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Treasury Committee - Minutes of EvidenceHC 1063
Taken before the Treasury Committee
on Monday 25 March 2013
Mr Andrew Tyrie (Chair)
Mr Andrew Love
Mr Pat McFadden
Mr Brooks Newmark
Examination of Witnesses
Witnesses: Roger Bootle, Managing Director, Capital Economics, Kevin Daly, Chief UK Economist, Goldman Sachs, and Michael Saunders, Chief UK Economist, Citigroup, gave evidence.
Q1 Chair: Thank you very much for coming to give evidence this afternoon. May I begin with you, Mr Saunders? Do you think the Cyprus deal, in its current form, is here to stay?
Michael Saunders: I think it will solve the immediate problem. It is a better deal than they had a week ago because it is only going to burn the large, uninsured creditors of the two failed banks, whereas the plan of a week ago looked like it was going to burn the large depositors and, of course, the protected creditors, of all the banks. I think both of those would have been an error, so the deal will serve the immediate purpose and Cyprus will probably get into the ESM programme. The ECB will keep on funding them, but even after that Cyprus’s fiscal position for the Government will probably be unsustainable. We have to expect that the economy will weaken and that the debt-to-GDP ratio will escalate-that is not the cost of recapping the banks, but the cost of the economy’s weakness-and that will have to be dealt with at some point.
Q2 Chair: So it has many of the characteristics of the Greek bail-outs.
Michael Saunders: Yes. The economy will fall sharply, like Greece and Portugal.
Q3 Chair: In that case there is going to have to be another bail-out if they are going to stay in the eurozone.
Michael Saunders: The package, which will probably be agreed over the next few weeks, is most likely going to be a three-year bail-out for the Government. They may, Greek-style, need to have a further bail-out beyond that, and, as we have seen in Greece and to an extent in Ireland and Portugal, the official loans, once made, may subsequently get restructured into lower coupons and longer repayment periods so that the programme sort of morphs into a much longer-term thing along the way.
Q4 Chair: That is another way of saying they are going to be given a gift by the back door.
Michael Saunders: Yes, or not obliged to pay their money-[Interruption.] I am sorry about that.
Q5 Chair: Will everybody please turn off their electronic devices? I mean off, as opposed to just slightly less noisy. Particularly those answering the questions.
Just to be clear, you are saying that the terms of the loan that they are going to be given are going to be varied or softened in some way.
Michael Saunders: I think they will have to be, yes.
Q6 Chair: And that effectively means that part of it will be turned into a gift.
Michael Saunders: In present value terms, yes. You take a debt and make it a 50-year with zero coupon. That allows one side to say they have not had a haircut, but, in effect, it is worth much less.
Q7 Chair: So this is a sticking plaster.
Michael Saunders: Well, it solves part of the problem. It solves the immediate recap needs for the failing banks.
Chair: That is what sticking plasters do.
Michael Saunders: It does not solve the deeper problem.
Chair: But the wound is still there. Okay. Thank you very much.
Q8 Jesse Norman: Mr Bootle, just picking up the Chairman’s question about Cyprus, how bad is the balance of payments crisis in the eurozone at the moment?
Roger Bootle: The internal balance of payments crisis underlying it all is extremely serious. Of course, some countries have improved their position quite considerably-some of the deficit countries have reduced their deficit considerably-but that is what you would expect if you have a depressed economy; that is no signal whatever of an underlying improvement. Meanwhile the surpluses for Germany and, even more so, for the Netherlands, are absolutely astronomical. So the underlying problem is very serious indeed.
Q9 Jesse Norman: So the possibility exists that British growth could be adversely affected as the eurozone crisis rolls on further up the chain, Cyprus having proved another embarrassment.
Roger Bootle: Yes. I think, focusing on the GDP outlook for the eurozone, it looks to be pretty grim this year, with the likelihood of further contraction for the economy as a whole. Maybe Germany will resist that, but France looks pretty soft, and France is in a much weaker position than was true a year ago. Of course, we expected the peripheral countries to be weak, but for France to be weak as well is an added blow.
The relevance of the Cyprus crisis is twofold. First, it has undoubtedly made more people question whether the euro is going to survive. Cypriots and others were speaking about Cyprus perhaps leaving the eurozone. But secondly, and more importantly, the initial plan, which Michael Saunders-in my view correctly-rubbished a few moments ago, was not implemented, but the mere fact that it was raised has let the cat out of the bag. This means that whenever there is a crisis in Italy, Spain, Greece, Portugal or other countries, depositors are going to think, "This could get very ugly indeed," and they are going to move huge amounts of money out of those countries into the German core. That is going to lead to huge problems-TARGET2 is the bit of jargon that is relevant here-with imbalances in payments between members of the European Central Bank system. That is going to place the Germans in a very difficult dilemma. They will have all this money pouring in, which they are then obliged under existing rules to recycle to the countries that the deposits are leaving, but the net effect is that the Bundesbank is holding this really rather large baby, with a huge risk attached.
Q10 Jesse Norman: When the Bundestag finance committee came to visit us recently, they suggested it was publicly understood that the cost to the German taxpayer could be of the order of €1 trillion to €2 trillion as matters stand. That is just a comment.
The OBR has forecast a reduction in growth over the next couple of years, down to 0.6% this year and 1.8% next year. Do you think those projections are about right, likely to prove soft or likely to prove optimistic?
Roger Bootle: As we all know, forecasting is a pretty dangerous game, especially, as Mark Twain said, when it is about the future. I think the forecasts are plausible, but I still find them a bit optimistic. Different people can no doubt quibble about all this. I suspect this year may be a bit softer. The forecast recovery that is in there for next year is, I think, too strong. There is no science behind all this, but as one moves forward in the forecast period, the OBR obviously sees a reasonable recovery beginning-later than was expected first of all, but still a reasonably paced recovery. My problem is that I cannot see at this moment where that decently paced recovery is going to come from.
Q11 Jesse Norman: Mr Daly, what do you think will be the main drivers of economic growth for the UK over the next three years?
Kevin Daly: Just to pick up that last point, I am a little bit more optimistic than Roger, and we are a little bit more optimistic than the OBR, on growth. There are three positives that we would see for 2013 relative to 2012. The first is that there has been a very significant easing in financial conditions as a result of the decline in the exchange rate, and, to a lesser extent, as a result of the rally in equity prices this year. The second positive is that the funding for lending scheme will, we think, have some success; I think it should have been introduced earlier and more decisively, but it will have some success in easing the availability and reducing the price of credit. The third is that household sector dynamics look a little bit more positive. Certainly that is not in an absolute sense, but relative to how they have looked in the past, they look a little bit better, with relatively high savings ratios and financial balances. Those are three positives that would lead us to be a little bit more optimistic than the OBR.
There remain a number of very large negatives to set against that. I would agree with the questions and previous answers that the euro area risk is the biggest among those. The second risk or drag on growth is, needless to say, the drag from the fiscal adjustment programme itself.
Q12 Jesse Norman: What about the risks, on the downside? What are the major risks to growth over the next three years? Obviously we have talked about the eurozone.
Kevin Daly: The eurozone is by far the biggest known unknown, if I can put it that way, and when we talk about risks it is difficult to do other than start with that and finish with it; it really is such a significant risk for the UK. If you look at the UK’s performance in recent years relative to other advanced economies, it has been the problems in the eurozone that have helped to drag UK growth down. That all said, I do not think it is all negative on the eurozone, as some of the adjustments have taken place at a more rapid rate than we expected-at least, than most market participants expected. Secondly, there is the composition of the growth within the eurozone: the UK’s trading partners are skewed towards countries that now see more positive signs, most notably Ireland but also northern Europe. But as I say, the biggest risk, going forward, is undoubtedly the eurozone.
Q13 Jesse Norman: A final question. Mr Saunders, there are some signs that market sentiment is picking up in the UK. Do you think that is true or does it have some way to go? Do you think that the Budget supported that process?
Michael Saunders: Financial market sentiment within the UK has picked up, but I do not think that that is because the economy is looking any better; I think it is more because the pound has been weak and markets are-I hope correctly-anticipating that monetary policy will be loosening further. That loosening is helping to float asset prices in advance of the loosening actually taking place.
Q14 Jesse Norman: This is discounting more QE, is it not?
Michael Saunders: Not just QE; in the Budget, the fiscal measures do not really affect the growth outlook either way. Frankly, they are astonishingly timid and limited in what the Government are trying to achieve: at a time when the economy has been so weak for so long, the fiscal measures are just not really significant either way. The changes to the MPC’s remit are more important. The loosening that I think will come through is not just QE, but probably further credit easing and perhaps other forms of monetary easing. The changes to the remit give the MPC a much wider toolkit that they can use, and encourage them to use it.
Q15 Mr McFadden: I would like to ask about the pattern of OBR forecasts, starting with you, Mr Bootle.
It seems to be a quite consistent pattern that over the last couple of years it has had downgrades for this year-whatever this year happens to be-a bit of a downgrade for next year, and then an assumption that we bounce back to something like 2.3% or 2.5% afterwards. What do you think of this pattern? Why do you think the OBR has been so consistently over-optimistic in its short-term forecasting since the election? Are they just committing the same sin as everyone else?
Roger Bootle: As I said earlier, forecasting is a difficult business. I do not want to make out that the OBR is uniquely dreadful in its forecasts; we have all made some pretty bad forecasts.
It seems like, as it were, a series of mistakes, and that therefore the OBR comes out looking bad. In fact, there is only one mistake: consistently to have underestimated how serious the problems are for this economy after the financial crisis-one mistake, and they keep making it. It seems to me that they think-arguably the Government have made the same mistake-that this is an economy that is in a fairly normal position; normally, in an economy after recessions, there is a fair old potential for bounce-back.
I well remember that the early ’90s recession seemed pretty dark at the time-similarly, the early ’80s recession was dreadful, and in some parts of the country it was catastrophic-and yet within a few years, the economy was experiencing not just recovery, but strong recovery. In the ’80s, we had very strong recovery after those first few years.
It seems that we are in a very different world, partly because of the points that we have already made about the eurozone, and, perhaps more importantly, because the banking system does not function in the same way-it is not in a normal position. The banking system is broken. It is a vital engine of recovery that simply is not working.
Q16 Mr McFadden: Can I ask you about the second part of this? If you look at their forecasts, not for this year or next year, but for 2015, 2016 and 2017, it is 2.3%, 2.7% and 2.8%. That is exactly the same as their forecast in December. If I go back to this time last year and look at the three years towards the back end of the forecast, they were forecasting 2.7%, 3.0% and 3.0%. It is the same pattern as you go back, all the time.
There is an assumption of bounce-back. We will ask them about this tomorrow, no doubt, when they are in, but to what extent do we need to reset our thinking about the so-called trend rate of growth? Does it still exist?
Roger Bootle: I find the expression "trend rate of growth" potentially extremely misleading. To the extent that we are going to have very low rates of growth over the next couple of years, the trend rates are of course going to come lower.
The question is, appropriately, about two things. The first is the potential growth rate-the supply potential of the economy. Has that been markedly impaired by the financial crisis? Does it not continue to be impaired by the absence of demand now? Secondly, and logically distinct from that, are we going to get the rate of aggregate demand that is necessary to take up all the productive resources that are there, in accordance with whatever productive potential the answer to the first question comes up with?
I am very much of the view that this is primarily a demand problem. If we could somehow get aggregate demand up-it might be because the eurozone recovers, breaks up or whatever, or something else happens-we would find that the supply potential was pretty good. I am not sure myself that it has been that much impaired, but of course there is another view that it has been very seriously impaired.
Q17 Mr McFadden: But as it says on all these adverts that try to sell us financial products, past performance is no guide to the future. What would be the implications if the so-called trend rate of growth was not going to be seen again in the medium term, that even if we had a better recovery we were bobbing along at 1% to 1.5% growth instead of 2% to 2.5%? Do you think politicians have got their head around what that might mean?
Roger Bootle: It would be an extremely pessimistic conclusion. The danger might be that, in so far as they believed it, they would act in such a way as to make it more likely to come about. We have to have at this stage an underlying assumption that there is a significant amount of spare capacity and that growth can return to something like the rate that it was running at before the crisis. The indications of the potential growth rate being very much lower are of course dire, not least for the public finances, because that means that the deficit is proportionately much more structural than cyclical, and therefore there have to be further cuts in Government spending or increases in taxation to bring about balance. Quite apart from that, of course, living standards will be increasing at a much slower rate than they would do otherwise. It is the fundamental question: if the sustainable growth rate of the economy is that much weaker, then all sorts of economic possibilities are that much more pessimistic.
Q18 Mr McFadden: Mr Saunders, what do you think about this "jam tomorrow" pattern that we are seeing in the forecast?
Michael Saunders: I think it has made similar errors to the Bank of England, with the consensus, as Roger said, of assuming that the economy would quickly return to pre-crisis trend growth rates. The major problem for the economy is the shortage of demand, and it is against that challenge that you have to judge the Budget. I thought that the fiscal measures, with beer down 1p and so forth, were minor tinkering but fairly irrelevant to that broader challenge. If we are to get the economy growing, monetary policy, through all of these various challenges, will have to play a major role in that, because it is not going to be fiscal policy and the euro crisis is not going to go away.
Q19 Mr McFadden: With regard to the Bank remit, in some ways is not the change to it more a recognition of what the Bank is already trying to do, because it has not hit the inflation target in the past three years anyway?
Michael Saunders: I think it is more significant than that. You have to distinguish between ex ante flexibility and ex post. The MPC for the past few years has genuinely tried to hit a 2% inflation target, aiming to hit it in the forecast two to three years ahead; its forecasts have repeatedly been wrong, but it has honestly been trying to hit 2%. In practice, from here to hit a 2% inflation target in the face of ongoing increases in the regulated prices, indirect tax effects, withdrawal of subsidies plus import prices, you probably have to crush the economy even further. That would be a major error.
What the new remit does is to make it much easier for the MPC to look through these persistent pressures, which I stress are not driven by UK costs or demand but by a whole series of one-off price shocks extending into the future. It makes it easier for the MPC to look through that at a time when the economy is quite depressed and broad inflation in the UK as measured by the GDP deflator or wage growth is very weak, and it then gives it tools by which it can loosen further. I think those changes are quite good.
Q20 Chair: So there is more discretion on inflation and there are more tools to find ways of influencing demand.
Michael Saunders: Yes. You must not regard the CPI as the same as inflation in the economy as a whole. A lot of the inflation we have is regulatory-driven-green surcharges, the withdrawal of subsidy for the rail industry and so forth-and when CPI inflation goes up as a result, that is not inflation in the economy that the MPC should be trying to offset.
Q21 Chair: Are you not worried about embedding inflationary expectations, particularly in the private sector wage round?
Michael Saunders: It could be a risk if this were to go too far, but on the other side there is greater risk at the moment of prolonged economic stagnation.
Q22 Mark Garnier: Mr Bootle, I will start with you, but if anyone else wants to chip in, please do.
How important do you think consumption will be to bringing the economy back to any sort of sensible growth?
Roger Bootle: It is of course a huge chunk of aggregate demand-roughly two thirds of the economy is accounted for by consumption-so, just in an arithmetic sense, it is going to be important. However, to the extent that the economy recovers because consumption grows strongly, then we will not have achieved the rebalancing that everyone has been banging on about over the past few years. What we need-in terms of getting a sustainable, strong, vibrant economy-is more investment and more net exports. It is very disappointing that, after the sharp fall in sterling that we saw a few years ago, we are still running a significant current account deficit. In relation to what we should want to achieve, I would regard a recovery brought about by consumption growth as being rather disappointing.
Q23 Mark Garnier: Do you all agree with that? Kevin Daly, you are the only one who did not nod his head then.
Kevin Daly: We have reached a stage where savings ratios are relatively high, the share of income that the household sector is saving, relative to their total income, is relatively high, and for households to increase-
Q24 Mark Garnier: When you say "relatively high", what is that relative to?
Kevin Daly: Relative to its long-term historic average, going back 20 or 30 years. For the household sector to continually push incremental income into pushing the household savings ratio and household financial balance ever higher would be dangerous and disappointing for the economy going forward. There is, however, some reason for optimism: having reached a relatively high level, the pace of deleveraging means that we are likely to level off at around that rate, so incremental income flows are more likely to be positive for consumption growth going forward. But I agree 100% with Roger: obviously, if there was a sharp decline in the household saving ratio, that would not be a positive thing, but even a stabilisation of household savings ratio would be positive for growth, from the recent trend.
Q25 Mark Garnier: One of the statistics that seems to be left out of the bigger debate is the level of household debt, which I think stands at roughly £1.47 trillion, of which about £1.2 trillion of mortgage debt and, of that, 40% is on interest-only mortgages with no really substantial repayment plans. When you compare that with figures from the 1990s, in today’s prices there was £565 billion of debt, so household debt in real terms has increased by 260% since then. In terms of trying to get consumption going, do you not see that as a colossal headwind?
Kevin Daly: But it is the rate of change of the savings ratio and the household financial balance that matters most for growth, so deleveraging can continue into the future, even if it takes place at a slightly slower pace, and that would be positive for growth. This is the aspect that many people miss: looking directly at the debt rates is to miss a derivative, as it were. You should be looking at the change in the rate of deleveraging. Deleveraging can continue, and should continue, for many years to come, but for it to continue at an ever rapid pace is not an outcome that we should welcome or call for.
Q26 Mark Garnier: But UK mortgage debt as a percentage of household income now is at around 132%, which has come up from around 70% in the ’80s; we have a different dynamic going on now. In terms of consumers’ prospects, have we not fundamentally changed to being now in a colossally difficult place going forward? If you add together that people are living longer so there will be more demand on people’s savings for retirement and we arguably have an overvalued property market, you suddenly discover that you have an over-leveraged consumer who is feeling pretty nervous about things. Is that not a huge drag on people going out on the street and buying things such as 50-inch flat-screen TVs?
Kevin Daly: That build-up in gross household debt has been more than matched by a build-up in gross financial assets, not housing assets.
Q27 Mark Garnier: Yes, but it is not always the same people, is it?
Kevin Daly: That is for sure, but the point is that it is a distribution issue rather than an aggregate issue. That is not to say that it is not an issue, but it is a different type of issue-let me put it that way.
What the high levels of debt tell you about most of all is the high level of house prices in the UK economy. We can have a debate about whether they are overvalued or not; my view would be that, given the heavily restricted supply in the economy, house prices are probably not overvalued at current levels, but-
Q28 Mark Garnier: Does anybody disagree with that and think that house prices are overvalued?
Roger Bootle: Yes, I think they are overvalued, but I can understand why. In relation to incomes, they are very high by historical standards. Obviously interest rates now are low. That, mortgage forbearance and comparatively good rates of employment are what are keeping the market where it is. But outside London, until the last few figures, the market has actually been quite soggy.
Q29 Mark Garnier: Michael Saunders, do you agree?
Michael Saunders: Yes, I agree.
Kevin Daly: Conditional on the restrictions on supply, and conditional on the fact that there are not enough houses in the economy, my view is that house prices are currently not overvalued. Whether they are overvalued or not, it is the high level of prices that has resulted in debt levels rising. The causation, in many cases, goes the other way: from house prices to debt levels, rather than the other way around. The fact that debt levels, in aggregate terms, are high reflects where we are in the housing market. Now, in terms of how that-
Q30 Mark Garnier: Do you not worry that 40% of mortgages are on interest only without any substantial repayment proposals?
Kevin Daly: A concern since the start of the crisis is what would happen if those mortgages rolled off. What we found, on the whole, is that mortgage affordability has improved rather than deteriorated through that period. I do not think there is some-
Q31 Mark Garnier: That is a slightly different answer. The point I am trying to make is that ultimately they have got to be paid off at some point in the future. Without any other repayment programme, they are going to be paid off by the sale of the assets, which, in theory would supposedly mean quite a lot of property coming in to it.
What I am trying to get at is, there is a very high level of personal debt-it is £1.47 trillion, which is 260% higher than it was 20 years ago-at a period when we have super-low interest rates and a significant proportion of these mortgages are on interest only, so there is no repayment plan alongside them, and at a time when interest rates can only go up. Do you not see any major problems from that scenario, or am I painting too gloomy a picture?
Kevin Daly: In a nutshell, my view is that you are painting too gloomy a picture. First, interest rates, in effective terms, are still pretty high.
Q32 Mark Garnier: Negative real interest rates.
Kevin Daly: In nominal rates, as a result of things like the FLS, I would expect interest rates to decline, rather than rise. Secondly, we are starting from a position where we are deleveraging at a very rapid rate already. In terms of the contribution to growth, I think that deleveraging will continue for many years to come. But if it takes place at a slightly slower pace going forward, that is more likely to be positive, rather than negative, for growth. So I am of the view that you are painting too negative a picture.
Q33 Mark Garnier: Mr Bootle, do you agree?
Roger Bootle: I do not think you are painting too negative a picture. These debt levels are a real burden. In many ways the British economy can be compared to the Japanese economy after its financial bubble and bust. Obviously there are some significant differences. In particular, so much of the over-borrowing in Japan was by the corporate sector, rather than the household sector, and the corporate sector then went into a long period of retrenchment. The Japanese economist Richard Koo has for a long time argued that what made the Japanese situation different-people in the west do not understand this-was that it was essentially a balance sheet recession. People’s balance sheets-in this case, mainly companies-were very strongly impaired, and they then had the hard job of restoring their balance sheets. When they are in that mode, and you prod them with all the usual pokers, you pull the usual levers and push the usual buttons, you find that they do not work. I think that something similar may be true in this country and some other western countries as well. Here, you have a very heavy burden of indebtedness hanging over from the past, but, on the whole, it is not the corporate sector; it is the household sector.
To go back to what I said earlier, to the extent that what I just said is not true-to the extent that people go out and spend an awful lot more and borrow an awful lot more-I do not think that is an unalloyed blessing. Yes, it will bring in some sort of recovery, and bring in tax receipts to the Treasury-that is, of course, a good thing-but it will be storing up problems for the future. It will mean that the debt burden will be higher, relatively speaking, to what it would have been before, and as you rightly say, at some point or other, interest rates will go up. I think that picture is somewhat distant, but at some point they will go up. We should not want the household sector to be heavily indebted at that point.
To go back to what I said before, the bits of the economy we should want to expand, and we should look to for growth, are the bits that have not had that borrowing binge, whose balance sheets are stronger and who can deliver growth without at the same time endangering stability and sustainability. They are the corporate sector, green investment and exports.
Mark Garnier: Which is the third that is not consumption.
Q34 Mr Newmark: Before I get on to my question on the productivity puzzle, you all analyse the Budget-I have seen Roger’s analysis in particular-and there have been criticisms all the way through, but the Chancellor had little room for manoeuvre. I am curious to know from you one thing that the Chancellor should have done that he did not do-can you each give me a quick answer?
Roger Bootle: Well, there are so many things that I would find it difficult to limit myself only to one. You say that he had little room for manoeuvre-I do not agree at all. He could have done all sorts of things. He could have cut faster, he could have cut slower, he could have done both. That is to say, he could have cut spending and taxes. He could have had a massive programme of public investment funded by public borrowing. I could go on and on and on. The extraordinary thing is the poverty of ambition and achievement about the Budget. It said and did nothing.
Q35 Mr Newmark: So basically you would be happy for him to borrow more in a debt crisis.
Roger Bootle: I didn’t say that, actually.
Q36 Mr Newmark: You said that he could borrow.
Roger Bootle: I said that those were the options he had. I think that it is a matter of magnitude, but I would have gone for a programme of increased public investment funded by increased borrowing. However, I would also have cut current spending by far more than the Government have done in later years and preannounced tax cuts correspondingly. That is to say I would have tried to move down both spending and taxation.
Mr Newmark: Okay, I do not want to tread on somebody else’s territory.
Q37 Chair: Well, that is more borrowing now and less later, isn’t it? Just to be clear.
Roger Bootle: It might be, yes.
Q38 Chair: Well it would be-it is not might; it will be.
Roger Bootle: It depends how it is done.
Q39 Mr Newmark: Borrowing is borrowing. You cannot be a little bit pregnant. You are either borrowing or not borrowing.
Roger Bootle: The exact magnitudes would be up for debate, but in essence we are facing probably the most serious economic crisis in the whole of our history. Have we had a Budget that has brought in measures of comparable magnitude? I submit that we have not. To me, 1p off a pint of beer does not seem equal to the worst recession in our history.
Q40 Mr Newmark: Okay, so Roger would happy to borrow more in a debt crisis. Michael, what about you?
Michael Saunders: I agree. I think that he could be more aggressive with the infrastructure programme, which has achieved very little so far. The other thing is that if there are areas where he is looking to cut labour costs-for national insurance, for example-that should be focused on young workers, because the overall jobless rate is not extraordinarily high, but the jobless rate among the under-25s is a crisis.
Q41 Mr Newmark: I will come back to you on that one. Kevin?
Kevin Daly: I agree that the problem with the economy is predominantly demand-related-cyclically-related. Nevertheless, starting from the position where the deficit reached 11% of GDP, and even now, taking out temporary measures, it is still 8% of GDP, there is little flexibility, other than to implement a fiscal adjustment programme. Relative to other economies, the UK’s cyclically adjusted deficit is actually tightening at about 1% a year. That is less than the OECD average, despite the fact that the UK deficit is still more than double the OECD average. So as much as I agree that there is a cyclical, demand-related weakness in the economy, I do not see the flexibility on the fiscal side.
Where I do see greater flexibility, and where I hope that there will be much more aggressive action, is on the monetary, credit-easing side. Effective interest rates in the economy for households and corporates are close to 4% and lending growth continues to decline. The combination of relatively tight fiscal policy and relatively easy monetary policy is right, given the current environment. The problem is that monetary policy, in effective terms, is not actually that easy-it is still pretty tight. I think that the focus should be addressed there, in terms of accelerating things such as the FLS to make more progress on that front. On the fiscal front, I think that there is not much room for manoeuvre.
Q42 Mr Newmark: Again, I do not want to tread on other people’s territory, but I want to return to Michael’s point. If I tread on your territory, John Thurso, I am sorry-I will let you follow up with those questions. Michael, I agree with you about youth unemployment. We have done tremendously well in terms of saying that we have more men and women in work than ever before, but that leads to the question of the productivity puzzle that everybody goes on about. The OBR states that output per worker and output per hour are running at around 14% below the level that they would have been if the pre-financial-crisis trend had continued. What do you think actually happened?
Michael Saunders: I think part of that is the collapse of high-productivity growth sectors, such as the financial sector and oil and gas, but a major part of it is the willingness of many people to price themselves back into work. The numbers of people who are full-time, non-temp employees is down 3% over the past five years, and over that period we have had rapid growth in self-employment, part-time work and temp jobs. Those are all important forms of work, but the thing that they have in common is that on average they earn less than full-time, non-temp employees. I think it is a story of core employment being hollowed out. The people who are displaced cannot claim disability benefit and so forth so they want to stay in work, and they will accept a squeeze on pay in order to do so.
Q43 Mr Newmark: But don’t you think it is a good thing that they stay in work rather than claiming benefits?
Michael Saunders: Absolutely. I think for society as a whole, the sharing of the labour and sharing of the pain through a widespread squeeze on real pay is better than the alternative of firing 10% of the work force and giving the rest a pay rise. You must not go too far with the idea that the resultant weakness in productivity is a sign that the economy has somehow lost its capacity to grow.
Q44 Mr Newmark: Do you think that there is hidden spare capacity in the economy? Do you think people are hoarding labour? Roger, you are nodding.
Roger Bootle: I think so. I agree with Michael’s remarks a moment ago. The fact that the labour market is working, and that people are pricing themselves into jobs so that the short-term productivity performance is disappointing, is not necessarily the same as saying that the economy’s capacity to grow is weaker. Once demand is growing, it is perfectly possible to see some decent rates of productivity growth even though the past few years have been low for the reasons that Michael gave.
Kevin Daly: On the productivity point, we estimate that of that 14% or 15% of productivity that has been lost, around 3% to 4% is due to measurement error on the GDP side. That still leaves a very substantial puzzle. It is a puzzle that is intrinsically linked to the issue of to what extent is the weakness in growth supply-related or demand-related? Is there an output gap or has it been a hit to potential output?
Our own view, and I would entirely agree with the two other witnesses here, is that it is predominantly a combination of cyclical factors and short-term supply factors. What do I mean by short-term supply factors? I mean factors that are specifically related to the weakness of the financial sector and the provision of credit to the wider economy. You have not had the normal amount of capital reallocation that typically happens subsequent to a recession and into a recovery because the capital is not available to households and corporates for that transfer to take place. If you solve specifically the problems in the financial system, you could get both the recovery in demand and the recovery in that short-term supply weakness. I entirely agree with the two previous witnesses: either way, I am relatively optimistic, for the long term, that we will be able to recoup a lot of this lost productivity.
Q45 Mr Newmark: Do you think that, effectively, companies have been destocking, and that as things begin to turn and people want to rebuild their inventories, that will help accelerate things-a sort of J-curve effect?
Kevin Daly: We talked about labour hoarding, and it is more the mechanism that is important in terms of cyclical demand weaknesses hidden within companies on the labour hoarding side. I think that is the more important channel. But these short-term supply factors are at least as important as the pure demand effects. That would come through the re-allocation of capital to other industries, so from new firms-new start-ups-rather than hoarding within existing firms.
Q46 Mr Newmark: I have one final question for Michael. The £2,000 employment allowance that was thrown out there during the Budget is seen as a positive thing, particularly for small firms. Would you rather that that had been focused directly on the 16 to 24-year-old market to deal with the youth unemployment?
Michael Saunders: Yes.
Q47 Andrea Leadsom: Michael, what are Goldman Sachs doing for the 16 to 24 age group?
Kevin Daly: I am from Goldman Sachs-
Andrea Leadsom: I beg your pardon. What are Citibank doing for the 16 to 24 age group?
Michael Saunders: We are one of the major sponsors of Teach First, which is the programme that encourages graduates to go into teaching as a first career choice. I think it’s a great scheme.
Q48 Andrea Leadsom: I mean as a business rather than as a bit of corporate and social responsibility.
Michael Saunders: We hire people.
Q49 Andrea Leadsom: Do you have an apprenticeship scheme?
Michael Saunders: It is called a graduate training scheme, but you could view it as the same thing.
Q50 Andrea Leadsom: Roger, you said that we have a demand problem in response to an earlier question. You also said that more consumption would be a bad thing as it would mean households would become levied up again. This is a very genuine question: do you think that there is an issue where younger people with mortgages are highly leveraged but actually one of the possible unintended consequences of QE has been to encourage the over-50s not to spend when in fact they are not necessarily the leveraged ones? In other words, could the existence of quantitative easing itself have hampered demand in the economy as a result of the impact on the over-50s who are looking to their actuarial retirement rates and so on?
Roger Bootle: I think it is possible, yes. This is an empirical question, isn’t it? It is all about those people whom you would expect to be stimulated by QE in various ways to spend more and the extent of their reaction against those people who will be retired in the not too distant future, who find that their savings income is a lot lower and therefore might actually spend less, and how these two match up. I don’t know of any really convincing study on this. I would have a strong prejudice in favour of the idea that QE was on balance a stimulant to the economy. It would be somewhat surprising if it were not. But it is possible that it might not be for the reasons you have given. There might be a particular sector of the community with a very strong reaction the other way, which outweighs the weak reaction from the first group.
Andrea Leadsom: So, with that in mind, how effective do you think further QE would be on the economy? We talked about the broader remit for the Monetary Policy Committee. Further QE-would that be a good thing?
Roger Bootle: I have always been lukewarm about QE. That is to say I have never thought that it would be a transformative policy. I certainly never believed that it was possible to calculate exactly how much QE would have exactly how much effect, which was an error that the Bank of England fell into earlier on in this process. I think there are several aspects of QE which are quite important. First, there is the effect of QE on Government financing costs. If those were kept noticeably lower as a result of QE, that is worth something in the Bank, as it were. Secondly, there is the relationship with the pound. I have argued repeatedly that the pound is the most important price in our economy. Whenever something goes wrong in the British economy you can bet your bottom dollar that the pound being wrong is at the root of it. The pound got too high from ’97 onwards. It dropped a long way in the financial crisis. It then went disturbingly higher and has recently come a bit lower. It may not have come quite low enough. I would see the importance of QE largely in relation to the exchange rate. If the exchange rate were to be carried higher in the next couple of years, which may be a serious danger with the crisis in the eurozone, then I think that would be a very serious blow to our hopes of rebalancing the economy through stronger exports.
Q51 Andrea Leadsom: Thank you. Mr Daly, do you think that QE has had the effect of fiscal transfers, as has been put by several witnesses in our inquiry into QE? In other words, it has enabled those who are asset rich to get richer and those who are struggling have not really been affected. The biggest beneficiary has simply been the lower cost of Government debt. What would be your analysis of the impact of QE on different sectors in the economy?
Kevin Daly: Our own view is that the first round of QE was materially beneficial and that its effectiveness reduced primarily as its ability to put interests rates lower declined. So there is a significant body of evidence looking at the impact of QE across countries that argues that once interest rates are very low, pushing more quantities through the system in and of itself has increasingly limited economic benefits. I agree entirely with Roger, in the current environment, pushing the exchange rate lower will bring benefits. But the benefits per pound of QE, if I could put it that way, are much fewer now than they were at the start of the asset-purchase programme. My own view would be that one would get much more effectiveness from pushing interest rates lower where there are credit frictions already.
The body of this research work by Michael Woodford has been heavily influential, including on the incoming Governor Mark Carney. That has argued that it much more effective to tackle asset classes where, as a result of credit frictions, interest rates are high, rather than continually purchasing assets such as gilts, where yields are now very low. That is why in our view the funding for lending scheme and schemes such as that will be much more effective than continually pursuing ever larger amounts of QE.
Andrea Leadsom: Is it right-
Chair: This must be the last question, if that is okay.
Q52 Andrea Leadsom: Okay, then I won’t ask that one. Mr Saunders, is there potential for the idea Paul Tucker floated of negative interest rates? Would you welcome that?
Michael Saunders: Right now, we probably don’t need to do it, but it is a tool that the UK may need to use, especially if the pound rises sharply. The important thing in the MPC’s remit is that it brings this other range of policy tools, including if necessary setting negative interest rates, but also credit easing through the FLS, liquidity policy, forward rate guidance, purchasing private sector assets-more or less anything they want to do, under the MPC’s authority.
Previously, there were in effect three groups in the Bank of England. There was the MPC that could do the bank rate and QE. There was the Bank of England hierarchy that controlled things such as the FLS. Then there was the Financial Policy Committee, which was generally tightening, through requiring banks to hold more capital. The MPC were loosening; the Bank of England hierarchy were quite lukewarm about credit easing; and the FPC was tightening. The overall effect was not very powerful in terms of boosting growth. Now the MPC have a much wider range and toolkit of measures they can use, and I hope they will use them.
Q53 John Thurso: Can I come to you first, Michael Saunders? The debate within which the Budget is being framed is essentially boiling down to austerity versus stimulus. You said several times in your earlier comments that you felt the Budget was timid. Is that because it was not austere enough or because it did not have enough stimulus?
Michael Saunders: Because it did not do enough to try to get the economy growing. You can do that by choosing where you spend your money, even within a neutral stance. Of course, you can also do it through temporary measures to increase borrowing. I think that markets would actually accept quite happily temporary measures to increase borrowing, if they thought that they would pay off in the long term by actually getting the economy growing faster, and that they are accompanied by credible medium-term plans, especially on current spending, to get us back to a sustainable fiscal path.
Q54 John Thurso: You make the very proper distinction between current spending and investment spending. Do you think that the Government has done enough to make that distinction both in its numbers and politically, and to understand that cutting current spending is quite different from encouraging spending on infrastructure or other investment that will produce a return?
Michael Saunders: By their actions so far, they have cut capital spending sharply and current spending slightly. I think that it would be better to do it the other way round.
Q55 John Thurso: Can I come to you, Roger Bootle? Do you accept that the debate is being framed at the moment as between austerity and stimulus? Do you think that is too narrow a definition? Should the debate be wider?
Roger Bootle: I think it should be wider, yes. There is clearly a debate going on about whether it would be possible and desirable for the Government to borrow more and, in which case, on what scale. But there are a whole series of other issues relevant to this as well.
For instance, we know that the corporate sector is sitting on substantial cash balances. It would be a pretty good thing if we could persuade the corporate sector to spend a fair chunk of those cash balances on real investment. The Budget, I don’t think, embodied any measures bearing on that. The cut in corporation tax, other things being equal, was good, I think. It enabled the Chancellor to hold it up as a totem. It sounds pretty good, but is that going to help real investment? I think the answer is no. I might have favoured some measures to try to increase investment direct through the tax system.
Q56 John Thurso: That begs the question of what would encourage companies to invest, because, broadly speaking, the average company invests only when they think they are going to get a return. If they think that the climate is such that they say, "Let’s wait another year to see how it goes," it seems to me-perhaps I am wrong-that there is not a lot that you can do that will make them go out and invest until they think the economy has sufficient confidence to merit investment.
Roger Bootle: The fundamental problem, as you say, is about demand in the economy and confidence, but given all that there are things at the margin that you could do. You could, for instance, have brought in a system of capital allowances. You could have spent money on the corporate sector that way.
Q57 John Thurso: Short-term capital allowances.
Roger Bootle: Yes. Short-term capital allowances to encourage companies to increase investment. Then there is the question that I was talking about before about both Government spending and the level of taxes. In principle, you could cut both in such a way as to be demand neutral. It would of course affect the type of spending in the economy, but you could be sharpening incentives in the process. We talked earlier on about national insurance. I applauded the measure, but the scale was surely inadequate to the problem. How can you get more? You can only get more scope if you actually cut current Government spending.
Q58 John Thurso: The other point that you quite rightly made earlier on was that the banking system is broke. You also said slightly later that we need to get demand up. To what extent is the broke banking system a root cause of suppressing demand?
Roger Bootle: I think it is a significant part of it. Looking back at previous serious recessions, I do not think that we had a single banking collapse in Britain in the 1930s, for instance. Once the exchange rate had fallen in 1931 when we came off the gold standard, we enjoyed a very rapid recovery indeed. Similarly, although there were difficulties in the banking in the mid-1970s, by the time we came out of that first recession in the early 1980s, the banking system was essentially okay and bank lending growth was pretty strong. If you look at the United States, it is quite striking that the US is growing-admittedly not rapidly, but it is growing not too badly-and you can see bank lending growing. You can see why it is growing, which is because they addressed the problems of the banking system quite early on, they recognised bad debts, and they recapitalised the banks.
Q59 John Thurso: So if we actually-Adam Posen made a very similar point-wanted to do something that really might act as a stimulus, it would be to provide credit, and you provide credit by taking the rubbish out of the banks’ balance sheets.
Roger Bootle: That would be one way of doing. I would perhaps put it in a more general way. If you think that the essential problem is a broken banking system, which I do believe, then you should go to very great lengths to fix it. There are a number of different ways in which you might want to fix it, but we have been pussy-footing around with fixing it ever since the financial crisis began with a series of half-measures. We have not even done full nationalisation. We have spent a lot of state money so that the taxpayer owns a substantial chunk of two very large banks, but the taxpayer does not own all of them and evidently cannot dictate their policy. That strikes me as rather half-hearted.
Q60 Chair: Okay. Whether or not we cocked it up getting to where we are, what should we do now with these part-nationalised banks?
Roger Bootle: I think we need to separate the bad bits from the good bits. If that means forming a wholly new institution, we ought to do that.
Q61 Chair: And the hit on the public sector balance sheet from doing that?
Roger Bootle: It would not be a real hit, would it? It would be recognising a hit that is already there. That is the point. To the extent that the public sector has invested in these dodgy assets, the hit is there. All you are doing is crystallising it. The markets are not stupid. The numbers will obviously look ugly, but I think the markets can take all this. It is the politicians who cannot take it.
Q62 Chair: You, Mr Saunders, were nodding your head, but I could not work out whether it was disagreement or agreement.
Michael Saunders: It was agreement. The greatest threat to the public finances is if the economy fails to grow. The fiscal cost of that would be far greater than anything you might lose in having to recapitalise the state-owned banks.
Q63 Chair: Is there anything that Roger Bootle said on this that you disagree with?
Michael Saunders: No, that is why I nodded.
Q64 Chair: Mr Daly?
Kevin Daly: I agree entirely that one of the best ways of stimulating growth would be to correct the lack of availability of credit and the high price of credit in the economy. I agree, certainly, with that prognosis. Where I differ somewhat is that I am not convinced that banks’ inability to lend necessarily reflects a lack of capital, although we will wait to hear the judgment of the FPC in that regard. The high funding costs that banks have faced do not necessarily reflect a lack of capital on their front. I think trying to address the high funding costs is the most direct route through which to improve lending conditions in the economy, so I partially agree with the prognosis of the problem, if not necessarily with the solution.
Chair: I am going to bring this session to an end. We are running behind time already, which is a reflection of my colleagues’ interest in what you have had to say. Thank you very much.
Examination of Witnesses
Witnesses: Paul Johnson, Director, Institute for Fiscal Studies, Carl Emmerson, Deputy Director, Institute for Fiscal Studies, Andrew Goodwin, Senior Economist, Oxford Economics, and John Walker, Chairman, Oxford Economics, gave evidence.
Q65 Chair: Thank you very much for giving evidence to us this afternoon. Can I begin by asking you, Mr Johnson, about public expenditure control? First of all, do you think that public expenditure has been brought under control? Secondly, do you think that this is more of an achievement than people might have forecast two years ago?
Paul Johnson: Departmental expenditure limits have certainly been controlled more, in a sense, than was planned even at the point when the spending review was put into place. The £10 billion underspend this year is very substantial. Although some of that is payments delayed, there is no increase in budgets next year, so that is genuine spending that is not going to happen, at least so long as limits are not bust next year. There is no indication that they will be bust, because Departments continue to come in under budget. So I think there is a sense in which there has been a tighter control on departmental spending than was expected a couple of years ago. Given what looked, at the time, like very tight limits, that is quite an achievement.
Q66 Chair: When you gave evidence to us, you told us that this was unprecedentedly tough and that it was going to be extraordinarily difficult. You said that you were afraid that we might tighten the belt so much that we would damage the patient, but you are now acknowledging that we have succeeded.
Paul Johnson: On departmental spending, what has happened over the past couple of years has been very tight. There are three things to add to that. The first is that given the scale of the underspend this year, there is not much in the way of planned additional departmental cuts over the next couple of years. One of the surprising things about the pattern of cuts in departmental spending is that it has almost come to a stop for this Parliament in terms of the published numbers. That, of course, depends on the degree of underspend in the coming years.
Secondly, I guess there is a question about whether the way in which this has been tightened down on has been the most effective one. Clearly, those Departments where you could stop things in the last few months of the year and push them forward have suffered more than those where you could not, and that may or may not be the right place. Thirdly, certainly if you look forward to 2017, relative to previous plans only a minority of the planned cuts have actually happened. There are still an awful lot to come.
I think the biggest wrinkle on all this is that I have been talking entirely about departmental spending thus far. Annually managed expenditure continues to rise pretty fast such that total spending even between 2010 and 2017 does not change, really, but the composition of it changes very dramatically, with departmental spending falling, and spending on benefits and debt interest, in particular, rising.
Q67 Chair: And what is the effect of ring-fencing on all this?
Paul Johnson: Within DELs, clearly the ring-fencing of health has a big effect on everything else, and an increasing effect over time: as the proportion of departmental spending made up by health rises, the cost on everything else of continuing to protect it is greater. Secondly, related to my last point, if you are trying to control the overall budget and you have still got spending on AME rising, that continues to have a downward pressure on everything else.
Q68 Chair: So the conclusion from that is that the Government should re-examine its ring-fencing.
Paul Johnson: There is a very clear arithmetic consequence of continuing to ring-fence, which is: if you look at departmental spending, in the Red Book, planned between 2010 and 2017, it falls on average by about 18% over that period, but in unprotected Departments it falls by a third. That is driven by the ring fences in health and education.
Q69 Andrea Leadsom: Do you think that this Budget has resulted in a tax simplification or a tax complication?
John Walker: Overall, I would have said that it was a tax complication. That is inevitable when you-if I may use this word-tinker with the system to try to encourage growth without necessarily having much more to spend. I am not necessarily in favour of that, but you can see why the Chancellor chose to do it.
Q70 Andrea Leadsom: Right. So, in terms of getting the economy going again, is the goal of tax simplification more or less important than that of tax reduction? Which of those is of more value?
John Walker: I am not sure that it is either of those. I would not restrict it to those. Going back to some of the questions we talked about before, to get the economy going, the Chancellor probably needed to do much more dramatic things than he did do. I would certainly be in favour of much more substantial action in terms of the banks, which was talked about earlier, and we would be supportive of a monetary policy that is more aggressive than we have seen over the last couple of years; that has been one of the biggest failures of the last couple of years. But we would also be in the position of supporting more infrastructure spending, as two of the previous speakers said.
I would not restrict the answer to one of those. Given the seriousness of the situation, I would have done all three of those, and they would have all been more important than, particularly, tinkering with the tax system.
Q71 Andrea Leadsom: So, Mr Johnson, would you say that the tax cuts proposed in the Budget will make a difference to the economy? What is your view on simplification versus cutting?
Paul Johnson: In this Budget there was very little in the way of tax proposals. There is a small increase in the personal allowance next year, which is much smaller than the increase this year-there is a big increase coming in this year-but that will put a little bit of additional money into people’s pockets. Then there is a cut in the real value of fuel duties.
The two of those have a not too dissimilar effect in terms of who benefits: the increase in the personal allowance essentially benefits people in the middle of the income distribution most; because of the way that it has been done, it will once again drag a few more people into higher rate tax, but the overall effect of these things, because of their very small cost and scale relative to the size of the economy, is that the chance that they will have much impact on the economy at all is very small. There is some possibility that the national insurance change will have an effect on employment levels, particularly because they impact directly on the employer, and on smaller employers in particular, but I do not think that we have any way of estimating what that impact will be, and I fear the we will never know.
Q72 Andrea Leadsom: There is a prediction that 450,000 small businesses will not pay any employers’ national insurance at all after these plans are put in place. Is that not a simplification?
Paul Johnson: I do not know the numbers, but that will clearly ease things for those employers who are affected. The structure of employers is such that there are an awful lot who have only one or two employees, and they will be affected. Of course, there is a whole range of other things that will affect small and other employers, including the introduction of real-time information within the next month or two, and other things that will move in the other direction on the income tax system.
Carl Emmerson: In terms of whether the national insurance change is a simplification, it depends very much on how it done. Costing assumes that take-up is 90%. That raises the question, why is it not 100%? Is it something about how you have to apply for it? There might be some addition burden on those who want to claim it, and have to jump though hoops to get it, but we have not seen that detail yet.
Q73 Andrea Leadsom: What about the corporation tax reduction-merging the main and smaller rates at 20%? Does that simplify corporation tax structures that might be two small companies instead of one big company for tax reasons? Does it encourage ease in doing business? Has the detail of this not been looked at?
Paul Johnson: That is a welcome simplification. It gets rid of a fairly anomalous system. Moving to a single rate of corporation tax is undoubtedly a good thing from the point of simplicity and efficiency.
Q74 Andrea Leadsom: What about the introduction of child care vouchers? I’m sorry that I’m leading my witnesses, but you are not jumping on these things. Does it add a burden to employers? Is it anti-business or pro-business? What is its impact?
Paul Johnson: As I understand the proposals, it is quite the reverse. At the moment, the system of child care support can only be accessed through your employer. The purpose of the new system, as I understand it, is that that happens directly from the individual, not the employer. That has two effects. It widens the scope-except that it is only for younger children-and, in the long run, it reduces any burden that there might be on employers. Although it is referred to as a tax relief, I have to say that my understanding of the way it is scored is that there is a spending increase, so you should not see it as part of the tax system at all.
Q75 Andrea Leadsom: No, but my question is about whether it is a tax simplification. When pressed, you have agreed that the reduction in headline rate, the reduction in employers’ NI contributions and the new child care vouchers could all be a tax simplification. But overall you think it is a complication.
Paul Johnson: No, I don’t think the Budget has been a complication; I think it has been relatively small. You are quite right that the corporation tax change particularly is definitely a movement in the way of simplification. The national insurance system is unclear; it depends how it is delivered. In the long run, the introduction of child care vouchers, given that it takes something away from employers and makes it the role of the individuals, will provide some simplification.
Q76 Andrea Leadsom: Is there anything you would like to add, Mr Goodwin?
Andrew Goodwin: The main thing with all these measures is how they are administered. If they require businesses to fill in extra forms and the like to administer the scheme, that will be an added complexity. If, on the other hand, they take a burden off companies, that can only be a good thing.
Q77 Andrea Leadsom: So you would all welcome tax simplification, but there is not enough information to decide whether these measures represent tax simplification.
Paul Johnson: It is pretty clear that the corporation tax change is a welcome simplification.
Q78 Mr Newmark: I want to go on to austerity. I will go to Paul’s and John’s wingmen because they have been very quiet. Carl, what do you make of recent arguments that austerity might raise the debt ratio in the short term by lowering GDP? What is your analysis of that comment?
Carl Emmerson: That clearly depends on what extra borrowing we are doing and what the multiplier is on it, so it depends on how you spend the money. The OBR assumes that the multiplier on investment spending is one, in which case you would get higher GDP from more borrowing if you spent the money on investment, but it would not be enough to lower the deficit overall. Others disagree and think that the multiplier could be much bigger. We have not done research into what the multiplier is in the UK at the present time, so I do not have an answer to what I think the number would be.
Andrew Goodwin: We have been looking into this as part of the wider debate about why GDP has been underperforming. Our view is that fiscal tightening is one of the main reasons why GDP growth has been weaker than most people expected over the past few years. That goes back to the idea of fiscal multipliers not being static and constant over time. They depend upon the circumstances you are in. There is a strong wealth of evidence out there that suggests that multipliers this time around probably are larger because of what is happening elsewhere. You have got the private sector deleveraging, both households and corporates. You have obviously got trade effects; the weakness of trade, particularly from the eurozone. And you obviously haven’t got quite the same sort of scope-or certainly it has not been used to the same extent-to loosen monetary policy in reaction to tighter fiscal policy. So, those three factors tend to suggest that you’d get higher multipliers at this sort of stage relative to previous crises.
Q79 Mr Newmark: If you follow Chris Giles’s argument in the Financial Times, he feels that the Chancellor is being too timid, not too austere.
Andrew Goodwin: There are probably two sides to that. I think Chris was probably referring to the very short-term concept and this idea that we need to get demand moving. I think in that sense that I would certainly agree with Chris. What we have advocated for a while now, and spoke about at length in the green Budget, is the idea that we need more capital spending really over the next two financial years or so, to get the economy moving. I would agree that certainly over the medium term there is a need to rein back the deficit and go through with the plan.
Q80 Mr Newmark: More austerity?
Andrew Goodwin: Over the medium term, I think it is the right level of austerity, but in the short term it does require looser policy to get the recovery moving, to generate some demand. We come from the same point of view of most of the previous speakers. We have predominantly a demand-based problem.
Q81 Mr Newmark: The sense I am getting from you is that perhaps we need more austerity, possibly in order to get out of the hole we are in. I want to go to John, as this sort of ties together. Do you agree with those who say that further borrowing would fund itself by promoting GDP growth sufficiently that the extra revenue would make up the cost of that borrowing?
John Walker: A bit like Andrew said, I think this whole question is about timing. We do a lot of looking at international comparisons. If you compare the UK and the US, the timing of the fiscal austerity is what has been substantially different between the two countries. That is partly because of inability to take decisions, one might say. In the US during the early period of recovery there was very little fiscal austerity. That generated, in our view, sufficient momentum in the economy that now they can have a period of austerity without it having the negative consequence.
Q82 Mr Newmark: But the structure of their economy is very different from ours. They are not as heavily reliant on the financial services sector in the US, for example.
John Walker: The differences are not that great. I would argue that, if you were looking for an economy most similar to the UK you would look at the United States: heavily dependent on services, heavily dependent on business services. We are maybe slightly more dependent on financial services, but to a degree that I don’t think would be that much.
Mr Newmark: As a percentage of GDP I thought that the banking sector was something like 350% of GDP in the UK, versus the US where it is about 50% or 55%. Or is it not? In terms of the size and looking at the impact the banking crisis had relatively.
Q83 Chair: The financial sector is broadly speaking five times the size as a proportion of GDP in the UK as in the US, is it not?
John Walker: My understanding is that financial services overall-and you have got to be careful by what you mean by financial services, because it includes retail banking and insurance-in the UK it is between 15% and 20%. It depends how you do the numbers. In the US it is just less than 15%. Within that, you might argue that some proportions of financial services are bigger, but overall financial services are not that different.
Q84 Mr Newmark: I guess I was looking at the balance sheets.
John Walker: I am looking at the share in GDP, rather than the balance sheet. Surely it is the share in GDP that matters at least as much.
Q85 Mr Newmark: Except the impact it had on those institutions was relatively far more dramatic as a result in the UK versus the US.
Chair: It is the balance sheet that we are busy mopping up, isn’t it?
John Walker: I agree that the impact on the institutions would be greater, but that would suggest that you would need to take more monetary policy action and more banking action to deal with that. It is not necessarily that the impacts on the economy would be different.
Q86 Mr Newmark: I just want to go on the forecasts if I can for a second, which goes back to you. So far, the OBR has the predictive ability of Mystic Meg. The OBR has forecast short-run growth of 0.6% in 2013 and 1.8% for 2014. That is a downgrade revision of 0.6% and 0.03% respectively. Do you think those forecasts will hold? Or do you believe they are over optimistic or pessimistic?
John Walker: As some of the previous speakers said, forecasting is a silly game. Despite the fact I spent 40 years of my life doing it-
Q87 Mr Newmark: Having obviously been overly optimistic in the first couple of years of their life, do you think they have now gone to the other extreme and may be slightly sandbagging the numbers so they can say, "Well, actually it ended up being much better"?
John Walker: My guess as to what has happened would certainly be that because they were too optimistic for a couple of years, they are now being cautious about any recovery. That is probably the right place for them to be. But that increases the chances, therefore, of their forecasts being more accurate this time around than in the past and may suggest that there is some upside risk to the forecast. It is always important to remember that just at the time when people think that there will never be a recovery, quite often the recovery starts.
Q88 Chair: We have been thinking that for some time though now, haven’t we?
John Walker: I know.
Q89 Mr Newmark: Paul, what do you think on prediction? Do you think that the OBR have now over-egged things on the pessimistic side or do you think they are spot on or are they being overly optimistic? What do you think?
Chair: Or do you just think it is a silly game?
Paul Johnson: It is certainly a game we don’t get into. I am sure they are giving their best estimate and it is now far from the consensus of others. Whether they have a better chance of being right this time than in the past, I don’t know.
Q90 Chair: Hardly worth having them then, as they are basically as good as the average of outside forecasters? Isn’t that what you just said?
Paul Johnson: I think they have broadly been pretty close to outside forecasters.
Q91 Mr McFadden: Following on from that, if the OBR and perhaps others have been consistently optimistic about forecasts in the near term-there has been a very consistent pattern where they have had to downgrade and almost every time they publish a document it downgrades what they said in the last one-what does this tell us about their assumption of a bounce back to 2% plus? It is always in two years’ time. Here we are three years on and it is still in two years’ time. Do you see this as a realistic scenario, these numbers for two years and three years hence that they have produced?
John Walker: As I said earlier, it is dangerous but our view would be that there are reasonable prospects that the growth position for the UK will improve over the next couple of years, just as the OBR has suggested. I think there are two or three reasons for that. One is that in terms of growth, most people now think that the really bad time for the eurozone is over. That may turn out to be optimistic again, and I am not talking about the eurozone crisis, I am talking about the outlook for growth in the eurozone and therefore the impact on our exports. We have had a pretty severe recession in the eurozone area. We are not saying the eurozone is going to recover strongly but simply that an end to sharp falls in GDP should improve the position for the UK.
The second reason to be slightly more optimistic about prospects is consumer spending, which I know was part of the earlier discussion. The prospects for inflation have come done. The prospects, therefore, for consumer spending are a little bit better than what they turned out to be. Again, if you look at the United States, a strong reason for the recovery has been consumer spending. So we are not as negative about the consequences of that as, say, Roger Bootle might be. The third reason is policy overall. In terms of spending, as Paul Johnson was saying, the actual cuts in the short term in spending may be all in the past. You might see a more aggressive monetary policy as well as that. All those things suggest that a modest recovery in GDP is the right forecast to make at the moment.
Q92 Mr McFadden: So you would disagree with Stephen King of HSBC, for example, who said that these optimistic medium-term forecasts are beginning to lose credibility?
John Walker: We would disagree with that. Part of it depends on what one’s view is of potential output and part of it is an assessment of what is going on, from a policy perspective, in both the UK and elsewhere. It is always dangerous to be there, given that we have seen no recovery in the past, but we still think that there is a set of reasons that support our view of a modest recovery over the next couple of years.
Q93 Mr McFadden: Paul and Carl, can I ask you about what Mr Walker has just been saying about the consumer’s role? The IFS has pointed out that the contraction in real household disposable incomes has been very sharp for consumers. If that is the case, how can the consumer be expected to be spending more in future years when in fact they are going through their budgets and cancelling this and cancelling that and contracting because their real incomes are declining?
Carl Emmerson: Because some groups of households have cut back on their spending by more than they have seen their incomes squeezed. People with mortgages, for example, have cut back on their spending by more-we have some research that shows that-so they are increasing their saving. If they do not increase their saving at an increasing rate, they could contribute to growth going forward. That would be one group where we have seen a response in which spending has actually been cut back a lot.
Q94 Mr McFadden: So you share Mr Walker’s view that there are reasonable prospects for increased consumer spending?
Carl Emmerson: We do not produce growth forecasts of that type. I am saying that from looking at microdata and what happened to UK households over the past few years, we can see some groups that have cut back their spending by a lot, and they might be groups for whom there is scope for them not to continue cutting back their spending at that rate and therefore have a positive impact on growth.
Q95 Mr McFadden: What is the data on their actual incomes, as distinct from their spending-what is happening with household incomes?
Carl Emmerson: We have shown that households on average are suffering a big squeeze. Many households are not seeing their earnings grow in line with inflation, and you are seeing a squeeze through tax rises and welfare cuts, so there is clearly a big squeeze on incomes, but I am saying that despite that, some households have cut back their spending by more than they are seeing their incomes cut back by.
Q96 Mr McFadden: I am curious-if their incomes are being squeezed, how are they going to spend?
John Walker: You have to be careful of just thinking about an individual consumer. Remember, given the positive numbers that we have seen for employment, the number of people actually earning income is going up, so an individual may not spend more, but overall consumer spending can rise because the incomes of people in employment has gone up and they will therefore have more money to spend. In aggregate, consumer spending can rise, even if it does not from an individual point of view. That has been a very positive factor over the last year, given the very positive numbers we have seen for employment.
Q97 Mark Garnier: Paul Johnson, can I turn to the productivity conundrum, puzzle, or whatever it is? In your green Budget, you assessed of the causes of falling productivity in the UK. You said that it was due to a fall in investment, misallocation of capital <?oasys [pc10p0] ?>and a flexible labour market, but you also dismissed the idea of labour hoarding, the demise of financial services and the changing work force composition. Are you still confident of your findings?
Paul Johnson: First of all, particularly on financial services, we are not saying that that has not played a role, because financial services are a very productive bit of the economy and they produce a lot of GDP, and productivity within that sector has gone down. However, the point is that is has everywhere else. So financial services have played a significant role, but they do not actually look so very different from what has happened in other bits of the economy.
The evidence as we see it-I do not think that anyone knows the answer to this-is that there has clearly been a reduction in wages and a high level of employment. I think it is difficult to determine what is pushing what, but clearly there is a flexible labour market, driven by two or three decades of changing policy, which is pushing people into work. It does not appear to be the case that it is being driven dramatically by a change in the composition of the work force, for example. The work force is better educated and more experienced than it was five years ago. Although there is some evidence of more people working part time or being self-employed, which is clearly having some depressive effect, that cannot explain anywhere near all of what is going on.
Given what is happening to GDP, we see a relatively small number of companies going under and a relatively small number coming in and accessing new capital. That is some evidence in favour of a misallocation of capital, alongside a very slow recovery or no recovery in investment in the economy.
That again suggests that workers are having less capital to work with. All those things appear to be playing a role in more people being involved in work. It does appear to be producing less, right across the economy.
Q98 Mark Garnier: Do you think forbearance has a lot to play in this? One thing you mentioned was very few companies going under, but there has been talk about, with interest rates being very low, it being very easy for banks to offer forbearance to businesses. Do you think that that is playing a bigger role than we imagined?
John Walker: There is clearly a whole set of factors that explain what is going on, but we are not terribly convinced that there has been a lot of labour hoarding in the more recent period. It may well have been a significant factor in 2008-09, but we do not see it that many companies are hoarding labour four or five years after the most severe period of the recession. The other thing is that employment is actually rising. We cannot see why people would be employing more. Hoarding labour-not sacking someone-is very different from taking someone on. We are not terribly convinced that labour hoarding has been a significant factor. We are also not terribly convinced that companies are keeping people on just because the banks have been lenient. We are a small company and I could not imagine us choosing to do that. I do not see it as a factor in many of the companies that we have discussions with, either large or small.
Q99 Mark Garnier: So what is the issue?
John Walker: One of the factors-this is a controversial statement-is that we are underestimating GDP. We do not think that the GDP figures that the ONS produces fully reflect what is going on in the economy.
Q100 Mark Garnier: On that point, do you therefore expect that at some future point it will reassess the figures upwards, as we have seen in the past, or do you think that we are just using a fundamentally wrong system to try to establish our GDP and need to work out a better way of doing it?
John Walker: I think there are a couple of things at work. It is extremely difficult in a global economy to measure GDP and some of the methods that the ONS uses need to reflect the more global nature of what is going on in the UK and other economies.
Q101 Mark Garnier: Have you got some proposals to do that?
John Walker: We are part of it as a company. That is my first comment. We employ people in the UK selling things all over the world. It is awfully difficult for the ONS to get an estimate of what we are doing.
Q102 Chair: We have the ONS along from time to time. What should it be doing that it is not doing?
John Walker: We have had discussions with it about this. I will make two points. First, there is this global question, but there is a second related question that is important. Measuring the inflation rate in the global economy is substantially more difficult than people imagine. There is a big focus on consumer prices, but from an output point of view it is the GDP deflator that matters. A lot of work could be done looking at inflation in the output side of the economy. Personally, I think that that has probably been overstated. One of the issues is a split between nominal and real GDP, as we economists call it.
Paul Johnson: That may be important. I do not know what the answer is in terms of whether the GDP figures are right, but it is pretty clear that the tax receipts are consistent with nominal GDP rising as the ONS says it is. Indeed, if anything, that suggests we are doing even less well than the ONS numbers, but that could be explained by the nominal/real split that John referred to. If you think inflation numbers are right, it is hard to square the tax numbers with real GDP being understated. The alternative is that it is the nominal/real split that is missing.
Q103 Mark Garnier: It is quite a techie area. Can I quickly go on to the household debt issue? I think you were in the previous session, where I asked questions about this. Household debt has gone up in real terms from 1990 by 260%. To what extent do either of you see that as a huge headwind to recovery, particularly in terms of consumption?
John Walker: It is a headwind, but it is not one that needs to stop consumer spending recovering. In contrast to some of the previous speakers, we certainly think that a recovery in consumer spending should be an element in the overall recovery in the economy. I mentioned a couple of times the contrast with the United States. Our consumer debt to GDP levels are broadly similar, but I agree that it is different in other parts of the economy. The consumer has been a critical part of the US recovery, and we would think that it should be an element in the UK recovery. Indeed, given the size of the consumer, it almost has to be an element in the recovery, because we do not think that investment or exports are going to be able to do enough.
Q104 Mark Garnier: Haven’t they treated their bad mortgage debt slightly differently in America with the troubled asset relief programme?
John Walker: They have treated it differently in the sense that many consumers can walk away from their debt and therefore the debt goes back to the banks and often then goes back to the Government. It is certainly true that consumer debt in the United States has fallen more sharply than it has in the UK.
Q105 Mark Garnier: That they can walk away from their debt and look to the future, rather than looking back at their credit card bill, must have had an effect on people’s confidence.
John Walker: You might argue the opposite in the short term. Certainly, it relieves them of their debt and they are therefore able to spend, but they still have to find a home to live in and pay the rent on it, so it is not obvious that it makes a massive difference overall. I do think, however, that the situation for confidence in the US is very different to the UK, but that is an element of monetary policy rather than an issue in terms of housing policy, but that is another question.
Q106 Chair: Could you do us a short note on that techy question about the relationship between the Revenue’s measurements of GDP using output and where you think the ONS is getting it wrong?
John Walker: We have done a short note already and we are happy to circulate that and to answer further questions.
Q107 Chair: You have already done something that we have not seen.
John Walker: I do not know whether you have been sent it or not.
Chair: I have not seen it.
Andrew Goodwin: It has only been published for our clients so far, but we can certainly make it available to you.
Chair: I hope you are not expecting a large fee.
Q108 Mr Love: Earlier in a reply to the Chairman, you mentioned that the underspend in 2012-13 was quite an achievement. That sounds to me as if you were surprised by that. Are you surprised? Do you think that there is something unusual going on?
Paul Johnson: If you look at the numbers, the underspend this year, at some £10 billion, is near enough double what it has been in the last several years. In that sense, quantitatively, it is clearly unusual. It also appears to be unusual in the sense that a lot of it appears to have happened or been made to happen in the last few months of the year. There are a couple of things that are unusual about it, and it is clear that at least some of that spending has been pushed forward into next year. The thing that is quite interesting about that is that it is not being reflected in an increase in the overall envelope next year. Next year’s envelope is actually a little bit less than planned. That therefore looks like a bunch of spending that was expected to happen, but actually is not going to happen this year or next.
One of the crucial things that will come out is actually what the underspend next year turns out to be. If next year’s spending goes right up to the wire and there is no underspend, that might be evidence of the pressure from this year pushing through into next year and less being taken out than hoped. If the Treasury manages to squeeze underspend to the same level next year as this, this looks like a really significant additional squeeze on spending relative to what is planned. It is worth saying that the level of spending currently planned for this year will imply a significantly bigger squeeze on public spending than was originally planned. How that squeezes out into next year does remain to be seen.
Q109 Mr Love: I am struck by the fact that the Secretary of State for Defence only weeks ago was saying that he could not suffer any further reductions. He comes in with a £3 billion reduction. If you look at the NHS, which is meant to be covered by a real-terms expenditure maintenance, it comes in at £2 billion under. Of course, there is the whole issue about whether you can shift things back and forward from year to year-whatever happened to resource accounting? I just wonder whether you think there is more to this than meets the eye.
Paul Johnson: It is worth saying that £2 billion on a £100-odd billion budget is not a vast number. I do not have the details of either the NHS or the defence budget, but what meets the eye is that there has clearly been a concerted effort within the Treasury across Whitehall either to stop spending happening at all or to push it into next year. That looks as though it will be achieved.
As I said, the thing we need to look out for is the scale of next year’s underspend and whether that changes the planned trajectory. My sense is that at least some significant part of the additional part of the additional underspend that we have seen looks like permanently reduced spending-by permanent, I mean over this couple of years. Some of it will be squeezed into next year. A lot of where we end up, and a lot of our judgment on this, will depend on the action of the Treasury on Departments over the next 12 months.
Q110 Mr Love: You mentioned also that although DEL was being constrained, annually managed expenditure was continuing to go up. Of course, the Chancellor partially addressed that by suggesting in his Budget speech that they would introduce greater control over annually managed expenditure. What do you expect that will mean?
Paul Johnson: I do not know what it will mean. There are two issues about controlling annually managed expenditure. One is that you can, clearly, just change policy to control it, so you could reduce the level of the state pension or you could do what the Government have done and reduce the generosity of certain social security benefits. That is a control on annually managed expenditure.
Q111 Mr Love: But you will not be expecting them to reduce pensions.
Paul Johnson: That is a decision for Government. The other kind of meaning that you can attach to this is an effort to manage the caseload more actively, which, again, happens within the welfare budget. The thing you do not want it to end up doing is to say to DWP, for example, which is far and away the biggest part of this, "Here is a budget, and if you have more people claiming disability benefits or unemployment benefits, you will have to squeeze down on your administration spending." That is almost certainly a false economy, because that reduces for the next year the amount of control that you have over the budget. I assume that that is not where we are going to end up, but I think it is very important that it is not.
Q112 Mr McFadden: The Chancellor indicated that he would protect the automatic stabilisers. Can that be done while exercising greater control over annually managed expenditure?
Paul Johnson: There are two issues about the automatic stabilisers. In a sense, the Government have allowed them to act in a remarkable way in that we are borrowing very many tens of billions more than was originally planned as a result of lower tax revenues. The Government are not squeezing down at that macro level on the deficit. To the extent that you are looking at social security spending, particularly, actually the proportion of social security spending at the moment driven by unemployment is remarkably small, certainly if you take account of working age and pension age together. So the protection of that within an annually managed expenditure system is a relatively small issue. The big issues are all the other benefits. Jobseeker’s allowance is a tiny fraction of the spending on social security.
Q113 Mr Love: So which areas do you think they could ring-fence if they decided that they would ring-fence parts of annually managed expenditure to protect the automatic stabilisers? What would be left outside the ring fence? It would be pensions, and it would be lots and lots of different benefits going back and forward depending on the level of output in the economy. It would be a significant amount.
Carl Emmerson: Prior to 1997, we had a control total in public spending. It was about 80% of public spending, and it was basically everything apart from debt interest and cyclical social security, so things like jobseeker’s allowance. Clearly, the previous Conservative Government did include a larger part of public spending within what they were trying to control. It was only after 1997, when we moved to this split between departmental expenditure limit and annually managed expenditure, that it was more like 50:50. Clearly we can plan how much to spend on child benefit and how much to spend on the state pension because we have a pretty good guess of how many children there are and how many pensioners there will be, and we can decide how generous we want to be to them on average. It is much harder to plan the debt interest or jobseeker’s allowance. As Paul said, if we have a good, strong recovery, we do not want therefore want to spend more on the administration of benefits, so we do not want those two things particularly closely linked.
Q114 Mr Love: Let me just take employment support allowance. That is supposed to be determined by a test that someone sits. What you are saying is that if they were to introduce a cap on that, they would then need to fit the determination of that within the cap.
Paul Johnson: One world is to say, "We want to spend £10 billion a year on employment support allowance this year, and if it turns out we have more claimants, we will just reduce the amount we spend on each." I would be very surprised if that is what the Chancellor has in mind. I do not think that employment support allowance is one that you would want to include among the ring-fenced automatic stabiliser benefits because you do not want to give the impression that, or behave as though, it is a hidden unemployment benefit. I am not sure in what sense this would have an effect on employment support allowance other than that, if you are trying to control total public spending and you put that as one of the things in the pot, thinking about next year you might say, "We are only going to increase it by 1% next year." But again, the Government has actually done that. How you make this change in a way that makes a real difference to behaviour is something that I am unclear about and something that we need to think about. I do not know-it is an interesting question-how the change that Carl described between the Government up to 1997 and then after 1997, in terms of what was considered as controlled expenditure, actually changed behaviour.
Carl Emmerson: If you take pathways to work, a pilot scheme tried under the previous Government to try to get people off incapacity benefit into work, part of that was through spending more money on advisers for people who were receiving incapacity benefit. Clearly, if we decide that this scheme is sufficiently good that we want to employ more and better advisers, because it is worth our while, we would like to have that incentive in the system. So in some sense you would like to think about the savings to the public purse from getting people off IB into work and the cost to the public purse of employing more advisers, so you might want to take into account the benefit spending. But if you take that argument to its logical conclusion, you also want to think about the increased national insurance contributions, income tax and VAT that you get when these people move off incapacity benefit into work, so actually it is not quite as simple as saying, "Just look at the benefit spending on that benefit and look at how much we spend on administering the benefit; is it worthwhile spending a bit more on administration?" You have this wider consideration, and when we carried out that evaluation, we found out that the scheme was good for the public purse once you took into account, in particular, the tax effects on top of the reduced benefit expenditure.
Q115 Mr Love: It sounds to me from all of this as if what we will be looking for, and what the Chancellor will be looking for, will be relatively modest savings in terms of £5 billion or maybe £6 billion. Would you disagree? I know you have not had a chance to look carefully at this.
Paul Johnson: If you look at the savings, these are big questions. What is the quickest way to save annually managed expenditure? It is to freeze pensioner benefits. That is unrelated to whether you think of this as annually managed expenditure or any other kind of expenditure. My guess is that, for that reason, the scope for really big social security benefit savings through the sorts of things that Carl is describing, in the short run, is fairly modest.
Chair: Thank you very much for coming to give evidence this afternoon. Again, we would have liked more time. It has been somewhat curtailed, but we have picked up a lot.
Examination of Witnesses
Witnesses: John Cridland CBE, Director General, CBI, and Paul Smee, Director General, Council of Mortgage Lenders, gave evidence.
Q116 Chair: Thank you very much for coming this afternoon. As you can see, we are trying to get through quite a lot of business in a relatively short space of time. Can I begin with you, John Cridland? Do you think the Government have a coherent energy policy? Does the energy policy they have command the confidence of the business community?
John Cridland: Energy policy will command the confidence of the business community when the Energy Bill has achieved Royal Assent. Key elements of the policy are supported by business, but confidence comes from the security of knowing they are rock solid. So we need the Bill to achieve Royal Assent on time, on specification. Clearly, behind that lie some very challenging negotiations on issues such as strike prices around contracts for difference. The current negotiations proceeding for Hinkley are a significant test case. I think business as a whole wants security of supply at predictable costs and it looks to energy policy to address that in a most cost-effective way. So within the business community the most important thing is that phrase "to keep the lights on". In that context business knows that energy costs will be higher, but it does not want them to be any higher than they need be.
Q117 Chair: What does that mean? What does it mean to say they shouldn’t be higher than they need be? Nobody puts them up for fun, except to collect profit, of course.
John Cridland: We are entering into a situation where the Government will be managing what is effectively a liberalised market and intervening on price through the negotiation of price support mechanisms. The question therefore about not being more expensive than they need be is that the vast majority of CBI member companies, who are users of energy, want the Government to have the skills, particularly in the Treasury and in DECC, to be able to negotiate with energy suppliers on an appropriate but not over-generous level of price support, whether it be in nuclear, renewables, or the successor to the renewables obligation. In that regard, I think those price negotiations should lead to a declining level of support over time as the availability of a range of technologies enables energy to be delivered more cost-effectively.
Q118 Chair: It sounds as though you are quite optimistic about it all.
John Cridland: I think business is supportive of the policy framework because for us it is the only way to deliver security of supply. I think there is a lack of confidence and, indeed, in some parts, scepticism about whether Government can deliver the fruits of that policy framework. The biggest concern for the investment community is uncertainty. Over the last year we have had significant investment uncertainty. For energy intensives there is a concern about whether Government are providing sufficient support to mitigate the impact on energy-intensive industries such as steel and chemicals that cannot bear the extra cost of higher energy bills that may be necessary to deliver security of supply.
Q119 Chair: Who is running policy? DECC or the Treasury?
John Cridland: Over the last year it has been very visible to business that there has been quite a tussle between those two Departments. That is a creative tension between the respective roles of the finance Ministry and the sponsoring Ministry. But it has, because it has been prolonged, led to more uncertainty, which has damaged business confidence and investor confidence. I have certainly urged both the Secretary of State for Energy and the Chancellor to resolve those challenges. At the end of the day, it is the Treasury’s job to make sure that increased energy costs are as cost-effective as possible because business wants a balanced mix of different energy technologies. It does not want all its energy in one basket.
Q120 Chair: We all know there has been a tussle. We all know the standpoints of the two players. Which one does the CBI want?
John Cridland: I think at the end of the day while DECC has a significant role in this, it is important for business that energy policy is a successful part of the overall growth narrative of the Government.
Q121 Chair: So you want this policy run out of the Treasury?
John Cridland: And the Treasury should therefore be able to sign off on the overall economic impact of energy policy such as my energy-intensive companies-
Q122 Chair: I am trying to cut through the diplomatic language-
John Cridland: I don’t want my energy-intensive companies priced out of Britain whereby we import sources of energy or other industrial products that we should be making in this country.
Q123 Chair: You would rather have the policy run on growth grounds out of the Treasury than out of DECC?
John Cridland: Energy must be part of the growth strategy and therefore the Treasury must be comfortable that energy policy is consistent with growth.
Q124 Chair: Did you agree or disagree with the remark I made?
John Cridland: It is a shared responsibility, but I think I am signalling that the Treasury must have primacy in that partnership.
Chair: Okay. We got somewhere. It took a while.
Q125 Mr Newmark: Looking at a good example of an energy-intensive industry, Tata Steel’s head of European business operations is on record as saying, "There has to be a drive to make the UK competitive in the motorcar industry or in the engineering industry…We are saddled with a high cost of energy and different costs that our counterparts in Europe may not be subjected to, and certainly in Asia we would not be subjected to." Do you share Tata’s concerns, and, if so, why are energy costs in the UK higher than elsewhere?
John Cridland: I do share those concerns. Clearly we are not where we had hoped to be on global agreements on climate change, such that we could have looked in years gone past with a bit more anticipation that there might be more global co-ordination, but the particular factor which is damaging competitiveness currently is the relatively disappointing situation with the strike price for the emissions trading scheme.
The net result is that because of the British Government’s commitment to a carbon floor price, it is having to increase that price. We saw it in the Budget: when the carbon floor price came in, the expectation for 2015-16 was that it would be set at just over £9, but last week’s Budget said that it is now going to be £18. That is the result of the UK Government having to increase the floor price unilaterally because of the fact that carbon trading in the European Union is not delivering a European price. The net result is that British industry is less competitive.
Q126 Mr Newmark: So you are saying that we are effectively handicapping ourselves by unilaterally implementing polices that are not being pursued by others.
John Cridland: Yes.
Q127 Mr Newmark: So, if we are hoping to attract businesses to the UK, surely that will have an impact on our ability to attract them here to the UK specifically, compared to other countries in Europe or even Asia?
John Cridland: Yes. Now, the CBI and British business is committed to achieving our carbon targets. We believe that to be necessary-
Q128 Mr Newmark: Yes, but we are in an economic crisis where we need growth and jobs, but we are pursuing an energy policy that is shooting ourselves in the foot.
John Cridland: We are pursuing an energy policy which is putting ourselves at more and more of a competitive disadvantage, which will affect the growth of British manufacturing.
Mr Newmark: So, in Sun language, we are shooting ourselves in the foot.
Q129 Chair: Which bit of the anatomy would you say that we are shooting ourselves in if we are putting ourselves at an increasing disadvantage?
John Cridland: The answer has to be that we need to engage more seriously in the European Union with ensuring that EU energy policy provides a competitive, level playing field-
Q130 Mr Newmark: Yes, but if you are an outsider looking in, you see the UK’s green brigade out there are getting their way, pursuing a very admirable, morally high ground energy policy. But when they think about it, they think of the bottom line because they are a profit-driven business, so they will not look at the UK because their energy costs are too high. I see that you are nodding.
John Cridland: I see real-life examples of companies that have to make those difficult investment choices. There are two policy instruments that are available to us that could mitigate that. The first is: I would like to see a bigger package of mitigation for energy-intensive industries. There are parts of the supply chain and parts of the consumer base that may have to cope with higher energy prices, but I do not see why steel mills, chlorine factories, chemical factories and cement factories should. Other countries, such as Germany, provide a more extensive support package for energy-intensives than the UK. The second thing is: we need an EU emissions trading scheme that works over a longer period-up to 2030-such that Germany, France and Italy also bear those costs, not just Britain.
Q131 Mr Newmark: But, in the meantime, our policy is hampering our ability to keep energy-intensive businesses here in the UK when times are tough.
John Cridland: Yes it is.
Q132 Chair: Could you possibly send us a list of all the industries that you think should be subject to these mitigating measures?
John Cridland: Yes, by all means.
Chair: It might be safer to give us the list of those that you think should be left out, judging by the list that you have already supplied us with.
Q133 Mr Newmark: I will give you one last chance here: the Chancellor, in his Budget statement, said that he would announce measures in his spending review to provide support for energy-intensive industries beyond 2015. Is there anything specific, other than what you have mentioned, that you would like to put on the record that you think that the Chancellor should really think about?
John Cridland: I think he should deliver on the commitment that he has already given that energy-intensives, as defined by my letter, are fully excluded from the impact of the electricity markets review.
Q134 Mr Newmark: That is helpful. Environmental groups such as the World Wildlife Fund have criticised the Government’s proposal on shale gas for extending "yet more tax breaks to the fossil fuel sector." To what extent does the introduction of tax breaks for shale gas exploration conflict with policies to reduce the UK’s reliance on fossil fuels and the move towards a low-carbon economy?
John Cridland: I do not think they conflict. The big change between where we are today and where we thought we would be when energy policy was redesigned-for example, in about 2006-is that gas will play a bigger role in the overall mix than was then envisaged, in part because of the availability of shale gas. Although I do not believe that shale gas in the UK will be quite the game changer that it is in the United States, it is in the interests of British industry to take advantage of it as long as it is properly regulated and environmentally controlled.
Q135 Mr Newmark: And you do not think it is a game changer because of economies of scale-the volume of shale gas opportunities here?
John Cridland: Indeed. I think it is a fundamental change to American industrial competitiveness. I do not think that it will be as significant here, but it will still be significant.
Q136 Mr Newmark: Do you think there is anything in the US’s approach towards supporting and stimulating the shale gas industry that we are not doing here?
John Cridland: I think the Chancellor’s most recent proposals are the right form of incentivisation. I think they will have the necessary impact. Gas will therefore play a bigger role in our energy mix, up to at least 2030, than we originally envisaged. Beyond 2030, which is a long time away, it will probably depend on the successful commercialisation of carbon capture and storage if we are to achieve our carbon targets in the long term. What British industry will not wish to see, from a security of supply point of view, is gas becoming the sole, or primary, source of energy in that period. But as part of a balanced mix, I see no reason for not utilising it as extensively as we can.
Q137 Mr Newmark: So shale gas is unlikely to be a game changer, in your view?
John Cridland: Not in the way that it is in the United States. The volumes will simply be different. I do not want to suggest that I do not think it will be significant.
Q138 Mr Newmark: In simple language, it is not going to mark much lower energy prices for consumers and businesses because of the small amount of it?
John Cridland: Yes, indeed. I think the effect will be proportionate.
Q139 Mr Newmark: I just want to touch on carbon capture and storage. I was on the Select Committee on Science and Technology back in 2005, when I first got in here. Carbon capture and storage was going to be the great white hope, but it has never really taken off. Is there more that the Government could be doing to energise that opportunity?
John Cridland: It is vital that we pursue the demonstrator projects. International co-operation is important; not every country should do this on its own. The CBI has never claimed that CCS is a proven technology commercially or a silver bullet. What we have said is that beyond 2030, to achieve our carbon targets with a significant amount of gas, it would clearly be very advantageous if by that time we were able to use CCS. There is lots of low-hanging fruit here. A better drive on business efficiency in the use of energy, consumer efficiency in the use of energy, and making the full use of available energy technologies, including shale gas, are all relatively low-hanging fruit before we get to CCS. But I repeat, CBI members are still committed to the carbon targets that are in the Climate Change Act. The closer we get to 2030, the harder it will be to do it without CCS on gas.
Q140 Mr Newmark: But given where prices are going, the competitive nature out there, and given that the scientific community have had the lead on this-we are great at creating ideas in the UK, but we generally are not good at taking them on to the next stage-and that we have at least 200 years of coal in the ground, surely if we can crack carbon capture this is a great opportunity for the UK. Without necessarily doing what happened in the past-polluting the atmosphere-we can reinvigorate and re-energise our coal mining industry.
John Cridland: That is why I want the demonstrator projects proceeded with. If we can recycle the carbon, we are more likely to achieve our carbon targets more with a full range of energy technologies. However, the days of using fossil fuels to generate electricity are limited without CCS, which is why the CBI has also supported new nuclear and supports cost-effective renewables.
Q141 Chair: When you send us that note on mitigation for high energy intensity industry, could you also send the CBI’s estimate of a comparison of the total amount done as a proportion of those sectors and of GDP, between Germany and Britain? I ask because you began your description of that policy area by saying that we were doing much less than the Germans.
John Cridland: Yes, Mr Chairman.
Q142 Mark Garnier: Mr Smee, perhaps I could take you off the reserve bench and talk about the housing market. What is your summary of the current state of the UK housing market?
Paul Smee: I think there is evidence that the market is coming back a bit. The mortgage market is certainly open for business and this year we have, for the first time since the events of 2008, forecast a significant increase in the amount of gross lending that will be available. We are predicting something in the region of £156 billion this year. The number of transactions is down from what one would call a more usual level, at about 900,000. I think that an ordinary market-not a bubble market-would see transactions more in the order of 1.2 million or 1.3 million a year. We have also seen a decline in the supply of new housing, and there must be a concern that new build is not picking up.
Q143 Mark Garnier: The Financial Times carried an article on 1 January that talked about house prices still being seen as too high, and 44 economists said that house prices were overvalued compared with 26 who said that they were probably not. Also, given the fact that the deposits banks are asking for tend to be relatively high, does a lot of this not suggest that the housing market is still quite overvalued, relatively speaking?
Paul Smee: There are several factors at play. Undoubtedly, the new capital regime that the banks have to follow is causing them to be a lot slower to lend at high loan-to-value. That is keeping from the market, or from purchasing houses, people who could probably service a mortgage and who in previous times would now be on the housing ladder. As the market starts to come back we may see some movement, but loan-to-value has remained obstinately around the 80% mark.
Q144 Mark Garnier: Obviously a key question from the point of view of this investigation is the proposal from the Chancellor to try to stimulate the housing market-the loan to buy scheme or mortgage guarantee scheme. What is your assessment of what is being proposed in terms of how it is going to affect the housing market?
Paul Smee: There are two strands to the Help to Buy scheme, as I understand it. There is the Help to Buy equity loan and the Help to Buy guarantee. I will start with the equity loan, which replaces First Buy and enables people to take a share of the house, in effect passing part of the risk of buying to a third party-in future, the Government. I think that that is solely intended for and aimed at stimulating the building of new houses, and I see that there is a target of 74,000 over three years from the scheme. One would hope that that sort of target could be achieved and that we would see additional building in the residential property market, because, as I said, starts on new builds are currently depressed.
The larger scheme, which probably will not come into force until the end of this year or the beginning of next, is the Help to Buy guarantee scheme. That should have an effect on those people currently saving for a deposit who previously would have had to save perhaps 5% or 10% of the value of the house but are now having to save up to 20%. It will enable those people to bring forward a purchase because of the element of Government guarantee. It will help the lender because the capital that has to support that loan will be calculated in the light of a Government guarantee, so they will have to reserve less capital. As you get to higher loan-to-value, the amount of capital that a lender has to put behind a loan increases really significantly.
Q145 Mark Garnier: Yes. That is very important. The Royal Institution of Chartered Surveyors has said it is worried that the scheme is going to create another housing bubble. Do you think that that is a fair comment? If you would like to come in on this as well, John Cridland, please do.
Paul Smee: Clearly one must watch against that. In the present circumstances, there are a lot of factors militating against a housing bubble. First, there is the question of confidence. Whatever this scheme does, people have to have the confidence to borrow. You are also not talking about the sort of situation around the peak of the market in the middle years of the past decade, where there were very deep financial markets where you could securitise and pass off your mortgages. Those are no longer there. The idea that people will start mortgaging and remortgaging and that the pace will pick up significantly can be overstated.
Lenders also have new regulatory requirements to cope with. I don’t think that this scheme should be seen as increasing the opportunity for irresponsible lending. The way in which the new mortgage market review has put regulatory constraints round lending should ensure that lenders give loans only to those people who can afford to service them.
Q146 Mark Garnier: That is quite interesting. What you are effectively saying is that there is really not much change from what we have got at the moment.
Paul Smee: If this scheme is to work safely it will bring forward purchase, and enable people to enter the housing market at an earlier stage than they otherwise would. That will free up the market and lead probably to more transactions.
John Cridland: The CBI proposed similar measures to Help to Buy in our representations for the Budget as a confidence-boosting measure. I agree with Paul. We need to look at this in the context of a growth strategy and what it is legitimate for the Government to do in the short term that can have a positive effect on both consumer and business-in particular, small builder-confidence. I think it kick-starts confidence. I am disappointed in some of the negative comments I have heard about the proposals, because they are out for consultation and these matters can be addressed in detail. But the principle that everybody gains-householders, builders and the general business community-if we get more houses built and sold quickly, is a given that has strong support across the business sector.
Clearly, there are dangers in the long term of asset price bubbles, but we are a long way from that. The problem at the moment is, in my judgment, primarily on the consumer side a lack of confidence and, secondly, an inability to get hold of mortgages in ways that they can handle. On the builder side it is thin balance sheets and the inability of more builders to build houses at this time. The two schemes address both of those concerns.
Q147 Mark Garnier: On that particular point, the terms of the supply side of this, you said in a recent speech that demand is still staying ahead of supply, and you have just highlighted that point again, that the supply is not coming through. Why is this going to change that?
John Cridland: I think there are small builders at the moment who have found the existing market very difficult for them to take a share of the pain in helping to bridge with potential buyers. The shared equity initiative, building on First Buy, should in my judgment mean more available to small builders than was the case in the past.
Q148 Mark Garnier: There are quite a lot of shared ownership schemes around at the moment. I visited one in my constituency on Saturday where they are doing exactly that.
John Cridland: I think it is just the scale of what the Government are now proposing. It will make a much more significant intervention in the market. Clearly, we were looking for confidence-boosting measures that were therefore primarily on the demand side. A full housing strategy, as the Government have made clear, requires a whole range of other measures on the supply side, not least changes to the planning system and, probably over time, changes to stamp duty. We will not resolve the UK’s housing challenges simply by the Budget measures, but I do think the Budget measures pass muster in their own right as a sensible intervention to take in the coming months, as part of a growth strategy.
Q149 Mark Garnier: What about this colossal household debt problem? Paul Smee, as you know, there is £1.2 trillion-worth of mortgages. From what I understand, 40% of those are interest-only mortgages. The consumer has become used to a super-low interest-rate environment, notwithstanding the loan-to-value ratios that are tighter on new mortgages. None the less, the Government are putting forward a scheme that is going to put taxpayers’ funds at risk in a very unusual environment where you have got high levels of debt, so it will potentially increase that level of consumer and household debt, knowing at some point that interest rates can only go up. There is, of course, an argument that, when interest rates go up, the economy has picked up, so people can absorb that, but even going from a super-low level of interest rates to just a very low level of interest rates could double the household’s cost of servicing their funds.
Paul Smee: You have made a series of very valid points there, and I will take them in order. Any mortgages under these schemes will be offered on a repayment basis. They will not be offered interest only, so as the loan proceeds you will see the debt being paid off. As for the existing stock of interest-only mortgages, of which there are a significant number-I think 3.2 million in total-the ones that mature before 2020, which is about a third of them, are generally on properties where significant equity is being held in the house, so the interest-only policyholder has a variety of options as to what they should do. We have been working very closely with the regulator on doing research about this, and it seems that the vast majority of people who have interest-only mortgages that come to the end of their term before 2020 have a valid repayment strategy in place.
The second comment you made was about increasing household debt at a time of low interest rates. Part of that will be in the evaluation of people’s application for mortgages. A stress test will be applied to see whether they could afford a mortgage were there to be a change in interest rates. We have done some research with existing borrowers, which indicates that borrowers are prepared to reprioritise their expenditure and that there is some-I stress some-ability to cope with a series of small, stepped increases in mortgage rates. Clearly, the quicker and the larger those steps, the more difficult it becomes. On the overall level of debt, mortgages account for a large percentage of overall household debt, but if it is a repayment mortgage, your debt will be decreasing over time.
Q150 Mark Garnier: John Cridland said that this was a start, but it does not comprise an entire housing strategy. What is your view of that?
Paul Smee: I think it addresses one significant issue, namely the lack of availability of higher loan-to-value mortgages, which are stopping people from getting on to the housing ladder.
Q151 Mark Garnier: But do you think it comprises a housing strategy as a total?
Paul Smee: There need to be other measures, particularly around supply. It is the lack of supply that in many cases is keeping prices so high.
Q152 Mark Garnier: But it sounds as though you are dubious as to whether this is going to generate supply as well.
Paul Smee: If you separate out the two strands, the Help to Buy equity loan bit is aimed to increase supply. Certainly, from what I hear from the building community, they are gearing up to meet those increased expectations. So that would deal with one half of it. The guarantee bit is much more about helping those who are already in properties to move on, but in particular getting those who are saving for a deposit into the market.
Q153 Chair: That part of the scheme is much bigger than the first bit, isn’t it?
Paul Smee: Yes, it is.
Q154 Chair: So you are saying that we need to match supply against demand, but the demand side is much bigger than the supply.
Paul Smee: I think that is the way it is constructed. The equity loan part will come on stream earlier, so I hope that supply will start to pick up before any boost to demand that is given by the guarantee scheme comes into play.
Q155 Chair: What about the alleged impairment on bank balance sheets, a large part of which is collateralised against real estate-office and residential-which at some point has got to get into the market and is likely to depress the price?
Paul Smee: There are obviously loans being carried on banks’ balance sheets that are collateralised against property. Given that property prices have maintained their value in many areas, that has not been a significant drag on the balance sheet.
Q156 Chair: That is because they have not come on to the market, because they have not been realised. That is a circular argument, if I may say so.
Paul Smee: I take your point. There are two points that I would make. One is that the fact that a loan is in forbearance at one point does not mean that it is in forbearance in perpetuity. We have evidence that people work through a period where their loan is in effect being carried on a bank’s balance sheet and go back into a repayment cycle and that is affected by overall economic conditions. When the FSA looked at the market and looked at the degree of forbearance, they ended their study in a slightly less nervous position than when they started it, because they believe that the way in which the loans were being managed was appropriate.
Q157 Chair: At some stage, this whole scheme is going to have to face the fact that there will be an unravelling of what is sitting on the balance sheets of those banks. I never make predictions, but I am going to insist that you do. Do you predict that the three-year limit on this scheme will be met?
Paul Smee: I would first say that one of the key questions that I would like to discuss with the Treasury about this scheme is what their exit strategy is.
Q158 Chair: How do you feel about the one that is being described to you so far?
Paul Smee: I am not aware of their exit strategy for this scheme so far. I have been looking at the entry criteria.
Q159 Chair: What you mean by that is that you have not spotted it.
Paul Smee: It has not been explained to me.
Q160 Chair: I see. There is an exit strategy in the Red Book, which is, "We’re going to pack it up after three years and tell the FPC that they’re in charge."
Paul Smee: Yes, I think that the-
Q161 Chair: You are bit harsh. There is one, but how do you feel about it?
Paul Smee: Thank you for drawing that to my attention. One of the risks with housing incentive schemes, which we have seen with things such as stamp duty holidays, is that they create spikes around the time when they come to an end with lots of transactions happening immediately before and then a period of dead calm thereafter. That is something that we must try to avoid with this scheme, particularly with a scheme as significant as the Help to Buy guarantee. I would hope that we would be in early discussions with officials so that the scheme does not fall off the edge of a cliff, but rather has a managed and bracing, but not precipitous, exit route, because that would seem to me to stop a short-term distortion in the markets.
Q162 Chair: So are we going to close this operation down in three years or not?
Paul Smee: That is clearly the Government’s intention. I would certainly hope that an intervention of this magnitude would not persist for much longer, because it will have longer-term distorting effects.
Q163 Chair: If you compare this with the long saga of mortgage interest relief, do you think there are some lessons to be learned about Government intervention to stimulate demand in the property sector?
Paul Smee: I think it is a bit different from mortgage interest relief in that it is not available to everybody on a whole loan. It is more targeted. Something that will be very important is to be clear on the scheme’s success criteria.
Q164 Chair: What should they be?
Paul Smee: I believe that, at the end of three years, if it is seen that the mortgages with higher loan to value are more readily accessible to those who can afford them-I keep coming back to the fact that these loans must be serviced by those who take them out-and if we see an increase in that level of availability, that is a very important success criterion for the Government. Possibly, you should add to that an increase in the number of transactions to what I would call a historically reasonable level in a gentle market-perhaps 1.2 million transactions a year as opposed to below 1 million now.
Q165 Chair: If I may say so, Mr Smee, you are giving surprisingly disinterested evidence to us this afternoon, bearing in mind that the people whom you represent all day for your bread and butter must be looking forward to the extra business that will result from this stimulus.
Paul Smee: I think quite a few of them are asking the sorts of questions that I have been posing as I give my evidence.
Q166 Chair: Not quite so disinterested as I tried to flatter you with.
Paul Smee: Thank you. It was very kind of you. I took it as a compliment. The response from our members has varied. Some are significantly enthusiastic and some are less than enthusiastic. However, many are saying, "We must see the detail of how the scheme will operate, particularly the commercial fee that we will be charged to access the scheme, because that has not yet been made public."
Q167 Mr McFadden: John Cridland, I would like to ask you about the funding for lending scheme. The Chancellor said in his Budget speech that he is actively considering, with the Bank of England, whether there are potential extensions to the funding for lending scheme. How do you think it has operated so far from a business point of view, leaving aside the mortgage side of it?
John Cridland: It is early days, and I think it will take time, on the business side, for the spring to wind up fully. But it is the first scheme of its kind I have seen that has the confidence of the business community and, over time, throughout 2013, it will make a material impact on small firm lending. Some of the concerns about the fourth quarter lending figures did not take full account of the cyclical factors: the fourth quarter typically sees a fall off in lending. Secondly, they did not sufficiently differentiate between the different lending institutions: there was a more favourable pick-up in lending from those institutions that are fully operating in the private sector market and a lower pick-up in lending-in fact, a decline in lending-from those banks that are still significantly deleveraging their balance sheet. The Bank of England’s credit conditions report shows an increase in availability of credit to small businesses, as well as in the mortgage market. That gives me some confidence that this scheme will have impact. I suspect myself that it will need to continue beyond the end of 2013 to have that full effect, given my point about the time it takes for it to work its way into the market. I also think it is worth examining whether some of the non-bank lending options should be included in the scheme-things such as capital for lending and the business finance partnership. That is worthy of examination, but I am particularly confident that we will see an extension of the scheme beyond its original termination date.
Q168 Mr McFadden: We have had a lot of efforts on this front: we had net lending agreements, gross lending agreements and Merlin, and now we have this. You appear to be saying that this is probably the most effective thing so far. Is the CBI saying to Government, "Just try this," or are there are other things on the lending front that you are asking for, particularly for small and medium-sized businesses?
John Cridland: Although lending to small and medium-sized businesses is a very important issue and a very important constraint on economic growth, because both the supply side and the demand side have declined, our representations to Government also try to put the full spectrum of pinch points, where businesses cannot get either loan finance, equity finance or non-bank finance for growth. Therefore I was particularly pleased, to take one example, to see the decision in the Budget to abolish stamp duty on share transactions on AIM, because for mid-market companies that is a particularly important way of opening up the market. I think some of the proposals that were announced the day after the Budget by Secretary Cable for the British business bank pursue some of the options of interventions in the wholesale market that could be attractive. I am not for a moment suggesting that funding for lending is the only thing we should do in the lending market, and I think that there are other options beyond the lending market. But I do think that what funding for lending had was an incentive structure for the banks; what previous initiatives did not have, other than a clarion call to increase lending, was an answer as to how banks with constrained balance sheets would increase lending. Although it is by no means a silver bullet and it is taking a while to have an effect, the effect will be positive if we stick with it.
Q169 Mr McFadden: What about the Government’s business bank, which you mentioned? How much confidence do your members have that that will make a difference?
John Cridland: I do not think that we should overstate the contribution that a business bank can make. When you look at the scale of the resources that it is given, in contrast to those of the KfW in Germany, which we often talk about, if you wrap up all the schemes together we are talking about a maximum of a bit under £4 billion for the business bank and something like €76 billion for the KfW. So the scale is completely different.
We have just been round our small and medium-sized enterprises again, to ask them what the problem that they are facing is. I appreciate that the profile of the CBI small business is probably different from the profile of some of the businesses in the membership, for example, of my colleagues in the Federation of Small Businesses, who have suffered significant increases in their risk profiles on working capital and have been writing to Back-Bench MPs. For my small businesses-some of them are very small-their concern is about the confusion of Government schemes. They see the one-stop shop approach that the business bank could offer as a significant prize. They also want to see a return to something closer to high-street-relationship banking, which is a matter for banks and no one else. In that regard, the role of the business bank in assisting challenger banks is an important contribution it could make. There is also the longer term proposal, which I have already mentioned, for it to get into some form of wholesale market intervention, perhaps through some form of securitisation.
Q170 Mr McFadden: What about the Government’s performance on aid to business? How satisfied is the CBI with the Government’s ability to get money they have promised out of the door through things like the regional growth fund?
John Cridland: Again, as with so many of these things, you will find CBI member companies supportive of the regional growth fund, but frustrated by the pace of delivery. That is an easy point for critics to make. It is a scheme that takes time to have effect and some of the grants have been very beneficial to regional economies. It is important that we get the money out to the customer. In general, the CBI tends to the view that the Government are doing most of the things it is reasonable to ask a Government to do at this point in the economic cycle to promote growth. We had our proposals for housing, which we discussed in earlier answers. The concerns of business are much more about the delivery of those initiatives and a relative sluggishness in delivery-I would include infrastructure investment in that-rather than intent.
Q171 Mr McFadden: Is it true that there are businesses that were promised money in the first round of RGF two years ago that have still not received a penny?
John Cridland: I am told that that is correct, but I do not have that information to hand because I have not been directly involved in RGF. I do hear that, however.
Q172 Mr Love: The Governor of the Bank of England made some comments recently that were widely interpreted as talking down the value of the pound. Indeed, he then corrected that and suggested that the pound was properly valued. Do you think that he was intentionally trying to talk down the value of the pound when it looked as if it was going up in value?
John Cridland: I think it unlikely that he was intentionally seeking to do that. It is very appropriate for the Governor to set a tone for how he believes the economy is likely to progress in the coming months and what the factors are that are most material to that. We all know that the factors that are influencing sterling are related to Britain’s place in a globalised economy and that has as much to do with factors outside of these shores as it does with things that are in our own destiny to control.
Q173 Mr Love: Do you think it would be important to have a further weakening of the pound?
John Cridland: We have a major objective to rebalance our economy away from debt-driven consumption, whether it is household or public consumption, and to have a greater component of trade as a positive component of growth. It is very disappointing that in the 2012 growth figures trade was such a significant drag. If one looks at the OBR figures, it looks like it is continuing to be a drag. I think we should not rely on sterling as a way of improving our export performance. That is a mistake that we have made in public policy in the past in this country with the post-war generation.
We need to focus on the core aspects of selling the right goods and services to the right markets around the world, with a rebalance to build up our position in emerging economies and the BRIC countries. I was with the Prime Minister less than a month ago on the very successful business delegation to India. I would not want to rely on currency devaluation to help achieve that. In fact, the evidence since 2007 is that with a significant depreciation in sterling-20% to 25%-our exports have not boosted to the extent you would anticipate they might have done with that, which suggests that the underlying factors behind our export performance are relatively more important than the level of the currency.
Q174 Mr Love: Let me press you for a moment on that. Martin Weale, who has come before this Committee on a number of occasions, has suggested that while we had that 20% to 25% currency devaluation, neither Germany nor the US had a similar devaluation, yet their export performance was better than ours. How do you explain that?
John Cridland: I think we have been selling products to the parts of the world which are not growing. So if you look at goods, goods have fallen by something of the order of 10%, because 50% of our exports go to the European Union, but they have increased since 2007 by over 30% in the non-EU part of the world, which suggests we are beginning to balance away. But that takes time. I think the fact that the devaluation did not have the effect that we thought it might reflects the fall-off in the services part of our exports, particularly the shrinkage of financial services exports. On the manufactured side, it also reflects the fact that we underestimated the amount to which imports would increase for exports to increase-the interdependency of our import performance with our export performance. So I come back to my answer, Mr Love, that I think that the non-currency factors are the most significant elements here of a slow rebalancing of our exports.
Q175 Mr Love: If you look at trade balances, even when our financial services sector was doing very well, the trade balance was still appalling. It is still appalling. Is there a structural problem within the United Kingdom economy? Do we need to regenerate our manufacturing base in order to address some of these issues?
John Cridland: I have been a strong supporter of a 21st century industrial policy. I am pleased to see now that there is cross-party support for ensuring that in the key internationally tradeable sectors we learn the lessons of the successful turnaround of the automotive sector and apply it to other sectors where we stand a chance of punching above our weight. But I would say two more things. If you look at the companies that should and have the opportunity to export more than they are currently doing, I don’t think it is the household names. Typically, it is the group that I have been focusing on at the CBI-the mid-sized businesses. If very small companies try to operate in those emerging economy markets, they may not have the scale to take advantage of those opportunities, but a company with a turnover of £50 million, £80 million, £100 million or £120 million ought now to be looking beyond the relative poor growth rates of the European Union to the markets where they have things to sell.
In terms of who they are, clearly it is across the business spectrum. If Germany was the exporter par excellence in the last decade, because it was offering those emerging economies capital goods at precisely the time they wanted capital goods, Britain has a particular strength in consumer goods and consumer services for the emerging middle classes of those markets. I have recently seen it on the export missions I have been to. So I think that rebalancing needs to take place. We need to get back the notion that we are a global trading nation as well as believing that the European single market is an important basis for being a global trading nation. We have underperformed.
Q176 Mr Love: I take your point about the Mittelstand problem. I think we need to address that. Much is said about the German export performance being built on a restraining of internal costs from 2000 onwards. If we are not to gain competitiveness by devaluing, do we need to do some of that German restraining of costs in order to make ourselves more competitive?
John Cridland: Undoubtedly, we need the leanest production and the most efficient processes. It comes back to the Chairman’s opening questions on energy costs in relation to manufacturing. The profile will not be identical to Germany’s. If I am right that many of the opportunities for British business lie in consumer goods, branded goods and services, the cost element will be different at that end of the business spectrum than it is for capital-intensive manufacturing.
Q177 Mr Love: I accept that, although I have to say that when I look round my kitchen at the white goods, they are all German, but I pass over that. What can we do to boost exports? There has been real disappointment that the 20% devaluation did not produce anything like the significant boost to export performance. We know these matters are complicated by what is happening in the eurozone, but I do not think there is confidence out there that, even when the eurozone improves, our export performance will match what is necessary. What more do we need to do?
John Cridland: We need to get behind a British Mittelstand. We need to focus on those companies and help with support networks that give them the ambition and capability to grow at home with a successful growth strategy as a platform for investment. I put it that way because I do not think it is just a case of these guys and gals getting on a plane to an emerging market. They are the forgotten army of the British economy. They are lonely companies and they need more help.
We also need to continue the efforts that Stephen Green has been leading as Trade and Investment Minister, with considerable success, to refocus and strengthen UKTI, Foreign Office commercial diplomacy and, most recently, the relatively weak network of export support that we have in market.
You will know as well as I that you go to a lot of these countries and you see a very significant in-market support for Germany companies that you do not see replicated for British companies. There are efforts to strengthen British overseas chambers at the moment, which I very much welcome. The biggest single component comes back to some of the questions that we had on access to finance-the biggest single component, I believe, to an improved export performance. To get anywhere near the Chancellor’s objective of a doubling to a trillion is export finance. Many of the constraints we have described on bank ability to support access to finance for companies are particularly graphic, given capital requirements, when it comes to supporting export trade finance. If there is going to be a significant gearing up by relative new entrants to exports to challenging far-flung markets, it is vital that export finance, the rebadged ECGD, and then the banks are able to gear up a range of hedging bond support and other forms of export finance and that international regulations such as Basel do not make it more difficult for them to do so.
Chair: Thank you very much, both of you, for coming to give evidence this afternoon. It has been a bit of a wait because we ended behind schedule, but we are very grateful to you for staying and making some very interesting points. It helps a lot.