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|©Parliamentary copyright||Prepared 30th March 2011|
Publications on the internet
UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE
This is an uncorrected transcript of evidence taken in public and reported to the House. The transcript has been placed on the internet on the authority of the Committee, and copies have been made available by the Vote Office for the use of Members and others.
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Mr Andrew Tyrie (Chair)
Mr Andrew Love
Mr David Ruffley
Mr Chuka Umunna
Witnesses: Jonathan Portes, Director, and Ray Barrell, Director of Macroeconomic Research and Forecasting, NIESR, Stuart Green, Chief UK Economist, HSBC, Roger Bootle, Managing Director, Capital Economics, and Simon Hayes, Chief UK Economist, Barclays Capital, gave evidence.
Q1 Chair: I am very sorry to have kept you all waiting, but we had some committee business that we had to sort out. I would like to begin-I do not know who has his papers best prepared so far-by asking all of you, and maybe I will start with Roger since I think you’ve been before us more than any other member of this panel, so you’re the right man for it: is this a Budget for growth?
Roger Bootle: I am pretty sceptical, actually, that the Budget will do much to alter the growth profile, and there are two issues. Growth in the short-term is all about aggregate demand and not about supply potential. In the medium-term, it is about supply potential, not about aggregate demand. As far as the contribution to aggregate demand is concerned, the direct contribution is nil because the Budget is effectively neutral. I do not think it is to be criticised for that, but one just has to recognise that it is not directly doing anything at the macro level to boost demand; arguably it could be boosting demand indirectly by helping to keep interest rates and bond yields low and by boosting confidence but I’m very sceptical myself as to what all that’s going to contribute.
With regard to the medium-term supply side stuff, I thought it was quite instructive that the OBR did not choose to alter its projection for the sustainable growth rate of the economy on the back of these measures. I thought many of them looked to be very sensible, good things to do, but if it were possible for Chancellors to raise the sustainable growth rate of the British economy by a series of measures like this presumably it would have happened a long time ago.
Q2 Chair: You would not have expected the OBR to come out with a change in nominal growth forecast on the back of a package of measures from one Budget would you?
Roger Bootle: I would not have expected them to because I don’t think the balance of evidence, historical evidence, supports the idea that Governments can very easily alter the potential growth rate.
Q3 Chair: So, with due respect, your judgment that they did not alter it does not tell us very much.
Roger Bootle: I would not quite say that. I think it is a statement of what I would want to say anyway that I think most among us would be inclined towards because they are sceptical of Government’s ability to influence.
Q4 Chair: Can we pursue that, moving to the left? The key issue then is whether we have some genuine supply side measures that over time might alter the long run growth rate. What do you think, Mr Green?
Stuart Green: I tend to agree with the previous comments in the sense that it is not the Governments would not have thought of making these measures previously. Corporation tax, and so on, the encouragement of research and development expenditure, all very much to be welcomed, but in terms of the short-term outlook for growth, the Budget would be effectively insignificant. It is very slight tightening of the fiscal stance over the next five years.
Q5 Chair: I am asking about the supply side changes.
Stuart Green: In terms of the assessment of the potential outcome for the economy, these measures are uncertain. They tend to happen over three or four years and I would not have expected, if I had a chance to see these measures before yesterday, the OBR to change their opinion of the supply side potential of the UK economy because-
Q6 Chair: What would you have done that might have altered their assessment? If you had been Chancellor, what is the supply side measure that you would have done that might have elicited the outcome that you have just said is your measure, which is that the OBR ought to have that assessment?
Stuart Green: Well, perhaps one of the ways that they could improve the supply side performance of the economy and boost potential growth over the medium-term would be to try to increase labour market participation breaks. This is a very favourable development both from fiscal policy and also from monetary policy. If we can get more people into work force, our fiscal position improves, potential output improves as well. So the measures that were aimed at youth unemployment, which has reached a very concerning level, they are to be welcomed, say, perhaps more of these measures, perhaps more targeted tax cuts to get people back into employment, but these measures take time. There is a structural trend towards declining labour market participation because of ageing-
Q7 Chair: Targeted tax cuts to get people back into employment. Paid for?
Stuart Green: Well, you could argue these measures will pay for themselves over a prolonged period.
Q8 Chair: You would argue that we should have departed from fiscal neutrality, increased the budget deficit and argued that there would be a supply side gain later?
Stuart Green: I would not say that you have to depart from fiscal neutrality to get that.
Q9 Chair: So where are you going to find this money for these measures?
Stuart Green: If your duty escalated, for instance.
Q10 Chair: Keep petrol prices the same, but do spend the money in the labour market?
Stuart Green: Potentially.
Q11 Chair: I am just trying to get a feel for what exactly you think on the supply side should be done.
Stuart Green: I think that very much the labour market should be a focus in the near term. If there is labour market response, it would help the Bank of England, for instance, keep interest rates at a lower level for a longer period. I think that would be a solid step that the Government could take that would help to improve supply side performance. It will not happen overnight. It would cost money, but I think that the measures that were outlined in that document yesterday-the measures aimed at reducing youth unemployment-could well be the most beneficial in the medium-term.
Q12 Chair: Parting from fiscal neutrality would have led to upward pressure on interest rates, would it not?
Stuart Green: I’d say that there were measures announced yesterday that may not be taken. That money could have been diverted to other areas. A very small movement in the fiscal position, I think, would not have made a major difference to the outlook for the Monetary Policy Committee.
Q13 Chair: But it would have made a major difference on the supply side?
Stuart Green: I think it would have helped.
Chairman: Okay, Simon Hayes.
Simon Hayes: I think in the context of fiscal neutrality, you are not going to get very much, I do not think, but I think some of the measures made sense in terms of it’s a bit of a gamble. For instance, regional enterprise zones, you may just end up financing activity that would have already happened; you may end up with some white elephants on your hands, but I think that regional rebalancing is really crucial for the economy over the next few years. One of the biggest concerns that I have is that the geographical mismatch between job losses and job creation and coupled with the housing market, which just is not functioning very well at the moment, means that you could end up with still high unemployment but high waged work as well because you’re not getting the pressure on wages that you should be getting from the degree of unemployment. I think it is extremely important to try and address that regional problem. You have introduced some measures that, fingers crossed, will do it. I am kind of sceptical that they are likely to be big measures because, as some people have said, if they were that successful, we would probably have done them in the past and they would already be known to be successful types of measures. I think it was, within the context of fiscal neutrality, worth trying.
Q14 Chair: If I may say so, so far we have had, "It’s all very difficult. It’s not going to make much difference. Governments can’t do it anyway, but a bit of tinkering is no harm".
Simon Hayes: Absolutely, and in the context of fiscal neutrality, which is the overarching concern, I don’t really see that you can expect anything more than that.
Chairman: Okay, Jonathan Portes.
Jonathan Portes: I agree with a lot of what Roger and Stuart have said, but I do think that Governments can make a difference, both positive and negative.
First, I think we should remember that growth has been quite good. If you look at the 1997-2010 period, growth in the UK, GDP per capita was better than any other G7 country except for Canada. I think it is just bizarre that this document the Treasury published yesterday does not have a single chart that shows UK growth performance or compares it with other countries, presumably because they did not want to paint the past 13 years in, actually, a relatively positive light.
Our research, mostly done by Ray, shows that this was mostly due to improvements in skills, labour market flexibility, which of course was very much the product of the last 20 or 25 years, not just the past ten years, the strength of UK higher education institutions and competition policy, all of those are the results of government policy over the last 20 or 30 years. Equally, the things that economists agree on that have restrained growth in the UK, the long tale of low-skilled workers, planning restrictions and poor management are also, to a large extent, the product of policy for the last 20 or 30 years.
On the specific measures in this Budget, I agree with Stuart about youth unemployment. Considerably more could have been done. On your question about how much you have had to spend on fiscal neutrality, it depends on the programme, but I would point to the cancellation of the education maintenance allowance, where the Government deliberately chose to cancel something that independent research evidence suggests had a significant impact, with improved participation rate and improved qualifications, and paid for itself over the medium to long term. That is something which some pretty solid research shows not to have any significant fiscal cost, maybe a benefit, but the Government chose to cancel it, and that is really shooting yourself. That is an example of how not to do it.
What’s good? Turning to this Budget, what are the good and the bad points? On planning, I think it is very good that this contradiction between the Government’s commitment to localism and to a business-friendly planning environment seems for the moment to have been resolved in favour of the latter. The commitment of shifting the burden of proof in favour of development I think, potentially, could have a positive impact on growth. I think we should also note that the last Government said the same thing, but failed to deliver.
By contrast, enterprise zones, I suspect, broadly have the result of spending Government money in order to shift economic activity around the country rather than to create anything new. And there are two measures in the Budget-
Q15 Chair: You are supporting that view with evidence, are you?
Jonathan Portes: Enterprise zones? Well, that is the experience of the last lot, mostly, and experience of regional policy and selective tax breaks in this-
Q16 Chair: You have done the work on that, have you? You will send us something to support that.
Jonathan Portes: We can send. I mean it is not all NIESR work by any means.
Chairman: Okay, sorry to interrupt. Carry on.
Jonathan Portes: I think there are two measures in the Budget that certainly exacerbate economic distortions and hence may make things worse over the long run. House prices in the UK are too high. It has all sorts of damaging economic and social impacts, and the main impact of giving financial help into first-time buyers is to pump extra money into the demand side and hence to boost house prices. That is the last thing that future first-time buyers, or the economy as a whole, needs.
Second, the fair fuel stabiliser: this just seems to contradict what the Government and the Opposition have said that they want to do over the long term, which is to reduce our dependence on oil, on petrol-driven vehicles, and to move to a low carbon economy. It will make the necessary adjustment to higher oil prices slower and more expensive. It will certainly not increase, and possibly reduce, domestic oil production. That is what the oil companies say. We may or may not believe them, but it will certainly increase consumption and it will therefore increase oil imports. Policy measures that ensure the UK imports more oil from the Middle East do not seem to be what we need either economically or politically. It also adds to it the general complexity and incoherence of policy on energy and climate change. Again, if you read the stuff on low carbon here, on the various grants, subsidies, price floors, levies, caps and so on, it is impossible to work out what the overall impact is, what the strategy is. Frankly, if you were an investor trying to decide whether to invest in low carbon technology or in electric vehicles, I think you would look at this and not know what to think.
Finally, on regulation, here I think the reality really does not match the rhetoric. The Budget claims to reduce the burden of regulation on employers by over £350 million a year, but we should note that the same analysis that produced those figures suggests that the benefits of the regulations outweigh those costs, so even that is not necessarily a gain. Even if that deregulation was beneficial, the extra employment regulation that Government has imposed on employers that wish to employ migrant workers, the cap on skilled migration, will, using the Government’s own methodology and the Government’s own impact assessment, reduce UK output by between £2 and £4 billion.
Q17 Chair: It sounds as if you’ve already done quite a bit of work on that. This is the migration issue.
Jonathan Portes: This is the migration issue. If you read the Government’s impact assessment and just do the basic arithmetic that the Government did not do, you get a fall in output by the end of the end of the Parliament by between £2 and £4 billion. That is not huge, but that is a significant non-trivial impact on output.
Q18 Chair: Perhaps you could send us that material as soon as possible. It would be very useful to us, bearing in mind we are reporting next week.
Jonathan Portes: Similarly, the restrictions on student visas that were announced, I think, the day before yesterday-again, just looking at the Government’s own analysis-will result in excluding maybe 60,000 perfectly genuine students. At least, that is what the Government seems to be saying.
Q19 Chair: Can I just take you back, unless you have other points specifically on the supply side?
Jonathan Portes: No, I was going to finish on that.
Chair: You seem to have a list of supply side points you wanted to touch on there. There is just one point I wanted to pick you up on when you were talking about buying more Saudi oil and less oil from the UK shelf. These effects are going to be tiny, are they not, the increase in taxation on overall exploration? Have you any evidence to suggest this will make a ha’penny of difference really?
Jonathan Portes: I have very little idea of what the impact on production will be because this is quite a complex tax change and I certainly do not know how the oil companies will respond. It is certainly not going to increase production, but it will increase consumption because we are putting down petrol prices.
Q20 Chair: That is accepted. The NIESR has quite a good innings so far this morning. Do you want to add anything quickly, Mr Barrell?
Ray Barrell: Just very briefly, obviously, there are things I can add. Only on the medium term: how could we raise growth? Well, we can raise technical progress, that’s quite hard; we can raise efficiency, that’s quite hard; or we can increase the supply of labour, and increasing the supply of labour is not quite as hard as we think. For instance, in the manifesto before the last election there was a commitment to raise the retirement age in 2016; that increases the supply of labour; that increases the trend rate of growth. That commitment has been delayed somewhat but could be changed. There are other ways to increase the supply of labour, and in the medium term it’s the supply side that matters. Changing migration laws would help that. So you can increase trend growth by increasing the labour supply.
The other thing that one could do that would increase growth, rather shorter term than that, is much more significant changes in planning legislation. We came out of the 1930s recession with a building boom. That building boom was based on house building. Schemes to encourage, for instance, build-to-let, and also allowing a lot more building, would actually strengthen growth in the very short term. It would be quite easy to stimulate the building industry where there is significant unemployment with significant changes in planning law. There may be immovable objects in the way of those changes.
Q21 John Mann: I will pick up first on these proposals on planning because I am a bit perplexed. Who are the people who are going to invest who have not been investing because of planning law? We are talking supermarkets potentially, but is there anybody else?
Stuart Green: Housing is the traditional focus, on planning legislation and so on.
Q22 John Mann: Okay, separate out housing; is there anyone other than the housing market and potentially some supermarkets, who have not invested because of complexities, delays, barriers through the planning system?
Jonathan Portes: First of all, housing and retail taken together are quite a big chunk of the economy. Second, it is more than just supermarkets. There is certainly research that shows that part of the UK’s productivity shortfall with respect to other countries, European countries and the US, relates generally to distribution and logistics. It is not just supermarkets. It is other retail companies, other manufacturing companies, shifting things around the country.
Q23 John Mann: Have you evidence of any examples of logistics and distribution where the planning regime has meant an underinvestment compared to what there would be? My constituency is the centre of the British logistics industry, and I have not.
Chair: John often raises his constituency at some point.
John Mann: Well, if there were examples I would want to know about them, and I shall pursue that with Government as well, perhaps even this afternoon, but I’m not aware of any. In the north of England, taking my area as an example, we have scores of planning consents for new housing-scores of them. Why are they not being built?
Ray Barrell: May I answer that question in two parts? First of all, if we are looking for places where planning restrictions may have constrained growth that would have been beneficial for the whole country and not just for the region, one can look, for instance, at Cambridge. That is a fine example of a town that could have grown much more rapidly over the last two decades based on its science and technology strengths, but has been constrained by planning regulations and green belt regulations. I am sure, if there was permission to build closer to Cambridge, that permission would be taken up very rapidly indeed.
Now, the second answer to the question: building needs to take place where people can create jobs and where people need houses. That is not always in the places where planning permission has been given. One could strengthen growth, not necessarily by increasing growth in London, but generally at the minute in the south of England, and it would be possible to strengthen growth by allowing rather more building than we have allowed. That would perhaps also increase our capacity to produce high technology goods.
Q24 John Mann: More house building in the south of England. Just look at what the Budget does for manufacturing. Manufacturing has a wide definition, but let us look at advanced manufacturing, technology and engineering. Why would there be more investment-which the Chancellor spent quite a lot of time on yesterday-as a consequence of this Budget, or is the Budget neutral in relation to advanced manufacturing, technology and engineering, Mr Hayes?
Simon Hayes: I go back to my term ‘gamble’, really, in that if you create any sort of enterprise zone that is focused on advanced manufacturing or with any other thing, what you are hoping to do is get the Silicon Valley effect, but more often than not you do not. I think it is worth the gamble, because the measures are not especially expensive. I think it is a good idea to try and play to that. I think the UK does have strengths, relative strengths, even in manufacturing at this sort of level. In the last 10 or 15 years, the bits of the manufacturing sector that have survived have tended to be the high tech areas, so it seems to me a sensible area to attempt to support, but I go back to the point that, whether or not it pays off, I am quite sceptical.
Q25 John Mann: Is there anything in this Budget, though, that changes the potential investors’ decision, Mr Green?
Stuart Green: I would say from the conversations I have had with the manufacturers as part of my role in the bank, the things that matter to them are the stability of the macroeconomic situation. Exchange rates help, probably less than they did so previously because they have less price competitive manufacturing. It is more the sense that there is a long-term commitment to manufacturing in the UK, so they can feel more confident in perhaps bringing production back into the UK that has been moved offshore. So if this does signal a general move towards supporting manufacturing over a sustained period, it seems to be helping the sustainability of the economy and the stability of the economy, that would help. Individual matters, individual policy measures, I would say, to manufacturers, are less important than the prospect of sustained support over the coming years because these people make decisions over the course of years, decades, rather than just one or two measures in the Budget.
Q26 John Mann: In relation to employment, the OBR does not seem keen to build in who the new projected jobs are to be for, and it does seem to me that is rather important. Of the jobs that they are expecting to be created, how many are going to be for new migrant workers coming in, and how many are going to be semi-retirements, delayed retirement, even coming out of retirement back into work? It does seem to me that knowing that is rather important, and they seem reluctant to do that. Has it even got that kind of analysis? Does anyone else regard it as useful if they would be able to provide that?
Ray Barrell: It is actually quite difficult to produce that analysis because at any point in time the number of jobs being created in the economy gross is very much larger than the net number of jobs being created. One would need a detailed study of the sort that the OBR probably do not have the capacity do. However, one can say in relation to the migrant comment, whatever has been happening recently, some of the patterns of migration we have seen are liable to change once Germany and the other members of the core European Union have to remove their barriers to migration from the new Member States. So we are liable to see many more people from the new Member States flowing to Germany and France and Italy in the next few years than has been the case. That would probably reduce the number of migrants in the UK from the European Union, which you can do nothing about other than let them come in.
In terms of job creation, it is clear that the majority of jobs that will be created, net, will go to new entrants to the labour force, but that is an exaggeration of what one might say. One could increase the number of people who are youths and getting jobs by subsidies to youth employment. We also need to skill youths more. It is what we do to make sure the right people get the jobs that matters. There are some measures in the Budget in that direction, but we could do a great deal more on apprenticeships than is currently proposed, for instance. Then the jobs would go to the right people.
Q27 John Mann: Is the OBR right with its projections on unemployment?
Ray Barrell: Unemployment-well, others may comment on this, and sorry to monopolise. I suspect unemployment will rise rather more than the OBR currently suggests; however, we have always been rather more optimistic than the economic commentator average on trends in unemployment. We expect unemployment to rise by 200,000 to 300,000 more than they do in the next six to nine months and then start falling. However, in the long term, unemployment is liable to be scarred by this recession as it always is. We are liable to see the sustainable level of unemployment lift above the number they have given, and settle at 6% or so. They have a rather optimistic projection for long-term unemployment because they are not necessarily taking into account all the evidence we have of the loss of skills from long periods of unemployment, especially for youths and those without particularly high skills.
Q28 John Mann: My last question, probably, Mr Green, you would be well positioned to answer. One of the things that have not happened yet is the public sector job losses. They are going to be happening pretty much April onwards. There are different estimates of how many, but I think there seems to be general agreement that the north of England will suffer more than the south and London, and significantly more. There will be some particular hotspots. It is not just job loss. It is also job relocation. For example, tax offices moving to cities from market towns, which is happening substantially. Social services departments are being amalgamated, usually in larger towns. There is a second trend going on there. One of the dilemmas for Government is going to be what happens to the high street, because in these market towns, of which there are many in the country, the private sector that could grow the quickest are the sole traders and small traders, the high street people, but they might be the very ones who suffer adversely from the loss of public sector income in terms of spend and also this relocation factor. I wondered what you thought about that. That is something that concerns me greatly. It seems to be something that simply was not recognised in the Budget as being a problem; therefore, there was nothing in it to address the issue.
Stuart Green: Firstly, on the issue of public sector employment, there has been a decline over the past year, which I think was larger than the OBR was forecasting. This, I think, is a function of the way the OBR does its forecast in the sense that it takes the expenditure limit, make a variety of assumptions for wage growth. It is just an aggregated process. It very much depends on individual departments’ turnover of staff rates in those various areas. Those forecasts from the OBR are nothing more, I would say, than a broad guideline, because of the complexity of taking these issues.
It is very right to say that certain areas of the economy are more vulnerable to this than others. Areas that did not show any growth at all in private sector employment in the 10 years to recession, there were two or three of them in terms of broad regions. What also concerns me with these regions is that the overall employment rate is somewhat lower, so it is not just a question of public sector job losses in these areas. It is the fact that employment generally is quite low, so one public sector job loss in that area would hurt more than one public sector job loss in different areas.
In terms of Government strategies towards this, it is a concern. The regional enterprise zones are probably a nod in this direction, but in terms of forecasting this, and the impact on the economy, to get down to this sort of regional level, I would say that is outside the scope of the OBR’s capabilities and remit. This is probably more a political issue than something for the OBR, but what I would say is that there are certain areas of the economy undoubtedly more vulnerable.
Roger Bootle: I just briefly wanted to comment on this question about unemployment. One of the reasons, I think, why private sector job losses have not been greater is that we have not yet seen the full impact of the squeeze. I do not just mean the public sector squeeze; also, the squeeze on consumer real incomes. This is a vulnerability in the OBR’s forecast. It is quite noticeable that consumption, although it’s weak in the forecast, it is nothing like as weak as it could be. Our own forecasts are much weaker. This is particularly sensitive for the unemployment issue, because a large number of people in the private sector are employed in consumer-facing activities, retail and support activities. That is where I suspect the outturn will be weaker for unemployment, if that indeed does happen.
On the regional aspect of all that, my suspicion is that that will be fairly well spread across the country. I cannot imagine that, if we have substantial job losses in consumer-facing activities, in the retail industry in particular, that would be concentrated in one area rather than another. It can be all over the country.
Q29 Mr Umunna: I just wanted to ask you all a bit about contingency planning. Jonathan Portes, in the Financial Times, you wrote this article earlier this month where you referred to the claim that had been made that, if the Government did not stick to its original plan for fiscal consolidation, it would lose market confidence. Then you went on to say, and I might as well just quote you, "This is not a justification, economic or otherwise, for the policy. Instead it is an argument for never changing policy at all." You go on to say that it relies on "an odd view of market psychology, one that says markets have more confidence in governments that never adjust policy, even when it is sensible from an economic perspective to change course" and you say that you do not think this is plausible.
HSBC and B arclays are two of the biggest players in the market. Do you agree with Mr Portes, Mr Hayes?
Simon Hayes: I think that the necessity of a plan B is pretty obvious to me. It is certainly true that, so far, we have seen the UK government bond market remarkably insulated against the concerns that have blown up elsewhere about sovereign debt. That is not just in the fact that 10-year bond yield is at 3.5%. We have looked in detail at the debt auctions that we have had over the last year. People were very worried that, when the Bank of England stopped its QE purchases, the private sector would be faced with an unprecedented amount of gilts to absorb and it would not be able to do it. In actual fact, we have seen very few signs of stress in the gilt markets. You could not tell by looking at these charts of normal stress indicators that this is an unusual period. All of that just really establishes where the Government is in terms of the markets is that they have a late market fit. The question is whether then deviating from this would lead to a sudden deterioration in that situation.
Certainly, you could have made the case last year when the Coalition Government introduced its additional tightening, which was twice as much as the previous Government had, that was the time really, if you were going to do less fiscal tightening, that you may have done so, instead of doing an extra £40 billion tightening. My view is the financial markets would have been content with that. You would not have lost your AAA rating and we would have been in a similar situation to where we are now.
Having set out the plan, we are where we are. I think it is a more difficult judgment, because financial markets are concerned when there are shifts relative to where you are. I think they set a relatively high threshold for you changing your plan. From talking to investors, particularly overseas investors, who look at the UK economy and are very concerned about its medium-term prospects and tend to be more downbeat about growth prospects than domestic forecasters are, I would say a lot of this is factored in anyway and there is a broad expectation that, actually, growth may not be as strong as the OBR is forecasting, that the deficit is not going to come down as quickly as the Government is projecting. I think there is some wiggle room there to have some degree of leeway on the plan, at the very least in terms of timing, so you may stick to the plan in terms of your budget, or you smooth it through that you do a bit less this year and you plan to do a bit more next year. I do not think that those sorts of changes will be a problem.
Q30 Mr Umunna: Mr Green, where are you on this?
Stuart Green: I broadly agree with those comments. Last June, it wasn’t clear that the additional tightening, the extent of that, was ultimately required, but it is a very imprecise area and I would really emphasise the lack of precision in knowing just how much was required last June to keep the markets ‘onside’, if you like. We have never subscribed to this opinion there was a genuine default risk in the UK. The UK is a genuine sovereign. It has multi-policy autonomy, flexible exchange rates. These things definitely help and it differentiates itself from the eurozone. Possible one of the reasons that the UK bond market has looked so solid is because of the difficulties that are developing in the eurozone. The UK may be seen as a safe haven now.
Q31 Mr Umunna: What about this changing course if necessary? Do you think that the Government would be punished for doing so?
Stuart Green: I agree with Simon in a sense that there is a broad that they may have to, that some of the growth forecast further out looks slightly optimistic, that the evidence of previous fiscal consolidations in growth may not be as applicable today as it was previously.
Q32 Mr Umunna: So is it fair to say that it would be unlikely that the Government would be punished if it changed course?
Stuart Green: Just as it was imprecise in terms of knowing how much tightening was required, it is not certain how much slippage would prompt markets. At this stage in the cycle, it is important to stick to the course.
Q33 Chair: Could I just ask if Roger Bootle could comment on that as well?
Roger Bootle: Yes, I have views on that. For a start, there is a big difference between an increase in borrowing, borrowing coming down less fast than the plan, because the economy has turned out to be weaker, and on the other hand its coming down less fast because the Government has somehow or other backtracked on some of its measures that it has announced. These two are not the same at all, and the market would react differently to them. I think the market would be comparatively forgiving if growth turned out to be slower and therefore borrowing came down more slowly. What the market would be worried about, rightly in my view, is a political sea change, a loss of nerve, because the problem would be people would wonder what the end to all this was, and the market would lose confidence that the deficit would come down at all.
Q34 Mr Umunna: Of course, Mr Portes’ hypothesis was based on the need to potentially change if growth continued to be sluggish. He would no doubt correct me, if I am wrong. I just wanted to ask, Mr Portes, were you asked to advise on alternative fiscal approaches in the event that growth was more sluggish than the Government imagined when you were at the Cabinet Office?
Jonathan Portes: I am not going to speak about what I advised when I was a civil servant. I am speaking here in my role as director of an independent research institute.
Q35 Mr Umunna: Well, that kind of answers. I cannot really go any further with you on those questions, I suppose. Just on what an alternative approach would look like and contingency planning, what would your plan B look like?
Jonathan Portes: Well, I think what we have said is that the core should have been changed now. NIESR has been saying for some time-indeed, before I arrived at NIESR, so we have a clear and shared view on this-that we would have both delayed the fiscal consolidation and shifted the emphasis away from spending cuts to, if necessary, somewhat more in the way of tax rises, so we would both have pushed back from fiscal consolidation and shifted the emphasis somewhere.
Q36 Mr Umunna: Would you implement that now?
Jonathan Portes: Yes.
Q37 Mr Umunna: Going to you, Mr Bootle, you were just saying, obviously, the markets would react according to the situation. Let me just take the second scenario presented that growth was sluggish. What, for you, would a plan B look like?
Roger Bootle: I think there are a number of options. For a start, there would be I think quite a strong political priority for this Government in sticking to its spending plans. That does not necessarily mean, however, that it has to stick to the announced path for the deficit. In their circumstances, I would have some as it were emergency tax cuts that would be available to enact, while still sticking to the overall plan for spending. Because there is still a distinction in the Government’s thinking and in the numbers between current and capital spending, I would also have what I think is called in the jargon ‘spade-ready’ investment projects on the books, which could be enacted and put into operation, without therefore harming the objectives for the current budget deficit. Of course, there is, in the background, the possibility of more QE. In those circumstances, I think it would be right to expect the Bank of England to do more QE.
Q38 Mr Umunna: On that, one thing that I suppose the Chancellor has said is that, if growth is sluggish, he needs to stick to his fiscal mandate to allow the MPC maximum flexibility to loosen monetary policy. In your view, if the outlook for inflation is as per consensus forecasts for this year, do you envisage the MPC having any room to further loosen monetary policy this year?
Roger Bootle: If inflation turns out as the consensus thinks it is going to this year, I would be very surprised if the MPC has the scope to do more QE this year, but in a sense the more important question is going forward. The issues about "what inflation?" can turn out to be much more live and valuable a discussion about next year and the year beyond. For that period, the Bank surely would have the scope to do more QE.
Q39 Mr Umunna: If I could just ask a final question, which is slightly different from the others, you referred to the plan for growth, Mr Portes. One of the provisions that has been included in there and has already obviously been pre-announced is to scrap the planned extension of the right to request flexible working to the parents of 17-year-olds, in addition to scrapping flexible working requests for those who want time off to train and what have you. Perhaps I will just start with you, Mr Portes, since you referred to that green book. Is there any evidence to suggest that doing either of those things will boost GDP and will actually provide a big benefit to business?
Jonathan Portes: No, I have read the impact assessments-
Mr Umunna: Me too.
Jonathan Portes: -for both of the Government’s own economic assessments of these policies. The first one that you referred to, flexible working for parents with children aged 17, is as you would expect very small. It has small cost to employers and small benefits to parents who use it. The benefits are assessed as outweighing the costs. Now, of course, you could argue with the calculation of either the cost or the benefits, but either way it is pretty small. The costs to employers, I believe, are £2.3 million. The time off to train one is somewhat bigger. Here, again, the benefits outweigh the costs economically quite significantly, but there are quite significant costs to employers, so if you care more about costs to employers than benefits to the wider economy, maybe you think scrapping it is a good idea. Certainly, the Government’s assessment of the costs and benefits suggests the economic benefits of the time off to train outweigh the economic costs by quite a large margin. As I said in my opening statement, even though that is quite a lot bigger, it is still nowhere near as big as the cost to employers in the economy as a whole resulting from restrictions on skilled immigration.
Q40 Mr Umunna: Given what you have just said, is there any economic rationale whatsoever for including that in a plan for growth?
Jonathan Portes: Well, let me say first of all that my view, my personal view, is that scrapping these two measures will do nothing for growth and may, as the assessment says, even harm it, but there are perfectly respectable economic arguments. If an economist said, "Employment regulation is damaging, these costs have been underestimated and the benefits are not as big; therefore, this would be marginally good for growth", that would not be a stupid argument to make, and I do not want to say that anyone who made it was necessarily wrong. Certainly, my assessment, and indeed the assessment of Government economists, is that this will be, on balance, marginally negative for growth.
Q41 Mr Umunna: Okay, let us just have quickly the view of business on this. Mr Green, what is your take on this proposal to scrap the right to such work? You may, of course, work flexibly yourself.
Stuart Green: I work as long as I need to, if that means flexibility. I do not have a strong view of this measure.
Q42 Mr Umunna: Do you see this measure contributing to GDP in a big way?
Stuart Green: I would not make reference to it, if I changed my GDP forecast in the next few weeks.
Simon Hayes: The only reason I can think of for thinking that this may not be a bad idea would be if you are trying to create a general impression of an environment that the UK is rolling back on costly legislation, but it is a scattergun, broad brush thing in terms of the individual cost-benefit analysis of the information, so it does not seem likely.
Q43 Mr Umunna: Is it a bit of a gimmick?
Simon Hayes: It seems to be designed to be part of a package of measures to create an impression, which may well be the right impression.
Mr Umunna: You are being incredibly diplomatic, Mr Hayes.
Simon Hayes: Thank you.
Q44 Chair: I do not mean this undiplomatically, but Mr Portes, you were involved for a long time in the design of some of those schemes, were you not?
Jonathan Portes: Well, as I said to Mr Umunna, I am not going to comment on the detail of what I may or may not have advised. I worked at the Department for Work and Pensions, which was not directly responsible for employment regulation. The DTI and its successors were, but I certainly was involved and discussed a number of these measures during my time, yes.
Q45 Chair: Simon Hayes, I just want to come back to something you said earlier. You surprised me a little when you suggested that the benefits in the markets were zero for the second half of the tightening that was undertaken. Correct me so far if I have anything wrong.
Simon Hayes: Zero would not be exact, but-
Chair: I thought you said there would not have been any difference in the markets. I wish I had written it down, but it was words to that effect.
Simon Hayes: What I would say, for instance, is that, to the extent that the Government’s objective was to retain the UK’s AAA rating, I think that could have been achieved with £20 billion more tightening rather than £40 billion.
Chair: That is not relevant, is it? I mean that is just an arbitrary yardstick. What counts is what the benefit in the long bond yield is.
Simon Hayes: Well, you can discern-
Q46 Chair: The long bond yield has improved. If you had done £20 billion less tightening, do you think there would have been exactly the same long bond yield?
Simon Hayes: No, but-
Chair: So it will have had an effect.
Simon Hayes: You can discern the effect on bond yields of the high deficit, but it is tens of basis points, not percentage points at the moment, so they are a bit higher now than they would have been had we not had such a large deficit. If you had not had this deficit plan, they would have been a little bit higher still, but I think in the grand scheme of things what you are trying to avoid is that trigger point where they leave, and what I am saying is that that extra £20 billion-
Q47 Chair: What is the debt stock-£1 trillion or so?
Simon Hayes: Roughly speaking, it is.
Chair: So a few basis points on £1 trillion is better than a slap in the face with a wet fish, is it not?
Simon Hayes: Clearly, there are costs, but there are costs to the deficit reduction plan as well. I am not sure the right benchmark is to say, if you deviated from this plan, you will be paying one or two percentage points more or even more than that on your debt.
Q48 Mark Garnier: I just wanted to carry on, if I may, with Mr Hayes and Mr Green, on the UK gilt markets. You just said the UK gilt market is worth about £1 trillion. Is that right? Yes, that is right. We know that it tends to be quite a long dated market, but how much of that market is maturing each year?
Simon Hayes: I must admit, I do not have-
Jonathan Portes: I think the average maturity of the dead stock is about 11 or 12 years.
Ray Barrell: Yes, it is a very long period of stock.
Q49 Mark Garnier: It is, but what I am particularly interested in is how much of it is maturing each year, because of course that has to be refreshed by issuing new gilts to replace it? Would you agree?
Simon Hayes: And gross gilt issuance for the coming year, I think, is back to £160 billion.
Q50 Mark Garnier: Okay, so that includes, what is it, £145 billion that the Government wants to borrow in order to keep the lights on effectively, plus an extra £15 billion or so that needs to be refreshed in terms of short-dated coming into maturity, and then going on? Is that right?
Simon Hayes: That sounds low actually, but I must admit I don’t have those figures in my head.
Q51 Mark Garnier: It is a very important figure, because as you know the key thing is, once the gilt has, and you are well aware of this-
Jonathan Portes: The figures are here.
Ray Barrell: Redemptions are about £50 billion.
Jonathan Portes: Gross gilt sales were guessed to be about £169 billion.
Q52 Mark Garnier: £169 billion. Of course it does not matter what the yield is on existing issue bonds because it is not going to change what the government is paying on them, but the new stuff coming through is obviously very important. I think just after the election the 10-year yield was just a shade under 3%, if I remember rightly. Now, this morning, it is 359 basis points, so it has clearly gone up. How important is a relationship between the UK 10-year yield and the German 10-year yield and can you comment on how that has changed over the last year or so, Mr Green or Mr Hayes?
Simon Hayes: I think the key point about that is that it has not risen. In fact it has come in.
Mark Garnier: So it has narrowed.
Simon Hayes: It has narrowed a little bit.
Mark Garnier: Which shows relative confidence in what is going on in the UK economy and the Government’s approach to the deficit reduction plan.
Simon Hayes: Yes.
Q53 Mark Garnier: You would say, okay. If interest rates were to go up, what effect do you think that would have on the UK government spending?
Simon Hayes: When you say interest rates, in terms of gilt yields or interest rates in terms of the policy rates?
Mark Garnier: In terms of gilt yields and, therefore, what the Government will then have to issue more gilts at in order to, as I say, sort of keep borrowing 25 pence for ever pound of spending. This is going to be the rate at which it is going to have to spend. If it is raising £169 billion in gilt sales and that interest rate is going up, what effect will that have on public finances?
Simon Hayes: Well, because we are borrowing so much money, it matters a lot more over the next several years. I think the over-arching projection for the next fiscal year is that debt interest will cost about £50 billion. I do not think it is so much about the redeeming bonds; it is more about the net. It is about the deficit.
Mark Garnier: Exactly.
Simon Hayes: It is so big that we are saying, "We borrowed a lot last year and the year before, and we are going to be continuing to borrow huge amounts over the next few years", so that the lower you can keep that marginal yield at the moment, so if it is a 10-year at 3.5%, that is going to make a big difference relative to it being 4.5%.
Q54 Mark Garnier: So is what you are saying that it is incredibly important that we keep the gilt market happy broadly speaking?
Simon Hayes: It would make the situation in terms of austerity and what kinds of measures you would need to do elsewhere that much more difficult if there were a significant rise in gilt yields. I do not think that’s-
Q55 Mark Garnier: It would cause you a problem. Mr Bootle, you said a little bit earlier that you felt that, if there was a fiscally motivated plan B, then the market would probably accept that, but if there was a politically motivated plan B then the market would be quite alarmed by that.
Roger Bootle: That is not quite what I said, actually. I was drawing the distinction between weakness in the borrowing numbers brought about by a change in the economy and weakness in the borrowing numbers brought about by a political decision. On that point, I would like to emphasise that there is nothing mechanistic about this. A lot of people say, "How much extra borrowing would have how much impact on the gilt yield?" The truth of the matter is no-one knows. This is essentially about confidence and about credibility, so a lot depends upon how something is done, when it is done and why it is done. There is, therefore, potentially the scope for a well-enacted, well-justified plan B to be accepted much more readily by the markets; and something that seems to be stumbled into as a panic measure, is put together badly and seems to be token, a rush for the exit.
Q56 Mark Garnier: Would you not agree that this whole argument about the deficit reduction programme is a highly, highly politically driven argument. You have a ferociously aggressive shadow Chancellor, frankly, who is trying to make as much political capital out of this as he possibly can, and arguably trying to divert as much attention away from the legacy of the previous Government, which I think broadly speaking a lot of people would agree was not exactly a golden one. If there was about to be a possibility of a plan B being seen to be driven by a political dust up, the risk to the Government of rising gilt yields would be incredibly important or significant, because at the end of the day, if you start having rising gilt yields, you end up having to issue more gilts and, therefore, you go into a vicious circle. Mr Portes, if you were the Chancellor, do you think that is an acceptable risk, to have a plan B, given the very febrile climate we are in at the moment?
Jonathan Portes: That was a very long and political question or preamble or something.
Mark Garnier: The reason why I ask about that is because, in your opening statement, you made some quite political comments yourself, and I am specifically interested. You made reference to the previous Government and I think you disagreed, broadly speaking, with a number of the policies in the Budget. I am particularly interested to hear your view that, if you were Chancellor, do you think it would be the right thing to do to have a potential political risk at a huge cost?
Jonathan Portes: Let me just first respond to your suggestion I made a political comment. I just made comments on my views on the policies that were in the Budget. The two policies that I singled out as being particularly harmful, the fuel duty stabiliser and the subsidy to first-time buyers, the first one appears to be broadly endorsed by the Opposition and the second was really a tweaking of what the previous Government said.
Mark Garnier: I think you indicated you had your own concerns as well.
Jonathan Portes: My criticisms on that implicitly extend across the political spectrum. In response to, what I would do if I were Chancellor, as I said, it’s not for us a question of a plan B. We think that the current plan A is wrong. It is that the pace of fiscal tightening is too quick and is unbalanced. If we were Chancellor-I will pass over to Ray in a second-we would have a different plan that we believe would lead to higher growth, higher employment, be clearly fiscally sustainable. I quit agree with Roger that a bad plan that is incoherent and is poorly presented is likely to lead to a fall in market confidence.
Q57 Mark Garnier: My question is more about the risk. I would not necessarily disagree that there are other plans that people have. We will have to take it as read that some people will think their plans are better than others, but my point is this: it is the risk that goes with changing plan, the risk to the economy and the risk to the public finances that, if it perceived as being a political change, for one reason or another, it may well have dire effects on the public finances.
Jo nathan Portes: I think Ray just wanted to say something. I just want to say what I said in my FT article, which is that failure to change a plan in the face of changing circumstances is unlikely to increase market confidence. My view of the previous confidence crises that I have had some involvement with-the ERM back with Andrew in 1992; Argentina in 2001-is that actually credibility and confidence is undermined by failure to change your plan to adopt your policy to changing circumstances. As Keynes said, "When the facts change, I change my mind. What do you do?"
Ray Barrell: May I? It is just a comment on the core issue of confidence and the spread on gilts. The important spread is the spread over the German bond yield, because many other things are affecting the yields everywhere. Obviously, that spread depends on what happens in Germany as well as in the UK. The spread over German yields would have probably peaked in about 2002, reached a minimum in about 2006-7. It is currently slightly above the middle of the range, but the most important thing about it, as far as one can see just by glancing at it, there was no impact on that spread around the time of the election and the Emergency Budget, which suggests to me that the Emergency Budget, which was a tightening, did not affect people’s confidence in the ability of the country to pay off its debts and did not change the default risk on those debts. Therefore, a movement of the same magnitude but in the opposite direction probably would not change people’s confidence.
More importantly, perhaps, changes in the structure of the consolidation would not change confidence. It is relatively clear, according to the IMF at least, that spending-led consolidations are more expensive than income tax-led consolidations; one could easily see a shift of plan to fewer spending cuts and higher income taxes that would both boost growth by, say, 0.25% and give you the same deficit target. The same deficit in the long run means that the market, not only will not lose confidence and you get more growth, but we could also see a plan where there was a larger deficit and the market would not panic. If we see a larger deficit than is currently forecast by the OBR, if that is because of weaker growth, the market will not panic. It did not clap its hands, actually, in terms of the rates of return in June 2010, and therefore it would not slap its ears if there was a slight loosening.
Q58 John Thurso: Roger Bootle, you mentioned the impact of current inflation earlier on. The OBR is forecasting it to peak, I think, in the final quarter of 2011, start to come down in 2012, and get back on target by 2013. Do you think that is a credible set of assumptions?
Roger Bootle: I think it is a credible set of assumptions. I am tempted, though, to refer to Mervyn King’s statement that the central view, a credible set of assumptions of the main body, is most unlikely to turn out in fact.
John Thurso: As he always reminds us.
Roger Bootle: Yes, it is credible. My own view is that, although it is the standard thing to do to assume that inflation comes back to the target, if the forces are in places to bring inflation sharply down next year, and I think they probably are, I doubt actually whether it will stop at the target; we will end up with inflation much lower than 2%. Indeed, I do not by any means rule out the possibility that inflation will be driven into negative territory beyond this blip, as I still think it is.
Q59 John Thurso: That is quite an interesting thought. Does anybody else share that view?
Ray Barrell: May I add something about uncertainty as well as views? I would not necessarily share the view, but I would say that we are uncertain about inflation, and our own forecasts, which are about as uncertain as the Bank of England’s, would suggest that there is about a 90% chance that in 2012 inflation will be somewhere between 0 and 4%. That is pretty uncertain. The average-
John Thurso: That is quite a wide band you have chosen.
Ray Barrell: It is a quite wide band. The middle is 2%, so all sorts of things can sound plausible within that band. There is even something like a 10 to 15% chance that we will see deflation in 2012, but the way I would see the economy evolving-and we do forecasts on a very detailed basis-is that there is some spare capacity. That spare capacity is putting downward pressure on prices.
The factors affecting the high inflation at the minute are relatively clear. When you put VAT up, the price level goes up. That is inflation. Oil prices have risen both temporarily and permanently, one might say. That is a distinction that is not clear in the OBR, as far as I can see. We have seen two oil price shocks: a permanent oil price shock that occurred before anything that happened in the Middle East, perhaps, and then a temporary one, given what has happened in the Middle East. That also puts inflation up. The temporary one, we expect to be reversed, because it is temporary. That will come out of the inflation figures quite soon. The permanent one feeds into the inflation figures for a year or so, but again, it disappears. The factors that are pushing inflation quite so high at the minute will largely disappear by 2012.
Of course, there could be many other shocks. For instance, Saudi Arabia could become a democracy and produce twice as much oil as it currently does, and therefore the oil price could go through the floor. That would be a great shock, but the world is a very uncertain place, so everybody can say anything they like and it is all within the range of possibilities.
Q60 John Thurso: What I am really driving at is: what is the risk from inflation to the Government’s plans? Is it a major risk or is it something that is not actually something we need to be too concerned about? I am concerned about inflation. I just want to know if that is just me being old-fashioned or whether there are real reasons for this.
Roger Bootle: I think there are a number of ways in which inflation poses a risk to the Government’s plans. It is quite striking to see in the OBR’s figures that one of the reasons why government spending is a bit higher than originally thought in the out-years is because of increased spending on social security payments and bond interest payments, or index-linked bonds, as a direct response to higher inflation, whereas the popular view doing the rounds at the moment is that it is in the Government’s interests to have higher inflation and that George Osborne is quietly rubbing his hands. I think this view is completely mistaken.
The impact on revenue and expenditure is a complicated issue. In broad terms, I think it is probably right to think that by and large, it is fairly balanced, although there is a lot to be said for the idea that at the moment this is, as it were, the wrong sort of inflation mirroring the wrong sort of snow. It is the wrong sort because it is coming from abroad, hitting real income, depressing activity and not directly boosting employment income, which is a primary source of revenue for the Exchequer. So there is that factor in the background, but the more important thing, surely, is the extent to which higher inflation really makes it impossible for the Bank of England to maintain very low interest rates for a lot longer. I think that is the biggest threat of all. Given how fragile the economy is, I would judge that to be the biggest risk, in fact, to the fiscal framework laid out by the OBR. That is to say, the Bank of England raises interest rates fairly early and carries on raising them, and the impact of that is big on the economy, and the result of that is obviously much higher borrowing figures.
Q61 John Thurso: I sort of asked Mervyn King vaguely that question when he was last here, and he said that, actually, real interest rates that the banks are paying for money are much higher than the Bank of England rate, so there are a couple of moves that would take up that slack. That is a gross paraphrase of what he actually said, but in other words, you will not really notice it. It seems to me to be counterintuitive that if rates start to go up, the message that everybody takes is that this is not good news.
Roger Bootle: Yes, I am not sure, actually, that in those remarks, the Governor meant to say that if interest rates went up, there would be no impact because it would be absorbed by the lenders. If he thought that, I think he would not be so keen to keep interest rates as low as he appears to be by voting consistently in favour of low interest rates. My own guess is that, as it were, to use that favourite economist phrase, ‘other things equal’, if the bank rate went up, I think we would see most lending rates move up pretty much pari passu; maybe not completely, but pretty much. That is to say, all those factors that have widened the spread between Bank rate and the rate that is actually facing ultimate borrowers would be largely unchanged. So I think, generally, that interest rates would go up.
Q62 John Thurso: Is that a fairly shared view? I do not want to prolong that if you think the same.
Simon Hayes: I think so. I would like to come back to the point about how concerned we should be about inflation. Again, I was very struck by this effect on the public finances, and it seems to me that it is sort of doubly damaging in that people see high inflation squeezing their incomes and real pays falling. And now we have this additional factor, which is that high inflation means that, despite this austerity, the borrowing figures are going up rather than down. I think, in terms of people’s perception of how the macroeconomy is progressing, that is an element that I was not previously so aware of; I knew mechanically that it could potentially happen, but the fact that it is the main driver of the OBR’s forecast really did worry me.
Q63 John Thurso: A different question and perhaps, either Mr Hayes or Mr Green, I will have fun asking you this. Merlin, is it going to make a blind bit of difference to SME finance, or is entirely cosmetic?
Simon Hayes: I think what is important for the UK economy is obviously the degree of business investment, which depends on the degree of business confidence. I think the extent to which business investment in the economy as a whole has been held back because of problems in the banking system is overstated, to the extent that the majority of business investment is by firms who have access to non-bank sources of finance, so I have never thought that that was going to be a significant impediment to a recovery. The impediment to the recovery is a lack of business confidence.
Stuart Green: I would agree. I think that somewhere in the region of 75% to 80% of business investment in the UK is conducted by large organisations. They have greater access to a variety of financing means. Also, one of the things that has changed, probably during the course of recovering from the recession, is that, whereas initially the reasons why in the various central bank surveys and the reasons why spending conditions were being tightened and lending was low was seen to be concerns over credit availability, one of the things we have seen over the past 18 months is demand for loans, which is seen to be low. That could change very quickly. That might turn around business confidence this summer, late towards the end of the year, but again, the evidence from a variety of means is that demand is also very important to supply, so there should be a recognition, I think, that it is not just the supply of credit that dictates business investment; it is also the demand for it. Of course, in the final quarter of last year, we saw a very sharp drop in business investment and that led to a further debate around spare capacity in the economy, and whether businesses really need to invest at a rapid rate over the coming months.
John Thurso: Does anybody else have a view on that? Thank you, Chair.
Q64 Mr Love: Can I go back to this issue of inflation? The Governor of the Bank of England has been coming to this Committee for the last couple of years saying in two years’ time, inflation will be at 2%, so we do not need to change policy. Yet, if you look back over the last few years, inflation has been well above 2%. What should give us confidence, as the OBR and the Monetary Policy Committee are suggesting, that it will reach 2% in two years’ time? Mr Bootle, you seem to be convinced by this argument.
Roger Bootle: Yes, I am very strongly behind the Governor’s view on this issue, while recognising the uncertainties. What should one be looking at? I look at a number of inflation indicators, particularly what is happening in the labour market. This seems to me to be absolutely fundamental. If wage settlements were moving up decisively then I would be concerned. There is some evidence they have moved up a bit, and Andrew Sentence has made, I think, rather too much of this point, not least because the settlements that have shown some increase have actually been multi-year settlements tied to the RPI, so no wonder they have gone up. On the ground, the evidence seems to be pretty clear, I think, that pay inflation is extremely subdued. If you talk to business people, they will confirm this. There are some minor exceptions in manufacturing where performance has been extremely good.
Another indicator I would look at would be what is happening to the monetary numbers.
Q65 Mr Love: Let me pick up on that and perhaps widen it to others as well. This is this issue about persistent inflation, internally generated inflation, mainly through wage increases. Is there not an argument to say that in two years’ time, after two years of wage restraint in the public sector and assuming that growth continues, it may well be that attitudes out there in the labour market will have strengthened towards trying to make up some of the undoubted restraint that has been shown in recent years?
Roger Bootle: It is possible, but I do not think the Government is planning to give up on public sector restraint after two years. It may relax the pay freeze, but the overall environment in the public sector is going to be very tight. The spending numbers make that perfectly clear. Unemployment is going to remain quite high-I personally think higher than the OBR suggests-so there may be a willingness and aspiration on the part of workers to make up for what they have lost, but I do not think it will be very easy to do so.
Indeed, echoing what the Governor of the Bank of England has said about this, the nature of this inflation is quite specific. That is to say, it is the result of a profound change in the terms of trade for the UK at the moment in reaction to higher commodity prices and oil prices, and actually there is nothing that workers can do to reverse that or make up for it. If they succeed in getting higher earnings then inflation will simply be correspondingly higher. Equally, there is nothing that the Governor of the Bank of England can do to prevent the squeeze on living standards that has resulted from that higher inflation. If inflation were forced down by the Bank of England by higher interest rates, then the rate of those increases will be even lower.
Q66 Mr Love: I am interested in this interaction between fiscal and monetary policy. The Governor tells us, when he comes here, that there is no behind-the-scenes discussion about these matters. Do you detect in the Governor’s attitude towards the stance that the Monetary Policy Committee ought to take one eye on the stance, option A, that the Government has taken? Perhaps I will ask Mr Portes or Mr Barrell.
Ray Barrell: Sorry to take this, Jonathan, it is just that I have written on this, and I wrote on it before Jonathan joined us, so I can comment on what we have said. One might say that we are in a situation where perhaps fiscal policy is a little too tight for the optimal monetary policy, and the Governor has to take that into account. We may be in a situation where tight fiscal policy produces a monetary policy that is perhaps too loose, because the Bank has to take account of the developments in the economy and the growth of the economy. It also has to look at inflation expectations. Inflation expectations are rising, and there is case to be made for raising interest rates to try to signal that inflation will be kept under control, but growth is currently so weak, especially in the last couple of quarters, that the Monetary Policy Committee must be nervous about raising interest rates, when many of them feel they perhaps should, I suspect
I think there is a worry on the part of the Bank of England. If I were at the Bank of England, I would be worried about the fact that fiscal policy is not leaving me the space for taking the appropriate monetary policy action, and therefore there are risks that inflation could rise. If inflation expectations take off, as Roger Bootle was saying, inflation will at least temporarily take off. We are in a situation where it looks like oil prices have risen-it looks like permanently-and a $20 oil price rise will reduce the sustainable real wage people can have by about 1%. That has to go into bargains, but we also have to have a monetary policy that stops the inflation expectations taking off, and a slightly different balance between fiscal and monetary policy might be wise at the minute. That is, tighter monetary policy and looser fiscal policy might be wise for the economy.
Q67 Mr Love: I will ask the two gentlemen sitting in the middle of very distinct views which one they prefer, Mr Hayes.
Simon Hayes: I agree with Ray. I think that the optimal policy mix at the moment would be more skewed towards tighter monetary and looser fiscal policy. In some ways, it comes back to the-
Q68 Mr Love: So you would argue that in this Budget, the Chancellor could have loosened policies somewhat without threatening the stance of the Monetary Policy Committee?
Simon Hayes: I think that is a very separate issue, actually. It comes down to this issue about retaining financial market confidence and how far you want to go to insulate yourself against financial market concerns. The Governor of the Bank of England was very clear. He thought that the UK needed a very much more aggressive fiscal plan.
Q69 Mr Love: But you said in an earlier response that you did not think that , if the Chancellor had chosen at the time of the comprehensive spending review to have half the level of retrenchment that he decided upon, it would have much impact on the market.
Simon Hayes: That is right, but what I was going to say was that, after the election, the momentum was there for a more aggressive plan, I think. What the coalition Government delivered on that was more aggressive than was absolutely necessary to calm financial market concerns and has led us into this position now where monetary policy is probably too constrained. If the plans at that time had been less aggressive, it would have given the Monetary Policy Committee more room to manoeuvre now. We are where we are, and I do not think, in terms of yesterday’s Budget, significantly moving away from the deficit reduction plan would have been a good idea.
Q70 Mr Love: There have been lots of arguments. I happen to sympathise with Mr Bootle’s argument that, if the Chancellor had moved, there would have been confidence issues raised about where we are going to end up, but that is a different matter.
Can I come on to a completely different subject? Again, to Mr Hayes: your central forecasts predict that the fiscal mandate will not be met. How did you reach that conclusion? Why are you so different from the OBR?
Simon Hayes: I think it is interesting how sensitive that projection for the current structural balance is to the growth forecast. I think you are referring to the pack that I sent around yesterday. We have put some scenarios in for different growth forecasts and what that does to the current structural deficit. As you say, on our central view, the current deficit does not go into surplus.
In our pessimistic view, it is way below, and you will be talking about another £45 billion of tightening needed in order to meet the fiscal mandate. They were actually calculated jointly between us and the Institute for Fiscal Studies. This was work that we did as part of the Green Budget, so there are macroeconomic scenarios and then the IFS ran it through the public finance forecasts, so I think they are reasonably good quality projections are, as good as are typically produced
Mr Love: But the IFS suggested that you ought to have a plan B. They did not quite put it that way, but that was the inference of what they were saying.
Simon Hayes: Yes. Our pessimistic scenario here was not that it was a double-dip recession or anything. It was growth of about 1% over the next couple of years, going up to about 1.5%, and even on that there was a very significant undershoot. Then the question is: what does the Chancellor do about that? Do you tighten policy more in order to meet your mandate, given that the conditions are that growth is turning out weaker than you expected? Really, the message from the IFS and us in the Green Budget was that that situation is not that unlikely, and you ought to think about it before it arises, because it could be very difficult. If the OBR goes to the Chancellor with a much weaker growth forecast and says, "Actually, your fiscal mandate is not going to be met under your current set of policies," the Chancellor has a very difficult judgement to make.
Q71 Mr Love: Is that because you are more sceptical about the growth rates that the OBR suggests further out, and is that scepticism based on your assumptions about the output gap? I mean the spare capacity. I do not want any technical issues, because you will lose me, but is that roughly where you are coming from?
Simon Hayes: There are actually three factors. One is just the overall level of growth. We have a low growth forecast. We do have a lower trend growth assumption in there, and that gets increasingly important the further out you go. The third one is to do with the mix of demand as well. If demand is concentrated in domestic demand, consumption in particular is quite revenue-rich, whereas if your growth is coming from net exports, it is less so. The OBR’s forecasts, as I think Roger was mentioning earlier, in terms of domestic consumption in particular, are stronger than we have in there.
Q72 Mr Love: Mr Barrell, I think you have a response to this.
Ray Barrell: Yes, much of what I was about to say has just been said. Our forecast for growth over the medium term-that is after this year; next year-is about half a point lower than the OBR’s. It is very hard for me to understand how they get such strong growth in the medium term, given the fiscal position and what is liable to happen to monetary policy. Some of that stronger growth will be gain in revenue, but they also make a very clear assumption that the savings ratio will be flat at 3.4% over the next four or five years. Therefore, that implies that consumption will be rising more rapidly than I think is plausible.
All the factors I see that might affect consumption as a share of income over the next few years should be forcing it to rise more slowly than income. House prices are liable to be weak; the OBR does not think so. Equity prices are not particularly strong; the OBR does not comment on that. One has to ask quite serious questions about its consumption forecast.
They a very interesting discussion in its forecast about the role of corporate saving, and they say that, because corporate saving is so strong, consumers will realise they do not have a need to save. Now, I may be paraphrasing what they say, but I think that even those who believe in rational expectations in macroeconomic models would not go quite that far. That may eventually feed through, so we have to ask serious questions about the consumption forecasts that the OBR have produced.
We have to ask serious questions about their employment forecast as well, because it is their employment forecast in the medium term that is driving output back to capacity rather more quickly than we would expect. We would expect the Government to be borrowing something like £55 billion in 2015-16, about twice as much as the OBR, or not quite twice as much. My comment on that is: it is best not to worry too much about that. The markets will not panic because, if it is slow growth that is producing that, the economy is still on track to reduce the debt stock. The OBR forecast does look rather optimistic in the end.
Q73 Mr Love: That is an area I would love to get into, but I need to move on. It is interesting to see that they have come down to the average forecast for this year coming, 1.7%, but they seem to be optimistic going forward. I am not going to ask you this question, but it will undoubtedly come up in future years: are they being overoptimistic and will they eventually be accused of coming under too much influence from the Treasury as a result of that? Of course, that was a previous Government’s reason for setting up the OBR and, unless they resist that tendency, they may well find themselves in some difficulty.
I want to come on to two final questions, and this is not directly in the budget documents, although we were rather surprised on our side that that did not happen. The Government’s flagship policy for economic growth is a National Insurance holiday for small businesses. There are no figures in there at all, though there was a rather punishing report in the FT some months ago about how-I have to say-badly this is going. I just wondered whether any of you had been tracking this or following it, and whether you had any evidence that you could give to the Committee on how this particular policy is shaping up? No, okay.
There is other question I wanted to ask is: there is a very lively debate going on outside at the moment that the new fuel duty stabiliser, the increase in the tax on North Sea exploration, will or will not feed through into the consumer. I wondered whether anyone had any view here about whether or not this increase in tax will eventually be paid by the consumer.
Ray Barrell: Ultimately, yes, because what happens to the profits of the companies who produce in the North Sea is that they get paid out. They get paid out into pension funds and life insurance funds. Therefore, pensioners will find they have less income. Only in that way do they feed through to the consumer and to their ultimate incomes, not through the price of petrol, I would suspect.
Q74 Chair: It is shared out, and divided between the consumer, the shareholder and the taxpayer, is it not?
Ray Barrell: Yes.
Q75 Chair: I just have one question for Roger Bootle. Are the housing market measures the ones you would have picked? What would you have done with the housing market?
Roger Bootle: I certainly would not have done this scheme to boost the position of the first-time buyers, to help them, because I very much agree with the comments that Jonathan Portes made earlier on. That is, simply increasing demand and the process doing nothing at all to ease the housing shortage in this country, there may well have been more aggressive moves that could have been made on the planning system, but I think the devil is in the detail. In essence, this is a supply problem. If we want to ease the shortage of houses, we have to make sure that more houses are built.
Q76 Chair: You, or a number of you, may want to supply further written information. If you do, please get it to us quickly. I know we have already asked for one or two things from Jonathan Portes. Can I just ask one very last, quick question about the exemption from regulation for business start-ups, and whether any of you have given thought to whether that is a good supply side measure?
Ray Barrell: One has to be very careful about the role of regulation and its impact on growth. I think it is relatively clear that, if we had had stronger regulation of banks over the last decade, output would currently be significantly higher than it is, so regulation is not always a bad thing. Some business start-ups are banks. Perhaps the business start-ups among banks are too tight.
Chair: There are a few of those, yes.
Ray Barrell: Yes, which one has to be careful with. It is the case that encouraging business start-ups matters, but it is perhaps better to do it not through relaxing regulation, but by increasing expenditure on science and technology. You then generate the people who can start up the businesses to produce the products that we want within the regulations we want.
Q77 Chair: Does anybody want to add anything?
Jo nathan Portes: I agree with Ray and, just to say, as Ray’s comments implicitly say, it is a very odd thing to say. Exempt start-up businesses from new domestic regulation for three years: does that mean start-up banks? Does it mean that if I start up a sweet shop that I will not be obliged to implement the new rules on tobacco advertising? I find that quite difficult to believe. The Government is not that crazy as to exempt banks from the new regulations, which will be coming, so there is probably quite a bit of detail behind this, which hopefully makes it somewhat more sensible than it appears at first glance.
Roger Bootle: I think I am the only member of this panel who can speak with some direct experience, having started a business that is no longer small. My own view of this particular measure is that it is unlikely in and of itself to make a great deal of difference. However, this is another one of those areas. It is a bit like gilt yields and the size of the budget deficit, where psychology is all-important, and I think we have allowed a view to develop in Britain that small business is there to be squeezed and that regulation is extremely oppressive. I have to say that I have not found it extremely oppressive, but I think there is an impression among people that it is extremely oppressive and all sorts of things, like the VAT system and the rules, are a terrible barrier. They may well put people off from starting new businesses, but I happen to think that this particular measure announced in the Budget, if that is their psychology, will not change it.
Q78 Mr Love: It reminded me that joined onto that is that you only need to look at the response of the small business groups, like the Federation or the Forum, who have been lambasting Government for the overweening regulation that they have to face, and who have universally welcomed the Budget as a contribution to reducing it. Whether that is the reality or not is a different matter.
I just wanted to ask about the enterprise zones. They have been universally characterised as being very expensive in terms of the cost of job creation and, rather than creating very many jobs, they just simply move them around the boundaries. Would anyone disagree with that? Would any one of you take a more positive view of the likely impact of enterprise zones?
Ray Barrell: If I may say, no.
Chair: There are no takers to disagree with that in this panel of five. It is very unusual to find so much agreement. You have been disagreeing most of the morning. It is very helpful. Thank you very much, all of you, for coming to give evidence to us.
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