Item 3 is evidence on the Scottish Government’s spending plans and draft budget for 2011-12. It gives me great pleasure to welcome to the committee some old friends; I was going to say some old faces, but I do not mean that. They are Graeme Blackett, a trustee of Reform Scotland; Peter Wood, a director of Optimal Economics; Sir John Arbuthnott from the Royal Society of Edinburgh; Jo Armstrong from the Centre for Public Policy for Regions; and Professor Brian Ashcroft, policy director of the Fraser of Allander institute.
As an economist, I would not presume to tell the Government what its priorities should be. I am more prepared to comment on whether the budget is moving towards those priorities. There is consensus on the need to promote growth and social justice. The Government has a difficult hand to play, given that it is faced with significant capital expenditure cuts that are front-loaded to the first year of the comprehensive spending review period; as all of us know, capital expenditure is an important ingredient of growth.
I agree with Professor Ashcroft about the decision to protect the health budget, which was made at the UK level in the first instance, was translated to the Scottish budget through the Barnett consequentials and was then adopted in the Scottish budget. However popular the decision may be—I am sure that many people are in favour of it—it does not suggest that the first priority in the budget is promoting economic growth.
There is also the question whether it is possible within the budget arrangements to pursue the objectives that the convener set out. I think that all members of the committee are familiar with Reform Scotland’s work on fiscal powers. The relevance of that to this debate is that the budget-setting process did not take account of what Scotland’s economy or public services might need but focused on historic levels in the Barnett formula. We are looking only at half of the equation.
A big problem with the budget statement is that it is for one year. We will probably talk about that.
I want to focus on the capital side of the budget. It is clear from the budget documents that there is a willingness to try to develop a profit-capping, non-profit-distributing funding model. That is to be applauded because, if we are not careful, we will have a serious potential problem on infrastructure spending, given that the capital cuts are significant and that there is pent-up demand in the project pipeline, which I think that the Scottish Futures Trust said a couple of years ago was in the order of £40 billion. If we do not have a mechanism for turning revenue spend into capital spend, that demand will not be met. The proposed approach represents a good outcome from the budget.
Thank you. I throw open the discussion.
Let us consider the draft budget purely through the prism of economic growth—I realise that other objectives are set out in the budget. What are the panel members’ impressions on the extent to which the kind of decisions that can be made within the current parameters of the budget could meaningfully influence economic growth in the financial year that we are discussing, or lay the foundations for economic growth in future years? Mr Wood has perhaps already answered my question.
It may seem a pedantic point, but it is important to distinguish between stabilisation issues and growth issues. In essence, when we talk about growth, we are talking about trying to build the supply capacity of the economy. Clearly, there needs to be a demand for that capacity, and a small regional economy needs an international dimension to that—it needs to sell goods and services effectively abroad. Fundamentally, the drivers of growth depend on improving supply capacity, and it seems to me that, in the long term, the Parliament has many powers here, largely through the enterprise, energy and tourism budget—through Scottish Development International and Scottish Enterprise spend—which is very important to that objective. There are issues around the need to protect that spending in the long term.
I will build on Professor Ashcroft’s point, with which I agree. We keep being told—quite rightly—that we face a reduction in public spending that is unprecedented in peace time. That is because over the past few years there has been a growth in public spending that has been unprecedented in peace time. There is no doubt that, with our relatively large public sector, Scotland has received some benefit from the growth in the public sector. Plainly, we are not going to have that for a good few years, so the question is what we can do to ensure that the non-governmental sector is capable of expanding to provide employment, incomes and all those other good things.
I will build on Mr Wood’s answer. On the conditions for growth and the type of investment that is required, we must be careful not to focus too much on physical capital investment—which is often the focus—and remember that building up other types of capital, human capital in particular, is also important. Part of that work involves further education, higher education and research.
I am not an economist, so I will just pick up two aspects of what has already been said.
I talked earlier about using capital as a way of developing longer-term economic growth, but I take the point that it is not just about physical infrastructure and capital spend revenue support, which has been mentioned before. I alluded to the idea of prioritisation—looking for the maximum benefits from the minimum input—and that fits with what John Arbuthnott has just said about how we allocate our funding for best use.
Ms Armstrong, do you think that it would have been more helpful if, instead of giving us just a one-year budget, the Cabinet Secretary for Finance and Sustainable Growth had followed it up with indicative spends for departments up to 2015, given that he knows how much money he has?
I think that Scotland knows what money it has. The issue about the one-year budget is a political one and therefore, as an economist, I do not want to get into it. It is what was done in March at UK level. Yes, it would be nice to have a longer-term budget and yes, those who want to plan clearly want certainty in their budget lines—there is no doubt about that—but politics is clearly a part of this budget, too.
Given the economic point that you are making, however, it would obviously be much more helpful to have more than a one-year budget. You have spoken about the council tax freeze, the pay freeze and the way that capital moneys are being allocated. Surely it would be more useful for the country, and for the target of economic growth, if each department knew how much money it would have to spend.
Everybody wants certainty in their budgets. If you could have a budget for three or four years, that would be much more helpful, but I think that lots of people are planning on the basis of an expected continuing downturn. We know in any case that, globally, the budget is reducing.
Before I bring in Mr FitzPatrick on what I presume is the same point, I should make the panel aware that members of the Finance Committee received a letter today from the cabinet secretary saying that this very issue will be discussed at Cabinet this afternoon and he will write again to the committee later this week. Mr FitzPatrick, did you want in on this point?
On the point about certainty, I wonder whether the idea that departments will have certainty is helpful when the Christie commission will take what we are all hoping will be a radical look at public services and how they are delivered. Would saying that health will have the certainty of this budget and that police force A will have the certainty of that budget not be a false premise, given that we are about to look radically at the make-up of public services?
Could I respond to that?
I think that Sir John beat you to it, Professor.
I will respond to that point briefly—removing the political dimension of the discussion that we are having. Since the end of 2008 it has been clear to everyone that there will be a major financial challenge. For various reasons, which are partly political, both in the UK generally and in Scotland, things have unfolded less quickly than I expected.
Thank you, Sir John. I am keen to move on because those were additional points to an earlier question.
I am interested in the general views that have been put forward on the economy. I suppose that the reason why the economy does not have greater prominence in the budget is, first—to state the obvious—the opportunity cost of that. Secondly, as we all know, the fruits of economic growth do not come towards our budget, except very weakly. As the Scotland Bill is published today, I would welcome any thoughts on that. If you do not want to comment on that, that is fair enough.
I will answer your second question by going back to your first question about the powers, because I think that that is important. No one will be surprised that this is a Reform Scotland view. In our view, the reason why public sector reform did not start earlier—and therefore why the benefits are not kicking in now—is that the incentive was not really there for Governments of any hue to pursue such reform—to do so did not benefit the budget.
On the first part of the question, we have had a comprehensive spending review from the UK Government, which sets the framework for three to four years ahead, to 2014-15. We have a spending envelope for Scotland, which gives us a broad sense of where the resource DEL and the capital DEL are going. That is slightly different from what happened in March at UK level, when the UK Government postponed the CSR. I think that we would all have welcomed an earlier CSR. Maybe that was political, too. However, there is a sense that, although we have the broad picture—the broad spending envelope—and we know where it is going over the next three or four years, we are stopping at the end of the first year.
Mr Wood, is there anything specific that you would like to say in response to Mr Chisholm’s question?
I will try to respond to the question from Mr Chisholm that has not been answered, which was whether we could have shifted the balance of the budget to protect recovery. The scope is not huge, but if it was an absolute must, I would suggest finding ways to transfer resources to protect capital spending, notably in social housing. The housing sector is facing a serious situation in the declining output across the public and private sectors, so that is an issue on which more could have been done.
I challenge the view that the current powers do not feed through and that we do not get benefit from economic growth. If we are looking to replace public sector jobs with private sector ones, we have mechanisms for getting at least some of the benefits of economic growth. We might not get the benefits through tax revenues, but we would certainly get them through jobs growth. I would like to think that the Christie commission will have sufficient time and resources to do a thorough review of what is possible, but I have my doubts. I accept that waiting until the commission opines would be of benefit at the fine level but, unless it gets its skates on and has an awful lot of resource to do it and a wide remit on which to deliver, one has to ask why we should wait until June.
I have a quick answer for Mr Chisholm. Three things strike me, although again not from an economist’s viewpoint. I do not know to what extent this has been done, but, if I were the minister, I would certainly look again at the budget to see whether things such as the spend on housing, roads and waste management and disposal, which are extremely important social measures that also impinge on economic development, are supported to the extent that they might be.
I welcome the remarks about social housing. I said in a recent budget debate that that should be the number 1 priority for our capital expenditure, although I said that because of social as well as economic objectives. I am aware of an argument among economists about housing expenditure versus transport expenditure and, obviously, there are all the issues that Professor Ashcroft mentioned about the enterprise networks and so on. I was trying to make some sense of that, but it might be that there is no agreement, although I was reassured that at least two of you mentioned housing. If Professor Ashcroft wants to come back on that issue from a purely economic point of view, I would be interested in his comments.
As Peter Wood says, the issue in part begins from the ring fencing of the health service budget. That is one third of the budget and, if it has an impact on growth, that is largely in the long term, although one would not necessarily want to make that link. Although one can see strong arguments for protecting health, that is normally thinking about particular critical health services such as cancer or heart care—Mr Chisholm will know them better than I do. However, as the figures show, protecting the whole health budget significantly affects the rest of the budget spend, given the cuts that we face. It is difficult to make suggestions at the margin when there is that fundamental elephant in the room.
I hesitate to ask economists whether they agree with other economists, but the Ernst & Young Scottish ITEM—independent Treasury economic model—club has predicted growth of 1.1 per cent this year and 2.2 per cent in 2011. Does anybody agree with that, or do you disagree?
As they are our competitors, I happily say that the ITEM club appears to agree with us. This year we are forecasting growth of 1.1 per cent, which is an increase on our June forecast of 0.7 per cent. Growth will be 1.1 per cent next year, but that is still quite a bit adrift of the revised OBR forecast of 1.8 per cent growth next year.
I bow to the modelling experts; I do not have a view.
I do not have a model in my pocket, as the saying goes, but I am sure that Brian Ashcroft will agree that studies that have been done on the reliability of forecasting have not always been flattering. It is quite a difficult activity. The big picture appears to be clear enough, and whether it is one percentage point one way or the other, we have not a double dip, but a recovery, albeit a bit anaemic. We would really like to see growth going north of 2 per cent before we can believe that we are getting anywhere. The figures are probably as good as can be estimated and they point to a slow and not very enjoyable recovery.
We are expecting a large number of job losses in the public sector in Scotland. How convinced are you that those jobs will be replaced by jobs in the private sector up here?
I was asked that question yesterday at the board meeting of that august body, the Dumfries and Galloway housing partnership. At the UK level, there will be private sector growth and employment in the private sector will go up quite strongly. I am, however, concerned about those parts of the country, especially those parts of Scotland, that are heavily dependent on public sector employment. Will we see private sector growth there? I do not have a firm numerical answer to that but I am concerned, not so much about the totality because there will be private sector growth in the wider economy, that some communities will suffer and will not benefit very quickly from renewed private sector growth.
I want to pick up on Sir John Arbuthnott’s point about the link between the public sector and the private sector. Some of what we have been talking about depends on how the budget is implemented. If agencies and local authorities decide to prioritise the areas in which they directly employ people and deliver services at the expense of areas that might be contracted out to the private or voluntary sector, there will be less growth than there would be if those agencies and local authorities were willing to look at the options that could help to drive growth.
You may not know that, using one of our quite sophisticated models of the Scottish economy, we have done a special exercise on the impact of the DEL cut on the Scottish economy. The worst-case scenario is that the private sector will lose about 43,000 jobs as a direct consequence of the public sector’s breaking of contractual linkages and cutting back spending with the private sector. If wages and prices were fully flexible we could get a crowding-in effect and some job gains in the private sector. That seems less likely, but it is certainly possible. We are forecasting that growth in the economy will be just sufficient to absorb job losses—so there is still positive growth.
I am wondering how the switch in employment will occur. In the communities that have been mentioned, there is quite a thriving private sector because there is a thriving public sector. If the public sector diminishes, will a new private sector come in, or will we have, as Graeme Blackett suggested, an expansion of the private sector, doing what was previously done by the public sector, using quite talented people? I am uncertain how the switch of employment will happen. Perhaps Brian Ashcroft can tell us a bit more about what kind of new developments there may be. Are we talking about new aspects that are created through private sector employment rather than about redeployment?
We are talking about the performance of the macroeconomy, which absorbs micro changes that go in all sorts of directions. We are not saying that there will necessarily be a switch of public sector workers into private sector jobs; areas that depend heavily on the public sector are likely to be significantly disadvantaged. All forecasters hope that the growth that will occur over the next few years will be largely driven by exports and investment. Most exports will come from our key manufacturing sectors, which do not require the same skills as jobs in the public sector. Some people will switch, as they did when the car industry declined, and move into other types of activity in the east of Scotland. The aggregate picture suggests that resources will be absorbed—resources can be drawn from any activity that is relatively high and from migration—but that does not mean that the people in the public sector who lose their jobs will necessarily be re-employed. Obviously, that is to be regretted. There may well be pockets where particular social action is required to address the hardship caused by job losses.
Good afternoon. I am struggling to match what the whole panel has been saying this afternoon with the key messages in the budget document. Under the heading “key messages”, it states:
Will I have to pick someone, or will someone volunteer to answer that question?
It is obviously a very difficult question.
Just for the record, there has been a very long pause between my asking the question and the response.
You have that effect on people, Mr Purvis.
I am prepared to answer the question; I have form on the topic. Some years ago I wrote a report for the committee in which I said that no Scottish Government since 1997 has really prioritised economic growth. That remains my opinion. I think that the pressure has been to improve the quality and delivery of public services, which some people think is a very good thing. That is a fact of life.
We flagged up in our report this year and last that the areas that are typically related to the generation of economic growth have been cut: higher and further education, water, housing and the enterprise agencies. Those budgets have been cut again this year, so it is difficult to see the link between the headline of sustainable economic growth and the current budget allocations. Universal services, a number of which effectively benefit the better off, rather than allocating spending to priority areas is also an odd one. If I jump off the fence I agree that it is difficult to see a direct link. Maintaining spending within a fragile economy might be the argument for the current allocation.
Can I make the—
Before Professor Ashcroft comes in, Derek Brownlee has a question.
It is perhaps an unfair question, so I apologise in advance.
Oh dear; I knew I should not let you come in.
If, for whatever reason, £50 million or £100 million became available and the Government decided to use it to bolster the economy, would it be more effective to give it to the enterprise agencies or to do something else with it?
My instinctive response is that, as a review of the enterprise agencies is taking place, if you want to spend some money quickly to make a difference quickly you should probably put it into housing.
I will not bring Mr Blackett in because Derek Brownlee’s question was specific to what Ms Armstrong said, but no doubt you will catch up and get to say what you wanted to say anyway.
On the appropriateness of the budget for growth, the first point to underline again is that the Government is faced with a 38 per cent cut in its capital budget, which is significant. It seems to me that, against that background, ring fencing a large area of current services that are unrelated to economic growth makes it even more difficult to protect the growth objective. The decision might protect the stabilisation objective, because the health service is a significant employer, so that might ring fence some demand in the economy in the next year, but in terms of growth it will not help the economy.
I invite Mr Blackett to address Jeremy Purvis’s question and, no doubt, Mr Brownlee’s interjection.
They are probably linked. You will not be surprised if I return to the topic of fiscal powers. It is one thing to look at what you spend money on, but deciding how big the Scottish budget should be is a fundamental issue. At the moment, no one has decided that. The Scottish Government has not done it because the money comes from Westminster, and the UK Government has not done it because the Scottish budget is determined by formula. Until you decide how big the Scottish budget should be, you cannot say that the budget is focused on economic growth.
I have read Reform Scotland’s proposals closely. I have sympathy with some of them, but many of them worry me considerably. You have probably seen the latest revenue figures from the Treasury. If Reform Scotland’s proposals were put in place straight away, as it would like, public spending in Scotland would be reduced by £1.25 billion. When you say that we should address who decides the size of the budget, are you arguing that the size of the Scottish budget should be reduced? Are you saying that that should be the political position because it meets your philosophical aims?
No.
Is it just an accident that the budget would be reduced by £1.25 billion?
I do not want us to get into that subject, which is a different debate. However, Mr Blackett may address the specific issue that Jeremy Purvis has raised.
The current financial situation does not really impact on the debate on fiscal powers, which involves deciding either to continue under the current system or to have fiscal powers and to take on debt rather than cut funding. The decision does not really change.
Mr Purvis asked whether the budget will fulfil its general purpose. If we must grow certain things and develop our capabilities in the way that Professor Ashcroft has described in order to get growth, we need to be clear about where we are going on further and higher education and on private sector investment in R and D. Those two issues are not clear on a recurrent basis. We have a talented group of young people and we have good institutions, but for some reason we have not translated that capability—with the private sector potential—into the growth in exports that we should have. I would ask for the emphasis to be placed on that.
I have another general question. Have you read anything in the budget that is a considerable departure from the decisions that were made on spending priorities in the UK comprehensive spending review?
I think that the sigh from Professor Ashcroft is an indication of his wanting to answer immediately.
I do have something to say. One of my concerns about the budget relates to the specification of efficiency savings. A general issue in the budget links to transparency about yields from actions that are taken, which seems to be a problem that runs through the document. That is common, but it does not occur in the red book, for example, which gives a bit more indication of the yield of a tax change at the UK level. That issue is important.
You think that the strongest difference between the Scottish budget and the comprehensive spending review is in the definition of efficiency savings.
No—I did not say that that was the strongest difference. I talked about what jumps out as quite significant.
My question was broad. The CPPR and the Fraser of Allander institute have produced tables on the priorities and on what they define as the winners and losers. Is it true that it is striking that those tables are broadly consistent with the percentages and the winners and losers as a result of the UK comprehensive spending review for UK Government departments, when defence and other reserved matters are stripped out?
We can look at the big picture rather than get down to the difficult detail. Scotland’s headline cut in DEL resource was less than the overall cut in resource at the UK level because of the share of NHS spending in our resource. Correspondingly, our cut in capital was higher than the UK average cut because of the weight of what is in effect social housing in our budget. It seems to me that, in essence, we have mimicked that: we have protected health and cut social spending, which are the two big drivers in the Barnett consequentials. If the Scottish Government had responded by saying, “Do you know what, we’ve got a bit more money than we might have expected because of the size of the health budget,” and decided not to keep that for health but spend it on something else, that would have been going in a different direction, but it did not. I am not saying that it is easy to make those choices, but the change that we have seen in the Scottish budget has largely been driven by the change in the UK-level budget. It is a version of the UK budget. Obviously, there are detailed differences and I am sure that one could find them somewhere, but those are the big swings.
One might argue that the Barnett formula worked in Scotland’s favour this time but we chose to mimic what went on down south. In the past, the rhetoric has been that we did not need to mimic what went on down south, but we have done that in the main.
I will come back on Mr Purvis’s point. It is important because, if we take the efficiency savings at face value—3 per cent of the budget—and add the pay freeze, those two measures provide the amount that we need to save this year, which is £1.2 billion. It is clear that that cannot be the case, but that is what one could deduce from the way in which the material is presented.
I have a question for Ms Armstrong, seeing as she raised her favourite topic of Scottish Water. What will be the impact of the unique way that the company has been asked to make a contribution, given that it is a big spender of the capital budget in Scotland?
My understanding is that it has reserves. Part of the settlement was that it would be allowed to build up reserves to cover cost overruns or shocks to the system that were not funded by user charges.
It would certainly be a shock to the system to be told that it was not getting any money next year.
I suspect that its reserves are being depleted to, if not nil, close to it. The budget document clearly states that the funding will still be available. I think that it is £700 million over the five-year spending review period with an equivalent remaining over the three-year period, so the capital requirement is being knocked into the last three years of the spending review. As far as I can understand, that is the basis of the settlement. Scottish Water will require that funding, so it will not go away.
Jeremy Purvis has a final, small question specifically for Professor Ashcroft.
It is on efficiency savings. From what Professor Ashcroft said, it sounds to me as if the Government has used a different mechanism on the efficiency outturns, because it has used the 2 per cent target and, I think, the 2007-08 DEL resource baseline without stripping out the elements that he mentioned. If that is right, is the Government now using a different definition?
To be fair to the Government, that is in the IBR report.
But what about the efficiency outturn figures that we have had year on year?
Well, the IBR report says that a
The Government could be using the same basis as the IBR, but it could be using a basis that differs from what it has said for the past three years.
I am suggesting that the Government cannot be using the total as the basis; the basis is resource minus pay minus capital, which is a much lesser objective than I first understood—I took the total to be the basis. It may be common practice to do that, but I suggest that that removes any need for efficiency savings in the labour input—because jobs would be lost—or in the capital input. I assume that that is in part because there is a pay freeze, which is seen as the labour element of the contribution. By “efficiency savings” one generally means seeking to minimise the inputs for a given output or maximise the outputs for a given input. What we have is quite different from my understanding of efficiency savings.
The elephant in the room today is the local government budget. We have been round most of the other lines. Have any of you done any work on this budget line? How will it work out, given the concordat commitments on police numbers and education, for example? Does it all add up or are there problems in that budget line? I suspect that a lot of the political controversies may come around that.
In his statement to the committee in your previous session, the cabinet secretary was clear that we have to do something to improve the interface between support at home and social support in the delivery of medical services to older vulnerable people. He said that the change fund is partly for that purpose. I am a little bit nervous about that. Public sector budgets are being squeezed significantly. I think that the headline figure for the percentage real cash cut in the local government budget line is shown in one of the tables as 7.4 per cent. That is a significant figure. In that situation, the tendency when money comes along is to use it to do things that you were always doing. I am concerned about that.
As the committee may know, I am the Local Government and Communities Committee budget adviser. I do not know the appropriate protocol that applies in that regard.
That paper will be useful. Thank you for drawing our attention to it.
I had the pleasure of being the Finance Committee’s first budget adviser, when the budget process started 10 years ago. It is a pleasure to give evidence to the committee this time round. It is good to see how the budget procedures have improved and I am pleased to see how good your current budget adviser is. He is far better at advising the committee than I ever was, and his paper is excellent.
I echo that point. A lot of information has been provided but it is still difficult to follow the pound. Greater reconciliation would be helpful. If people are being asked to understand what is being done, what has been done ought at least to be made transparent.
I will not return to my theme of fiscal powers.
Why not? I rather liked it.
The committee knows my view on that.
I echo the point Professor Ashcroft made about information. I am adviser to the Economy, Energy and Tourism Committee. We have still not seen level 4 figures. I cannot understand why more detailed information cannot be provided earlier in the process. I will leave it at that.
I will cheat a little bit and go back to the session before.
You can do anything you like as far as I am concerned, Sir John.
The reason for doing that is to pick up on the strong emphasis that the cabinet secretary put on preventative spending and the discussion in which it was indicated that the issues are really rather short term. In my original submission to the committee some months ago, I said that I hoped that the Finance Committee could take a long-term view that is not always derailed by our electoral cycle. It is well placed to do that.
I thank everyone for attending the meeting, which has been useful for the committee.
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Preventative Spending Inquiry