q3  Chair: Alan Clarke, Adam Posen of the MPC has warned in evidence to this Committee that if you do not fix the banking system by the time your stimulus runs out then private demand will not pick up when the stimulus does indeed run out. Is the logical consequence of that, that the fiscal stimulus cannot be withdrawn until the banking system is firmly back on its feet?

  Mr Clarke: I have some sympathy with that. If the economy cannot grow this year when there is all the fiscal stimulus there—the reduction in interest rates, very strong disposable income growth, in the last quarter disposable income growth was 5.2% year-on-year, there are only two quarters in the last decade that have been faster than that—we are going to grow reasonably this year but that stimulus will fade and as we go into 2011-12 it is not going to be there to help it and furthermore, the banking support systems will fade. If they are not prepared to lend and if the constraints on credit are not fixed by then, then we are in serious trouble.

  Mr Hayes: I think that we are looking at a period of relatively subdued growth but I do think the risks of a double-dip are relatively low now. Very often people say that a recovery that is based on inventories is a bad thing, it is a flimsy foundation for a recovery, but it is a standard part of a recovery from a recession and so long as firms are producing more stuff, they are paying people, you hope that evolves into more sustained recovery in final demand. There is a risk that does not happen in the current circumstances because people are repairing balance sheets and it could go into savings. There is still a question mark over that. Even so, I think as things stand the dynamics are in place for a muted recovery.

  Q4  John Thurso: Mr Hayes, can I ask you this. Many analysts have been a bit disappointed that our export performance has not been better, given a 25% broadly devaluation in sterling. Why has our performance not improved as much as people would have liked?

  Mr Hayes: I think there are a couple of issues. One is simply the configuration of UK export markets. Around three-quarters of our exports go to the euro area and the US and developed economies generally have been in recession and have been slow to come out of recession. The recovery in the global economy has been much stronger but that has been focused on emerging markets where the UK does not have such large direct trade exposure. The other thing is to do with the mechanism whereby lower sterling should feed into stronger exports, and there are basically two ways. There is a more immediate way, which is exporters cut their foreign currency prices and gain market share, and then there is a slower way, which is they do not cut their foreign currency prices, they gain higher margins and that encourages entry into industries and eventually those gains get competed away. It seems the latter one, if anything, is likely to play out. I think over time we will see a benefit from lower sterling, it is just that we need to wait for the euro area and the US to recover more strongly and perhaps for this process of entry into export markets to play its course, and that could take some time.

  Q5  John Thurso: Mr Clarke, the Chancellor has assumed pretty robust growth in consumption from 2011 onwards but over the same period import growth appears to be pretty restrained. This rather flies in the face of historic evidence. Is it a credible forecast?

  Mr Clarke: That is one of my biggest criticisms of this Budget. If you look at the history of imports versus consumption, they move similarly but imports are a very geared version of consumption; so if consumption does well, imports rise much faster. If we look at the forecast over the next two to three years, the Chancellor has assumed that consumption and imports are pretty much joined at the hip. Certainly sterling has weakened and that reduces import demand, but to be joined at the hip for three years is not credible, in my view. If we go back to the early 1990s when sterling depreciated by 20% or so, yes import growth was curtailed to some extent but that lasted a couple of quarters. I think the import forecast is too low and in that context that has made the GDP forecast too high with ramifications for the assumption for tax receipts and also deficits-GDP ratio and debts-GDP ratio. That would be my number one criticism for macro purposes.

  Q6  John Thurso: It is a fairly substantial assumption to be off on, as it were?

  Mr Clarke: Yes. If you were to push up imports to a more reasonable level, I think you should add about two percentage points to import growth and that would subtract about three-quarters of a percentage point from the GDP projection. Investment is the other area that I had a point with. I think investment will do okay. Cash investment in the economy as a percentage of GDP is at the lowest since at least 1955. The same is true in the US. When we have been at past troughs like this, over the next two years you do tend to get a rebound of about 5-6% year-on-year for two years, so that should support investment. However, we know government investment is going to be held back. We know that commercial property is not really booming that much. I have some sympathy with the Government forecast of faster investment, but 9-10% year-on-year growth in 2012 is brave, I do not buy that.

  Q7  John Thurso: Robert Chote, the Governor of the Bank of England has repeatedly stated the UK needs to rebalance the economy with more resources allocated to business investment and net exports and fewer to consumption. Looking at the Chancellor's growth projections there is an assumption that growth will come from consumption of between 2.5-3% during 2011-12. Is it realistic to expect such a sharp rebound in consumption, and what does that do for what the Governor is saying?

  Mr Chote: I think I would pass that question to my colleagues, that is macro forecasting which I do not undertake so I will fob that one off if I may.

  Q8  John Thurso: Martin, are you interested in that?

  Mr Weale: I must say, on the one hand were consumption to resume rapid growth or consumers regain their confidence, as some people put it, that would be helpful in the short-term but not in the long-term for precisely the reasons that the Governor of the Bank of England has given. I am not expecting such sharp consumption growth but, as I said, if consumption does not grow in the way the Treasury hopes then you do have to be more optimistic about exports than they are, and if not the economy will be appreciably weaker than they suggest. I do expect it to be weaker than they suggest in 2011 and going into 2012.

  Q9  Mr Todd: Following that line of questioning, what policy instruments might have been used to assist the much vaunted rebalancing of our economy? I think the line of questioning has indicated we are going to see more of what we are familiar with. What could have been done which has not been done to encourage manufacturing and export activity?

  Mr Weale: There are questions what you legally can do.

  Q10  Mr Todd: Setting aside protectionism.

  Mr Weale: There are also questions about how far the Government should support particular areas or what it could do. There are things like improving credit availability that one might think would help those manufacturing firms that are now looking to take advantage of the competitive situation in international labour markets. Of course, until 1971 we did as a matter of course have a policy of making credit more readily available to manufacturers than to, say, property speculators. The Government has been talking about improving credit to small businesses and maybe it could refine what was mentioned in the Budget to give a particular focus to exporters and the manufacturing sector.

  Q11  Mr Todd: Would one of the possible assistances or, for that matter, obstructions be the fiscal treatment of investment by businesses because that has been one area which did feature within the Budget and maybe could have gone further or alternative views are that it should be abolished altogether and be entirely neutral between different kinds of businesses.

  Mr Weale: I think there are two arguments which pull in very different directions. There is one that you should essentially give full tax relief on investment and tax businesses as funds are withdrawn from them. That almost amounts to the Government having an equity interest in the private sector capital stock, and I can see much to be said for that. Of course the disadvantage if you want to collect a particular amount of revenue is that you then need much higher tax rates and you have a large gap and that can create arbitrage opportunities. On balance, I suppose I tend to favour now the idea of fairly broad taxes on businesses at a rather low rate and, indeed, I would favour an eventual withdrawal of debt interest relief so that we could have lower overall taxation. I think the Government could think about specific businesses which would support those particular areas of the economy which it regards as important.

  Q12  Chair: How much support would there be for the phasing out of debt interest relief, do you think? Would it be universally acclaimed?

  Mr Chote: There is a very strong case for levelling the playing field between the treatment of debt and equity. You can clearly go in either direction in doing that. There are countries which have gone in either of those sorts of directions, but there is also a case for extending the treatment of debt more to the treatment of equity. That, of course, has revenue consequences which need to be raised elsewhere, but I think the disparity between the two is certainly something which is worth addressing.

  Chair: During the private equity inquiry we had, we had lots of representations from manufacturing about this particular issue, so it does strike a chord.

  Q13  Nick Ainger: We were talking earlier about the availability of credit and that potentially being a drag on the economy. I remember receiving evidence from some bankers claiming that in fact the demand was not there, particularly from certain sectors of business to lend to them; they were basically paying back loans rather than seeking new loans. What is your view on that?

  Mr Weale: Could I say that of course I do not have the direct experience that bankers do have. I am very aware that what a business regards as a safe proposition, a banker would regard as a risky proposition, and in many cases with good reason, so you will have that sort of divergence of view. What we have seen is an increase in other forms of borrowing recently which I think is a good thing but that must itself indicate that credit from banks is not as readily available as it used to be. There is some market evidence for tightness.

  Q14  Nick Ainger: This Budget actually withdraws the 40% capital allowance for short life assets. While there is a great concentration on aid for SMEs, many of those SMEs are dependent upon larger companies asking them to do business for them, giving them orders and so on. Do you think there is a gap now in the capital allowances for larger businesses to encourage them to invest?

  Mr Weale: I think if we want to see more investment, and we do, then there is, as I say, a very good case across the board for incentives to invest. That would need to address large businesses as well as small businesses. Obviously it would cost something and that is hardly a trivial point in the current circumstances, but I cannot see a strong case for having incentives focused on SMEs and not also available to large companies.

  Q15  John Mann: Mr Hayes, over the next 12 months, unemployment: up or down?

  Mr Hayes: On our forecast flat. Clearly the rise in unemployment has been a lot less than we would have expected given the fall in output. I think there is a genuine puzzle here in that we have seen weaker pay growth as well but that weaker pay growth has not been sufficient to prevent unit labour costs from rising, so firms are in a situation now in the UK where they seem voluntarily to absorb things from the unit wage costs. This can resolve itself in one or two ways. Either demand picks up, and the fact that firms have hoarded labour turns out to be the right call, and we see productivity improve and unit labour costs fall because of that or you get to the stage where demand does not pick up as firms are expecting and then firms end up thinking, "Why are we holding on to this labour?" That to me is the double-dip risk scenario. The evidence that we have so far is that firms are content with their current levels of employment and we have seen some reasonably positive signs in the labour market. As puzzling as it is, I would say most likely we have seen unemployment around about its peak at the moment, but I am still concerned about that.

  Q16  John Mann: Mr Clarke, in the next 12 months, net private sector job, growth or loss. What are your projections?

  Mr Clarke: In the very near term, I am pretty optimistic. I have one of the most optimistic growth forecasts in the market and that is because the survey indicates they are very elevated. Phase one of the shake-out in the labour market is complete, people thought the sky was falling in, they were laying off workers left, right and centre, but now we know the sky is not falling in, services have bounced back, the economy is doing quite well, so we have seen employment pick up. I think GDP numbers in the very near term are more likely to be on the upside than the downside and in that context it is consistent with employment in the private sector doing better. But my view is enjoy it while it lasts, because I think it is temporary. When these favourable tailwinds fade, I think they will turn to headwinds.

  Q17  John Mann: So net change over the next 12 months in the private sector?

  Mr Clarke: In the private sector I think improvement.

  Q18  John Mann: In jobs?

  Mr Clarke: In jobs. Beyond 12 months I think we are going through a second phase of job losses.

  Q19  John Mann: Mr Weale, taking some of the more, shall we say, robust proposals for public sector job reductions. What is the maximum in your view of the sustainable job reductions in the public sector without impacting on a multiplier effect basis on the rest of the economy?

  Mr Weale: I think, other things being equal, until the economy has returned to normal circumstances, reducing spending in the public sector does have multiplier-type losses. The multiplier, I should say, I do not think is particularly large for an open economy like Britain's. We, as students, used to learn about a number of 10 and it is certainly not remotely like that; a number around 1 or slightly larger than that I think is probably much more appropriate. But until market circumstances have returned to normal, and I do not think they have yet, we do have resources which, if they are released by the public sector, probably will not be taken up by the private sector.



 
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