Lord Deighton
That this House takes note of the economy of the United Kingdom in the light of the Budget Statement.
The Commercial Secretary to the Treasury (Lord Deighton) (Con)
My Lords, the UK’s economic recovery has finally taken hold. No major advanced economy grew faster in the fourth quarter of 2013 than the UK’s. Employment is at record levels. Some 1.7 million private sector jobs have been created since early 2010 and over the same period more than four private sector jobs have been created for every public sector job lost. Inflation of 1.7% last month was the lowest for more than four years.
During this debate last year I argued that the Government’s focus on deficit reduction could go hand in hand with a successful strategy for growth. Some noble Lords disagreed. At that time the independent OBR had forecast growth of 1.8% for 2014. Last week the OBR forecast growth of 2.7% for 2014—nearly a whole percentage point higher. That is the biggest upward revision to growth between Budgets for at least 30 years. However, there is clearly more to do to ensure that our recovery is balanced and will protect us against future shocks, so today I will speak about how the Government are taking the difficult decisions to rectify the mistakes of the past so that everyone in the UK experiences the benefit of the recovery.
In the build up to the financial crisis the UK economy was characterised by severe imbalances and long-running structural weaknesses. In 2008, UK investment as a percentage of GDP had been the lowest in the G7 for a decade and our level of productivity was also lower than that of our peers. The economy had become increasingly reliant on the services sector. Manufacturing had fallen from 19% of the economy in 1997 to 11%—not helped by the long-run decline of North Sea oil. The UK financial system had become the most highly leveraged of any major economy, with a total balance sheet inflated to more than 200% of GDP. Total household debt had risen from around 100% of income at the start of the decade to more than 170% and the saving ratio had collapsed to just 0.2%.
Imbalances were also building up in the public finances. In 2005-06, public expenditure had already increased to 41% of GDP while revenues were at 38%. Despite the buoyant economy, we were spending more than we were earning. All of this meant that when the financial crisis hit, the UK economy was among the most vulnerable and it was for that reason we experienced the biggest recession of any major advanced economy apart from Japan. By 2009-10 we were running the highest structural deficit in the G7, borrowing one pound for every four we spent. The deficit had climbed to 11% of GDP and every year that deficit adds even more to the debt that has been accumulated. Faced with a challenge of these proportions, restoring balance between public expenditure and receipts was the only credible option.
Following the financial crisis our economy was hit by further shocks. Some 40% of UK goods exports go to the euro area and as the eurozone crisis intensified it weighed on UK export performance. Commodity prices rose steeply between 2009 and 2011, increasing costs for households and businesses. In addition, it became apparent that the financial crisis had had a deeper and more lasting effect than we previously anticipated. The UK economy shrank by 7.2% in the aftermath of the crisis. Of course a crisis of that scale would have an impact on millions of households.
In the face of such a daunting economic challenge, it is essential to have a clear and comprehensive plan. I remember that in the debate last year, the noble Lord, Lord Desai, said that there was not much to say about the Budget because the Government had a plan and they were sticking to it. I chose to take that as a compliment, and we have continued to stick to our plan. Our plan made it clear that we would: fix the economy and deal with the deficit; cut tax to encourage investment and entrepreneurialism; back businesses across both the sectors and the regions; reform welfare, the cost of which had spiralled out of control; and invest in schools and skills so that the youth of today could drive the economy of the future. We put that plan in place. We have adhered to it, and we are delivering results with it. I would like to spend my time with noble Lords this afternoon discussing just what that plan has achieved to date and what more needs to be done to embed this recovery for the long term.
The scale of the fiscal challenge we faced required urgent action. This meant not just committing to reducing the deficit but doing it in a way that gave markets faith that it would be delivered, and helped keep interest rates low. Such is the level of the UK’s accumulated debt that interest payments alone are forecast to be almost £60 billion in 2015-16, which is more than the annual budget of the Department for Education. Maintaining market confidence in the Government’s determination to restore sustainable public finances is critical. A one percentage point rise in gilt rates would add around £8.5 billion in interest payments by 2018-19, a risk my noble friend Lord Higgins has questioned me about before.
Again, this Government’s decision to deliver the majority of the consolidation through reduced spending was the only credible option. However, the severity of the financial crisis and its impact on the UK public finances mean that returning to a sustainable path will take time. The independent OBR predicts that in 2018-19 we will have a surplus for the first time in 18 years, but even then our work will not be complete. Accumulated debt will still be in a position to make the public finances vulnerable. Without maintaining a continuing grip on the public finances and running surpluses during good years, debt will not fall, and future Governments risk being hampered in their ability to support the economy at times of stress, which we are sure to have. As my right honourable friend the Chancellor said in his Budget speech last week, we aim to,
“fix the roof when the sun is shining”.—[Official Report, Commons, 19/3/14; col. 784.]
This Government are committed to improving fiscal discipline. The creation of the independent OBR has given confidence to the reliability of the economic forecasts, and public pay restraint has been a tough but necessary action. The welfare cap announced at Budget, which was debated in the other place yesterday, will further tighten fiscal discipline and place the welfare system on a sustainable footing. Every other part of government spending is carefully managed, and welfare is too large an area of spending to be left without strong controls. As a result of all the measures laid out, public finances are now returning to a sustainable path.
Monetary policy formed the first line of defence following the crisis, supporting the economy and stimulating demand. By keeping the bank rate low and through quantitative easing, the Monetary Policy Committee has helped maintain low interest rates, reducing costs for households and businesses. Furthermore the Government have updated the remit of the MPC that ensures the committee provides greater transparency and certainty. Finally, the Government have created an entirely new macroprudential framework with the Financial Policy Committee at its heart. This fiscal and monetary action rescued the economy from crisis and provides a stable framework for us to continue to address some of the challenges which have impeded the UK’s economic performance.
At the heart of these challenges is the UK’s productivity challenge. This Government recognise productivity growth increases real earnings and improves the day-to-day lives of people around the UK. The future path of productivity growth is the most important judgment in the OBR’s economic forecast too and, by its own admission, the key uncertainty. Historically, the UK’s level of productivity was weak compared to many of our international peers and, despite some growth through the 1990s and early 2000s, when the financial crisis hit, UK productivity was still below the rest of the G7.
The causes of the UK’s weak productivity performance are hotly debated, and the implications are far reaching. While I am sure that in our debate this afternoon noble Lords will offer some excellent insight into possible areas for action, I shall address what I think are some of the key areas, namely, business investment, access to credit and skills and infrastructure.
Investment by businesses is a key driver of productivity growth. It improves their capital stock and enables them to produce more outputs with fewer inputs. More recently, business investment growth has returned, up 2.4% in the fourth quarter of 2013, and 8.5% compared to a year before. The OBR has forecast that investment will grow strongly in the coming years as uncertainty recedes and credit conditions improve. However, business investment is still considerably below its pre-crisis peak, and, as with productivity, UK investment over the longer term is weak compared to our international peers. There have been only five years since the late 1970s when we did not have the lowest investment in the G7.
The Government have a simple strategy for encouraging business investment: we want the UK to be the best place to set up and do business. We have already committed to reducing corporation tax to 20% by 2015, and last week the Chancellor announced that we would both extend and expand the annual investment allowance, which will give virtually all businesses a 100% allowance on new machinery or plant.
We also addressed the high energy costs that burden businesses, particularly manufacturers, by capping the carbon price support rate—a problem the noble Baroness, Lady Worthington, anticipated in her eloquent contribution to this debate last year. To help address the historic problem of imports outweighing exports, we are expanding the reach and support provided by UKTI. The Budget also doubled the amount of lending that UK Export Finance can make and reduced the cost of those loans to exporters. That positive business environment not only supports our home grown success stories, such as Jaguar Land Rover, but also attracts overseas investment and jobs; recent examples are Hitachi with rail and Siemens with wind turbines. However, businesses cannot invest if they cannot access credit.
When the Government took office, bank lending had fallen to record lows as a result of the financial crisis. There is also evidence that innovative, new, high productivity firms—the drivers of growth—struggled to access the credit they needed to get off the ground, which further exacerbated the UK’s weak productivity performance. Opinions divide on whether that was a result of constrained supply by banks, or lower demand by businesses that were just not confident enough to borrow. However, either way the outcome was the same: existing businesses, SMEs in particular, were not accessing the credit that would enable them to invest and grow.
Action has been taken. The Funding for Lending scheme was introduced to provide incentives for banks and building societies to boost their lending to the real economy. In November 2013, as mortgage lending to households was recovering, the scheme was focused on SME lending. Credit availability for small businesses is now increasing at its fastest rate in almost four years, and gross lending to SMEs was 13% higher in 2013 than in 2012.
Further, the Government are supporting increased competition within the banking sector and are nurturing alternatives to the banks, such as peer-to-peer lending and initiatives with equity finance. Specifically, the Business Finance Partnership has already unlocked £1.5 billion of additional lending to small and medium-sized businesses exclusively through non-bank finance. However, for productivity to grow and UK businesses to succeed, both domestically and globally, takes more than just investment. The Government must remove supply-side blockages, too, which means investing in infrastructure and skills.
The quality of this country’s transport, energy, communications and water networks is vital to improving our productivity. That infrastructure enables the rest of our economy to work, and we have underinvested in it for decades. Our national infrastructure plan sets out how the UK’s infrastructure needs will be delivered over the long term. We have published a pipeline of projects and programmes worth more than £375 billion, and at last week’s Budget we published further analysis of how we expect that to be financed. That builds on the long-term funding we have already announced for sectors such as roads, rail and flood defences and the steps we have taken to support private sector investment. We are continuing to reform our planning system, and are focused on ensuring that these projects are delivered on time and on budget.
The final ingredient for a productive and competitive economy—many would argue the most important one—is an educated and skilled population. That is why the Government are boosting funding for apprenticeships, removing the cap on student numbers, and increasing investment in science and innovation. The changing nature of the labour market means that the economy demands higher skills. Investment in skills and education ensures that the UK is able to compete in the global economy. Equipping the country’s workforce with the skills businesses need will provide more opportunities for our young people to find employment and reach their full potential.
Building a resilient economy is the only way in which to improve and maintain living standards. Given the scale of the financial crisis that we have experienced, it is no surprise that earnings growth slowed. Paul Johnson, the director of the IFS, acknowledged that falls in real earnings are a direct but delayed result of the 2008 recession. But throughout our time in office, this Government have taken huge steps to make sure that our policies impact households fairly across the UK. The personal allowance will increase again to £10,500 from April next year, meaning that a typical basic rate taxpayer will be more than £800 a year better off in cash terms. Fuel duty has been frozen until the end of Parliament; we have helped local authorities to freeze council tax in every year of this Parliament; we have increased the tax-free childcare cost cap, against which parents can claim 20% support, to £10,000 per year for each child; and we have made it easier to save and for people to access their pensions—a change that has been well received, on an issue that is perhaps closer to the hearts of Members of this Chamber than to those in the other place.
The most important way of getting money into people’s pockets, and helping them to raise their living standards, is to make sure that as many people as possible are in employment. Those figures I referred to in my introduction—1.7 million new private sector jobs, with four private sector jobs created for every public sector job lost—are a real demonstration that this Government’s policies are working, and the recovery is happening. But let us be clear: increasing growth and productivity is the only way to ensure that people feel the recovery for the long term, because it is productivity which determines real earnings growth. As we see the recovery take hold, the OBR predicts that earnings will grow faster than inflation this year and throughout the forecast period. It expects real household disposable income per capita to grow at 0.5% in 2014 and 1.2% in 2015. That improvement will be supported by a continuing strong employment performance.
In conclusion, it is indisputable that we have an improving economic picture, with growth and jobs up, and inflation and the deficit down—but there are, of course, significant challenges remaining. The Government’s economic plan has bolstered stability in the markets, given confidence to businesses and provided security for households, but there is no doubt that the job is not done, and we must continue to boost productivity and address the challenges that face our economy head on. We are now taking the next steps in our long-term economic plan, and last week’s Budget provided the right mix of policies to address the challenges that remain. I believe, as does my right honourable friend the Chancellor, that with the help of the British people, this Government are securing this country’s economic future.
Lord Deighton
Along with the noble Lord, Lord Davies, I pay tribute to the very stimulating contributions from right around the House. The past five hours have simply flashed by. Like the noble Lord, Lord Davies, I hope contributors will excuse me if I do not refer to them all individually. I think the most helpful way to sum up is for me to try to break down the discussion into the five or six key areas and go through what I think were the pertinent issues and the points that I should address.
I begin with pensions and savings because, as my noble friend Lord Bourne said, this was a transformational Budget precisely because of what we were able to do in terms of the pensions revolution. With one or two exceptions here today, it has been very broadly welcomed, particularly by my noble friends Lord Wakeham, Lord Higgins and Lord Stoneham, as well as by a number of other noble Lords. I absolutely accept that the provision of expert guidance is a critical part of making this transition work. The Government have laid out a clear plan and commitment to that, which we will follow through. I was very taken by the very thorough analysis offered by the noble Lord, Lord McKenzie, of some of the potential impacts which will flow from a change this radical. He is absolutely right to bring those to our attention, and the consultation that we have started will attend to them very directly.
My noble friend Lord James referred to the risk to the annuity companies. A similar change occurred in Ireland and the health of the annuity companies was just fine. My general attitude to the financial services business is that in the same way as we have given pensioners the flexibility to respond based on their own requirements, I think we will find that pensions and insurance companies will be able to respond very flexibly to the new environment. I will certainly take away the request from my noble friend Lord Flight to have a look at the NISA tax issue with respect to the tax treatment of the surviving wife.
We have had this discussion—I think we had it last year as well; in fact, I am sure we had it last year as well—about whether our debt and deficit are really going down fast enough, or whether they have gone down at all. I thought that I was quite clear about the process we are going through, and my noble friend Lord Higgins echoed the way in which I approached it. The situation is really not that complicated. We inherited a record deficit. Until you get that deficit to zero, of course debt will continue to go up. The OBR tells us that we will be back in surplus by 2018-19. It is only at that point that the accumulated debt can begin to go down. We expect the deficit as a proportion of GDP to hit its peak in 2015-16 and then begin to come down.
It is a difficult, long-term process. There are many more cuts that need to be made in order for us to be able to accomplish that. My right honourable friend the Chancellor could not have been clearer about that. I really do not accept the suggestion of the noble Lord, Lord Skidelsky, that this is driven by some ideological rage to reduce the size of the state. It is driven simply by what I regard as an extremely sensible approach of reducing the amount of debt because debt will eventually overwhelm you and leave you with absolutely no protection against future shocks. It is true in personal finances, it is true in company finances and, while there is more flexibility in sovereign finances, ultimately you have to deal with the same issue. We were overleveraged and we have to fix it. I absolutely agree with what I think was the most popular contribution of the day, from the noble Lord, Lord Desai, that the deficit just has to be eliminated, and we have stuck to the plan to do that. My noble friend Lord Horam pointed to the fact that there are still some risks out there, whether in China or Ukraine or deflation in the eurozone. It is by no means plain sailing even if we stick to the plan.
I will talk about the recovery. The debate we had last year was about there not being a recovery. We have moved on from that. As the noble Lord, Lord Desai, said, we were discussing whether or not we were having a triple-dip. We have moved the debate on. Now the debate is about whether it is the right kind of recovery, which is a higher class of problem for us to be addressing. It is interesting that the essence of the Opposition’s position on this is the risk of, “It might look as though there are some of the components of all the mistakes we made”. If that is the best criticism that can be levied, that tells you something about the potential strategy of an alternative Government.
The Chancellor has been quite clear—and I think I was quite clear in my opening comments—that this is a recovery that has some challenges. It is a partial recovery. There are some real issues in the imbalances. I was not trying to disguise that. The Chancellor has not disguised that. Investment has not yet come back as we would have hoped, although there are some signs. That is not unusual at this stage of a recovery so we should not be surprised. Exports are not performing as well as we had hoped.
On investment, the noble Lord, Lord Kestenbaum, made the case strongly for innovation, as did the noble Lord, Lord Hunt, and my noble friend Lord Eccles. I think that there was a lot of agreement about our need to tackle the productivity question and, looking at our science and research capability, the intangibles in the economy which do not get measured in the productivity numbers quite as we would like. I take all that on board.
On the balance of the recovery, the right reverend Prelate the Bishop of Sheffield implied that all the employment growth was in London. That is not consistent with the ONS statistics, which show that it is much more broadly based than that. My noble friend Lord Holmes made an excellent point in saying how crucial the employment recovery is, because those are real jobs for real people. At the beginning of the recovery, there was perhaps a greater proportion of temporary work, but if you look at the employment improvement over the past 12 months, you see that it is fundamentally in good, solid, long-term jobs. The sector which has seen the most benefit in terms of employment growth has been professional science and technical research, so there has been a lot more substance to the employment recovery in the past 12 months.
My noble friends Lord Sheikh and Lady Neville-Rolfe talked about exports. There are a number of combinations. It is clear that we need to switch over time from the EU towards the BRICS and the MINTs. I am joining the Chancellor in two weeks’ time on a visit to Brazil, where we hope to address what my noble friend Lord Holmes pointed to as our underperformance relative to the Italians. I think that everybody welcomed the extra support for UKTI and UKEF, so that funding can be provided to exporters at the most competitive rates. We now want to support our exports in the most aggressive way rather than try to make available a facility which made us the good guys in terms of complying with OECD rules in the most gold-plated way. I am very much in favour of a much more aggressive approach.
It was inevitable in a discussion on the balance of recovery that mention should be made of house prices and the housing market. I think we all accept that we have a long-term challenge to build the supply of houses that this economy needs. We tried to attend to this challenge at this Budget as we have in previous fiscal events. The initiatives at Ebbsfleet, Barking Riverside and Brent Cross, together with the expansion of the Help to Buy equity loans scheme, which is available solely to new house purchases, should all add up to improving the pipeline by about 200,000 houses. This year, we have seen more housing starts than in any time since 2007, so a degree of normalisation is going on in terms of the recovery from the financial crisis.
On the argument that house prices have been inflated by the Help to Buy scheme, I think that the scheme has been much maligned. If you look at the data behind it, you see that 75% of the houses supported are outside London and the south-east. I do not think that anybody regards us as having anything close to a housing bubble outside London and the south-east. Appearing in front of the Treasury Select Committee this morning, the OBR described the higher inflation in London house prices simply as a function of excess demand over supply. The problem was a lack of supply of houses; it was not a bubble. I think that one defines a bubble in terms of people speculating and buying houses on the basis that prices will go up and up, but that is not what is driving house price behaviour in London.
There was a lot of discussion about infrastructure, particularly from the noble Lord, Lord Hollick, who asked whether we should have borrowed more to be able to accelerate development. From my experience over the past 15 months in trying to tackle this problem for the country, it is clear to me that you do not turn infrastructure on and off like a tap. The political debate about it mildly amuses me, because we spend all our time trying to take credit for the things that are being built on our watch whereas, of course, those are all things that other people did all the hard work on to get them to that stage by the time you are in government.
The work I am doing is really to make the next one, two or three Governments look really good by having a stable pipeline of terrific projects which will come through. Those are things such as HS2, which we are trying to do in a first-class way. That will also bring growth back to the north, which we have talked about. That is why we spent so long trying to get Hinkley Point right. There was misinformation about the Hinkley Point investment. It is of no surprise to anyone that it is currently going through state aid; something of that scale was always going to go through state aid; we accepted that. The noble Viscount, Lord Hanworth, said that this was a bad deal for the British. The basis of the deal is that the French will construct at their risk a nuclear power station, and it is their problem if they cannot build it on time and on budget. I am very happy to have signed a 35-year contract with them on the basis that they can do that, because that was a risk that I did not want our taxpayers to bear.
More broadly on energy, which both the noble Lord, Lord Hollick, and the noble Baroness, Lady Worthington, addressed, the focus on energy in the Budget was about ensuring that our manufacturing businesses remain competitive. A number of things have happened in the short term. This morning, Ofgem referred the supply side of the industry to the Competition and Markets Authority for review, which is a good thing. We need a good, evidence-based review so that we can look at the facts to decide what we need to do with the supply side of the industry. That is the right outcome given the noise around it and the shortage of facts and evidence.
On generation, I think we are in good shape in our nuclear plan. The new energy policy has enabled us to write contracts for difference which can support that investment. We have a series of wind and other renewables projects under way based on the same CFD process, and we will see at the end of the year how the new capacity market auction works to trigger gas investment. It is extremely tricky to get the right combination of securing supply, making prices affordable and decarbonising at a rate which balances all the different interests, but we have a plan and it will work.
We had a little discussion about quantitative easing. There were questions from the noble Lord, Lord Myners, and a response from my noble friends Lord Higgins and Lord Flight. I shall not give a point of view about that because I think it undermines the independence of the Monetary Policy Committee of the Bank of England, whose job that is, but I accept that exit from quantitative easing is an economic issue that will need to be addressed intelligently.
The noble Lord, Lord Davies, said that there is really nothing in the Budget for young people. I really could not disagree more. This Budget is all about shaping an economy which will provide the jobs and opportunities that our young people can succeed in. For me, it is completely the other way round.
There was a very interesting contribution from the right reverend Prelate the Bishop of Chester on social mobility. For me, there is no better measure of a successful society than whether that is working. I know that Terry Leahy was certainly a product of that; as was I. For me, education is absolutely at the heart of that, which underlies all the work that this Government are doing in that area.
There was some discussion of tax policy. There were very interesting suggestions from my noble friend Lord Wakeham about the longer-term plan to remove anomalies from some of the other taxes in place. Of course, stamp duty is a very profitable source of revenue for the Exchequer. The noble Lord, Lord Sheikh, mentioned increasing the personal allowance and bringing down tax rates. I would just point him towards the Chancellor’s comments that he is, ultimately, a believer in low taxes.
I should say as a coda that the noble Lord, Lord Northbrook, mentioned the Economic Affairs Committee’s recommendations. We will carefully consider and address those as part of the Second Reading. We decided not to address them today.
In short, and as noble Lords can tell, I believe that we have a plan that deals effectively with the extraordinary challenges and very high debt levels that we inherited from the financial crisis. As I have acknowledged and noble Lords have discussed, the economy faces many longer-term structural challenges that, crucially, we must address consistently over time. I think of our economic management as stemming and managing down the consequences of the crisis while at the same time putting in place structural reforms to position us to be a winner in the global economic race.
I thank all noble Lords for their contributions. The debate has been extremely stimulating. I apologise to those to whom I have not referred or answered in person but, as always, my door is open.