Cable on the Pre-Budget Report

11.23.50am GMT Sat 9th Jan 2010

• [Jan 07] Vincent Cable: ' . . I DO not think we should rush into rapid cuts . . It is a difficult issue and there is a balance to be struck, but rushing into expenditure cuts in 2010-11 would carry a greater risk of precipitating deeper recession. My party takes the view that the Government's eight-year plan, with a four-year halving of the deficit, is a reasonable starting point . . '

We have had two debates on the economy this week. I judged, wrongly, that this would be the centre of attention, but the Chancellor and the shadow Chancellor clearly took a different view. Nevertheless, I persist in my belief that this is an important debate, for several reasons. First, it centres on the pre-Budget report, which was a very important event, however we judge it. As the Chairman of the Treasury Committee pointed out, the debate represents an advance, albeit a small one, in parliamentary accountability, because it represents an acceptance that the PBR should be subject to debate. Moreover, we now have access to the Treasury Committee's review of the PBR, which we did not have on Tuesday. There is therefore a lot to discuss today that we were unable to discuss properly then.

I want to say something about the deficit and the controversies surrounding it; something about the issue that dominated the PBR but has now largely been forgotten-the banking tax, and what has happened to it; and something about the long term, because we are very preoccupied with the short-term fiscal position. There was an interesting half one-liner in the PBR about the creation of an infrastructure bank and a vision of how the economy could develop in the very long term, and we need to refocus some of our attention on long-term structural issues.

I start with the deficit. This debate has been a good deal less emotional than bits of the one that I heard on Tuesday, in which Mr. Field among others proclaimed that the fiscal crisis was comparable to the crisis in 1940. Other speeches were at a similar level of emotion. Today everybody has been a little bit calmer, but we clearly have a serious problem and it is helpful to start by stating what the deficit problem is.

There are two linked problems: a deficit or borrowing problem and a debt problem-a cash flow problem and a balance sheet problem. The problem of debt and the balance sheet is clearly serious, because the situation is deteriorating rapidly. However, as is often pointed out from various parts of the House, as things stand the level of British public debt in relation to the economy is actually one of the lowest in the developed world and much lower than at various periods historically.

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William Cash (Stone, Conservative): Will the hon. Gentleman give way?

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Vincent Cable: Perhaps I can anticipate the hon. Gentleman's intervention. I know he believes that there is a measurement problem, and that if we measured public debt differently we would come up with much higher figures. I am merely citing the international conventions of the OECD and the International Monetary Fund; he might have something to add.

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William Cash (Stone, Conservative): The figures on which I rely are from the Office for National Statistics, and indeed the researchers in the House of Commons Library have confirmed them. They illustrate the point that I, my right hon. Friend Mr. Redwood and my hon. Friend Mr. Newmark have made that the figure is not £850 billion, as is suggested. The true figure, which I believe is now endorsed by our Front Benchers-it certainly appears to be-is nearer £3 trillion, and maybe more. If the measurement is out by a factor of three or four, does the hon. Gentleman not agree that that underlines all the difficulties about what the deficit is and what the definition of net debt should be?

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Vincent Cable: I am sure it does but, equally, other developed countries have the same problem of incorporating public sector pensions. However, I accept the hon. Gentleman's broad point that there is clearly a problem. A more acute one is the borrowing problem. Some 13 to 14 per cent. of GDP is currently being borrowed, and it is being done in a very artificial way because the Government are buying up their own debt in the current strange monetary circumstances. The level of borrowing is unprecedented, I believe, and it is the highest in the developed world except possibly the United States, which is in the rather different position of being able to borrow in its own currency. There is a serious cash-flow problem, which we must take seriously and which is at the heart of the debate.

Two policy issues come out of that problem, both of which have been touched on. There is the historical problem of how we got into this situation and who is to blame, and the forward-looking problem of what we do next and how we manage what we all accept to be a difficult balance. Mr. Hammond summarised in numbers how we got here and why we have our public financing problem. Roughly a quarter of the problem is accounted for by the cycle, the ups and downs of the economy and the recession, and three quarters is structural. The problem is that the word "structural" is bandied around, but it is never terribly clear what people actually mean when they use it.

I know that the Conservative argument has always been that the structural problem is the "hole in the roof" showing the neglect of the budget over many years. That argument is partly true, but the problem with it is that the hole in the roof was actually quite small. I have been doing this job for five or six years now, and I remember debating the matter with the predecessors of the hon. Member for Runnymede and Weybridge, Mr. Letwin and the former Member for Arundel and South Downs, who had an unfortunate slip-up at the last general election. When we talked about the structural deficit then, we were talking about roughly 1 per cent. of GDP. Now we are talking about something rather different-an over-dependence of the economy on the banking sector and to some extent on the ups and downs of the housing market as a source of revenue. It is quite right that we now talk about how to adjust the level of public spending down to one that relates to stable sources of revenue. That is what we mean by the structural debate.

In the wider context, it is a little disappointing that although we are talking about that very real problem, which we have to face, there is little discussion of how we can make the British economy much less dependent on banking in the long term. The Chairman of the Treasury Committee touched on this, but it is a fact that in the British economy, the balance sheets of the banks together account for about four times gross domestic product, which is about four times as large as in France or Germany, and much more than in the United States. We cannot sustain that position and it must be changed. Equally, our economy has become highly over-dependent on people's belief that property prices rise and rise, which we also need to address. That is the real structural debate, but we are not having it.

On the background and the history, it is certainly true that the bulk of the problem we are now dealing with is structural rather than to do with the cycle of recession. It is almost unique to Britain and it is not shared by the US and other countries. That takes us to what we do next and how we manage the situation. I was struck that in the more temperate passages of the speeches from the Government and Conservative Front Benchers, there was an acknowledgement that that is a very tricky balancing act.

It is certainly true that unless action is taken quickly, or at least unless action is seen to be taken quickly, there is a real risk of a sovereign debt crisis, with all the consequences that that brings-higher interest rates and the downgrading of credit worthiness, which is a real issue, not just a hypothetical one. On the other hand, we must balance that against the fact that precipitant action before private consumption and private investment get going risks aggravating and prolonging the recession, which in turn would make the public financing problem even worse. Getting that balance right is incredibly difficult, and nobody should pretend that there is any simple dogma that gives the correct solution.

The Government and Conservative Front Benchers quoted economists on various sides of the argument. The hon. Member for Runnymede and Weybridge cited the Financial Times survey of 80 economists that was taken over the new year period. The result was rather predictable: they were roughly divided 50:50 on what we do about the problem. Some were predictably in the half who argued that we should just get on with the job and start slashing the deficit-it included Professor Patrick Minford and Ruth Lea, and Philip Booth of the Institute of Economic Affairs, who have an ideological dislike of the public sector. However, it is fair to say that that half also included sensible, balanced people, of no obvious ideological inclination, who believe, for perfectly good economic reasons, that we must get on with the job.

The other half, who were equally reputable, interesting and varied, said, "Actually, we have got to be very careful, and it would be rather foolish to embark on big cuts in public spending before 2011." It is worth while going through some of the names in that half: David Blanchflower and Sushil Wadhwani, former members of the Monetary Policy Committee; Julian Le Grand of the London School of Economics; George Magnus of the UBS bank; Sir Samuel Brittan; John Philpott of the Chartered Institute of Personnel and Development; Andrew Hilton of the Centre for the Study of Financial Innovation; and Peter Spencer of the Ernst and Young ITEM Club. I have no idea of the politics of many of those people, but they are all arguing on good economic grounds that it would be dangerous to embark too rapidly on slashing public spending. The argument is therefore finely balanced.

It is worth looking at what Ian McCafferty, the chief economist of the CBI, who is taken very seriously, says. He has probably got the balance about right. He said:

"Whoever wins the next general election, fiscal consolidation is unlikely to start much before 2011. The exact starting point is less important than the credibility of the medium term plan, which requires...a clear direction of travel and sufficient detail on quite how the headline borrowing targets will be achieved."

That summarises what the central issue is and takes us to the Treasury Committee report.

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Liam Byrne (Chief Secretary, HM Treasury; Birmingham, Hodge Hill, Labour): The hon. Gentleman is making an excellent speech, but I think it would be useful at this point in the debate, since we have heard from the Government and official Opposition Front Benches on this subject, to ask him whether in his judgment the reduction in the deficit in the first year of the Government's plan should be faster, or whether the Government have broadly judged it right?

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Vincent Cable: I do not think we should rush into rapid cuts. One of my areas of disagreement with the hon. Member for Runnymede and Weybridge is that I do not think there is a strong case for that. It is a difficult issue and there is a balance to be struck, but rushing into expenditure cuts in 2010-11 would carry a greater risk of precipitating deeper recession. My party takes the view that the Government's eight-year plan, with a four-year halving of the deficit, is a reasonable starting point. My judgment is that we will probably discover that it is not enough, but we have to start somewhere, and it is a reasonable working assumption.

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Stewart Hosie (Chief Whip; Dundee East, Scottish National Party): I agree that precipitate cuts would be foolish and weaken the ability of the economy to recover. What does the hon. Gentleman make of the Government's already announced £800 million cut to the Scottish budget, which will start in the spring of 2010? Those cuts are already under way. Does he think they should be overturned or some other course of action taken?

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Vincent Cable: I do not think that Scotland is fundamentally different from the rest of the UK. We all face the same problem and we are all experiencing the beginning of cuts. For example, I am meeting the Minister for Science and Innovation in a few days' time about the impact of cuts in that sphere. We cannot have an indiscriminate approach to public spending reduction, and my argument is not that the cuts should not happen, in Scotland or anywhere else, but that they have to be much more carefully thought through and targeted. That is the approach that I would adopt.

The Select Committee's report, although expressed guardedly as it represents a cross-party consensus, contains some serious implied criticisms of the pre-Budget report, which take two forms. The first is the acknowledgement that the Government have been nowhere near detailed enough in spelling out how they will approach future cuts in spending. The key conclusion reads:

"However we note that although the Treasury believe the Pre-Budget Report contains sufficient detail about the way in which the structural deficit would be reduced, our expert witnesses all criticised the document for not providing enough information about how this will be achieved."

The Committee does not say that it agrees with the expert witnesses, but that is implied.

The second criticism is of excessive optimism about economic growth in the future. The report states:

"There is, however, considerable scepticism among economists around the Government's growth forecasts for 2011-12."

That is a hedged-around comment, but its drift is clear. The criticisms have been made and need to be taken seriously. I would add the additional, and most serious, criticism that the Government have mobilised to raise taxes-£113.5 billion over four years-but instead of using that money to consolidate the budget, as they will surely have to do as they themselves acknowledge, they have committed it to additional spending. That is surely wrong and has sent all the wrong signals.

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Liam Byrne (Chief Secretary, HM Treasury; Birmingham, Hodge Hill, Labour): The hon. Gentleman will accept that a judgment has been made about the right level of deficit in the next financial year when the economy will still be growing at a rate below trend. In the subsequent year, there will be a sharp fiscal tightening, but that will be at a time when the economy will be growing at above trend. There is an element of judgment involved, and the Government have made a decision about the right level of deficit commensurate with the forecasted level of growth in the economy.

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Vincent Cable: I am sure that that is right: the extent and timing of the fiscal contraction have to reflect the state of the economy. I have suggested five tests that might be used to ensure that, one of which is-obviously-the rate of growth. Another is the growth of unemployment. Another one has to be the state of the borrowing markets.

I hope that the Government are right about the expectations of economic growth. I hope for rapid economic growth because hundreds of thousands of people's jobs hinge on it, but one has to be realistic: an awful lot of factors are holding back growth, and are likely still to be doing so in a year. Private consumers are unlikely to embark on another spending splurge when they are heavily in debt. We have an underlying problem that British consumer debt in relation to the economy is the largest in the developed world, and certainly the largest in our history for a very long period. It would be surprising-and probably unwise, in many cases-were people to rush out and start spending.

Private sector business investment is unlikely to take off rapidly. There is an enormous amount of spare capacity, but as the Chairman of the Treasury Committee just reminded us, there is a severe credit squeeze. That will be even more the case once we enter a period of expansion, because the banks are over-reacting to the crisis and not lending to sound British companies. We will not get any growth from public spending, whether consumption or investment. The entire expectation of economic growth rests on exports, but actually they are a relatively small part of the British economy. It will require a near miracle to achieve the kind of growth for which the Government, and indeed all of us, hope. Frankly, we have to be realistic about that.

I want to comment on two other aspects of the PBR that have not today received the attention they probably should have done. One is the Government's tax on bank bonuses, which was put together in a hurry. Given that it is a fairly short-term tax, I hope that, in the conclusion to the debate, the Chief Secretary or his colleague, having had a month's reflection, can summarise what, in their judgement, has been the impact of the tax. Furthermore, how are they meeting some of the criticisms that have been thrown at the tax, of which there have been several? The first was advanced from the Liberal Democrat Benches. We were very sceptical about the ability of the tax to capture bank bonuses because of the numerous opportunities for potential avoidance, through multiple payments of bonuses, payments in salary and payments in kind, and it would be useful to have an assessment of how far the Government think they have plugged those various potential holes.

Secondly, the Government themselves argued that the main purpose of the tax was to change the behaviour of the banks, to discourage them from paying out bonuses and to encourage them to build up their capital reserves. Are the Government in a position to estimate how much capital reserves will be changed-improved, from the Government's standpoint-as a result of the measure? It was all done in a hurry and we did not get much analysis at the time. Can the Government now tell us what they think?

Thirdly, we are being told by the banks themselves, rightly or wrongly, that they are all now stumping up the money, that they are paying it and that the Government will receive a lot more than £500 million. What is the current estimate of the amount of money that will be raised? Finally, over the holiday period, we heard many rumours and much speculation about banks running off to Switzerland and other places because they object to paying this high tax and other things. I suspect that much of that is rhetoric and an attempt to blackmail the Government.

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Edward Leigh (Gainsborough, Conservative): While we are on the subject of high salaries, does the hon. Gentleman agree that the public sector must set an example? There is understandable public anger about the fact that 50 people who work for Transport for London earn more than the Prime Minister and that 50 people who work for the BBC earn more than the Prime Minister. Would he support any proposal that would limit salaries in the public sector to what the Prime Minister earns?

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Vincent Cable: Indeed, I think I was the first person to advocate that, and I am certainly willing to go along with other people who say the same thing. Our view on the public sector pay freeze that came in was that it should perhaps have been more progressive and there should have been a fixed cash award for everybody, rather than a percentage increase. However, I take the point that the public sector has to show similar discipline.

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Andrew Pelling (Croydon Central, Independent)

When considering the performance of the banks, is it also important to focus on how the additional liquidity provided by the authorities can be used most effectively? There are issues and dangers of a return to the high-risk culture that drove the banks before in terms of performance. I understand that the Department for Business, Innovation and Skills has summoned many senior bankers to discuss that very issue.

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Vincent Cable: Yes, although I think the hon. Gentleman is making several different points. The short-term intervention in the form of the bank tax must not obscure the much bigger issue of how bank bonuses will be regulated in future in such a way that banks do not take excessive risks. That is the important long-term question. However, I would like to ask a final question about the bank tax. In view of what appears to be its rather greater success in raising revenue than some of us predicted, do the Government now intend the tax to be a permanent feature or, as was implied at the time, does it merely cover the period up to the end of March this financial year?

My final point relates to a small detail in the PBR, but none the less an important one in the long term, which is the concept of an infrastructure bank. We must not constantly be sucked into negative thinking about cuts in the short run, overlooking the problem of how we create a more viable and balanced economy in the longer term. Several serious people-not just in the engineering industry, but in the insurance industry-have surfaced in the past few weeks to indicate that this area represents both a big challenge and a big opportunity. The chief executive of Legal and General, for example, has pointed out that he has hundreds of billions of pounds sitting in his institution in annuity funds, much of which is currently going into buying American corporate bonds. He has asked, "Why can't I put this money into British infrastructure?", to build railways, barrages or other forms of useful infrastructure on a commercial basis, albeit with some Government pump-priming.

Although the Government's proposal is modest-there is a suggestion of a co-ordinating body in the Treasury-I wonder whether the Financial Secretary could set out in his conclusion to this debate how they envisage what seems to me a constructive and sensible idea evolving in future years. What scale of operation are we thinking about? What might the Government's role be financially? The insurance companies are not asking for guarantees; they are asking for Government equity in any funding. How can that be done on a sufficiently large scale to make a difference and help to create a more balanced economy?

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William Cash (Stone, Conservative): In the light of the disaster that we have just experienced on the economic front with the banks, just as we did in the 1850s, does the hon. Gentleman not agree that his line of reasoning perhaps leads to the idea of companies similar to the water, gas, electricity and even railway companies of the 19th century, which were supported by debenture stock, so that the elements of loan that he has mentioned are in place, but focused on companies that are not exclusively under Government control?

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Vincent Cable: That is exactly the idea being promoted. The problem that we start from is that it is not now possible to envisage making large-scale investments in British infrastructure. The banks will not do it, because they are de-leveraging, and the stock markets will not do it, because of their short-term perspective in most cases, while private equity companies are worried about over-borrowing. The only mechanisms are likely to be what we now think of as new ideas, but which have a precedent in the 19th century, as the hon. Gentleman said. It would be interesting to see how far that idea can be pursued.

With that, I would like to listen to the remainder of the debate.

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