Howard Flight – 2003 Speech at the Institute of Economic Affairs Conference
The speech made by Howard Flight, the then Shadow Chief Secretary to the Treasury, at the Institute of Economic Affairs Conference in London on 11 November 2003.
Political Context
Michael Howard sends his apologies that he cannot be with you today – as you may have noticed, he has got a new job.
I believe his becoming the Leader of the Opposition, marks a “Tipping Factor” for the Conservative Party’s fortunes since 1992. The media, the business community, and the public, now perceive the Conservative Opposition as led by our most experienced, heavyweight and able politician. Moreover, at a time when the Conservatives have come together, the Labour government is beginning to tear itself apart. The Cabinet cannot agree on Europe, the Euro, foundation hospitals, ID cards or top-up fees – apart from the growing personal strains.
Our key objectives as the next government, are to improve the delivery of public services, and to get better taxpayer value from public expenditure – two sides of the same coin.
We continue to believe that lower taxed economies tend to have higher growth potential and we hope to be able to reduce the tax burden; but we will not promise tax cuts unless and until these can be backed by carefully worked-out and agreed savings in non-value added public expenditure.
My main task as Shadow Chief Secretary to the Treasury is to provide the analysis of how we can improve taxpayer value. I have nearly finished a year’s work on a top-down analysis, department area by department area, and I am now starting on a bottom-up review of particular problem areas in public sector spending.
I remind you of the ECB’s report this summer, that there is £70 billion of wasteful public expenditure by the UK government, which it described as particularly inefficient in comparison to the US and Japan. Years of bumper increases in tax revenues have exacerbated the inevitable, profligate tendencies and poor management in the monopoly, non-commercial public sector.
Fact and Fiction – the Policy Framework
Michael Howard has also made it clear that his style of politics will not be to oppose just for Opposition’s sake and to give credit where credit is due. This contrasts with the government’s own continuing rhetorical spin.
In his book “Reforming Britain’s Economic and Financial Policy”, the Chancellor claimed he would pursue a wholly new monetary and fiscal framework. Both claims were, in truth, a fiction. Under the new monetary framework, however, Gordon Brown changed only who should do the interest rate targeting. Under IEA influence, the last Conservative government determined what should be targeted and made controlling inflation a key objective. Post 1997, the monetary framework was not wholly new – albeit that we accept and support the decision to entrust the Monetary Policy Committee and the Bank of England with the task of setting interest rates.
The monetary policy framework is, moreoever, now threatened by the government’s in principle commitment to join the Euro, which would mean a one-size fits, all-in interest rate, not based on the UK’s particular economic conditions.
Part of the Chancellor’s Euro convergance strategy also involves changing the existing inflation target from 2½% p.a. RPIX to an unspecified HICP target. This will leave the Monetary Policy Committee and the Bank of England with significant problems as the Governor of the Bank of England has pointed out recently – especially given the omission of housing costs from the HCIP inflation index. This is also, at the very time when Council Tax increases are a growing concern to citizens, where the Chancellor is shifting to an inflation index, which excludes the effects of Council Tax. Also, on 12 occasions since the end of 1999, HICP has been more than 1% below the anticipated 2% HICP target; and during the year to September, the gap between HICP and RPIX was 1.4%, not the 0.5% the average which the Treasury has pointed to.
We have two proposals for improving the workings of the MPC:-
To replace the 3-year term with possible re-appointment for members with a fixed, 4 year, non-renewable term.
To increase transparency, by requiring the appointment of members of the Monetary Policy Committee to be approved by a joint committee of both Houses of Parliament.
Fiscal Policy
On fiscal policy, the Chancellor has based his “prudence” claims on his Golden Rule, requiring the current budget to be balanced over the economic cycle; and the Sustainable Investment Rule, requiring public sector net debt to be stable, at a level below 40% of GDP. Here, again, these principles are not wholly new.
Essentially, Ken Clarke’s framework set out in the 1996 Red Book, planned to bring the PSBR into balance in 1999/2000 and to reduce public sector debt to below 40% of GDP in 2001/2.
The biggest fiction is, however, that the rules are not clear.
The Chancellor is free to determine when the economic cycle started and ends. In the US, this decision is taken by the National Bureau of Economic Research – an independent body. In the case of the Sustainable Investment Rule, the figures for public sector net debt have been fudged by the government’s extended usage of PFI, PPP and similar off-balance sheet arrangements such as Network Rail. Off-balance sheet government funding is now equal to approximately £100 billion in total, calculated as the present value of future PFI/PPP liabilities.
Public sector debt figures also ignore the dramatic growth in unfunded, public sector pension liabilities, recently reported by the government at £380 billion but using the private sector’s pension discount rate rather than the real yield on index-linked Gilts.
These two main rules are, moreover, not the final word on economic and fiscal policy. Borrowing for investment, could in principle, be unlimited; the distinction between investment and current expenditure is also capable of being blurred – including the Chancellor’s own use of language when referring to investment in public sector services. Right now, Treasury spin also appears to be downplaying the Golden Rule in principle.
We will be looking at the US, Congressional Budget Office as a model for independent consideration and analysis of spending, borrowing and taxation.
Downgraded Forecasts and Britain’s Performance relative to other Economies
The Chancellor has claimed his repeated downgrading of growth forecasts and increases in borrowing forecasts have been caused by events in the world’s economy. He claimed 2001 saw the sharpest contraction in world growth since 1974. Yet, the IMF advised that the world economy grew by 2.4% in 2001 and by 3% in 2002, compared with growth of around 1% p.a. for the three years in the early 1990s. The Chancellor also claims the UK economy is performing better than other countries, but the IMF says Britain will grow less this year and next year than either the USA or the world as a whole; it has also grown by less than the US, Canadian and Australian economies since 1997.
On tax, Labour was elected on Blair’s 1995 pledge that “We have no plans to increase Tax”. Since 1997, there have been 60 tax increases and the tax take has risen by 50% in cash terms. As a proportion of GDP, it has risen by 2% since 1997 and is projected to rise by 4% in the Chancellor’s forecast through to 2007/8.
Spending, Reform and Productivity
Labour committed in 1997 to be wise spenders, not big spenders and to route out waste. Extra spending on public services was promised, only on the principle of it being tied to reform, in order to improve the delivery of services. Overall, since 1997, of the 50% increase in public sector spending, 83% has gone in public sector inflation. On the ONS figures, public sector inflation has risen from 1.6% in 1997 to 6.5% this year and is now over 7%. In the year to Q2, 2003, government consumption expenditure was up 11.8% but outputs were up only 3.9%, implying a 7.6% rate of public sector inflation. The ONS figures have shown public sector productivity falling by 5% over three years to 2001.
Moreover, overall UK productivity growth since 1997 has been only half the pre-1997 level – at an average of 1.58% p.a. compared with 2.85% p.a. in the last six years of the Conservative government.
Business investment fell by 3.5% in 2002, where in announcing his £5 million p.a. increase in pension tax in 1997, the Chancellor said the changes would encourage investment.
Employment
While the overall employment figures have remained strong, they have masked the fact that private sector employment has been falling – the fall of 75,000 last year was offset by the rise of 86,000 in public sector jobs, with a total increases in public sector employment of 400,000 since 1999.
Through to 2006, public sector employment is scheduled to increase by 674,000 from 1997, costing £20 billion p.a.
In the productive economy, manufacturing employment is down 698,000 since May 1997, and manufacturing output down 4.1% last year, and below 1997 levels.
Burdens on Business
Business investment has been weak, reflecting in part, rising tax and regulatory burdens. In 1998, the Chancellor said ” I want tax cuts for businesses not tax rises”. The CBI has reported total UK business costs pushed up as much as £60 billion over the five years from 1997 to 2002, with government policy actions specifically driving up business costs by £15 billion p.a. The CBI estimates that by 2005/6 – using the Treasury’s own figures – business taxation will have risen cumulatively by £54 billion. The IOD estimates the extra cost for business from Labour’s additional regulatory burdens is £6 billion p.a.
When the Chancellor cut employers NIC as part of his 2000 budget, the Treasury press release said this would provide employment opportunities. The increase in employers’ NICs this year will cost an average of £166 p.a. for each employee earning £20,000 p.a.
Savings
Finally, before 1997, Labour argued that Britain needed a savings culture, both to benefit individuals and to increase investment. The savings ratio has halved under Labour, from 10.0% in Q2 1997 to 4.8% in Q2 2003. The Stakeholder Pension initiative has been a failure, in part as Pension Tax Credits, no matter how well intended, serve as a major disincentive to more than half the population to save for a pension.
The wider economy
1. The essential point is that all is not as rosy as government spin has implied – several chickens could come home to roost.
For 11 years, since 1992, and since Stirling’s expulsion from the ERM, the UK’s overall economic performance has been impressive. Average growth has been 2.8% p.a., with output up every quarter, and inflation averaging only 2.5% p.a. Unemployment has fallen from 10% to 3%. This has reflected both the major supply side and labour market reforms of the Conservative governments in the 1980’s; rising consumer expenditure across the Anglo-Saxon economies, and generally propitious economic circumstances for the West as a whole. Between 1992 and 2003, the UK economic performance was, however, less impressive, at 36% compound growth, than those of Australia at 50%, Canada at 44% and the USA at 41%, but very impressive against France at 22%, Italy at 17%, Japan at 15% and Germany at 14%.
An important contribution to both growth and stability has been the 10% improvement in our terms of trade since 1996, enabling rising consumption in relation to national income, well above the extent of the deterioration of the external balance.
There are now growing threats to growth and stability.
1. As pointed out above, UK productivity growth has fallen and is in danger of falling further, with the significant shift of resources and employment to the public sector.
2. The increase in government spending, and in the tax take (up 7% this year alone) has served already to reduce disposable income growth in the private sector to zero over the last 18 months.
3. Continuing growth and demand in consumption will depend on further increases in household borrowing – largely dependent on further and potentially unsustainable rises in house prices. UK consumer debt now equals GDP and was up 13% year on year to this September.
4. There is the risk of at least part of the 10% improvement in the terms of trade over the last 7 years reversing. Already, shipping rates have risen markedly and raw material input costs from Asia and elsewhere are rising.
5. The Treasury now seems to be implying that the Chancellor may break his Golden Rule on borrowing and may breach the EU 3% of GDP rule.
6. The ECB is concerned at the high rate of growth in the UK money supply with M3 up 8% y.o.y in the year to September. The output gap – spare capacity – is estimated by most economists at no more than 0.7-1% and well below the Treasury’s projected 1.5%.
In short, the dangers now are of rising inflation and rising interest rates, which could end the remarkable consumption driven run of the last 11 years in due course.
In the near term, the UK economy should benefit from the bounce in the US – US third quarter growth was the fastest in 20 years, at a rate of 7.2% annualized, with a surge in consumption and business investment – albeit also with a rise in inflation. There should be some, long-awaited, pick-up in UK business investment, although the UK has declined to being only the 3rd most attractive EU location for business in terms of tax and NI costs.
The next two years are likely to see a more difficult environment for the UK economy and for the Labour government, in which the options for fiscal manoeuvre have been curtailed severely by Labour’s massive shift to “Tax and Spend”. The key risk is an “economic shock” if there are more than small increases in interest rates and inflation and particularly via the impact on house prices. The change to the HICP inflation measure is unlikely to conceal, or of itself, to prevent this.
