Independent Assessment Key To Credibility of Economic Policy

9.20.00am UTC (GMT +0000) Mon 10th Jan 2005

We need a proper monitoring mechanism for the Government's Gershon programme and fiscal tests to see if they are meeting their targets, says Dr. Vincent Cable

This article is based on a speech by Dr Vincent Cable MP, Liberal Democrat Shadow Chancellor, during the Queen's Speech debate in the House of Commons on December 1st 2004. It has been edited slightly to improve the flow and reduce the length. The full speech can be viewed by clicking on this link.

We support the practical measures on the Inland Revenue and Customs and Excise in the Queen's Speech. I am glad that the Government have noted the concerns that I have long expressed about consumer debt, which is to be dealt with in limited but useful legislation that we will support. I also support the sensible suggestion of the Conservative Shadow Chancellor, Oliver Letwin, about introducing legislation on the independence of the statistical service. A key theme over the next few days will be the integrity of Government figures, so such legislation would be a useful building block.

It was clear from his speech that the Chancellor has not listened to the advice from the Chancellor of the Duchy of Lancaster and our man in Brussels to stop boasting about the Government's economic record. However, I am rather on the side of the Chancellor of the Exchequer, because the Government have very little to boast about, and almost all that there is of positive note is on the economic side, so his points about economic stability were fair, as I have always acknowledged.

As for basic economic growth over the past seven years, the British economy has averaged about 2.8 per cent. a year, a little above the average for the Organisation for Economic Co-operation and Development. Some European countries such as Sweden and Spain are doing better, as is the United States, but we have a perfectly commendable growth rate which—there is no point denying the underlying facts—is the product of a combination of fortunate external circumstances and a favourable international economic environment. The Chancellor has also enjoyed a helpful inheritance, including liberalised labour and financial markets, which have contributed to low inflation. Another helpful factor is sensible economic management, notably monetary policy the independence of which, we all now accept, was a good move.

The Chancellor began by focusing on fiscal policy, and I am happy to respond to the challenge that he threw down. He obviously finds it psychologically difficult to adjust to an environment in which the Liberal Democrats are more disciplined about public spending than he is, but we shall continue to argue the case for making tough choices in public spending.

The Chancellor asked me to account for our spending proposals, but it would be useful if he could elaborate on the progress of the Gershon savings exercise. How will he report on that progress? It has never been clear how we would know if the Gershon savings had been realised and there are some opaque memorandums flying around Whitehall on implementing the recommendations. Will the Chancellor therefore undertake to set out concretely how much money is being saved under the Gershon programme year by year? What progress, for example, is he making in reducing the number of procurement agencies? We need to evaluate those concrete steps to be sure that the Government are serious about making savings. Whatever their motivation, we need a proper monitoring mechanism.

On fiscal policy, the Chancellor will have to acknowledge over the next few days that there is a growing consensus that he has a problem in meeting his fiscal objectives. It is not a political point. The International Monetary Fund, the OECD, the Institute for Fiscal Studies and the National Institute of Economic and Social Research are not politically driven bodies, but they are all arguing that he faces that problem. It may not be a big problem quantitatively—£7 billion, £8 billion or £10 billion is a very large sum to most individuals, but in terms of the economy it is not a very large sum. That is the standard consensus projection of the extent to which the Chancellor will be adrift in respect of his fiscal policy objectives.

My concern is not the sum of money. Economically, it is not large and could easily be absorbed in the Government's overall borrowing requirements, since the debt position is comfortable. The issue is credibility—fundamental economic credibility. If the Government set tests, they should be able to meet them. The Government clearly understood from the outset that economic credibility was important. Indeed, this year the Nobel prize went to a couple of economists who spoke about the importance of economic credibility. Credibility was what lay behind the decision to establish the Monetary Policy Committee, and it has enhanced the credibility of interest rate setting enormously.

There is a problem, however, with the way the Government have approached fiscal policy. They set fiscal rules, which are broadly sensible, and more or less followed them, but there is a question about who decides whether those fiscal rules have been met. Will that be determined independently or by the Government? The golden rule is a highly technical area. Even for anoraks, it is a recondite subject. There are a couple of specific issues. First, who evaluates the assumptions that the Government make in their forward projections? At present, the Government invite the National Audit Office, on a restricted basis, to examine those assumptions and pass judgment on them. That is sensible, but the NAO does not have unrestricted access to evaluate the Government's assumptions, and it should.

The second aspect that is defective is who decides what the golden rule is and whether it has been met. That is a technical point but it is extremely important. Who decides when the cycle started and when it ends? That is a difficult question. In my private sector days, I was once set the problem by my company. If the company had known the answer, it would have saved a lot of money in investing in refineries and chemical plants.

Somebody must answer the question, and it should not be the Chancellor, but a genuinely independent body. That is why we argue that the National Audit Office should have an enhanced role—economically and technically, it has competent staff—to evaluate the full range of fiscal policy and give an independent judgment on which the Government can then base a credible fiscal policy. There is no party political advantage in arguing for such a structure. It would be in the Government's interest to have a fully credible fiscal policy, which they do not have at present.

On the wider question of economic policy, we have discussed the rate of economic growth, which is respectable. It would help, though, if instead of looking back, we looked forward. Any honest assessment of the future must be based on the fact that the Government will face economic challenges that will make economic management much more difficult. Some of them are external and the Government have little control over them. It is still possible that we could be hit by a major oil shock. The Saudi Oil Minister was in London yesterday arguing that something of the order of $15 dollars a barrel is still being paid, on account of the political risk arising from the war and enhanced terrorism risk in the middle east. The oil price could get a good deal worse, but it is not a factor that the Government can control.

A second challenge that is looming is the problem presented by the collapsing dollar. I could make the point that sterling is now higher than at any time since the days of black Monday, but it is not a domestic issue. It relates to the United States. The American currency is collapsing, at least in part because of fiscal irresponsibility caused by a tax-cutting agenda on which, I fear, we differ substantially from the Conservatives. It has had disastrous consequences in the US and it will have a major impact on this country.

We also have a home-grown problem, which is the problem associated with personal debt, and the linked problem of boom and bust in the housing market. Some revealing figures on personal debt were produced in the past couple of days. People who retire are facing mortgage repayments into retirement—40 per cent. of all mortgage holders face repayments into their retirement, which is twice the level 10 years ago. People are literally paying till they drop because of their mortgage liabilities.

On the position in the housing market, I have no views—it is not sensible for politicians to have a view on whether it is good for house prices to rise or fall. What is serious is that we have a boom-and-bust environment. Within the past few weeks, we have seen growing evidence of a very substantial collapse in lending and in equity withdrawal, which almost certainly, according to analysis by the Bank of England, will have major economic consequences. I do not raise the matter simply as a problem. It would be helpful if the Government thought through some of the steps that they could take to alleviate the problem. I shall make a few suggestions.

The first is to ensure that we have a price index that reflects the housing market. At present we do not. I understand that the Treasury is working with EUROSTAT to establish a new index that will fully incorporate the price of housing. It would be helpful if the Government would say whether they intend to adopt it and when. That would enable the Bank of England to take house prices much more explicitly and clearly into account.

Another problem relates to credit insurance. One way of stopping hundreds of thousands of people facing the disasters that people experienced in the early 1990s would be to ensure that their mortgage payments and credit payments were insured. If the Chancellor had studied the problem and thought about it, he would know that the mortgage insurance market in this country is unsatisfactory. It is expensive and defective. I hope that he can take some initiative to ensure that the competition authorities look at it.

Long-term growth and the factors that drive it is the third issue that I want to raise. I sympathise with the views expressed by the Conservative spokesman about the Government's remarkable optimism that their intervention in promoting innovation and growth will produce consequences. One of the reasons why I am sceptical about pouring large amounts of money into the Department of Trade and Industry, which does some useful things, is my extreme scepticism about the extent to which that can drive economic growth.

Scientific research is clearly a Government responsibility: the market will never do it, but it is clearly a public good. That is why I am in favour of, among other things, bee research, which the Chancellor and the Prime Minister found so surprising and amusing. Research is clearly desirable and the Government should fund it. It is, however, another thing to argue that private companies, many of which would invest anyway, should be subsidised to do so, when they can raise money in venture capital markets and from charitable bodies such as the Wellcome Trust. The market enables growing companies to function without large-scale funding from the DTI, and I am sceptical about the role that the Government are playing in driving economic growth.

The other area of scepticism relates to the complexity of Government regulation. The Chancellor has a view, with which I happen to disagree, that somehow or other the Government can fundamentally change how business behaves and operates. The classic example of that is the belief that the Government have invested in research and development tax credits. R and D tax credits are a superficially attractive idea—"R and D is a good thing. Let's give them a big tax credit to support it."

All the research done in the past two years shows that R and D tax credits have made no difference to the level of research and development, because most private companies were doing it anyway and the policy has a large associated dead-weight cost. I am not suggesting that we should simply stop that tax credit, but we must evaluate its consequences. The belief that tweaking the tax system and adding great complexity somehow or other changes business behaviour and increases investment, innovation and growth is fundamentally flawed.

This morning, the Financial Times published a letter supplied by the Treasury, which makes the opposite point from the one that it was intended to make. It was published to highlight the horrors of tax avoidance and the iniquity of tax avoidance lawyers and states: "As the government regularly changes the rules of the tax game, you need to be very vigilant. You have to check continuously to see you're still getting the best from your company".

That underlines the point that, if tax policy constantly changes, business behaviour is affected in order simply to skim the tax system.

My final point is rather different and relates to an issue, inequality, on which I probably share much more common ground with the Chancellor than do the Conservatives. One thing that has emerged from the statistics, which are somewhat unsatisfactory, is that, despite the Chancellor's undoubted commitment to that issue, income and wealth inequality in the UK are not very different—in some respects, they are even worse—than they were in the days of Mrs. Thatcher. There are several reasons why, some of which involve the workings of global markets, and some of which involve the workings of the tax system.

If we have a tax system in which the top 20 per cent. pay a lower percentage of their income than the bottom 20 per cent. of the population, it is clearly not working to alleviate the problems of inequality. A few months ago, a Labour Back Bencher tried to defend the highly regressive system of council tax. One of our criticisms of the possibly well-intentioned measures that the Chancellor has introduced on tax credits is that tax credits perversely aggravate the problem.

In conclusion, the Chancellor has let it be known in the press over the past few days that he wants to present himself, his Government and his Budget with a flavour of Britishness. Economic policy will gain a patriotic element, which I appreciate because we all like to feel that we are patriotic rather than nationalistic. Under this Government, however, we have finished up with American levels of inequality, French levels of centralisation and, if the Home Secretary has his way, we will get Chinese levels of civil liberties.