Examination of Witness (Questions 40-59)
PROFESSOR IAIN MCLEAN
WEDNESDAY 3 JULY 2002
40. For the benefit of the record, can you explain your reference to Goschen?
(Professor McLean) Yes, I am sorry. George Goschen was Chancellor of the Exchequer in the Government of 1886 to 1892, the Unionist Government which took office after the failure of Gladstone's Irish Home Rule proposals. Because it was a Unionist Government, they needed a formula to keep the Scots and Irish happy, and the Goschen formula was intended to be in proportion to the yield of property taxes in Scotland and Northern Ireland, or that the grant should be in proportion to the yield of property taxes.
41. Thank you. You have said that in more recent times the convergence effect has started to occur. I wonder if you could explain to the Committee why you think that is the case? Here again I am looking for the technical reasons.
(Professor McLean) The technical answer is that I believe that once the present Government, the 1997 Government, broke out from its self-imposed corset of no public spending increases in its first two years, there were substantial real increases, and therefore even more substantial nominal increases in public spending, and the faster the increase in public expenditure in England, the more the convergence effect of Barnett operates on Scotland, Wales and Northern Ireland.
42. The Committee has already had evidence, and I suspect will get more, from various people in Wales and the North of Ireland about the so-called "Barnett squeeze" and its effect on them and their desire to change the Barnett Formula. Are they right in thinking that there is a "Barnett squeeze" on Wales and Northern Ireland, and is there also a so-called "Barnett squeeze" now on Scotland?
(Professor McLean) Yes, they are right. I believe there is a "Barnett squeeze" on all three territories. If my rough and ready calculations are right, the effect of the "Barnett squeeze" on Wales would have been that public expenditure in Wales would be pushed too low were it not for the effect of the Objective 1 row of the year 2000. In Northern Ireland my calculations suggest that it is not yet the case that Barnett has driven Northern Ireland below what one might regard as an evaluation of needs, but it will not be very long before that happens. It will take longer in the case of Scotland, but eventually the mathematics implies that it must.
43. On this point, just quickly, I wondered if you could say a little about the extent to which the fact that Scotland has revenue-raising powers affects the argument for the retention or the argument against the retention of the block transfer formula?
(Professor McLean) At a practical level, not very much because there are huge political pressures, and I think that there would be huge political pressures against the powers being used, whichever party governed Scotland and whichever party governed the UK. However, from the point of view of a theoretician of public finance, I think there are quite good grounds for saying that greater fiscal autonomy to territories, including Scotlandbut it would have to be territories including Scotland, not only to Scotlandcombined with a system of equalisation grants, might lead to a system that was equitable and more efficient.
44. Where would the efficiency come?
(Professor McLean) The efficiency would come from the fact that authorities would have the power to tax and that they would be likely to be blamed when the consequences of their decisions conspicuously went wrong; and they would therefore be more careful about exercising the power to tax. The present situation in this respect seems to me to be the worst of all worlds. The devolved authorities do not have fiscal autonomy, but they also do not have fiscal responsibility because the block grant that they get is a consequence of decisions taken by the UK parliament and the UK executive, so they have no control over that money. It works the other way as well: the devolved authorities can split their spending as between revenue and capital as they choosethat is part of the devolution settlementand they have a natural incentive to cut down on capital expenditure, let the consequences fall after the next devolved authority election, and, when they do fall, blame the English for being stingy to them. As there is a control, the Chancellor operates a golden rule, fiscal rules and so on about the ratio of expenditure to borrowing, which are UK rules, there is an opportunity open to the politicians in the devolved administration to do something that brings responsibility to England but which the English cannot control. There is what I hope is a somewhat clearer statement of the point in my evidence.
45. I am only thinking that the case for transfers is much weaker where fiscal autonomy has been granted and where it has not, is it not?
(Professor McLean) In the case of transfers to an area with approximately average GDP per head it is much weaker, but if Wales and Northern Ireland had taxing powers and their relative GDP stayed as it is now, between 80 per cent and 90 per cent of GDP, then in any reasonable country one would expect there to continue to be an equalisation rate, as there is in Australia, Canada and Germany, such that there would be grants from the centre to those territories as well as those territories having tax-raising powers.
46. In your paper you say, "local government spending began controversially and has become more so." What are the factors that make it more controversial, in your view?
(Professor McLean) It is not local government spending that began controversially, but the formula allocation of funds to local authorities by what is now called SSA began controversially. I am not sure where you are in the paper.
47. Page 12. The exact quotation is, "The vertical distribution for local government spending began controversially and has become more so."
(Professor McLean) The vertical distribution is distribution from the UK Government to the local authorities. The present system could hardly have begun more controversially because it began in the wake of the poll tax, and the present system is still quite affected by the fact that the government of the day in 1990 had some urgent political needs; it needed to find a distribution system that got it, let us say, out of a hole. As part of the ideology of that government at the time, since there was huge scope for efficiency improvements in local authoritiesand certain flagship authorities were exemplars of thisthe replacement formula had to be one under which the flagship authorities did reasonably well. At least three separate teams of academic analysts, whom I quote in the paper, have all come to the same conclusion, which is that the formula when set up had the effect of disproportionately benefiting the flagship authorities. That is what I mean by saying it was controversial at the beginning. The reason that I say it remains controversial is that at a technical level with this technical query, there are the severe, and I think fundamentally insoluble problems of using a regression formula where the data comes from the very bodies to whom the money goes: the data comes from the local authorities and the money goes to the local authorities. To my view, that is an insuperable problem, so SSA has never gained legitimacy, and the Government has announced that it is going to abandon it, but has not said what will come in its place. A third problem is that there is a huge and really intractable issue about relative costs and the area cost adjustment component of SSA, where everybody in the policy network in the areas that get it thinks it is too little, and everybody in the policy networks in the area that do not get it think it is too much. As I say in the paper, I believe that one of these sides is rightthe trouble is, I do not know which.
48. Those weaknesses in the system that you describe were in it from the outset, as I recall from also being in local government. I am just trying to get a handle on what has made it get worse.
(Professor McLean) I am not sure that it is objectively worse, only that it now has no friends. In 1990 the Conservative government was its friend; in 1997 I have to assume that the incoming government was happy with it because it did not make any efforts to change it until the Local Government White Paper last December, in which the present Government announced that SSA was no good. I have not heard the Conservatives or Liberal Democrats coming to the defence of SSA, so I have to assume that it has no friends.
49. That has brought us to the present position. You say we cannot escape from the element of regression. Why is that?
(Professor McLean) That is not what I intended to say: I said that we cannot escape from a problematic element of regression, namely the one I have just mentioned; that it is difficult to avoid the data being drawn from the same bodies that receive the grant. If that problem could be cracked, then in principle I would be happy with the regression-based formula. The problem is tractable for health services because you can get objective data about death, morbidity and so on, from small area census data. Nobody that I know of has yet found a wayand this may something on which the Committee might like to take evidencefor doing that for local government services.
50. How distorting is the area of cost adjustment and can you see any way of avoiding the distortions in the alternative system?
(Professor McLean) The best way to answer that is for those members that have it to look at the figure in my table. This is the one I earlier promised the chairman to produce the update of (figure 4). That is the one that has a very high spike of spending in London, compared to an inverse GDP basis. I ask you to notice what is, to my mind, very strange about that. The two most prosperous regions, which are also the two other regions where costs are highest, namely south-east and east, are not anomalously high. My conclusion therefore is that either the effect of area cost adjustment on the south-east and east regions is leaving them with too little, or the effect of it on the London region is leaving it with too much. I do not know which of those is the case, but I think one of those must be. The real anomaly is not that London is an outlier but that London is an outlier and east and south-east are not. That is an anomaly that remains to be explained and if the Committee were interested in trying to explore it further with expert witnesses, I think that would be of considerable interest.
51. We do not have details of the new system yet, and we will learn more about it later this month, but if it is going to avoid, in your view, some of the reasons that the SSA has lost all of its friends, what key features must the new system have if it is to have a home and starting with friends and retaining friends?
(Professor McLean) There are two ways that Government can go. It may sound paradoxical, but one way is to get a more refined formula and the other is to get a more coarse formula. You could get a more refined formula perhaps by trying to get more objective evidence about the factors that cause a local authority to have to spend money, and there is ongoing research in ODPM and a number of other departments on indices of deprivation. That would be the finer approach. You would have to develop an approach whereby the relevant index of deprivation was built up from census data, not from returns by the local authorities. That would get away from the circularity effect. The coarser approach would be to go for something like inverse GDP applied at the level of the region; so instead of going below the local authority, you would go above the local authority. Then, maybe not at this time but in five years' time, you would say to each region, "This is the region's allocation of public spending." I notice that in their written evidence that is what the North-West Development Agency asks for. It would then be up to the region to allocate it to its local authorities. A problem there is that they would then face the same problem as the present Government faces.
52. Surely, to overcome some of the crudeness that has arisen in the SSA system, what replaces it needs to get more refined or complex, rather than go the other way, does it not?
(Professor McLean) There are pressures in both directions. Mr Beard rightly said earlier that one of the reasons SSA has no friends is that it is impossibly complex to understand, and if you make it yet more complex, it will not gain any friends by that route; and yet you might have to make it more complex to make it fairer, if you go down the finer route.
53. The system that was felt or seen to be fairer might have a chance of having friends, even if they did not understand how the friends came about.
(Professor McLean) It might.
Mr Tyrie: That is a very optimistic view.
54. Can I ask you a simple layman's question, following some of this technical analysis. If the Chancellor asked you for a quiet drink down at the pub and said to you: "I have been very convinced that the whole way in which we distribute money within the region within the UK is very unfair. I would like you, from what you know, to develop a perfectly fair system and I am going to set up this inquiry and have you go away and do that; however, please tell me before I set up this inquiry the brutal final result that we are likely to get in terms of which areas and nations within the UK are going to lose, and which will be the big gainers." Without going into the methodology, what advice would you give to him?
(Professor McLean) I think first of all we would have to go to a quieter pub than the Red Lion because it would take a very long time to give an adequate answer to that question. If I can attempt to give an answer, I would say that the answer would depend on how much fiscal autonomy one gave to the territories. If one gave fiscal autonomy to every one of the 12 territories to some degree, and equalisation authority modelled on the Australian Commonwealth Grants Commission, as I commend in my paper, ten you might achieve a settlement that was regarded as fair by all, especially if you had a back-up, a publicly known default, if the parties failed to agreewhich, in my paper I propose should be inverse GDP.
55. Who would be the big gainers and losers?
(Professor McLean) Compared to where we are now, Scotland would be a loser, at least if this were implemented in the next five to seven years. Northern Ireland would be a loser if this were implemented in the next two or three years. Do not trust these numbers too much, but those would be broadly the points at which they go below needs when continuous in operation. Whether London would be a gainer or loser I just cannot say at the moment because a lot depends on the data. We just do not know whether the London data in particular proves what it seems to prove. If in particular the AOS cost-of-living numbers are right for London, then London would be a loser also
56. Who would be the biggest gainers?
(Professor McLean) It looks like the north-east on this table. Looking at the most up-to-date version of my table, the rank order would actually be the south-west; the south-west has overtaken the north-east as the biggest loser region, followed by East Midlands, followed by north-east, followed by West Midlands, followed by Yorkshire, Humberside, followed by north-west, followed by the English regions.
57. I shall suggest to the Chancellor that he has that drink with you, and then Mr Laws would be one of his most enthusiastic supporters! Is there at present in the Government any mechanism that assesses regional needs, across departments or within them?
(Professor McLean) The short answer has to be that there are not. Departments are working on such measures, but there is no cross-departmental index. Within ODPM I think there is not even a "within departmental" index as yet because ODPM as it is now is itself an amalgamation of many different units, and there are people looking at areas of deprivation and people looking into urban policy. Over at Defra people are looking at rural policy. They all have their indices, and there is nothing like an overall index that I have yet observed in government; nor does the Treasury have one.
58. So if one looked at a region like mine, which happens to be the north-east, it performs poorly under the indicators where human capital formulation is not good and educational under achievement historically is bad; yet, although it has higher than average spending it does not seem to have spending that corresponds with its needs. Is there any mechanism that exists now within government that could, if we just trusted it and let it get on with it, reduce those inequalities and raise that performance?
(Professor McLean) Unless you trust the SSA for education in that case, my answer has to be "no".
59. I would like to press you on a couple of points. Are there lessons we can learn from other countries about distributing public expenditure across the regions? The examples you have chucked at us in the paper tend to be federal countries. Are there any other unitary authorities/federal, whichever system we are now in, that have looked at this and come up with some answers?
(Professor McLean) Some specialists say that the French system is one to emulate. I really do not know whether that is correct or not. I would only warn that the French system of government is very different from ours, although both are broad unitary countries. There is a tradition in France that has no equivalent in this country of the local spending being settled by the mayor and the prefect of each regional city, when the mayor is also very likely to be a member of national government. I would be chary of drawing lessons from France, but that is one of many countries in which I am not a specialist, even though, like at least Mr Plaskitt and probably others round the room, I have had to each the politics of France in my time. However, I am pretty rusty on that. I am more confident talking about Germany, Australia or Canada, simply because of this matter, that I know more about them.
Chairman: Thank you very much. That was a fascinating start to our inquiry.
4 Note by witness: In fact, the South-West remains the second biggest `loser' region compared to an inverse GDP standard. The North-East remains the biggest `loser' region. See Ev 9. Back