Thank you very much indeed, convener, and good morning everybody. It is a great pleasure to be back and thank you very much for asking me.
I will open with a few remarks on how the forecasts that we produced at the time of the budget have moved since previous forecasts, both in terms of the economy and the public finances. Perhaps I should say something after that about what the forecast for the public finances over the next five years is implying for the change in the shape and structure of the state, relative to the pre-crisis period, in order that you get a sense of what the aggregate movement has been over the crisis period and the consolidation period on which we have embarked.
I will start on the economy. On the forecast that we produced in December 2013, by the time that we got to the budget it was clear that there was a bit more momentum in economic growth coming into 2014 than we had anticipated. The growth number for the first quarter of 2014 was actually the same as what we predicted back in December, but there had been upward revisions to previous gross domestic product data for 2013 that suggested that there had been more of a pick-up in the economy in 2013, following a period of relative stagnation in 2012 and earlier. We therefore elevated our growth forecast for this year up slightly to 2.7 per cent growth over the previous year. That was in line with the average of outside forecasts at the time that we made it, although the outside average has now nudged up another 0.1 per cent in the wake of subsequent data.
I guess that the main reason for the economy growing a bit more quickly than we had anticipated a few months previously is that consumer spending performed slightly more strongly. Notably, that seems to have been the result of people drawing down savings more quickly than we had anticipated, rather than the long-awaited pick-up in real income growth, which is important for the long-term sustainability of the recovery. Our forecast thus assumes that there will be a slight slowing in the quarter on quarter pace of growth throughout this year as consumer spending moves back into line with the underlying growth in incomes, rather than assuming a continued rapid fall in the proportion of people’s incomes that is being saved, which we would not expect to see continuing at the sort of rate that it was over 2013. We will therefore have a slightly slower growth rate in 2015 than in 2014, because of the way in which the arithmetic works. That is not a forecast that we are expecting the economy to run into choppy waters in 2015; it is about the fact of the slight slowing during the course of this year that we anticipate as consumer spending moves back more into Iine with income growth.
Looking out over the five-year horizon, we expect the economy to grow by about 2.5 per cent a year over that period. Needless to say, consumer spending is as always an important driver of that because it is the larger share of spending in the economy by some margin.
We have a pick-up in business investment. The numbers there have been revised up, showing stronger growth in business investment through 2013 than we had anticipated at the time of the previous forecast. What we do not have is any additional contribution to growth over the next five years from net exports, so we are not relying on additional improvement in net trade performance in order to deliver the growth pattern over the five years; it is much more down to consumer spending and the pick-up in business investment.
Government spending cuts act as a drag over the five-year period. We are actually surprised that they have not acted as more of a drag already, partly because of how public sector output is measured, but we are expecting that to be more the case as we move forward.
As I said, these forecasts are not a million miles away from the outside average. The Bank of England is slightly more optimistic about the pace of growth over the course of the year and is expecting 3 per cent plus, partly because, in addition to forecasting what is going to happen in the future, the bank also forecasts how the Office for National Statistics will revise past history. That is not something that we try to do. The main reasons for the bank’s optimism are that it expects a swifter pick-up in business investment than we do and slightly more consumer spending activity.
We think that there is a little bit less spare capacity in the economy than we thought back in December. That seems to fit with the fact that unemployment fell rather more rapidly in the early part of the year than we had expected, which suggests that some spare capacity was used up. As ever, however, there is enormous uncertainty over any estimate of spare capacity in the economy at any given time.
With regard to public finances, as the official data on borrowing will have been published and made available only five minutes ago, I do not know the outturn data for the latest set of numbers. However, the forecasts that we have produced suggest a picture pretty similar to the one we produced at the end of last year. Borrowing is slightly lower than we had expected, partly because of a strong showing from stamp duty as a result of activity in the housing market and partly because of lower inflation than we had expected, which reduces the cost of servicing index-linked gilts. We are also expecting the budget deficit to continue to shrink year in, year out over the next five years, primarily because of the on-going cuts in public expenditure as a share of GDP.
I think that it is worth going back to the pre-crisis period and contrasting where our forecasts now imply where, on current policy, the Government will be at the end of our five-year forecast in 2018-19 and where we were prior to the financial crisis, say, in 2007-08. We expect that by 2018-19 the overall budget will be back in balance for roughly the first time in 18 years. At that stage, taxation and spending would be at about 38 per cent of national income, which is not a million miles away from where they were the last time we had a near-budget balance, which was back in the early 2000s and early on in Labour’s term in office in the United Kingdom.
With regard to how we get to that balance, I think that there are some striking comparisons to be made with where we were in 2007-08 prior to the financial crisis. First, back in 2007-08, we were running a budget deficit. In the run-up to the financial crisis, the budget deficit would have been about 2 to 3 per cent a year over the period; the forecasts imply that the Government wants to get rid of that deficit, which means that it has to find 2 to 3 per cent of GDP from somewhere.
At the same time, we know that in 2018-19 we are going to have to spend a bit more on debt interest than we spent back in 2007-08 because of the amount of borrowing that has been going on in the meantime. We would also expect the welfare bill and social security spending as a share of GDP to be slightly higher in 2018-19 than it was in 2007-08, partly because retail price inflation has been relatively high over the period, which means that the generosity of many social security payments has risen relative to the living standards of people in work and the size of the economy. We are going to have to find a bit more money for that.
Given that the Government is not planning to raise a great deal more tax revenue than it was back in 2007-08, how will it get all of this to add up? The answer is a continued squeeze on public expenditure, which is where the bulk of the continued work on fiscal consolidation will happen over the next few years. Capital spending will be a bit lower in 2018-19 than in 2007-08, but the Government has indicated that it does not want to squeeze it that much further. The real squeeze, therefore, will come on the day-to-day non-investment running costs of public services. It is hard to make a long historical comparison here, but as a share of national income I think that that is heading to levels that we have not seen since at least 1948. If you are trying to close a budget deficit, spend a bit more on welfare and debt interest and not raise very much more in tax, you will need to squeeze the day-to-day running costs of public services to make everything add up.
I hope that those introductory remarks are of some use, convener.