Author: johnredwood

There’s been a lot of noise for some years about the high cost of public sector pensions. The last government talked a little about it, but tried to ignore it. Indeed, most of their actions led to a large surge in the overall costs, as they added to the public sector payrolls, put the pay up, and finally presided over a surge in UK inflation. BY the time they left office the unfunded liability of public sector pensions was over £1 trillion, or more than the stated public sector debt.

The public sector overall gets better pensions treatment than the private sector. There the ravages of inflation, poor investment returns and greater longevity of pensioners combined with Mr Brown’s tax attack and regulatory strictures to close most final salary schemes or lead to cuts in future benefits in the ones that survived. The more the last government regulated the funds, the fewer stayed open or survived. The funds were literally taxed and regulated to death.

Within the public sector there are very different terms and conditions. At one end of the spectrum lie the contributory schemes with employees paying a sum each month creating a fund to pay the bills – like the MPs scheme. At the other extreme are the pension plans like the civil service one where there have been no funds put aside and no contributions.

The Public Sector Pensions Commission has recently reported on this topic. They claim that the government will pay £18 billion in 2010-11 for pensions, when it should be putting aside £35 billion if all the pensions were properly funded. The huge gap between public and private is summed up in two figures. In 2008 94% of the public sector employees were members of a final salary pension scheme, compared to just 11% in the private sector. The normal pension age in the public sector outside local governemnt is 60 and in the private sector 65.

The Review offers nine different ways of closing the gap – a flexible menu from which a suitable set of policies can be drawn. They are:

1. Higher employee contributions
2. Later age of retirement
3.Lower accrual rate – so people have to contribute more over their lifetime
4.Using a career average salary for the final pension
5.Salary ceiling
6.Lower index linking of pensions in payment
7.Ending the contracting out lower rate of National Insurance
8.Switch to funded defined contribution, ending the final salary promise – people get the value of what they save
9.Notional defined contribution

Different people will have different views of how they would like to see reform. As a future beneficiary of the MPs scheme I prefer 1 and 2 – a full contribution rate to cover the cost coupled with a higher age of retirement. As long as the extra burden is removed from the taxpayer there is much to be said for fashioning flexible choices for public sector employees to gain the maximum consent to changes that will be far from popular with many of them.

On the Today programme this morning we debated the impact of public spending changes on the construction industry.
I argued that according to the Office of Budget Responsibility – and most private sector forecasts – overall investment in the economy is forecast to increase every year to 2015 from next year. Business investment will rise substantially, investment in housing somewhat, whilst public capital investment will fall until 2013 and then will start to rise again. The total figures are:

Investment
2009 – 14.9%
2010 -0.5%
2011 +3.9%
2012 +7.9%
2013 +8.8%
2014 +8.0%
2015 +6.9%

Total growth in investment 2010-15 40%
Total growth in investment 2009-15 19%

I am glad to say the others accepted that total investment is likely to go up over the next few years. They concentrated on falling capital expenditure in the public sector. The BBC’s Economics correspondent said that public capital investment was going to fall from £38.9 billion in 2010-11 to a low of £19.9 billion in 2013-14, before starting to rise again.

I said the departmental captial spending limits showed capital spending at £51.6 billion this year, falling to a low of £37 billion in 2013-14 before rising again. I could have used the gross public sector investment figures, which show spending of £59.5 billion this year, down to £43.3 billilon in 2013-14, before rising again.

The difference is important. The BBC figures are net of depreciation. In other words they take away from the amount spent an estimate of the losses on exisiting buildings and equipment from wear and tear and old age. This is not a cash item. It is an entirely notional figure. Their figures do incidentally show that despite the cuts the stock of government capital continues to rise.

The correct figures to use to assess construction output are the gross figures. This is the amount of money the public sector spends on capital spending, raised from taxs or borrowings. It is spent on new buildings and equipment.

The government needs to change its rhetoric about public sector cuts. It should not allow Labour the space to campaign against “deep and damaging” cuts by giving any credence to the idea that public spending is being cut by 25% or some such fictional figure. There will be hotheads in the Labour movement who wish to move on from falsely vilifying Tories for seeking and liking spending cuts, to organising protests and strikes against the cuts in particular services. When public spending overall is going to continue to rise in cash terms that would be needless and stupid.

Good management does not seek confrontation with Unions or workforce. Good management understands that leadership is about persuasion, carrying your workforce with you for the changes you need to put through. It is always best to demonstrate why necessary change for the organisation you lead is in the interests of the staff as well as the customers or taxpayers. The government should say they have approved cash increases for every year of this Parliament overall but the settlement is tighter than previous years. In order to serve the public well it will require new ways of doing things and much better cost control. Management wishes to work with staff to see how this can best be delivered. Be open minded about how you do it, but single minded about doing it.

Here Mr Clegg could play an important role from his central position in the Cabinet Office, the hub of the British civil service. The Liberal Democrats have good lines of communication with public service employees and a membership base oriented towards services paid for out of tax revenue. He could make a speech setting out a vision of streamlined and more effective public service, where improvements in quality and productivity go hand in hand with better employee management. The government is putting together the ingredients of such a strategy. They include:

1. A stated intention to use staff freezes to cut the number of back office and overhead posts as people leave, avoiding compulsory redundancies whereever possible
2. A pay freeze for two years to reduce the need for service cuts, ameliorated by pay rises for the lowest paid.
3. A willingness to ask the employees how they would suggest hitting the new tigher budgets, involving staff in the evolution of their own service.
4. A preparedness to consider new models of service delivery, inviting employee buy- outs, contracting out to former staff and other solutions
5. A new rigour over purchasing costs to cut the cost of bought in items
6. Cancelllation of heavy reliance on consultants and temporary labour

These methods of cost reduction mean that the core staff of the public sector gets a much better deal than private sector staff did in many companies forced into rapid cost reductions to survive in the recession. The government can say to its staff that they will have chances of accelerated promotion in a world where little external recuritment is allowed. Their jobs will become more interesting as the role of the external consultant is rolled back. The emphasis will be on adopting new methods to ensure better quality and service delivery , making up for the msising decade when productivity stood still in many parts of the public sector.

Management should show quiet determination to get more for less. It could start by tightening up on absence from work, and by turning down many more requests for temporary labour and consultancy assistance to do tasks. Management should talk softly, seek cooperative working to drive change, but leave staff in no doubt one way or another we do have to do a lot more for less. There is no need to have strikes. Strikes are not a sign of successful machismo, but unfortunate diversions from the task of improvement. If managements end up with one they have to win it, but it’s better not to go there in the first place.

There are two sensible answers to the Euro crisis. Greece could leave the Euro, devalue its currency, and come to an accommodation with the markets over what it needs to do to enable it to borrow again. That would be the best answer for the Euro, and would enable Greece to take part of the cuts in its living standards through devaluation, as the UK is under its own version of an unsuccessful economic policy based on too much state borrowing. Alternatively, Greece could cut its public spending more substantially, until the markets believe it can then afford the debt it needs and already has.

Instead, the governments debate two dangerous answers. They take seriously the idea that Greece should fail to make payments on its debt – a form of government theft from the savers who have in the past supported Greece and believed its promises. They discuss lending Greece more money on easy terms, based on the absurd idea that the way to sober a drunkard is to give them another drink.

I find it suprising that so many governments, Euro commentators and so called experts expected the Euro scheme to work when they put several economies into it that had not come into line with the performance and costs of the core countries. I and a few others warned strongly about the dangers of the debt and the starting exchange rates when we made the case against the UK establishment, arguing that the UK should never enter such a scheme. In “Just say No: 100 arguments against the Euro” I pointed out the destabilising effects of the countries having different levels of debt and different levels of new borrowing. I said “Controlling budget deficits is central to this task” of creating a decent currency. It was quite obvious that for the scheme to work member states had to surrender domestic budgetary control to the EU, to avoid free riding on average interest rates or to avoid Greek style disasters. Indeed, in the founding paperwork of the Euro it was spelt out that member states had to keep their stock of debt to 60% of GDP and their extra borrowing each year to no more than 3%. The decision to allow relaxation of these necessary rules has led directly to the Greek crisis.

It was also clear that a country had to bring its private sector costs into line with the zone as a whole as well as control its state deficit. “If you cannot devalue your currency when your costs are too high, you have to sack people and close factories” – exactly what has happened to the olive belt economies.

It does no-one any favours to imply there is a quick fix, or to suggest lending Greece billions this year will solve the problem. The underlying problem is fundamental. The Euro can only work and be a decent currency if there is in effect one state budget for the Euro area. Germany needs to reinforce the rules over how individual members do borrow, not grant an easy loan and watch as Greece still fails to sort out her borrowing habit.

Promoted by Christine Hill on behalf of John Redwood, both of 30 Rose Street Wokingham RG40 1XU

The Office of National Statistics tells us today that we can add £1 to £1.5 trillion to the £700 billion national debt to allow for the banks coming into the public sector. That makes our national debt up to a collosal 150% of National Income on the official figures. We could add some more for pensions liabilities and other off balance sheet items.

So after all those months of being told the UK has low public borrowing around 40% of National Income, at last the government’s own statistics office tries to make an honest institution of the government with these much larger figures. I am not going to argue today over over the odd trillion of understatement, now they are coming up with some more realistic figures. I just want to know why it has taken so long,and why we had to put up with all those denials when I tried to set out the true figures in the Commons and elsewhere.

It is usually dangerous when the Establishment unites behind a single policy and says there is no alternative. The last time that happened in the UK we were lumbered with the Exchange Rate Mechanism which gave us a rapid inflation followed by a recession.

Recently in the USA the Republican and Democrat leadership united with both Presidential candidiates behind the Paulson plan. That plan turned out to be bad politics, failing its first vote in Congress, and bad economics, leading to subsequent modification by its own author.

It ws therefore a relief that this week David Cameron and George Osborne signalled that they do intend to be critical where criticism is warranted, and to offer an alternative. That is called democracy. Criticism of George Osborne is fashionable and unfair. It was George who thought up “Tax con not tax cut” to characterise the unsuccessful 10p tax band budget. It was George who rightly pointed out that the government did not mend the roof when the sun was shining, and George who is now using colourful language about a house burning down to draw attention to the problems.

The Opposition now needs to flesh out its alternative strategy to see us out of the current severe dfficulties. They can draw on the Economic Policy Report they commissioned. We called for a stronger Bank of England, making better decisions over banking capital, liquidity and interest rates.We warned against lurching from too easy an approach to credit and money to too tough an approach. We sought better control over public spending, an effciency drive throughout government, less useless regulation, and concentration by government on a limited number of things that government did have to regulate well – especially money and credit levels. We recommended a big increase in infrastructure spending, mainly privately financed.

Today I suggest a threefold aproach to the crisis.
The first is to amend the government’s way of handling its approach to the banking crisis.
I fully support the privison of liquidity and longer term loans to the banks. They must take full security for these advances to protect the taxpayer. The withdrawal of too much liquidity at times over the last fifteen months has intensified the crisis.
The government should not spend £37 billion it cannot afford on buying bank shares. It should refuse to finance the HBOS/LLoyds merger, leading to LLoyds going it alone in the private market for its capital needs. The Regulators should give HBOS and RBS time to increase their capital ratios, whilst the government makes it clear it stands behind both banks with loans and cash if needed. They could both improve their capital ratios by stopping dvidend payments, cutting very high pay and bonuses, reducing staff through natural wastage and other cost reducing measures, and reducing their loan books. It should be their choice which combination of these measures they adopt.
The government and Bank are right to experiment with other ways of lending and using guarantees to get the banking markets moving again.

The second is to get control of the public finances. Cancelling the £37 bllion will help. There are many other ways of starting to control public spending, whilst keeping every nurse, teacher, doctor and teacher and other important public service workers.

The third is to take action to stimulate the private sector, which is crashing downwards rapidly. That means cutting interest rates by 200 basis points or 2% immediatey, with the prospect of more to come if needed. It means working with the energy, water and transport industries to see which larger investment projects can be brought forward to provide some work for the construction industry. It means redoubling efforts to help people back into work who lose their jobs as the redundancies build up this winter.

Readers of this site will know I have long been advocating that the Bank of England cuts interest rates and concentrates on fighting recession. Inflation will fall next year anyway. This has proved contentious with some of my readers. I ask them, how much more evidence do you need of slowdown, how much bigger a fall in property prices, how much more of a squeeze on incomes and lending before you accept that conditions are disinflationary, even recessionary?

Yesterday I was delighted and amazed to read the words of David Blanchflower, Monetary Policy Committee member. He delivered an extraordinary broadside against his own Committee. He accused the Bank of relying on “wishful thinking” in its forecasts, and condemned the whole monetary policy as “misguided”. He agrees that next year inflation will fall, and states “18 months down the road and inflation is going to plummet like a rock”. In a now famous remark he said “ To sit and worry about inflation expectations and what is going to happen to those, rather than worry about the fact that the economy is going to go into recession seems to be misguided”.

Of course, under the requirements set down by the government to the MPC, they are required just to worry about inflation expectations. Their remit prevents them from considering the impact of their actions on the real economy, unless that has an impact on inflation. For years we have been fed the soundbite that the UK has an independent Central Bank and that is a guarantee of economic stability. The truth is we do not have an independent Bank, and the actions of the MPC have helped destabilise the economy. They kept money too loose allowing a credit binge, and they are now keeping money too tight, assisting a Credit Crunch. They have been aided in this by pro cyclical regulation of the banks – too loose on the way up, too tight on the way down – and by a government which does not seem to understand money markets.

We will now see many of those who have spent the last few years praising the mythical independent Bank demanding a change in its government remit. The truth is that in a democracy if any institution or group of actors gets things wrong and inflicts economic misery on the public, their roles, jobs and remit will be debated and changed. No quango or Bank stays “independent” for long if its actions do not please. The politicians have to respond to the popular anger about failure or mistakes. The government will have to look at adding a requirement to the MPC to consider its impact on the real economy, just as the Fed has to in the USA. In the last quarter the USA produced annualised growth of 3.3% (where are all those pundits who told us the US is in recession now?) whilst the UK slowed to a standstill and Euroland fell. The USA has a Central Bank that has to work with the government to influence the level of economic activity as well as prices. Euroland and the UK have central banks which just concentrate on inflation, and manage to get that wrong.

Perhaps the most important thing David Blanchflower said was “We need to actually get ahead of the game and it appears that we are now behind”. Exactly. It is as if all those clever economists have forgotten one of the basic things they teach their students – there are leads and lags in economic policy. Changing interest rates has a delayed effect, as it takes time for all rates to adjust and for banks and borrowers to adjust their behaviours to the new levels. Many people have protection from higher mortgage rates for a period. Larger companies can use interest rate futures to protect themselves for months ahead. Many people and companies have a bit of money for a rainy day, but not enough for a rainy year.

The present high inflation reflects mistakes of the MPC and others a year or two ago. There is nothing the MPC can do in the short term about that. The issue is what are conditions going to be like a year or two ahead? Most commentators agree they will reflect the current squeeze. It is difficult to see inflation staying high against such a background, and strange to see a government and a Bank so keen to intensify the squeeze by most of their actions. The rest of the MPC need to join David Blanchflower, by trying to project themselves into the future. Most of them seem to be at best living in the present, if not stuck in the past. Applying a second load of bolts to the stable door after the horse has bolted won’t bring it back. The issue is how we get a new horse into the stable in times of slowdown or worse.

I remain strongly of the view that the US has got its policy response right to the Credit Crunch, and the UK is still getting it wrong. It will not be easy for the US authorities to chart a successful course, given the magnitude of the mistakes made on the way up. They still have to contend with a very weak banking sector, with more bad news still to come, and with a very weak property market, which adds to the banking weakness. So much lending is secured against property, so falling property prices undermines old loans and puts people off making new ones. The Fed’s slashing of interest rates helped, but it cannot get all the market rates down in line with its rates, because the banks are short of cash and reluctant to lend. There will be some excitement about a change of President, and the two main candidates seem to be lining up to continue fiscal stimulus to assist low interest rates, with the emphasis on tax cuts to alleviate the squeeze on personal incomes. All that means the US is better placed than Europe.

Meanwhile Euroland remains mesmerised by inflation despite the obvious evidence that the slowdown has now hit Germany as well as Italy and Iberia. Destocking is adding to the woes of companies, as they fight to become more liquid against a backdrop of declining turnover. The UK is going for a huge fiscal stimulus based on increased public spending with revenues falling from the downturn. The fact that the government sector is as overborrowed as the private sector before entering the downturn leaves it in a weak position, at the mercy of the markets. The pound is now falling against the dollar, having devalued against the Euro, increasing the cut in living standards.

(Previous blogs on this topic on www.johnredwood.com include
“Halve interest rates and cut wasteful spending” 18.7.8
“The lies about the EU economy” 14.8.8
“The Bank of England is fighting the wrong dragon ” 9.8.8
“An inflationary or inflammatory letter?” 17.6.8
“Why have the government and the Bank of England failed us on inflation?” 17.5.8)

I heard this morning that UK house prices are now down by more than 10% so far this year. I listened in vain for a government Minister to come on to claim success from their policy. For years Ministers have told us we needed to make houses more affordable. They have become mighty shy now their policy of starving the Money markets of cash last summer and nationalising the UK’s most aggressive lending bank, Northern Rock, is delivering lower house prices with a vengeance.

Could it be that they have at last worked out that lower house prices do not automaticallly make houses more affordable, if there are too few mrotgages to buy them with? Could it be that at last they understand there is one thing worse than house prices soaring, and that is house prices falling? Aren’t we owed some explanation of their latest thinking, and some comments on where they want to take the mortgage market next? After all, they now own and manage one of the largest mortgage banks, and intervene regularly in the money markets, so much of this is down to their efforts.

We should be told by the government how much further they intend to let house prices fall before taking the necessary money and mortgage action to stabilise them. We should be told whether they think that the shortage of housing they identified in previous years has now corrected, given the lack of buyers for new homes. Does that make them want to alter their targets for new house construction, as they think new home starts determine house prices?

Commercial property has already fallen by more than 20%, twice the fall so far in houses. There is more and more empty space available as developers finish building projects in progress. As migrants from overseas return home in search of jobs elsewhere, and as people staying here give up on trying to find a mortgage for a better home, we should expect further falls in residential property prices. There will be more repossessions as people struggle to pay the mortgages they already have, forcing more properties onto the market.

No more boom and bust? That does not seem such a clever soundbite now ownership of Northern Rock and clumsy mismanagement of financial regulation and the money markets has made the UK government into an architect of bust in the property market, presiding over the collapse of the mrotgage book of one of our bigger mortgage lenders at a time of general mortgage shortage. And how does Vince Cable now think about the outcome of nationalising Northern Rock, having acted as the government’s spinner to win over fashionable opinion to such an ill judged course? Is he happy with the collapse of house prices, the shortage of mortgages and the redundancies at the Rock?