Lord O'Neill of Gatley
That this House takes note of the steps Her Majesty’s Government are taking to build a stronger economy.
The Commercial Secretary to the Treasury (Lord O'Neill of Gatley) (Con)
My Lords, it is an honour for me to lead this debate today on the economy and our prospects. Let me add that I am glad to see that the topic of economics is as stimulating as always. The purpose of this debate is partially to give noble Lords an opportunity to contribute, in view of the fact that the Budget debate was held in the Moses Room, given the heavy legislative agenda. With this in mind, as many might have participated there, my opening remarks will be offered in a slightly different style so as not simply to repeat much of what I offered that day.
I also take this opportunity to pay tribute, on the sad news of his recent passing, to the remarkable contributions made by Lord Peston to this House and our country as a whole.
Since this Government came to power, the economy has made good progress: no other G7 economy has grown faster; we have record levels of employment; our fiscal deficit has declined considerably; and we have a clear path to the goal of a fiscal surplus and reduced government debt. Nevertheless, we face a considerable period of uncertainty around the world and, as an open economy, we live in that world with consequences for us from what happens to the rest of the world and the actions we may take in engaging with it. With this in mind, I will make some comments about the EU referendum and its possible interplay with two of our ongoing economic challenges: our low recorded productivity performance and our large external deficit.
It is a fact that for a long time, the UK has experienced much weaker levels of productivity than our G7 neighbours. It is apparently also the case that since 2010, our productivity performance has been weak compared to the pre-crisis period, as is seemingly true for the rest of the G7, but with ours deteriorating more than others. We have spent time debating the causes, and in the past year we have introduced a range of policies to remedy some of these challenges, but I will present some further aspects of this complex and challenging issue today.
Interestingly, there is no real evidence that financial markets are especially troubled by this—at least yet. Since 2010, our trade-weighted exchange rate—the average of our exchange rates against all our neighbours—has risen by around 6%, while those of five of our G7 partners have declined. Since 2015, our trade-weighted exchange rate has indeed declined, by just under 5%, which is more than the rest of the G7, but this only takes back some of the rise since 2010.
If there were concerns around the world about our ongoing productivity performance, you might expect a larger sustained weakness. It is also evident from other key financial indicators—be it our appropriate measure of equity indices or our gilt market performance compared to elsewhere—that there are no signs of structural underperformance. This is gratifying and could be read as suggesting that markets do not entirely believe the accuracy or importance of the reported productivity data, or that there are much important influences at work, including perhaps our strong GDP and employment performance. None the less, we cannot take this “kindness of strangers”—to paraphrase the Governor of the Bank of England—as a given, and if our productivity underperformance persists or deteriorates further, and/or other, strong aspects of our economic performance reverse, then markets might behave differently. I shall return to this later, but as the Treasury has shown recently, a vote to leave the EU might be regarded as a negative productivity shock.
If you adjust our reported productivity data for their employment strength, and again compare them with the rest of the G7, our underperformance does not look quite so bad. Although the link between productivity and employment is uncertain, recent work by the French academics Bourlès, Cette and Cozarenco—apologies for my pronunciation—has identified a relationship between the employment rate, the number of working hours and the level of productivity.
Making use of this work, and adjusting our competitors’ employment rate and working hours to match our own, we can generate illustrative estimates of what one might regard as a truer productivity gap. These estimates find that the gap drops considerably with some of our neighbours: approximately 40% with Germany, around 50% with France and over 70% with Italy.
There are also some important facts to highlight from the reported productivity data. For example, and again in contrast to much of the perception, some of our key service sectors have been reporting strong productivity performance: notably, wholesale and retail, which has grown by 11.3% since the start of 2010.
It is not true that, as is often perceived, manufacturing is the source of the strongest productivity performance. As reported—and again, not generally appreciated—in fact, two of our weakest productivity performers since 2010 have been financial services and oil and gas, both reversing previously apparently strong productivity performances. There is a case to be made that the recent weakness might simply be compensating for what was actually, in hindsight, not sustainable productivity. If that is indeed true, this part of our supposed recent productivity weakness is not something to be concerned about. Of course, it might be that these sources of productivity weakness need to be reversed, which, if so, is contrary to much popular perception of our immediate challenges. More analysis on this conundrum is definitely necessary.
Whatever is the case with that interesting challenge, I remain happy in general with our progress in pursuing the policies that deal with our longer held major sources of underlying productivity weakness. An essential part of that plan is to invest in skills and training so that we can meet the needs of employers. That means, for example, making sure that the adult skills budget is protected, or creating a new network of national colleges and institutes of technology.
It also means giving more young people the opportunity to develop high quality skills, and our expansion of apprenticeships is about quality as much as quantity. By 2020, we will have doubled what we spent on apprenticeships in 2010 in cash terms.
We also need to make sure that we have the best possible infrastructure in place. That is why we have established an independent UK Infrastructure Commission and stepped up investment in the road and rail networks we need, such as Crossrail 2 and so-called High Speed 3.
Lastly, we need to realise our vision of a northern powerhouse—something in which I am particularly involved—to make sure that we realise the productive potential of all parts of the United Kingdom. As well as investment, devolution remains a crucial aspect of this.
I turn to the second so-called Achilles heel: our current account balance of payments. This is a perceived weakness which is of course worthy of some concern. The latest data show a sharp deterioration in the fourth quarter of last year to 7% of GDP, and as a consequence of that quarter’s number, for 2015 as a whole the reported deficit was 5.2% of GDP.
As I shall explain in a minute, there are important qualifications that suggest that this external deficit might not be quite as concerning as it might be if it were dominated by a deteriorating trade deficit. But, whatever that explanation, it is also true that if strangers were to become less kind, it could be problematic, especially if it coincides with a new, clear negative productivity shock.
Examining the data in detail reveals that for the past four years, our trade balance has stabilised, albeit with a deficit that is still too high. The actual source of the current account deficit deterioration is in the so-called non-trade accounts. Earnings from our overseas investments have declined—presumably reflecting lower economic growth—while our returns to overseas investors, perhaps reflecting our superior economic performance, have stayed relatively strong. As such, we ran an income deficit—the difference between the two—of nearly 2% of GDP last year. One might imagine that, as the rest of the world economy strengthens, especially in the rest of Europe, those returns should increase as this part of the external accounts improves, possibly significantly.
However, as I personally have discovered in recent discussions with many large foreign investors, including some that I have visited—I was in the Middle East the week before last—if we were to adopt policies that might give rise to increased risk premia in their eyes, they might decide to stop investing here, which would result in an investment shortfall for the UK that would, among other things, immediately require a corresponding domestic rise in our savings rate. This could be translated in a number of different ways, but it would quite possibly be the case that this could be forced through an immediate cut in our consumption, which itself could be forced by an adverse reaction in financial markets.
Against the background of these two issues, let me now turn to the EU referendum. As shown in the document we published on Monday 18 April, a decision to leave the EU would represent a classic trade and productivity shock, and it would occur at a time when our current account requires ongoing net positive capital inflows to maintain financial market stability. This analysis found that a decision to leave the EU would lower GDP by 6.2%, leaving the average household £4,300 worse off, if we assume that the UK would negotiate a bilateral trade agreement such as Canada’s. However—I am sure most noble Lords are more than aware of this, but for those who are not—it is not just the Treasury’s analysis which shows this: the bulk of credible economic analysis, including that produced by the Bank of England, the IMF, the LSE’s Centre for Economic Performance and, yesterday, the OECD, corroborates the broad findings of the Treasury. This seems a very unsatisfactory risk/reward ratio unless there are clear, definable long-term benefits.
Lord Forsyth of Drumlean (Con)
My noble friend referred to the Treasury document and its estimate of the effect of leaving the European Union. It included an estimate projecting 15 years ahead that we will have 3 million more people in this country as a result of immigration. Will he tell the House what provisions are made by the Treasury to fund the health, education, housing and other costs that would arise from that?
Lord O'Neill of Gatley
My Lords, I could spend a lot of time specifically wading into this question. I will reflect on other comments I hear and try to incorporate them in my closing comments. In our transparent and clear fiscal policy framework we have committed to a path for all sorts of areas of government spending over the remainder of this Parliament, including protecting those areas that we think most need it.
I will finish my opening remarks as quickly as possible.
Lord Forsyth of Drumlean
My noble friend has not answered my question. The Treasury document assumes that there will be 3 million people here as a result of our inability to control immigration. That has huge implications for spending. The document made no reference to that and I can see nothing in any of the Treasury’s plans that indicates how the costs of the schools, hospitals and other infrastructure that will arise will be met in those circumstances. Surely the Minister has an answer. It was his document.
Lord O'Neill of Gatley
My Lords, as I said, I will make some further specific comments in answer to this question after I have heard the collective input of the whole of the House.
Lord Davies of Stamford (Lab)
My Lords, is it not the case that the Treasury document referred to by the noble Lord, Lord Forsyth, makes it absolutely clear that the growth in our income as a result of our remaining part of the EU will be much greater than would occur if we left the EU under any circumstances and that the amount of additional gross domestic product that would be generated as a result would be more than sufficient to cope with any additional costs involved in social security, health or educational provision?
Lord O'Neill of Gatley
My Lords, for now I shall try to answer that question in the context of the remaining part of what I had planned to say—otherwise I will be eating into everyone else’s valuable time.
As somebody who has spent considerable time exploring the rise of the so-called emerging world and the changing patterns of world trade, I believe that I can articulate the case for the UK to benefit from a rise in the role of China, India and others while continuing to benefit from being a member of the EU. Indeed, as was clearly shown in this document, despite the challenges that being a member includes, the growth in our trade has been quite considerable since we became a member.
It is important to recognise that the presumed changes in trade patterns that I have been at the centre of articulating may never happen anyhow: that is a possibility. Even if they do, though, it remains the case for the foreseeable future that the EU is set to remain our dominant trade partner, currently accounting for around 44% of our exports. As I said, there is no doubt that our membership has made it easier to trade with not only the EU but the wider world. Trade as a share of national income has risen to over 60% in the last decade, compared with under 30% before we joined the EU. Membership has also made the UK an attractive place for foreign investors, with the equivalent of £148 million invested here every day for the last decade. Almost three-quarters of foreign investors cited our access to EU markets as an important factor in their choice of the UK.
In conclusion, there have been indications recently that our economy is continuing to grow—but, as I have highlighted, there are clear risks to that being sustained. We must continue to work hard to address the systematic issues that are a barrier to strong growth, in particular those of weak productivity and our current account deficits, where the issues are genuine and not, as perhaps some aspects are, statistical quirks and issues of economic interpretation.
The financial markets will of course continue to watch closely what happens in the debate over the UK’s membership of the EU. This has clearly had an effect already in the recent past. Some measures of so-called sterling volatility have increased dramatically since January, and in the week following the February European Council the pound fell quite sharply. The Monetary Policy Committee commented a couple of weeks ago that,
“much of the fall in sterling reflects uncertainty surrounding the forthcoming referendum on the United Kingdom’s membership of the European Union”.
In the past week the pound has made a notable recovery as the markets have readjusted their probabilities concerning the EU vote outcome. No doubt this volatility will remain and possibly intensify.
The longer-term ramifications of us leaving could be far more wide-reaching than just volatility for the pound. In my judgment, a vote to leave would constitute a considerable risk to both our economic security and our global influence that we would be bringing on ourselves with no certainties about the alternatives. In that regard, it is not a risk worth taking. There are no silver bullets for our challenges. That is why the Government must continue to follow a long-term plan to take action over not just the next few months but the next few years and decades.
Lord O'Neill of Gatley
My Lords, the best news is that people were hopeful early this morning that we would be over by 4 pm and, unless I am particularly long-winded in my summary, we should achieve that. I start by thanking everybody again for their varied contributions. I have presented myself with an additional risk in summing up because of how I started out. I deviated deliberately from my normal style to highlight—despite some of the comments of the noble Lord, Lord Davies—some of our really problematic challenges, particularly on productivity and the current account. That has led, in a very stimulating manner, to many of your Lordships offering extremely thoughtful comments, as always. I thank you all and apologise in advance if I do not give the right credit to everybody for their important contributions.
I cannot resist saying I am particularly pleased that the noble Lord, Lord Haskel, referred to antimicrobial resistance because three weeks from today, I will present the final reports of the important independent review I have been undertaking. I look forward to having a chance to debate that in this place. I say that because from my brief time as a Member of your Lordships’ House, I am aware of our collective belief that we conduct ourselves on a higher level than the other place. But I gather that yesterday, there was a debate in the House of Commons on antimicrobial resistance, which is to be welcomed.
Let me quickly return to the issues raised. In my judgment, there generally continue to be signs that our economy is in fundamentally better shape than it has been for some time. However, as I have pointed out, particularly with respect to productivity and the current account, and especially given what lies ahead on 23 June, there are some considerable risks—not least because as an outward-facing economy we are strongly affected by all sorts of forces around the world, none of which I had or will have the time to go into, although many others mentioned them. I would point out that while we have been sitting here, we have had the first estimate of US GDP growth for the first quarter: 0.5%. That annualised number is much less than expected. Despite the comments about how supposedly disappointing our growth is, that means that our first-quarter growth was four times stronger than the United States’. Some of the issues we face—on productivity and otherwise—are affecting many parts of the world.
As I tried to do during the Budget debate, I am going to summarise the comments made by noble Lords today in the context of specific areas. I have identified five: the economy itself and its performance; the Budget and the appropriate policy; global trade, especially with respect to the EU issue; productivity; and distributional analysis/inequality.
Before I do that, let me address two specific issues that arose early on in the debate. I was challenged by my noble friend Lord Forsyth on the immigration issue and the contents of the HM Treasury document. I am rather pleased that, despite the length of our debate, others did not make the same point. Of course, as the Government have articulated clearly in the run-up to this referendum, we believe that net migration remains too high and we are committed to reforms to bring that down. Many examples of that can be given. I would also point out, as that document pointed out, that most evidence suggests net migration in aggregate is a net positive for our economy—if for some more than others.
On the topic of PIPs, raised by the noble Lord, Lord Tunnicliffe, I thought I put that to bed during the Budget debate but perhaps not all noble Lords heard what was said there. The figure of £4.4 billion over the course of the rest of this Parliament, which the noble Lord referred to, is really a minuscule sum compared to the considerable volatility that will arise from the OBR’s changing its view again—one of the few things we can really predict about the OBR. For example, over the course of the last forecast, the figure changed by £75 billion. While many people have been right to point out the huge dangers of forecasting, I have very strong confidence in one forecast: that it will change its assumptions for the next Autumn Statement and the next Budget. That will be much bigger than anything that has happened with PIPs. It is a shame that that debate took place in such an environment. As far as I understand it, the underlying intention is not necessarily to save money but to make sure that those most worthy of the payments are getting them and that the system is not being gamed in the way we suspect it is.
I turn now to the five issues. A number of noble Lords made important comments on the economy, including the noble Lords, Lord Northbrook, Lord Hain, Lord Suri, Lord Sheikh and Lord Davies of Stamford, and the noble Viscount, Lord Hanworth. I have touched briefly on some of the many challenges that exist. Despite what I have just said about the latest US GDP figures, I note last month’s purchasing managers’ indices—a highly important leading indicator of probabilities—which showed a noticeable pick-up in a number of countries around the world, including the US and China, although sadly not the UK, which in itself is interesting.
I smiled to myself with considerable amusement when I heard the noble Lord, Lord Hain, refer to the very optimistic-sounding view of Oxford Economics on productivity, compared to that of the OBR. Of course, the OBR was set up in a particular way. I imagine that some people, including me, hope that Oxford Economics is proved right, because the fiscal outcome would by definition be considerably stronger than that implied by the latest OBR forecast. We can agree or disagree with what the OBR says, but it was set up to serve the purpose of independence, which, in general, it does pretty well.
I cannot resist pointing out the irony in the comments made by the noble Viscount, Lord Hanworth, about the problems of manufacturing and the rather strange situation with foreign ownership. Ten yards to his left as I look, is the noble Lord, Lord Bhattacharya, who pointed out—as we do a little less often than we should—the miraculous development going on in our auto industry, most of which is owned overseas but is the most productive auto industry in the world, with record numbers of exports. If we could bottle that and do the same with a lot of other things, it would be pretty good for all of us.
I turn to the second topic: the Budget. I will end up repeating things I have said before, as have many noble Lords, but I will try to be brief. Most of your Lordships are aware that there are some who would like the pace of deficit reduction to be faster, while many—perhaps the majority here—want it to be somewhat slower. It continues to surprise me when I hear that said so often here. There is something called the full employment adjusted cyclical position. Many academics are saying that, at this stage of our level of employment, we should be in a fiscal surplus. The idea that we should suddenly do things that involve spending a lot more money, and ignore that issue—that we should not worry about the rainy day in the future—is very questionable. The Government, faced with the self-imposed constraint of the OBR, are trying to choose the right path of deficit reduction, with the goal of achieving a future surplus to support both the private sector and, in the areas where it is necessary, the public sector, but with respect for trying to lower the deficit.
I have to apologise to the noble Baroness, Lady Kramer, who raised an issue which I had not quite understood from her comments on the Budget debate: whether we should introduce a goal of a surplus adjusted for capital spending. It sounds very reminiscent of what was called the medium-term fiscal strategy, specifically adjusted for capital spending. In principle, it is of course a very important idea, and I will give it some thought and discuss it with colleagues. However, as that experience demonstrated, when times are tough it becomes rather convenient to redefine certain elements, and you end up with unintended consequences.
Topic number three is trade and the vital issue of EU membership. The noble Lords, Lord Newby, Lord Sheikh and Lord Bilimoria, among others, outlined the issues wonderfully and in a very clear style, which I admire—I want to borrow some of it next time I have to do the same thing. As I said in my opening remarks—and as I have done myself many times in the past—one can easily articulate a future in which the only place where any of us are exporting to is China. In fact, I once produced a chart showing that by the end of this decade, Germany will be exporting more to China than it will to France. I have occasionally added the joke that German companies would rather be in a eurozone with China than with France. That was a forecast. It is not going to happen by 2020, because China’s economy has slowed, but it could still happen in the future. I give that example because, despite how good Germany is at exporting, the Germans are not, so far as I am aware, thinking of leaving the EU because of the opportunities they might find elsewhere. However, that is the sort of risk that we seem to be putting to our electorate here. All of us here—and I detect that most Members of the House strongly agree —need to ensure that the people of this country are correctly informed about the risk they may be facing.
I should also add, because there is sometimes confusion of membership of the euro and membership of the EU, that there is often no more powerful voice than the one and only Martin Wolf, who earlier this week outlined 10 reasons why we should not leave the EU. As I am sure noble Lords know, he is not the most vocal supporter of the euro.
With respect to trade, it was very nice to hear the interesting comments of my noble friend Lord Sheikh about Africa and Islamic finance. Coincidentally, today in Manchester my ministerial colleague the Economic Secretary is hosting a big conference on Islamic finance, which involves participation from some of the most important policy-makers in the Middle East and others. We are very committed to that.
Topic four is productivity, which itself took more time and had more contributions than I will have a chance to do justice to. Very briefly, with respect to the very interesting comments of the noble Lord, Lord Mawson, about technology, young people and the health service, this is a major area where things will happen, the scale and dimensions of which most of us in this place, because of our age and minds, will not be dictating. But I share the noble Lord’s excitement, especially as it relates to giving the right mental and financial support to encourage young people to go down that unpredictable path of discovery. That is very important for us to do, and we are trying.
As that relates to education and skills, I will highlight something which I think has not had much coverage. Specifically in the Budget as it relates to the northern powerhouse, we set up the northern powerhouse education fund. It has not yet started, of course, because the Budget was just a few weeks ago, but it will be considering marginal initiatives in the education and skills space specifically to help some of the most challenged areas of the north.
In the same spirit, the noble Lord, Lord Mawson, also touched on health. We are pursuing many things on that front that again I think the Government should be very proud of. A particularly exciting one is of course the devolution of health to Greater Manchester. It will be very important for many parts of the country, particularly urban parts, to watch how this progresses, because of what it means for an integrated health approach that could help our society in so many ways.
On finance, as always, I listened really closely to the important comments of someone as experienced as the noble Lord, Lord McFall. I pointed out in my opening comments something that is not often understood. There are lots of measurement issues with productivity data, but as they are reported, we have seen a dramatic fall in the productivity of the financial sector. It is not obvious to me, as someone who spent so long in that sector, quite what is going on. We must be very careful that our desire to hold people to account, as we should, and punish them—as I think that parts of the Bank of England Bill will—does not smother the financial system from doing what it needs to in its connection to the rest of our economy, linking to some of the comments of the noble Baroness, Lady Kramer. That is a very important challenge and one that I and some of my colleagues are spending considerable time on.
In the broader context, let me turn briefly to long-termism, which the noble Lord, Lord McFall, talked about in a broader sense, as did the noble Lords, Lord Haskel and Lord Mair. That takes up an important part of my mental time, because I, too, believe that initiatives need to be considered. If you look carefully at some of our published documents, you will see that the number of words we are giving to it is creeping up. We are spending a lot of time thinking about the right way to try to change the incentive reward system by linking it to investment and productivity. Many ideas that I have heard here will play in my mind, and we will welcome many others.
To finish off on productivity, on both industrial strategy and R&D, when I was listening to the wonderful comments from the noble Lord, Lord Mair, which many have highlighted, in particular, but also from the noble Lords, Lord Bilimoria and Lord Dykes, many things that they talked about I spend much of my day talking about to research staff, including many of my officials. If I had time, I could proudly highlight what we are doing. We have directly supported the National Graphene Institute at the University of Manchester. There is advanced manufacturing at the University of Sheffield. Yesterday, I gave a speech at the launch of our direct support for sophisticated energy research involving the top six universities in the Midlands. I could go on and on.
Very lastly and importantly, I turn to the comments of the noble Lord, Lord Tunnicliffe, about distribution analysis and the underlying issues of inequality. We believe—with some justification, I think—that what is provided in the Budget is the fullest available evidence about how money is spent. I think the statistics show that 50% of the money that goes on welfare and public services goes to the 40% at the bottom. I repeat for the third time in this place: if you look at internationally credible, accepted and used measures of inequality, you will see that although we are more unequal then we should be, we are not as unequal as we were 10 to 15 years ago.
I would love to respond to the comments about my supposed howler on productivity. If it was as bad as the noble Lord said, I should be allowed out of this place because, although I have made many howlers in the past and will make many howlers in the future, if I was unaware that our productivity is inferior to that of Germany it would be a very bad howler, and I am sure that the noble Lord must have misunderstood.
Lord Tunnicliffe
The Minister has made claims about the impact of inequality before, and he referenced various international studies. Will he write a letter and put it in the Library referencing where I can see the arguments and the figures behind them?
Lord O'Neill of Gatley
I thought I did write—I apologise if that has not taken place—particularly because of the reaction to an Oral Question on this issue. But if I did not write, I will make sure that I do.
I conclude by saying that this has been a stimulating debate. I have heard many interesting things, particularly on angles with respect to R&D and the key interplay between the strength of our universities and the fact that we need somehow to get more of this R&D going from them into industry.
I will finish where I started. We have two quite clear, large economic challenges in our productivity rate and our current account. If we do not make the right decision on 23 June, they will cause us bigger problems than, luckily, they have as yet.
Motion agreed.