Category: Blog

Last night BBC’s Newsnight created a TV Star Chamber to examine three areas of public spending. Two of the areas they raised are large and central to the task of reducing spending. They asked a panel of 3 including myself to evaluate a 5% cut in all public sector pay, and a five year freeze on benefit levels.

I rejected both their specific proposals, but agree the two large areas of public sector pay and benefit bills need to be reduced. I have tabled some questions to get the exact figures, but roughly the state is supporting around 24 million adults – 6 million direct employees, 6 million unemployed on various benefits and 12 million pensioners receiving state pension and in some cases top up benefit. It’s too many.

The task is to get more of the unenmployed into private sector jobs, and to transfer some of the public sector employees into private sector jobs. We need to release the entrepreneurial energies of some public officials and find new ways of delivering some state supported public services which could be privately financed.

I did not favour an EU style 5% across the board pay cut. The public sector pay freeze proposed for this year amounts to a real cut, with price inflation in the UK currently running at 5.3%. I would not myself wish to expalin to low paid care assistants or public sector cleaners why they would have to face a 5% cut. I would be quite happy to see the 5% cut taken by MInisters extended to other better paid state employees, and to see pay cuts negotiated within services or departments with the employees as part of a package to cut the overall costs of their area of work. The private sector found it was possible in the depth of the private sector crash in 2008-9 to agree lower pay in return for no redundancies where the money was running out.

The government has pledged to undertake major reform of the benefits system. Again, I would not wish to explain to a severely disabled person they had to face five years of no increase in benefit. They don’t get that much to start with, and present inflation would make that cruel. I would be happy to defend welfare reform where someone who is offered a job is told their benefit will be removed whether they take the job or not. I do wish to see more positive and successful programmes to get the workshy or the ill equipped into employment. Curbing new immigration will also help with this. There should be more control over the levels of housing subsidy.

All final salary public sector pension schemes should be closed to new members, as most private sector schemes have been. There should also be a review of the terms for future accrual of additional benefits for exisiting members.

The third area Newsnight raised was the question of do we need free libraries? It was an interesting choice of service. My response was we need some free libraries, but we could do it for much less cost. Why do we have a University library, secondary school libraries, specialist public sector libraries and municipal free libraries all in the same urban or suburban area? Could there be more pooling and joint use? Why is the LEA overhead so high? Why does it cost so much to borrow each book? Can more be delivered on line? Have libraries diversified to offer too much free? What if we split the LEA library monopoly? Would librarians like to turn their lilbraries into not for profit charities or social enterprises? Could commercial organisations manage or provide the library facility for less? There must be enormous scope here for innovation and lower cost.

George Osborne has called for a debate on the limits to what the state should do. I hope he will be inundated with people’s views on all the needless interventions, meddlesome actions and over the top spending which has characterised national and some local government in recent years. It is difficult to know where to begin.

Today I propose a new approach to business. Government should stop the cash and cut the interference.

The last government in its final years went back to the 1970s, intervening , subsidising and trying to pick winners or stop losers on a grand scale. On its own underestimates it spent £120 billion on clumsy support for banks. It subsidised car manufacture. It spawned a whole host of small schemes to offer consultancy, advice and guidance and to reward certain types of technology or “new” undertakings. The result of all this was the worst recession we have lived through since the 1930s, and no evidence of a robust recovery led by the winners of the future that Labour so craved to create. Its regional policy was no more successful either. The more it spent in the poorer regions, the more they fell behind.

The new government has to sort out the dreadful banking inheritance. I argued at the time against nationalisation of the banks in difficulty. Labour stupidly replied that I wanted them to go under, refusing to see the true alternative – offering short term loans and guarantees for collateral and forcing major restructuring of banks at risk to reduce their liabilities and bring in new private sector capital. We now have to undertake that review of the nationalised banking estate, and get it into a shape which can lead to early sale of the assets and a better structure of banking in the UK.

The business consultancy, guidance and related schemes should be offered to the private market. If the work the quangos and civil servants do in these areas is valued, then let it be done in the private sector by them using private money to finance it. If it is not valued, then let’s close it down.

Let’s shut the RDAs, as we have often argued together on this site. In return for cutting cash to business, let’s cut costs for business at the same time. That means a substantial programme of deregulation using Nick Clegg’s Bill as the early legislative vehicle. I put in my letter to Mr Clegg some of the measures I would repeal which would cut business costs. Whitehall should set itself the target of cutting business costs of responding to regulation by say, £5 billion a year, which is as good as a tax cut. It would make a direct contribution to improving UK competitiveness and therefore creating more jobs. Start by scrapping the ludicrous Money laundering procedures which seem to be based on the belief that money launderers do not have utility bills and passports. Move on to the working time or anti overtime regulations.

Over to you for more ideas.

Labour are still at their old game. Their response today to David Cameron’s warnings about the deficit is more of the same. In their economic song book more public spending and more borrowing equals a stronger economy. On that basis why then is the UK economy so weak? Can’t they see that the UK is on its knees with record levels of public spending and borrowing? Shouldn’t that lead them to ask if all that spending and borrowing is such a good idea?

Let’s try once again to explain our plight. The UK has been living beyond its means for too long. Labour’s disastrous money policy and banking regulation meant too many people borrowed too much in the private sector, leading to the blow up of the private credit system in 2008. The private sector was suddenly and abruptly made to live within its means when they switched the credit off. Pay was slashed, jobs destroyed, companies went bust, factories and shops closed.

Labour then transferred many of the dodgy debts to the taxpayer, and added yet more public sector borrowing, learning nothing from the debt crisis in the private sector, but trying to replicate it in the public sector. People were recruited – often for non jobs – pay boosted and new programmes opened, all on borrowed money.

We can’t go on like this, for two good reasons. First, the lenders will run out of patience, and in the end force up the interest rates we have to pay and cut the credit. That’s what they’ve just done to Iceland, Ireland, Greece, the Baltic republics, Hungary and a host of other countries. Second, all that borrowing has to be repaid at some point. Spending more you have borrowed does not stimulate the economy if you borrow the money from within that same economy. Borrowing from British savers is like taxing them. It takes their money away from them so they cannot spend it on job creating activities.

The world does not owe us a living. There is a huge transfer of economic activity underway from west to east. The UK and other western countries are not competitive enough to withstand the super competitive activites of India, China and other emerging market countries. The rest of Euroland is not competitive enough to withstand German competition.

There is unfortunately no subsititute for a country like the UK working harder to earn its preferred living standards. There is only so much we can borrow to put off the necessary adjustment to our economy. The UK economy needs to make and produce more to sell in world markets and needs to produce more of the goods and services we ourselves need in an efficient manner. It’s no good flexing the credit card one more time when you are nearly bust. You need to get a better paid job and start paying off the mortgage.

In the early 1980s all the figures you needed to understand public finances were published annually in the Red Book. Tyically around 40 pages long, it had a plain red cover. If you read it you knew the state of the national accounts.

Labour’s last Red Book, published in March 2010, was 227 pages long. Whilst the titles on the cover were still in red, it was glossy with photos of police, underground trains, windmills, a woman in safety goggles and a couple of women at the greengrocers. There were more figures and tables than in the older versions, but the shifting series, differing baselines and questionable forecasts meant it was more difficult to understand what was going on with the public finances. The differences sum up the age of spin.

I was pleased to read today that David Cameron is now warning the country about the likelihood that the new Office of Budget Responsibility will come up with lower and more realistic forecasts of growth for 2011 and 2012. Readers of this site will remember I set out the possible impact this will have on the deficit a few days ago. If you read the Labour 2010 Red Book carefully you can see officials already had their deep doubts about the Chancellor’s forecasts.

In one of the most interesting full page essays officials got away with publishing “Uncertainties around current forecasts”. In this they pointed out that the Labour government had forecast 0.75% more growth for the year ahead on average during the period 1998-2009. They stressed that these errors mainly reflected poor forecasting in the last three years. They also pointed out that most independent forecasters and the Bank of England were forecasting lower growth, or forecasting more risk of lower growth than the government.

That same 2010 Red Book revealed that public sector net worth has crashed from 70.9% of GDP at the end of the Thatcher period to 22.4% in 2008-9. Despite the massive spending, net worth has fallen as a result of public sector wealth destruction and heavy borrowing. It also shows that the government spent £118.6 billion on interventions with the banking sector with no path identified to get all that back. Any potential “profit” on share sales has to take into account this large sum of total support, and the risky assets we are all still underwriting.

In 1999 a Euro was worth 71p. Between 2000 and 2002 it was around 60p. From 2003 to 2008 it fluctuated around 65-70p, just a bit below its first issue price.

From 2008 the Euro took off against a falling pound, going above 90p. Since March 10th 2010 the Euro has been in freefall, and has devalued by 8% against sterling.

The Uk devaluation by more than 20% was helpful to UK competitiveness. By the same argument the recent 8% devaluation of the Euro has blunted that advantage.

The Euro was a scheme designed to let Germany export her manufactures to the Euroland area countries at a fixed exchange rate. The other members either had to improve their productivity and control their costs, or live with a perpetual German balance of payments surplus. When the Credit Crunch hit Germany suffered badly, as many countries in Euroland and beyond reined in their purchases of German product, leading to a sharp fall in German output. This reminded the Germans that their manufacturing superiority was a weakness as well as a strength, as it left them vulnerable to larger swings in output and employment given their heavy reliance on exports.

The German government decided to cushion the blow by introducing the Kurzarbiet scheme. This scheme allowed companies to keep employees on who were temporarily surplus to requirements, with the state picking up a large amount of the bill. At one point around 1.5million workers were covered by this scheme. The German government has just decided to continue with it into 2012, even though the economy is now in recovery phase.

The costs of this scheme are part of the cause of the German budget deficit, and further background to why Germany is reluctant to pick up the bills for other countries around Euroland who have had to lay off people in the name of curbing costs and trying to compete with Germany. Earlier this year when the Euro was high against the ppound it was generally quite high, making it even more difficult for the weaker Euroland economies to export their way to prosperity.

Germany has her own keepwork or work share scheme to deal with troubled times, but the rest of Euroland still lacks such a comprehensive scheme. The price of a relatively high Euro, and of German competitiveness, is the high and rising rates of unemployment in Ireland. Spain, Portugal and Greece.

This week the Bank of England published figures to show just how its balance sheet has changed between 2008-9 and 2009-10. Its balance sheet has been swollen to a massive £223 billion, supported by just £4.2billion of shares and shareholder reserves. It is 50 times leveraged.

Its loans to banks have been cut dramatically by £124 billion. At the same time its gilt purchase scheme means effectively it has lent £200 billion to the government. Commercial banks now deposit £170 billion with the Bank of England, up from just £42 billion a year earlier.

In other words, over the last year there has been a huge swing at the Bank of England from financing the private sector banks to financing the government. The commercial banks as part of the regulatory drive to get them to hold much more cash and capital relative to their loans have changed their positions at the Bank dramatically in a way which makes them safer but also in a way which means much less money available for the UK private sector. No wonder the economy scarcely grew.

At RBS in 2009 the balance sheet was cut from £2.2 trillion to £1.5 trillion. In the first quarter of 2010, recently reported, the balance sheet did grow a little, from £1.522 trillion to £1.582 trillion. The increase came in derivatives. Loans to the private sector were static. On a risk weighted basis they stayed around £140 billion, or about 10% of UK GDP.

The policy of the last government and the RBS management was to cut their balance sheet by another £300 billion during 2010.

We need a more vigorous private sector recovery. This needs better balance in the amount of credit extended to the private sector relative to the public sector. Even RBS now has a Core Tier One Capital Ratio of 10.6% (including the effect of the Asset protection Scheme). Its leverage is well down on the high peak levels of 2007-8. The banking regulators need to allow the banks to finance a faster recovery.

The government was right yesterday to say it would await the findings of the police investigation before discussing our gun laws. The Prime Minister was right to say we cannot legislate to prevent a madman going on a murderous rampage, much as we would like to. Of course we need to do everything in our power to make it less likely.

Alan Budd’s job at the Office of Budget Responsibility is to inject realism into the inherited forecasts from Mr Darling’s Treasury.

He inherits some racy forecasts for economic growth. The last government thought the UK economy would sprint to growth of 3-3.5% next year, and stay above 3% for the following two years. The average of independent forecasters think 2.1% is likely in 2011, followed by 2.4% in 2012 and 2.7% in 2013.

There’s a difference in the impact on the government deficit. If the economy grows by 1% more next year that will generate around £6 billion of extra tax revenue, and save maybe £1.5 billion of unemployment and other costs. If the following year the economy grows by another extra 1% roughly the same favourable improvements occurs, taking the cumulative total to £15 billion. Go on like that for long and you will be talking serious money.

Turn it round, and it means that the new government may have to say the prospective deficit in 2011 will be several billions higher, and the 2012 one worse still compared with the current forecast.

When I wrote the Economic Policy Review I commissioned a paper which looked at the long term growth rate of the UK economy. Labour had recently hiked it to an unbelievable 2.75%. We concluded it was more likely to be below 2% once the debt bubble was blown away. It is true there is a big downturn to recover from, but it seems very unlikely that the long term rate of growth is anything like 2.75%, which in turn makes it unlikely we can enjoy three years of growth above 3%.
The only thing that could change that is aggressively to set out to make the UK the best place for jobs and business in the developed world by following pro enterprise tax and regulatory policies.

In opposition the Conservatives were sympathetic to the idea that the Treasury needs a more dynamic model to forecast the consquences of changes in tax rates. Many in the debate over CGT rates seem to still believe that higher rates yield more revenue, when past experience suggests higher rates may reduce the revenue.Sales of properties and shares can be brought forward or delayed, depending on the tax rates.

There is a more general point at stake here. Sensible commentators agree that to remove the huge deficit we need to collect more tax as well as cut spending. Under the old Labour sketchy plans to halve the deficit in four years, they said 80% would come from spending cuts and 20% from tax rises. However, that was only part of the story. They also said a lot of the deficit reduction would be down to faster economic growth – another way of saying they would collect more in tax as well as some cyclical reductions in public spending. Under Labour plans the total amount of the deficit reduction to be achieved by extra tax was well above 20%.

Between 1979 and 1990 there were substantial cuts in Income Tax rates, and the abolition of several smaller taxes. Over this time period the total tax collected went up by by 170%. Under the last Labour government, following a self described policy of no Income tax rises for much of its tenure, revenue went up by 125%. The rate of increase in tax revenue was faster under the more overtly tax cutting Conservative government, even after allowing for inflation.

Government has a choice – higher tax rates or faster growth of revenue. It should be obvious which we need now.

Tonight I have been asked to talk to a group of Economists about the state of the UK economy.

I will start by praising David Cameron’s stated aim of creating conditions for a strong private sector led recovery. It is the best way to curb the deficit and raise living standards. It is no good cutting public spending without at the same time facilitating the growth of the economy and the provision of new jobs. The UK’s budget deficit has to be brought down. One of the main reasons it is so high is the large pool of unemployment with people sitting on benefits. We ned to tackle that as part of the deficit reduction policy.

So what should the government do to promote this recovery? They need to take action in four areas: tax, regulation, banking and public procurement.

Tax

If you want more of something you need to cut the rates of tax on it. The government is right to propose cutting National Insurance, the tax on jobs, and Corporation Tax, the tax on company profits. They also need to cut CGT, the tax on business success by entrepreneurs, and cut the higher rate of Income Tax, which is currently at a thoroughly unfriendly and uncompetitive 50%. We need to cut effective Income rates for the higher paid and for the lower paid.

Regulation

Regulation on Labour’s scale is another form of backdoor taxation and strangulation of enterprise. The British Chambers of Commerce have identified aorund £100 billion of extra burdens imposed on British business over the last 13 years. I have set out elsewhere how to start to bring this down. Mr Clegg’s Repeal Bill provides the mechanism to do so and must be used extensively to make an impact. We are driving business abroad to less regulated territories by our current stance. Much of the current regulation is the sledge hammer to miss the nut.

Banking

The banks do not currently have the capability to lend enough to fuel a good recovery. The government should tell the Regulator to become more counter cyclical. Relax the cash and capital requirements at this low point of the cycle and strengthen them as the recovery gets underway and as the banks make more profit.

PUblic procurement

Split up contracts and make sure specifications are friendly to UK based businesses bidding for public contracts. The public sector will still buy a lot even after the cuts. Make sure it buys British as often as possible at good prices which stand up to scrutiny.