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Growth forecasts for 2011 revised down

Last week the newly formed Office for Budget Responsibility (OBR) provided economic and public finance forecasts for the UK economy prior to today’s policy announcements. Today it has provided revisions in light of the emergency Budget measures. According to the OBR, economic growth (GDP) for 2010 has been revised down by 0.1 percentage points (pp) to 1.2% relative to last week’s pre‐emergency Budget forecasts. The OBR now expects growth to accelerate at a weaker pace next year, down from 2.6% last week to 2.3%. By way of reference, this is now almost a full percentage point below the previous government’s forecast of 3.25% in the March 2010 Budget.

Growth is set to rise to 2.8% in 2012, in line with last week’s forecasts, which compares to 3.5% back in the March Budget. This will be followed by 2.9% in 2013 and 2.7% in 2014. These forecasts for the latter two years are 0.1 percentage points higher than last week’s initial OBR forecasts. Overall, the impact of today’s measures will have a marginal negative impact on the growth profile over the period 2010‐2014. The latest forecasts provide a cumulative downward revision of 0.2pp over this four year period relative to the pre‐emergency Budget position.

NI to lag the UK in the recovery

In our view, the NI economy is going to lag significantly behind the UK in the economic recovery. The negative overspill from the RoI, the hangover from the property downturn and the impact of the forthcoming public expenditure cuts are the primary factors behind this. We anticipate growth of less than 1% in 2010 followed by 1.5% in 2011. The risks to next year’s forecast lie to the downside. Looking beyond this near‐term horizon, NI will struggle to get out of first gear in the economic recovery.

Deficit reduction now well underway

Today’s Budget highlighted that the most urgent task facing the UK is to implement an accelerated plan to reduce the deficit. Public Sector Net Borrowing, which can be viewed as the annual fiscal deficit, is set to fall from £155bn in 2009/10 (11% of GDP) to £149bn (10.1% of GDP). The OBR forecasts then project a sharp fall to £37bn (2.1% of GDP) by 2014/15 and dropping further to £20bn by 2015/16 (1.1% of GDP). Thus the UK’s annual fiscal deficit is set to fall by 2 percentage points below the EU Stability and Growth Pact threshold of 3% of GDP by 2015/16. Meanwhile, the UK’s structural deficit, which is the non‐cyclical deficit, will be eliminated by 2014/15 with a surplus of 0.8% of GDP projected in 2015/16. Public Sector Net Debt, the total stock of national debt, will peak at 70.3% of GDP in 2013/14, before falling to 67.4% in 2015/16.

Public expenditure bears the brunt of correction

As expected, public expenditure cuts will bear the brunt of the fiscal correction. Some 77% of the reduction in the fiscal deficit is a result of planned expenditure cuts. Meanwhile, tax increases account for the remaining 23%.

Public sector pay & pensions

All public sector workers earning over £21,000 will receive a two year public sector pay freeze. Those 1.7 million public sector workers earning below this level will receive a flat increase of £250 per year for these two years. This pay freeze will save the UK exchequer £3.3bn by 2014/15. The decision to freeze public sector pay for two years, from next April, for those individuals earning more than £21,000 will affect a significant proportion of NI’s 220,000 public sector workers. In reality this amounts to a pay cut in real terms with inflation, using the retail prices index (RPI), expected to top 4% in 2011. The public sector is expected to receive further bad news on the pension front in the autumn. A review into public sector pensions is already underway and it is anticipated that employees will have to increase their contributions through a pension levy. Again such a move would in effect represent a pay cut. Declining public sector incomes will have a knock effect not consumer sensitive sectors of the economy such as retail.

Is public sector pay at the right level?

In NI, the median public sector wage in NI, for full‐ time employees was £27,800. This is almost 40% higher than the median in the private sector (£19,900) and represents the highest public‐private wage differential of all the UK regions. It should be noted that the headline wage gap exaggerates the true difference in pay levels as exact like‐for‐like comparisons of occupations are not included in this analysis. Nevertheless, even if these are taken it account it is estimated that a substantial difference remains. Given that public sector pay accounts for around half of the NI executive’s budget it is vital from both a public expenditure perspective and an economic development viewpoint that public sector wages are set at a level that is appropriate for the local economy.

Need to focus on what ‘low pay’ actually is

It is important that those individuals genuinely on low public sector pay are supported. However, it is vital that the Executive actually establishes what low pay is. It has become increasingly evident that the ‘low pay’ that some of the lowest grade workers in the public sector are receiving is arguably quite generous relative to the private sector average. For example, according to the latest pay scales for Administrative Officers, employees can expect to earn over £22,000 per year alongside 30 days annual leave entitlement (excluding statutory holidays) and a pension. This compares with a private sector average of just under £20,000. According to the NICS recruitment brochure no qualifications are required for these positions and the post‐holders are involved in the most basic of administrative functions which require minimal responsibilities.

Need to define and identify ‘frontline services’

The Stormont Executive needs to define and identify what frontline priority services actually are and what the public expenditure implications associated with these versus non‐frontline. Whilst the media attention often focuses on the need to protect frontline priority services such as nurses, teachers and policemen it is important to remember that there are tens of thousands of public sector jobs that are not frontline priority services.

25,000 public sector jobs created since GFA in 1998

Since the Good Friday Agreement (GFA) was signed in April 1998 there have been almost 25,000 jobs created in NI’s public sector. This represents an increase of 12.8%. As a starting point, the Executive could look at what proportion of this surge in public sector employment was in frontline priority services and what was in non‐frontline administrative functions. Clearly, the growth of the latter is unsustainable and this area should undergo more rigorous efficiency savings. It should also be remembered that not all Departments, such as Health or Education, can be classed as frontline priority services. They too will contain significant elements of non‐frontline administrative functions.

Back Office Pay versus Frontline Pay

The debate in recent months has focussed on the need to protect frontline public sector services. On close inspection, however, it is clear that there is not a meaningful pay premium between certain frontline public sector services and back office functions. For example, the starting salaries for teachers, social workers and staff nurses, all of whom require qualifications is on a par with established Administrative Officer Grades in the NICS (i.e. around the £22k p.a. mark). These public sector workers have substantial responsibilities in terms of our pupils, patients and most vulnerable in society.

Equal pay for equal productivity

Given the sheer scale of the public expenditure cuts facing NI it is vital that an independent review of public sector pay is undertaken as soon as possible. This should focus on rewarding higher productivity jobs and ensuring equal pay for equal productivity. Furthermore, public sector pay should be set in a way that enables the retention, recruitment and motivation of suitable staff. Within these parameters, current DFP guidance quite rightly states that “public sector pay should also reflect the circumstances specific to the local labour market”. It is important that this is adhered to. Moreover, given the influence and potential distortions public sector pay levels have on the local labour market, DFP should consider including an explicit objective to promote economic development. After all the economy remains the Stormont Executive’s number one priority and DFP has an even greater influence on the economy than DETI.

Osborne takes the axe to Welfare benefits

The Chancellor announced a number of initiatives to curb the UK’s huge welfare bill. The Budget announced £11bn of welfare reform savings by 2014. These are designed to simultaneously reward work and protect the most vulnerable. Measures announced today include adopting the Consumer Prices Index (CPI) for the indexation of benefits tax credits and public service pensions from April 2011. The significance of this is the Retail Prices Index or RPI is the current measure used for indexation. Traditionally it is much higher than CPI and includes housing costs such as mortgage interest payments. As a result, going forward these benefits will be up‐ rated by a lower amount using the CPI measure. This will reduce the level of income coming into all parts of the UK include NI. The Budget also announced that a new medical assessment will be applied to new disability living allowance claimants from 2013. This is designed to be more rigorous and will impact on the high benefit claimant regions such as NI, Wales and the North East of England.

Pensioners now have security of the ‘triple lock’

On a positive note, from next year, the basic State pension will once again be linked to earnings. The Government guarantees to increase the State pension by earnings growth, inflation or 2.5 per cent. This provides a triple guarantee of a rise of at least 2.5%. The Government will up‐rate with whichever measure is highest from April 2011. It was also announced today that the Government wants to accelerate the rise in the retirement age to 66. No date has been fixed for when this will be brought in.

Child Benefit frozen and tax credits scaled back

Alongside the public sector pay freeze, Child Benefit payments are to be frozen for the next three years. Low income families, however, will receive more tax credits to offset this loss. Over the best part of the last decade NI household incomes were boosted by working family tax credits for household incomes up to a threshold of £50,000. This in turn boosted consumer spending in the local economy. These credits are now to be scaled back to a threshold of £40,000. Again this will have a negative impact on consumer spending. Further changes to this threshold will be made in 2012/13 with a focus to targeting more credits to lower income families which will experience above inflation increases. Maternity payments will also be scaled back with the Sure Start Maternity Grant restricted to the first child only from April next year. The Health in Pregnancy Grant will also be abolished from January 2011.

Tax rises accompany public expenditure cuts

Overall, the Chancellor raised taxes by less than perhaps had been expected. The key tax rises were the VAT rate hike, the introduction of a bank levy and the increase in capital gains tax (CGT). All of these were anticipated. The bank levy will eventually raise some £2bn per annum, while a new higher rate of CGT of 28% was announced.

VAT rise to 20% in January 2011

The rise in VAT, from 17.5% to 20% will not take place until 4 January 2011. This was later than we had anticipated and will mean the negative impact on consumer demand will not kick in until next year. NI’s retail sector has already begun to experience a tailing off in cross‐border shoppers as falling prices in the Republic of Ireland coupled with a strengthening in sterling relative to the euro have made NI’s retail offering less attractive to RoI shoppers. Consumer demand, both domestic and cross‐border, will be further reduced with the rise in VAT to 20% in January 2011. This will increase the cost of goods and services outside of the zero‐rated items such as food, children’s clothes, newspapers and books. All consumers will be affected by this tax rise with those on lower incomes affected the most.

But no rise in alcohol, fuel and tobacco duties

No doubt there will be some welcome relief with no planned increases in duties over and above what the coalition Government inherited. Furthermore, the 10% increase in cider duty announced at the March Budget will be reversed by the end of the month. It should be remembered that fuel duty will be increased by two 1p rises in July and then again in October. Furthermore fuel, alcohol and tobacco prices will rise following next January’s VAT hike.

Personal income tax threshold raised

One of the more positive announcements today came in the rise in the £1,000 personal income tax threshold. This is for all individuals under the age of 65. The new threshold is now £7,475 with the Chancellor reiterating the coalition’s long‐term objective of raising this to £10,000 per annum. This will take some of the low paid out of income tax altogether and will boost the disposable incomes of those on low incomes.

Pro‐Business Taxation Policies

The threshold for employer National Insurance contributions (NICs) was raised by £21k per week above the standard rise through indexation. This largely reverses the negative effect of the Labour government plans to raise employer NIC by 1 per cent in April 2011. A phased reduction in the UK corporation tax rate was also announced. This will see a 1 percentage point fall each year up to 2014. This will lower the UK corporation tax rate from 28% to 24%. Meanwhile, the small profits rate will be reduced to 20% from April 2011. The planned reductions in corporation tax, however, were accompanied by a reduction in the main and special rate for capital allowances to 18% and 8% respectively from April 2012.

Protecting vital economic infrastructure projects

Today the Chancellor stressed the importance of progressing with investment in infrastructure on those projects with the greatest economic benefit. The Government will make no further cuts to capital investment in gross public sector investment relative to the plans it inherited. We would urge the Stormont Executive to protect its capital investment plans as much as possible to limit the economic damage to the local economy. It is noted that the NI construction sector has already lost more than one quarter of its workforce in just 2 years.

NI awaits a Government consultation paper

One of the most significant announcements today from an economic development perspective concerns a couple of forthcoming government papers. A White Paper is due later in the summer setting out the coalition government’s plans for a new approach to sub‐national growth. This follows the failure of the previous administrations regional economic policies which failed to narrow the gap in regional economic prosperity during its tenure. One strand of this new approach includes a new scheme to promote growth for those areas outside of London, the South East and Eastern regions. This will include a reduction in employer NICs for new businesses from up to £5,000 of employer NIC payments for each of their first 10 employees hired. According to HM Treasury estimates, up to 15,000 businesses in NI could benefit from this scheme.
Northern Ireland is also singled out for special attention. A consultation paper is due for release this autumn which will look at rebalancing the Northern Ireland economy. This is anticipated to provide more detail on the idea of turning NI into an ‘Enterprise zone’. In addition, mechanisms for exploring a reduction in corporation tax alongside other economic reform options will be explored.

Tackling the ‘welfare benefit zone’

Clearly, obtaining the status of an ‘Enterprise zone’, with an array of enhanced incentives, would be beneficial to the economy. However, the other side of the enterprise coin will be trying to tackle and dismantle NI’s current status as a ‘welfare benefit zone’. Without aggressively tackling the latter, NI will fail to make meaningful progress in fostering a new entrepreneurial culture. Northern Ireland needs to look at more radical, region specific solutions, to address our welfare dependency and economic inactivity. It is noted that number of NI individuals neither in work or looking for work due to sickness (@90,000) is broadly the same size as the combined workforce currently employed in manufacturing and the financial services sector.

Round 3 of fiscal austerity due on 20 October 2010

Today’s Budget represents Round 2 of the UK’s fiscal austerity programme and follows the £5.7bn (net) of expenditure cuts for the UK announced last month. This translated into £128m of in year public expenditure cuts for NI and came on top of the £367m of efficiency savings announced previously. As a result, NI faces £495m of public expenditure cuts in this financial year 2010/11. However, Round 3 of fiscal austerity will come on 20th October with the Comprehensive Spending Review (CSR) detailing the planned departmental spending plans for the three years from 2011/12 to 2013/14.

£0.5bn of cuts announced another £1bn+ to follow

For NI, we estimated prior to the emergency Budget that the CSR could give rise to cuts of at least £750m in 3 years. However, today’s announcements signalled a cut in UK departmental expenditure, outside the protected areas of health and overseas aid, of the order of 25% as opposed to 20% as identified previously. Therefore the likelihood is NI could see annual expenditure reductions of £300m+ per year for the 3 years to April 2014. Add this figure

to the 2010/11 figure and additional spending pressures (e.g. water charges, DARD EU fines and a potential bailout of the Presbyterian Mutual Society) and you can quickly get to a figure in excess of £1.5bn over the next 4 years.

Time for a fiscal consultation exercise

NI has no alternative but to forensically analyse its current public expenditure programmes and come up with a shopping list of public expenditure cuts and new sources of revenue. The Executive could take a leaf out of the coalition Government’s book by embarking on a consultation exercise with the public on where cuts could and should be made and where revenue could and should be raised. At the national level, an engagement programme will be launched on Thursday giving public sector workers and members of the public an opportunity to come up with ideas of how to reduce spending while protecting the quality of public services. Will the Executive embark on a similar engagement programme bringing together the views and ideas of the private sector, unions, public sector workers and the wider NI public?

More transparency leads to more fiscal policemen

The Chancellor has already made a commitment to publish online all new items of central government spending over £25,000 from November 2010. In essence, the new Government’s strategy is to use the same transparency that was provided for MP expenses for wider public expenditure. The aim of this is to secure buy‐in from the wider public who in effect become fiscal policemen. In a similar vein, the Stormont Executive could throw more sunlight on its public expenditure than has hitherto now been provided. This could include a detailed list of all the subsidies that NI currently enjoys, specifically identifying those that are unique to NI. This would help inform the choices we are currently making with public expenditure. Similarly on the revenue side, there needs to be greater transparency and communication surrounding the level of revenues raised by NI relative to other UK regions such as the North East of England and Wales.

Treating NI’s ‘fiscal deficit attention disorder’

Historically, local politics has paid little attention to NI’s public finances and this has given rise to what has previously been termed a ‘fiscal deficit attention disorder’. This affliction has helped fuelled unrealistic expectations by all NI’s stakeholders as to what NI can afford. Furthermore it has given rise to economic myths that NI is less well provided than it actually is. In many respects NI needs a reality check. Perhaps NI’s annual rates bill could be accompanied by an expenditure and revenue statement which illustrates NI’s public expenditure and revenue per capita relative to other UK regions. Such communication may help to provide a fiscal reality check for those individuals who do not realise how well off and subsidised NI is. Furthermore, such messaging would help to defuse dissent against unpopular tax rises such as water charges.

Redefining VFM and more emphasis on economics

Given the scale of the public expenditure cuts NI has to re‐define what value for money means in this new era of austerity. Perhaps there has been too loose an interpretation of this in the past. Going forward, the Executive needs to start making more decisions based on hard economic and financial facts. Ultimately this will result in better decision making. It should be remembered that economics is all about the allocation of scarce resources. In turn, this requires making choices and deciding the mix of resources and public sector services that are affordable, realistic and desirable. In order for informed decisions to be made politicians, policy makers and the wider public need to be made aware of what public expenditure is going where. The next round of fiscal austerity, the CSR, is now just four monthsaway.