Written evidence submitted by Adam Lent,
Head of Economic and Social Affairs,Trades Union Congress
INTRODUCTION
The TUC would like to thank the Committee for requesting
a brief submission to aid them in their questioning of the Office
for Budget Responsibility (OBR) in relation to the OBR report
of November 2010.
The TUC strongly supports the principle of introducing
greater independence into Treasury forecasting believing this
will ensure greater credibility for policy-making and should aid
the general achievement of market certainty and confidence. To
this end, recent measures to improve Select Committee oversight
of the OBR, the appointment of a new Chair with an impeccable
record of independence and efforts to separate the operation of
the OBR from that of the Treasury are very welcome.
We hope the Select Committee will play a key role
not just in exploring the immediate outputs of the OBR but will
also adopt a clear "watching brief" to ensure that the
independence and transparency of the OBR is maintained and improved
over coming months and years and that its remit remains appropriate
to changing fiscal and economic circumstances.
The TUC believes the OBR's Economic and Fiscal
Outlook report was an extremely useful contribution
to the wider debate about the Government's plans that exhibited
an appropriate level of detail combined with comprehensive coverage.
The OBR team deserve congratulations for producing what must have
been a very demanding analysis in a short space of time.
Given the very tight deadline, this submission will
briefly focus on just three aspects of the report which we believe
are particularly noteworthy and should provide useful lines of
inquiry for the Committee both in their questioning of the OBR
and other witnesses.
1. UNCERTAINTY
The report's central forecast has been widely interpreted
as offering support to the Chancellor's plan. The OBR's conclusion
that growth will remain steady if not spectacular over the next
five years, that employment rates will rise and that fiscal targets
will be met does seem to offer comfort to the Treasury.
However, we note that this is a report that very
strongly stresses the uncertainty of its forecasts. This uncertainty
is of two types. The first is based on the OBR's assessment of
previous forecasting errors and the application of that assessment
to its current forecasts. The second is based on the current volatility
of conditions in the UK and global economy.
We note that as early as page 3 of the report, reference
is made to the "high level of uncertainty that lies around
all economic and fiscal projections".
The report clearly shows the high level of probable
forecast error in Chart 1.1 where it is indicated that there is
a 40% chance that the actual outturn by mid-2014 may deviate from
the median forecast to the extent that the economy displays no
growth. Alternatively there is a 40% chance that the actual outturn
may deviate enough to generate growth of over 4% by mid-2014.
Similarly Table B.1 shows that the standard deviation for the
forecasts of growth, PSNB and the structural deficit, all imply
high levels of forecast uncertainty.
In paragraphs 3.9 to 3.11, the OBR is at particular
pains to indicate how difficult it is to estimate the size of
the output gap both due to the inherent problem of forecasting
something which cannot be directly observed but also because the
financial crisis has added to uncertainty around this issue. To
illustrate this point, the report highlights the range of different
estimates of the output gap from different economic organisations.
This is, of course, particularly significant because the Treasury
has chosen the elimination of the structural deficit by 2015 as
their key fiscal target and any estimate of the structural deficit
is fundamentally based on the estimate of the output gap.
We also feel it is very noteworthy that the OBR is
so concerned about the uncertainty of their forecasts that they
have gone to the trouble of generating two alternative scenarios
- based on "persistent weak demand" and "delayed
rebalancing" - to assess what the impact on various indicators
may be of their median forecast being wrong. This is important
not simply because it indicates a concern about past forecast
error but also that the trajectory of the economy itself is currently
unclear due to the inevitable post-recession volatility.
If the reader has been left in any doubt, the OBR
states towards the end of the report (p.134) that:
"past experience and common sense suggest that
our central forecasts for both the economy and the public finances
are almost certain to be wrong".
It is maybe only slightly frivolous to note that
the words 'uncertain, 'uncertainty' and 'uncertainties' are used
no less than 63 times in the report.
While it is admirable that the OBR is being so clear
about the inherent problems of economic forecasting, we feel that
this does raise matters that should be of vital concern to the
Treasury. While the Chancellor opened his Autumn Statement with
a clear acknowledgement of the uncertainty noted by the OBR, the
rest of the statement continued as though the median forecast
incontrovertibly upheld the Treasury strategy. At one point the
Chancellor states:
Indeed, to use the OBR's own words, "the Government
has a slightly wider margin for error in meeting the mandate than
appeared likely in June". For the first time the OBR have
also tested the resilience of the fiscal mandate to two alternative
scenarios for the economy that critics have put forward. In both
cases the mandate is met.
Mr Speaker, it is clear that our decisive actions
have proved to the world that Britain can live within her means.
This Government has taken Britain out of the financial danger
zone and set our economy on the path to recovery.
That is not only the judgment of the OBR. It is the
judgment of the IMF, the OECD, the European Commission, the Bank
of England and all the major business organisations in this country.
We believe this passage is mistaken in its attempt
to present the OBR forecasts, and those of other bodies, as proof
that the Chancellor is on the right track. Proof will only come
from the actual economic out-turn.
This is not simply a rhetorical or technical matter
however. If the OBR is right that their forecasts are subject
to such high levels of uncertainty, we think there are important
questions to be asked about the flexibility and responsiveness
built in to the Chancellor's plans.
In particular, it is noteworthy that by targeting
the cyclically adjusted current budget rather than public sector
net borrowing, the Treasury plan does, in theory, allow the automatic
stabilisers to work in the context of a limited slowdown without
damaging the planned elimination of the structural deficit assuming
no further capacity is lost to the economy. In addition, the Chancellor
has claimed that the OBR has judged that he will meet his key
fiscal target of eliminating the structural deficit one year earlier
than he originally planned. In this sense, the Treasury may also
have space to somewhat slow the pace of consolidation should the
out-turn prove less favourable than the OBR predicts.
While these flexibilities are undoubtedly welcome,
they are certainly limited in scope. For example, should there
be a much more significant slowdown or simply ongoing sluggish
growth, then any restimulation of the economy may require more
than monetary measures, the automatic stabilisers and fiscal reprofiling
is able to deliver. Given that the OBR report suggests both outcomes
are well within the realms of possibility, we feel this issue
needs much closer investigation than has currently been the case.
2. UNEMPLOYMENT
There has been much debate about the extent to which
the labour market over the next five years will be able to absorb
the job losses in the public sector resulting from the fiscal
consolidation.
In this context, we note that the OBR has revised
down its expectations for public sector job losses from 490,000
to 330,000. This fall is in part explained by new a methodological
approach but also by the decision of the Government to find a
higher level of savings from AME rather than DEL.
While the prospect of fewer job losses is welcome,
it is once again noteworthy that the OBR clearly states this forecasts
is based on "stylised assumptions" and are "subject
to a large degree of uncertainty".
We also feel that finding very large savings in the
welfare budget, while reducing job loss in the public sector,
is very far from being a cost-free solution given the likely impact
this will have on the well-being of benefit claimants and social
cohesion as well as the consequent increase in pressure this will
place on government activities such as health-care, social services
and policing.
It is also important to acknowledge that the OBR
has forecast a further 80,000 public sector job losses in the
year 2015-16 beyond the 330,000 as a result of plans to freeze
spending in that year.
The OBR now expects the private sector to generate
a total of 1.4 million jobs between 2010 and 2015. When job losses
of 330,000 in the public sector are taken into account, this means
that the OBR is forecasting that employment will rise by 1.1 million
over that period.
The total figure is broadly in line with the number
of jobs created over a five year period from when employment began
to rise after the recessions of the 1980s and 1990s. However,
we would point out that after both of those recessions many of
the new jobs were created in the public and financial sectors;
the former will definitely not now play the same role and the
latter seems likely to prove less significant than in the past.
However, the point of particular concern that arises
from the OBR's forecasts, is that despite a rise in employment
of 1.1 million to 2015, claimant count is only forecast to fall
by 370,000 and ILO unemployment by (on our rough estimate based
on the OBR forecast for the ILO rate) 500,000. This would leave
claimant count at around 1 million in Q4 in 2015 and ILO unemployment
at just under 2 million. These are still very high levels which
well exceed their levels for early 2008 before the labour market
recession began with claimant count hovering around 700,000 and
ILO unemployment around 1.5 million.
This suggests that the OBR expects a large proportion
of the rise in employment to come from growth in the working age
population, migration and currently economically inactive individuals
joining the labour market rather than from the ranks of the unemployed.
This should be a matter of deep concern to the Government. Indeed,
while the Government claims that the OBR has identified sufficient
capacity in the labour market to absorb public sector job losses,
it would be equally accurate to state that the OBR now expects
unemployment to remain higher for longer as a result of those
job losses. It may be slightly simplistic but illustrative nevertheless,
to point out that without the 330,000 job losses expected from
the public sector, claimant count would be very close to returning
to its pre-recession levels while the ILO level would be making
much stronger progress towards the same by 2015.
3. RECOVERY
The OBR's central forecast and the comfort it provides
to the Chancellor is dependent on a significant switch in economic
performance in 2011. This is well illustrated by Table 3.5 of
the report which outlines the contribution to growth made by different
economic activities over the next five years. This table reveals
four major shifts the OBR expects next year. The first is the
decline in public spending which turns from making a contribution
of 0.4% to growth in 2010 to reducing growth by 0.5%. The second
is the slowdown in business restocking which shifts from making
a contribution of 1.3% this year to contributing only 0.1% next
year. These headwinds are compensated by a significantly increase
in business investment, which sees its contribution increase from
0.1% to 0.8%, and from net trade which leaps from - 0.9 to 0.7.
The OBR's expectations are supported by the recent
strong PMI data from manufacturing which does suggest that the
opportunities for exports are growing. However trade figures also
show that exports from the UK's service sector remain weak while
imports have continued to grow alongside exports suggesting that
achieving a trade surplus will not necessarily be easy.
In addition, both business investment and trade are
heavily reliant on confidence and the latter is particularly reliant
on exchange rates. Given the current febrile nature of the global
economy and recent rising geo-political tensions, neither improving
confidence nor favourable exchange rates are in the gift of economic
policy-makers in the UK. We believe this, once again, means the
flexibility and responsiveness of Treasury plans require much
closer scrutiny.
It is also interesting to note that despite the Government's
repeated claims that the best route to growth is to reduce the
"crowding-out" effects of public spending and borrowing,
the better than expected growth of Q2 and the recent recovery
of manufacturing exports have occurred prior to the consolidation.
It would be interesting to know the Chancellor's perspective on
this apparent rebuttal of the crowding-out argument.
CONCLUSION
The TUC believes there is much in the OBR report
which is highly informative and should prove of great benefit
to parliamentary and wider debate. In particular, we feel that
despite the tone of the Chancellor's Autumn Statement, the report
raises many tough questions for the Treasury. We would greatly
welcome any opportunity the Select Committee might take to explore
these questions with the OBR, other witnesses and particularly
the Chancellor himself.
November 2010
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