HC Deb 17 November 2000 vol 356 cc1231-40

Motion made, and Question proposed, That this House do now adjourn.—[Mr. McNulty.]

1.28 pm
Mr. Edward Davey (Kingston and Surbiton)

This is the first time that I have spoken while you are in the Chair, Madam Deputy Speaker. May I welcome you to the Chair and to your new appointment?

I am grateful for the opportunity to hold the debate. Many colleagues will have seen its title and considered it to be one of the least interesting subjects, but I believe it relates to some of the most important challenges that face this country's senior policy makers. The United Kingdom and other countries may be measuring inflation and related economic statistics incorrectly, which may be undermining our economy's prospects for growth. Simple measurement errors could have genuine effects on the fortunes of families and businesses in every constituency throughout the country.

As a result of those errors, interest rates could be too high, the investment decisions of international capital might be biased against Britain, and jobs might have been unnecessarily lost. That is a bizarre but alarming claim. If experts outside the House who present that argument are right, and countries such as the United States are benefiting from incomparable international statistics while the United Kingdom is suffering, the Government must not delay resolving the matter.

Given the interesting developments in Florida, I am not sure whether we should wait for an American recount, even of economic statistics.

In case listeners or readers think that I have taken leave of my senses by making such outlandish claims, I immediately refer to a report by the Office for National Statistics, which was published this year with the snappy title, "Review of Short-Term Output Indicators". A small part of the analysis used in that ONS report relates directly to the claims I am making. Using a United States-style inflation measure, the ONS estimated growth in the United Kingdom's manufacturing output to be a massive 6 per cent. higher since 1995 than the recorded figures show.

That one reference to a highly credible source should suggest that that is not a scare story. Many other respectable analysts point to the problem, so those are serious and alarming claims. My understanding is that many senior people in the Treasury and the Bank of England share my grave concerns, but, to my knowledge, this is the first time that the issue has been raised on the Floor of the House.

Before I explain the background to my argument, I reassure those statisticians from the ONS and elsewhere who might be interested in this debate that I am not attempting to take a wide swipe at economic statistics in this country—far from it. The ONS report reviewed the quality of short-term output indicators in the UK and was generally very positive. We owe a debt of gratitude to the many hard-working and talented statisticians in the ONS, Departments and the Library. The statistics that we receive from them are of high quality.

Previous concerns include the divergence between the various measures of gross domestic product in the late 1980s and, more recently, the average earnings data series, but they were the exceptions that prove the general rule.

Despite the title of the Adjournment debate, I am not making a wholesale criticism of the public sector's statistical service. In fact, my argument rests not on criticism of it or the economic statistics it produces, but on how to achieve comparable international statistics for some key economic variables. The debate is an attempt to point out that the lack of uniformity might be unnecessarily handicapping UK plc. It would be absurd, and a concern that statisticians would surely share with us, if mere statistics could be said to be undermining economic policy making or performance.

The central question, which involves the background to the debate, is about how a country should measure changes in prices of goods and services, when those goods and services are changing in quality. That technical question about inflation measurement has major policy ramifications. The problem of adjusting inflation measures for quality changes has always existed. Consumers in 1990 were buying different items of different quality from those bought by consumers in 1890, let alone in 1790.

However, some people now argue that the problem has become much worse. Major improvements in computer technology and in communications technology make it even more difficult to compare the price of what consumers buy in one year with the price of what they buy the next, especially because purchases of information and communications technology products have taken up a larger share of consumer expenditure. That is especially significant because such products have become a major intermediate input cost to other services and goods that we buy, whose quality is also being continually enhanced by those technologies. It is argued that quality-adjustment problems for measuring inflation have become far more significant in recent years.

If every country had reacted to those problems in exactly the same way, there would be no difficulty for anyone. After all, price changes are only signals of relative changes in supply and demand, and if measurements of aggregate price changes for each country dealt with new developments in the same way, arguably nothing would have been lost. However, different countries have reacted in different ways to the measurement challenges of ICT. In America, the way in which inflation is measured has been altered recently, mainly as a result of recommendations from the 1996 Boskin commission. Key changes involve new ways to adjust for quality improvements in high-technology goods.

So-called "hedonic" pricing methods have been adopted. They strip out the effects of quality improvements in, for example, home computers, cars, clothes and televisions in new ways. Those methods break down a product into its key features, such as the memory and speed of a computer, and assign prices to those features rather than to the whole product. Thus, by controlling for quality improvements using such new techniques, hedonic inflation measures tend to show significant price reductions for technology goods, lowering overall recorded inflation for countries using those methodologies. Therefore, inflation in the United States may seem lower relative to inflation in the UK and most other European countries, but some or all of the difference may be explained simply by differences in how the statistics are compiled and how different countries adjust for quality changes.

Some people may ask, "So what? Why should we worry if the Americans want to record inflation differently from us, so that it looks lower than ours?" The next stage of the argument is where it gets interesting.

Inflation figures are not just some theoretical measure existing in a void, published in a press release and reproduced in economic tables, gradually to be consigned to the top or bottom shelf of the Library. Inflation figures affect real things. They impact on wage negotiations, for example, and decisions on pension rises, as the Government know only too well. They impact on the decisions of those who set interest rates—the Monetary Policy Committee—so they impact on mortgages paid by families throughout the country. Presumably, if our inflation is measured higher than it could have been measured, mortgage rates—real things—are higher than they need to be.

Again, inflation rates of different countries affect the decisions of international capital about where institutional investors wish to place their cash. If the United States' inflation measure is flattering its economy and ours is under-selling Britain's, are we missing out on our share of international investment funds? Is the wider European economy and, dare I say it, the euro being undermined by over-optimistic statistical signals from the United States?

Those questions are probably impossible to answer, so the Minister can relax. I ask her rhetorically to illustrate the enormity of the issues that might be involved by different countries treating economic statistics differently. For the record and to save the Minister the trouble, I am not arguing that Britain or other European countries now measure inflation incorrectly. I am arguing that perhaps the United States is wrong, and perhaps all the countries are measuring inflation wrongly. It is a difficult concept. There is clearly more than one way to measure inflation, but the key policy issue is: why are we measuring inflation differently and could that be damaging the UK's economic prospects, at least relative to America's, just because of statistics? Perhaps we should be worrying.

I say "perhaps" for reasons of modesty. It is a complex issue and I am no statistician. I would not wish the Minister to think that I am so confident of my case that I know that it is having damaging effects. It may not be. I simply raise the real possibility that it could be, in which case the Government need to act.

Therefore, I look for two possible answers from the Minister. Either she will say that I am nuts, that I have been bamboozled by the latest economic theory and that we should not worry because Great George street and Threadneedle street have it all under control; or she will say that there is an issue of substance behind some of the points that I make and that other people have made outside the House, that the Treasury is concerned about it and is giving it serious thought.

The only indication that we have had so far of what the Treasury thinks about the matter is contained in box 1.2 and annex A of a report, published with the pre-Budget report, entitled "Productivity in the UK: the Evidence and the Government's Approach." I welcome that report. I share many of the Government's concerns about the UK's productivity performance. I do not wish Ministers to think that, because I am questioning official statistics, especially their relation to America's, I seek to undermine that productivity thesis and the stated goal that we need to do more to improve our economy's productivity. We can argue over the size of the productivity gap between America and the UK, but the fact that there is one seems relatively uncontentious.

I am concerned about the way in which the Treasury deals with the measurement issue in that publication. It is as if, because the measurement problem works against the paper's main thesis, it is stuck in the annex and the narrative tries to down play the significance of the measurement problem. I am not sure whether that is a good way in which to examine the issue.

It may be true, as the annex suggests, that the simplistic application of hedonic pricing measurements to the United Kingdom can overstate the differences that result. The paper quotes a recent OECD report, which suggests that other factors offset the impact of the simplistic application of hedonic measurements, reducing the apparent biased output and productivity figures. Although those academic charges and counter-charges are interesting, some senior people are worried about the issue. That is presumably why, in annex A, the Treasury writes: The ONS is at the forefront in trying to get international agreement within the OECD and Eurostat as to what quality adjustment methodologies should be used in order to allow consistent inter-country comparisons. All that gobbledegook means that the Treasury is trying to push ahead and solve the problem, but they are not quite saying so.

Yesterday, when Sir John Kingman was giving evidence to the Select Committee on the Treasury, I asked him what he intended to do. I hope that I do not paraphrase his words too much, but he replied that he took the issue seriously and would look into it. I apologise to the Minister for being unable to stay to hear her evidence to the Committee and for not asking her some of today's questions yesterday. I hope that she told the Committee that she shares Sir John's concerns.

Although it is good that people are now waking up to the issue, I remain troubled by the timetables for the research and debate needed to put it right—there does not appear to be one. When will we get to the bottom of this? When will formal discussion papers be published? When will the changes take place? The issue matters because, if the argument is correct, it is having very real effects, now. I want the Minister to reassure me that the Treasury is making it a top priority and that the Treasury will give every possible support—if necessary, extra resources—to the National Statistician and the Statistics Commission, to resolve the problem.

It is instructive to remember how fast people moved when problems were perceived with the average earnings index. The Treasury did not wait very long then. I should like a similar fast-track resolution to take place now and the Chancellor to make this into a public issue to give it the profile that it needs. Just by giving the matter the oxygen of publicity, some of the potentially damaging effects—from appearances, not based on reality—could thereby be corrected.

I should like the Minister to go further than simply talking about timetables and how seriously the Treasury are taking the matter. I want her to tell the House that she will draw this debate to the Chancellor's personal attention and to suggest that he focus the attention of his European counterparts on the issue. He and his international colleagues should demand that the OECD and Eurostat do not drag their feet on the issue, but get a move on.

We can all understand that major changes to vital series of economic statistics must be undertaken carefully, without political pressure, and, in this case, with maximum international agreement. There is no dispute about that, yet I am seriously worried that the Americans have—wittingly or unwittingly—already stolen a major march on the United Kingdom and Europe by changing their data. Perceptions engendering expectations can have real effects, even—perhaps especially—in sophisticated economies. It is perhaps ironic that the measurement of information technology has led to misinformation. Let us consider whether the US's over-optimistic data have contributed to the golden halo effect around the wider US economy.

Is that effect and the data at least a partial explanation of the enormous surge in the US stock market, as the dot.com mania appeared to be based on solid macroeconomic data? Was it then also an underlying cause of the subsequent fall in values, as investors realised that many of the individual firms that they had backed during that gold-rush dot.com period were actually poor prospects?

Let me stress that I do not doubt that the extraordinary performance of the US economy is built on more than mere statistical manipulation, but it is possible that some of the hype has been. It could have caused some of the froth that has sucked world investment funds out of Europe into the US. Let us face it, Alan Greenspan—the chair of the Federal Reserve—has made a virtue of not worrying about US inflation because of the USA's good productivity data. So the Americans have not waited too long to make those supporting corrections to their data with respect to the new economy. The improved perception that they have given has brought real benefits, drawing in capital and magnifying America's first mover advantages in ICT investment.

This is not the only area of economic statistics relating to new technology and e-commerce that the Government should be concerned about: I know that the Office for National Statistics is concerned about others. A member of the Monetary Policy Committee, Dr. Wadhwani, is worried about other measures. There are large differences in accounting for software investment within ICT between the United States and the United Kingdom and Europe, which could have a knock-on effect on the way in which we measure productivity. In a recent speech, Dr. Wadhwani highlighted concerns about the different measurements of capital stock. It is tempting to develop those arguments, but I hope to do so on another occasion when I try to catch your eye, Madam Deputy Speaker, so I shall not try your patience much longer.

This is a serious problem. Some of the articles and discussions in the technical press may have overestimated its effect, and in taking up some of their points perhaps I have done so, too. I am willing to debate that point. I hope that they and I have overestimated it, but some real issues need to be addressed. I do not think that the problem has had the publicity that it deserves, and I hope that the Minister will reassure me that the Government will try to sort it out.

1.46 pm
The Economic Secretary to the Treasury (Miss Melanie Johnson)

I join the hon. Member for Kingston and Surbiton (Mr. Davey) in congratulating you on your appointment, Madam Deputy Speaker. A wise choice has been made, and I am delighted that you have become a Deputy Speaker. I also thank the hon. Gentleman for raising this important and interesting issue, and congratulate him on securing the debate.

There is a public debate about whether price indices are fully taking account of quality improvements in new technology, particularly computers. Different methods of allowing for quality improvements can have a significant impact on measured economic growth. The Government, the Bank of England and the Office for National Statistics are actively involved in research on this complex statistical issue.

It is unfair for the hon. Gentleman to suggest that we have not been dealing with this measurement gap. All the bodies to which I have referred are significantly involved in dealing with this matter. That is a clear indication of the fact that we are well and truly engaged with the issue.

International comparisons of productivity have always been complicated by measurement difficulties, which introduce considerable margins of error. In recent years, these have been compounded by developments associated with the new economy. Information and communications technology has become an important driver of economic growth. Its importance has risen, not just because more ICT equipment is available, but because the quality of ICT has improved substantially.

Different countries' national statistical agencies have adopted different approaches to adjusting prices of ICT products and services for quality change. In particular, the method adopted in the US, known as hedonic price adjustment, has a significant effect on the measurement of output. Applying the same method to the United Kingdom would affect the size of the productivity gap.

Specifically, although both the UK and the US national accounts allow for changes in ICT quality, the hedonic price adjustment approach carried out in the US implies a much faster rate of decline in computer prices. That means that any given change in nominal sales or spending on computers will show up as a much larger real change in the US accounts than in the UK accounts. So there has been a growing perception that recently GDP—and hence productivity—growth in the UK may have been understated relative to that in the US. The hon. Gentleman has remarked as much.

However, quantifying such effects is less straightforward than it appears at first sight. Applying, for example, United States computer price indices in the United Kingdom accounts would increase measured gross domestic product growth by less than the effect on real investment and consumer spending on computers to the extent that they are imported rather than domestically produced. In other words, and more generally, the effects on measured GDP growth differentials of harmonising the measurement of ICT prices between countries would depend on the relative size of their ICT sectors as well as their spending on ICT.

None the less, it should be recognised that the US-UK productivity gap cannot be explained away, as the hon. Gentleman maintains, by statistical treatment. The gap is too large and has persisted for too long to be a statistical artefact. It cannot be attributed only to methods of measurement.

The hon. Gentleman seemed to be saying that the information in box 1.2 in "Productivity in the UK: the Evidence and the Government's Approach", a paper accompanying the pre-Budget report, had been hidden away. As I am sure he realises, as he has read the paper, much of what I have just said is a summary of that information. Nevertheless, it is worth making the points for the benefit of those who do not have direct access to the paper.

The hon. Gentleman was also being rather unfair by saying that we had not flagged up the issue. The issue is not only flagged up in the paper, but is the subject of an annexe to which he referred that addresses in considerable detail various technical issues.

Mr. Edward Davey

I do not wish to fall out with the Minister on this. I am merely trying to say that the issue is so important that the Chancellor should be talking about it, and that—although addressing it in a supplementary publication to the pre-Budget report is welcome—the Treasury should be addressing it more emphatically, to ensure that economic commentators and the wider public take notice of it.

Miss Johnson

It is important to recognise that debates in the House are followed closely by the Chancellor, who takes a keen interest in the comments of Opposition Members. Moreover, the fact that we have addressed the productivity issue in a paper accompanying the pre-Budget report demonstrates that we recognise its seriousness.

In the light of the hon. Gentleman's comments, I should emphasise that the first national statistics quality review, "Review of Short-Term Output Indicators"—the STOI review—found that the short-term economic indicators produced by the ONS were of good quality and fit for purpose. Various detailed studies were conducted as part of that review and formed the basis of that conclusion. One of the studies highlighted the importance of correctly measuring improvements in the quality, and hence the prices, of items in the information and technology sector, such as computers.

The quality review, which the hon. Gentleman mentioned, pointed out that there could be a significant impact on measured growth and investment in the United Kingdom simply by making different assumptions about the value to attribute to those quality improvements. That point was also made in the pre-Budget report publication that I mentioned.

The United Kingdom approach, contrary to what is sometimes asserted, does make quality adjustments for improved computer quality, but our approach differs from that of the United States. The United Kingdom uses two methods when considering the price of manufacturers' output.

One method is that, if an extra characteristic or option is added to the specification of a product, such as a computer, the producer is asked whether it is priced separately. If so, the overall price of the computer is adjusted downwards by half the cost of the new option. The figure of one-half is used to allow for the fact that standardising an option allows manufacturers to exploit economies of scale.

In many cases, however, a separate price for a new option or specification change will not exist. In such cases, the manufacturer is asked for his estimate of the cost of upgrading the specification, and that amount is fully taken into account in the quality adjustment of the price. That is used in a number of ways to upgrade a number of outputs.

A priority is for consistency of methods by which quality is taken into account in price indices in the UK. Thus, whether one is looking at producer price indices or export and import deflators, the user can be assured that the same or very similar methodologies are used, and any differences must be for sound methodological reasons.

Interest in this area is currently high, as policy makers look for evidence of the new economy and the associated sustained high productivity growth due to the input of increased information and communication technology—a phenomenon attributed in particular to the United States. Various research papers have taken United States producer price indices for information and communication technology and applied them to United Kingdom growth data.

The short-term indicators report came up with estimates of the maximum—I stress maximum—effect that use of alternative estimates for computer prices might have on output. The STOI study found that, had US price indices been applied to the output of the UK computer industry, the output of the production industries would have grown by a further 6 per cent. since 1995. I emphasise the fact that the figure is only illustrative, that it applies only to the index of production and that it is the upper limit. The hon. Gentleman referred to it as though it were a point on the scale, but it is at the far end of the scale.

Other effects could be offset in different ways. The report clearly states that the figure is illustrative. The fact that the topic is found in the report shows that we are engaging with the discussion, and indeed playing a central role in it. We are happy for there to be transparency and wider public awareness.

The report said: this review hasn't investigated the complex issues related to computer prices, nor can it recommend using the US price indices within the UK Index of Production. The analyses given here simply demonstrate the potential impact of doing so. As I said, it is the potential at the upper limit.

I want to emphasise that the role of the review has been to identify areas for further development. By necessity, the analysis carried out during the review could not be a deep investigation covering all aspects of each area. In particular, on the impact of price indices on growth, there are some methodological issues that should be considered when assessing the studies.

It is misleading simply to take the output of the computer industry and look at how much the value added by that industry increases if prices are assumed to fall faster. Much of that output is bought by other companies in other industries, so if the value added by the computer industry rises when different price indices are used, the estimate of the value added contributed by the purchasers of the equipment will fall.

In other words, much of the effect of changing price indices is to redraw the picture of growth between sectors, with the computer industry growing faster than we first thought and its customers growing more slowly. We do not yet know the effect on the overall growth of the economy.

It is also very important to consider the situation regarding international trade in such products. A higher value assigned to computer products will increase the import bill for such goods as well. Of course, exports will also be revalued, but as the UK is a net importer of such products, the final outcome is likely to be a bigger boost to the measure of imports than to the measure of exports, which means that there could be a negative effect on overall growth to counter the positive effect highlighted by the commentators.

There is an important international context to this issue. One of the important uses of economic statistics is to make international comparisons, so it is important that methods are consistent across countries.

Earlier this year, the go-ahead was given for a European hedonic centre, which has been funded by Eurostat. In parallel, an OECD committee—to which the hon. Gentleman referred—is producing a handbook on computer quality adjustment, and a further OECD-sponsored group, which is investigating the international transferability of hedonic models, will produce useful conclusions for the European hedonic centre. The Office for National Statistics will be an active participant in that effort. The centre will begin work in January 2001, and its first year will be devoted to data collection and construction of various hedonic models. The models will then be tested, and we might see useful results in 2002. We and the ONS aim to be key participants in all the activities involved.

It is important to note the time scale, which makes it clear that there is much work to be done. It is also important to emphasise that the ONS is, as the hon. Gentleman readily granted, at the forefront of national accounts on the international scene. I feel that the hon. Gentleman's remarks about errors in national statistics were a little misplaced. The ONS leads Europe in terms of quality and timeliness, and presentation of an integrated set of national accounts. Much good work is going on, and to ensure that it continues we must make haste slowly—or, at least, with due care.

The hon. Gentleman suggested that a significant impact could have been made in a number of ways. He spoke of the loss of jobs. It is not true that interest rates would necessarily change: there is no evidence that rates rise according to different measurements on computers. Interest rates have been very low recently, and long-term interest rates are at their lowest for some 35 years.

The hon. Gentleman asked whether we were treating this as a priority. As I have said, we have produced formal papers, and formal things have been said in very public contexts. I assure the hon. Gentleman that the Treasury, the Government as a whole and the ONS take the issue very seriously, and the studies to which I referred are under way.

I have mentioned the need for methods that are consistent across countries. The United Kingdom has been active in the harmonisation of economic statistics. There are no international standards at present, and the hon. Gentleman suggested that a lack of uniformity undermined economic policy making. We are actively participating in the OECD committee's work—I mentioned the computer handbook earlier—and in that of the European Hedonic Centre.

The hon. Gentleman also suggested that inward investment might be affected by errors showing a smaller growth in gross domestic product than was the case, and made a comparison with the "golden halo" around the United States. I see no evidence of that. Inward investment is at record levels: we are second only to the United States in that regard.

The hon. Gentleman asked whether we were measuring inflation differently from the United States. Indeed we are, but that is not entirely true within Europe. For example, we now have a harmonised index of consumer prices across Europe, which represents our first attempt at an international standard for consumer price indices. It means that consumer inflation rates can now be compared across Europe. The ONS is actively participating in the work of the Eurostat taskforce, which developed the index.

The hon. Gentleman made comments about international comparability, some of which I have addressed. We think that comparability should be a priority, and will continue to urge our international colleagues to make progress—consistent, obviously, with thorough research within the necessary time scales. It is not currently clear how we should proceed.

I was not present when Sir John Kingman was here before I gave evidence to the Treasury sub-committee yesterday. As the hon. Gentleman said, he had left by the time I arrived, so we experienced different parts of the discussion. However, I have been given evidence that Sir John Kingman did not say that he had concerns in the evidence that he gave on behalf of the Statistics Commission. He said that the commission would investigate the concerns of the hon. Gentleman and others if it felt those concerns should be progressed in light of the hon. Gentleman's remarks.

The Office for National Statistics is giving priority to a programme of work to evaluate the different methods used to adjust for quality changes in the output of information technology industries. That project will also study the way in which computers have contributed to the growth in capital stock. The ONS will seek the advice of experts in the field, key users, its own methodologists, economists and national accountants, and will look closely at the approaches adopted in other countries. Wherever possible, the project will have as one of its aims international comparability, for the reasons that I have given. It will be essential that any adjustments made to current methods, and therefore to current estimates of growth and productivity in the United Kingdom, are based on thorough, soundly grounded research. The ONS plans to publish periodic progress reports, starting in Spring 2001 with an article in "Economic Trends".

To sum up, we have been actively involved in research and discussions on this topic. We are working with Eurostat and European counterparts on the issue, as is the Bank of England. The size of the effect suggested by the hon. Gentleman is speculation at this stage, and I hope that I have explained to the House how the issue is being appropriately addressed. At the moment, the degree of the hon. Gentleman's concerns is misplaced.

Question put and agreed to.

Adjourned accordingly at six minutes past Two o'clock.