Examination of Witnesses (Question Numbers
CBE, MR ALAN
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
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
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cannot be withdrawn until the banking system is firmly back on
Mr Clarke: I have some sympathy
with that. If the economy cannot grow this year when there is
all the fiscal stimulus therethe 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 thatwe
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
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
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
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
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
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.