Economic surveys and country surveillance

Launch of the OECD’s Economic Survey of the United Kingdom

 

Remarks by Angel Gurría, OECD Secretary-General

 

16 March 2011, London, United Kingdom

Ladies and gentlemen,
It is a pleasure to be here in London to share the OECD’s latest assessment on the UK. This is in fact the first time that we launch the UK Economic Survey in the United Kingdom.

These are challenging times, especially for the United Kingdom. The economy came into the global recession off-balance, and was therefore more severely hit than other major OECD economies. The recovery remains subdued and is likely to stay so for a while as the economy regains balance. But the UK economy has many fundamental strengths and the pursuit of fiscal, financial and structural reforms is key to harness these strengths and to secure sustainable long-term growth, welfare and prosperity. The question is how?

In today’s “report card” on the UK economy we recommend the fiscal consolidation program, while essential, could be fine tuned; call for further financial sector reforms; and for measures to enhance the supply side performance and sustainability of the economy, notably by improving the functioning of housing markets; educational reforms targeting disadvantaged children and effective climate change policy measures that are consistent with a growth strategy.

I shall now elaborate on each of these points.


The consolidation programme is essential, but could be fine-tuned

In 2009, the United Kingdom’s fiscal deficit was 11 per cent of GDP, among the highest in the OECD area. The fiscal position was clearly unsustainable. The consolidation measures and plans that the Chancellor and his colleagues have put in place were therefore vital.

In the short run, fiscal consolidation is generating headwinds for the recovery. However, inaction would have been worse. Policy makers could then have been at the mercy of financial markets. Early and resolute action ensures that debt will stop growing and help contain upward pressure on interest rates. A fair sharing of the social costs of the crisis within the current generation is also crucial; protecting the weakest should be a priority.  

The composition of fiscal consolidation could be adjusted to enhance growth and efficiency. To do this, our report identifies several concrete measures. Public investment could be cut less severely to support growth. Structural reforms could make the health care system leaner and provide better services at lower costs. Limiting the use of reduced rates and exemptions in the VAT system would increase tax-efficiency and costs of CO2-emissions. Accompanying such a VAT-harmonization by measures targeted at poorer households would protect their incomes.  

Solid fiscal frameworks and institutions are also conducive to a stability oriented fiscal policy. The creation of the independent Office for Budget Responsibility and the Government’s fiscal mandate (until 2015/16) are welcome initiatives. In due time, the fiscal mandate should be supplemented by a stringent and permanent fiscal framework.

A combination of domestic and international developments has driven inflation above 4 per cent. This is twice as high as the Bank of England’s target. The Bank is therefore torn between a more subdued recovery and the danger of higher inflation. As high inflation mainly reflects an unfortunate combination of one-off factors (tax hikes and commodity price spikes), interest rates should be kept low. However, further increases in inflation expectations and wage increases may nevertheless force the Bank to raise rates earlier. 


Financial sector reforms need to be implemented in a coordinated way

The recent financial crisis and the following recession has made it clear to all of us that wide ranging reforms of the financial sector are needed. Significant progress has been made globally, within the G20 process, within the European Union and within the United Kingdom. Well coordinated implementation of agreed reforms will be important to avoid regulatory arbitrage and to ensure they succeed in building not just a better UK financial system, but a better functioning global financial system.

Financial institutions and markets need to be more resilient in the face of capital losses. Increasing capital requirements in Basel III is therefore useful. Risk-based weights may be vulnerable to capital arbitrage however. A leverage ratio covering all relevant assets, including off-balance sheet exposures, should therefore also be used.

The financial crisis put strains on public finances as banks and building societies became reliant on public support. This reliance on taxpayer support needs to end. The problem that some banks are “too big to fail” should be dealt with. Instruments for doing this include taxes, capital requirements and limiting the size of financial institutions.


Improving the productive performance of the UK economy

I now turn to the issue of how to improve the productive performance of the UK economy. The crisis has left its scars here in terms of lower potential output. Specific measures that improve the functioning of housing markets and education reforms could help strengthen potential growth. Our report explains how.
House prices affect us all, whether as home owners, renters or prospective buyers. Despite recent falls during the recession, prices are high and affordability is low. Low affordability makes it difficult to enter the housing market. This makes it difficult for younger people to find their own accommodation and leads to lower labour mobility. It also puts strains on social housing.

High house prices mainly reflect too low housing supply, especially in the South East. An incentive to local communities to allow development, like the recently announced “New Homes Bonus”, is one significant step towards higher supply. More is needed, however. “Green Belt” planning restrictions should be reformed to free more land for construction, while continuing to protect the environment. Providing sufficient funding for local and regional infrastructure is also key for convincing locals to accept development.

If housing supply becomes more flexible, housing demand needs to be kept in check. If not, volatile demand may manifest itself in a large stock of unsellable properties. This is what we’ve seen in the United States, Spain and Ireland. Taxation of housing should therefore be reformed to better reflect the value of property. This would support efficiency and curb price swings.


Educational reforms need to target disadvantaged children

Providing high quality education to all children creates a strong foundation for economic growth. It also supports equality and social mobility. Educational spending has increased rapidly in England.  Improvements in education have been elusive, however, at least when looking at international indicators, such as the OECD’s PISA. Children from disadvantaged backgrounds underperform more in the United Kingdom than in most OECD countries. Resources in pre-schooling and schooling should therefore be more focused on disadvantaged children and families.

The expanded “academies” programme and the setting up of “Free Schools” increase choice for parents. As many of these new schools will cater to better-off families, further reforms are needed so that all children can benefit. One way would be to give other schools similar freedoms.

The OECD has for a long time said that the quality of vocational training in the United Kingdom is too low. This was echoed two weeks ago in the Wolf Report (Review of Vocational Education). If you want teenagers to attend training you’d better make sure that they deliver benefits to the individuals and to potential employers.

The fiscal consolidation effort has necessitated painful increases in university tuition fees. Graduates (on average) gain a lot from a degree and pay a fraction of the costs. Costs for taxpayers still remain large, and there is no fiscal room to expand higher education even though demand and social returns are high. The increase in tuition fees could provide extra resources to universities and some of these resources should be used to expand the number of study places to allow more young people to attain higher education.


Ambitious climate change policies are consistent with a growth strategy

The United Kingdom is serious about climate change policies. Ambitious long term targets are in place and additional resources are put forward, despite the fiscal challenge. The UK is a role model for other countries to follow suit.

A cornerstone of climate change policies in the United Kingdom is the European Union emissions trading system. The United Kingdom’s long term emission targets are however more ambitious than current quotas. As a forerunner in climate change policies, the United Kingdom needs to work with its European partners to tighten the trading system further.

There is an impressive array of domestic climate change policies. In fact, there are so many of them that their number needs to be slimmed down. Fewer and better coordinated instruments would be more efficient, less costly and fairer.

Finally, whatever climate policies governments across the globe agree on, some climate change is bound to happen. Whether it is harsher winters (as you’ve recently experienced), heavier rains, warmer summers or stronger storms remains unclear. Still, climate change adaptation needs to start now. Planning should go forward and immediate action should be taken on well-understood risks.

Ladies and gentlemen. I started this speech by talking about the challenges that the United Kingdom faces. The challenges are certainly significant. But challenges also mean opportunities. Opportunities to do things in a different and better way. Working together with our member countries to achieve better policies for better lives is, after all, the OECD’s job. I hope that this Survey will serve that purpose too.

 

 

 

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