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# 52013SC0378

**COMMISSION STAFF WORKING DOCUMENT Assessment of the 2013 national reform programme and convergence programme for UNITED KINGDOM Accompanying the document Recommendation for a COUNCIL RECOMMENDATION on United Kingdom’s 2013 national reform programme and delivering a Council Opinion on United Kingdom’s convergence programme for 2012-2017 /\* SWD/2013/0378 final \*/**

  

Contents

Executive summary. 3

1........... Introduction. 5

2........... Economic developments
and challenges. 8

2.1........ Recent economic
developments and outlook. 8

2.2........ Challenges. 9

3........... Assessment of policy
agenda. 12

3.1........ Fiscal policy and
taxation. 12

3.2........ Financial sector 18

3.3........ Labour market, education
and social policies. 20

3.4........ Structural measures
promoting growth and competitiveness. 24

3.5........ Modernisation of public
administration. 30

4........... Overview table. 32

5........... Annex. 37

Executive summary

Economic Outlook

The UK has experienced a subdued and stuttering recovery from the financial crisis. In 2012 as a whole the economy grew at a meagre 0.3%, after
recovering from a double dip recession in the first half of the year. The
Commission's spring 2013 forecast predicts GDP growth of 0.6% in 2013 and 1.7%
in 2014. Unemployment, which has been relatively low given the weakness of GDP,
is projected to remain relatively stable, at around 8.0% in 2013. Inflation,
which peaked at 5.2% in September 2011, is set to average at 2.8% in 2013,
before falling back through 2014 to 2.5%.

Progress
in reducing the fiscal deficit stalled in 2012-13 in a context of weak GDP
growth, although the UK government has stuck to its fiscal consolidation
strategy. According to the Commission's spring 2013
forecast, the headline budget deficit is expected to be 6.9% of GDP in 2013-14
and 6.1% in 2014-15. The average annual structural effort (excluding one-off
and temporary measures) made by the UK since 2010-11 is 1.1% of GDP a year,
which is lower than the 1.¾% recommended by the EU and will be insufficient to
correct the excessive deficit by the 2014-15 deadline. Meanwhile, government
debt has been increasing steadily for more than a decade, with the Commission
predicting an increase to 98.7% of GDP by 2014-15 (up from 90.7% in 2012-13).

Key Issues

In
the last year, the UK government has made significant progress in designing and
legislating for an extensive reform agenda in financial regulation, spatial
planning, education and welfare. The reforms are
relevant and ambitious in their stated aims, but in most cases, it is not yet
fully clear how effective they will be. Indicators on housing, access to
finance and infrastructure have been either stagnant or deteriorating, linked
in large part to the challenging economic environment.

In
the short to medium term, the UK faces considerable challenges and tensions in
reconciling needs for deleveraging, maintaining financial stability and avoiding
compromising investment and growth. Fiscal
consolidation remains a pressing challenge for the UK, and needs to be balanced
with fairness and growth-promoting investment. To provide the conditions for
sustainable, investment- and export-led growth, the UK also needs to address
the economy’s structural weaknesses, including a lack of housing supply, skills
gaps, and the need to renew and upgrade transport and energy infrastructure.
These and other shortcomings also contribute to the UK's consistently weak net
export position. The current account deficit grew to 3.7% of GDP in 2012 and
the UK has a large goods trade deficit (-6.9% of GDP).

·
Public finances: While the UK government has continued to
implement its fiscal consolidation strategy, the deficit is now expected to
fall more slowly than previously envisaged, due to weaker medium-term growth
prospects, while government debt is on the rise. The UK deficit for 2013-14 is
forecast to be 6.9% of GDP, one of the highest in the EU. Total public
investment remains low, following sharp cuts in 2011, and the UK has a challenge to correct its excessive deficit while achieving differentiated,
growth-friendly fiscal tightening and structural reforms. In this context, the
potential revenue contribution from tax reforms, for example extending the
standard VAT rate, remains relatively under-exploited.

·
Private debt and
housing: Household and
corporate debt is relatively high (206% of GDP at the end of 2011, above the
euro area average of 164%) and has been identified by the Commission as a
macroeconomic imbalance. At the same time there is not enough housing to meet
the demands of a growing population and to help bring down house prices
relative to incomes, and the level of residential construction remains low.

·
Unemployment and
skills: Unemployment stood
at 7.8% at the start of 2013, but youth unemployment is considerably higher at
20.7%. There are too many low-skilled workers, for whom demand is falling, and
a shortage of workers with high-quality vocational and technical skills. This
is a particular problem amongst the young, where the numbers of early school
leavers and those not in employment, education or training (NEET) are high.

·
 Welfare reform and
childcare:  At 17.3%, the
proportion of UK children living in workless households is the second-highest
in the EU, which has a significant impact on child poverty. A lack of access to
suitable, affordable childcare still discourages many parents from working, or
from increasing the number of hours they work.  In 2011, 22.7% of the
population was at risk of poverty, slightly below the EU average. The UK
Government aims to increase employment through welfare reform measures, such as
Universal Credit, which will provide clearer work-incentives, but successful
implementation and monitoring will be essential.

·
Access to finance
and the banking sector: Net
lending to the corporate sector remained negative in 2012 and corporate
investment is very low (gross fixed capital formation fell to 14.2% of GDP in
2012). While larger firms with strong balance sheets are able to borrow at a
historically low cost, many other firms, particularly SMEs, are having
difficulty accessing credit, and there are signs of less-than-viable companies
being kept in business through low interest rates and bank forbearance. Access
to non-bank lending remains largely restricted to bigger firms, and competition
in the banking industry is still limited.

·
Energy and transport
infrastructure: The UK needs substantial investment in new electricity generation capacity by 2020, and has a
low share of energy from renewable sources (only  3.8% in 2011). Shortcomings
in transport networks are a problem for the whole economy, especially goods
producers, distributors and exporters, and there is a significant gap between
investment needs and committed funding. The costs of transport infrastructure
construction and maintenance also remain high in the UK.

1.
Introduction

In May
2012, the Commission proposed a set of country-specific recommendations (CSRs)
for economic and structural reform policies for the United Kingdom. On the
basis of these recommendations, the Council of the European Union adopted six CSRs
in the form of a Council Recommendation in July 2012. These CSRs concerned
growth-friendly fiscal consolidation, housing, youth employment, education and
training, welfare reform and childcare, access to finance and infrastructure. This
Staff Working Document (SWD) assesses the state of implementation of these
recommendations in the UK.

The SWD
assesses policy measures in light of the findings of the Commission’s Annual Growth Survey 2013 (AGS)[1] and
the second annual Alert Mechanism Report (AMR)[2], which were published
in November 2012. The AGS sets out the Commission’s proposals for building the
necessary common understanding about the priorities for action at national and
EU level in 2013. It identifies five priorities to guide Member States to
renewed growth: pursuing differentiated, growth-friendly fiscal consolidation;
restoring normal lending to the economy; promoting growth and competitiveness
for today and tomorrow; tackling unemployment and the social consequences of
the crisis; and modernising public administration. The AMR serves as an initial
screening device to determine whether macroeconomic imbalances exist or risk
emerging in Member States. The AMR found positive signs that macroeconomic
imbalances in Europe are being corrected. To ensure that a complete and durable
rebalancing is achieved, the UK and 12 other Member States were selected for a
review of developments in the accumulation and unwinding of imbalances[3].

Against
the background of the 2012 Council Recommendation, the AGS and the AMR, the UK presented updates of her national reform programme (NRP) and of her convergence programme
on 30 April 2013. These programmes provide detailed information on progress
made since July 2012 and on the future plans of the government. The information
contained in these programmes provides the basis for the assessment made in
this Staff Working Document.

The NRP and the convergence programme outline in an integrated
manner the UK’s fiscal consolidation efforts, key structural reforms and
reforms that underpin macroeconomic stabilisation. The NRP does not include
the national targets envisaged under the Europe 2020 framework, except for the
target on renewable energy, in line with Directive 2009/28/EC. Instead, it describes indicators of performance in areas connected
to the Europe 2020 headline targets and records their current level[4]. The lack of quantitative targets makes it difficult to assess
reforms, in particular whether policy efforts are adequate and whether they
will be implemented promptly enough.

The policy content of the UK NRP and convergence programme is drawn
exclusively from previous announcements and publications, mainly the Autumn
Statement 2012, Budget 2013, and the Office for Budget Responsibility’s (OBR) Economic
and fiscal outlook, as well as other publicly available documents and data. In
parliamentary debates on the convergence programme, the government underlined that
it contained no new information and that no additional costs were incurred. The
government defended its decision not to fully align the convergence programme
with guidance provided by the Commission, noting timetable constraints related
to the UK financial year and Budget.

Stakeholder engagement events were held in Scotland and Wales, attended by representatives of
the UK government, the European Commission, devolved administrations and other
stakeholders. However, there is no evidence of significant stakeholder input in
the development of the NRP itself. Since the NRP draws on publicly available
information, it is not subject to formal consultation. The NRP is illustrated
with examples of how stakeholders are involved in the delivery of policies. The
UK NRP includes information on the policy programmes of the devolved
administrations in addition to UK-level information. As in previous years, the
Scottish Government also submitted a separate NRP to set out its policy
strategy in more detail.

The House of Commons debated the country-specific recommendations
addressed to the UK on 25 June 2012. The convergence programme was approved by
the UK Parliament following debates in the House of Commons and the House of
Lords. The 2013 NRP has not been debated by Parliament. The House of Lords EU
Committee has asked that the NRP be covered in the annual debate on the
convergence programme, but the government has rejected this on the basis that
there is no legal obligation and no precedent. The House of Commons European
Scrutiny Committee and the House of Lords debated the AGS.

Overall assessment

The
analysis in this SWD leads to the conclusion that the UK has made some progress on measures taken to address the CSRs of the Council Recommendation. To date, these reforms have only been partially implemented and
progress in improving relevant outcomes has been limited.

While
the UK government has stuck to its fiscal consolidation strategy, progress in
reducing the structural deficit has stalled in 2012-13 in a context of weak GDP
growth. The UK deficit for 2013-14 is forecast to be 6.9 %, one of the
highest in the EU. Fiscal consolidation therefore remains a pressing challenge
for the UK, and needs to be balanced with fairness and growth-promoting
investment.

The
challenges identified in July 2012 and reflected in the AGS remain valid. To
provide the conditions for sustainable, investment-led growth, the UK needs to both maintain macroeconomic stability and succeed in reforms to address the UK economy’s structural weaknesses.

The
policy plans submitted by the United Kingdom address almost all the challenges
identified in last year's Staff Working Document, and broad coherence between
the two programmes has been ensured. The national reform programme confirms the
United Kingdom's commitment to address shortcomings in the areas of the
financial sector and the labour market. The NRP sets out the significant
progress the government has made in designing and legislating for an extensive
reform agenda across financial regulation, spatial planning, education and
welfare. The reforms are relevant and ambitious in their stated aims, but in
most cases it is not yet clear how far they are likely to be effective in
addressing difficult challenges. Successful implementation will be key and many
of the impacts will be gradual. To date, indicators related to the CSRs on
housing, access to finance and infrastructure show stagnant or deteriorating
investment. These trends are largely linked to the challenging economic
environment, but in the cases of capital investment and welfare reform, other
government spending cuts run counter to the stated aim of headline policy initiatives.
Necessary reforms to secure financial stability are also constraining access to
credit. Employment has been surprisingly resilient, but skills gaps remain. Working
age poverty rates could increase due to real terms benefit cuts.

The
convergence programme demonstrates the United Kingdom's commitment to improving
the budgetary position and ensuring the long-run sustainability of public
finances.

2.
Economic developments and challenges
2.1.
Recent economic developments and outlook

Recent economic
developments

The UK has experienced a subdued and stuttering recovery from the financial crisis. As
of the first quarter of 2013, the level of real UK GDP was nearly 3 % below the pre-crisis peak five years
earlier in the first quarter of 2008 (real per capita GDP is approximately 6 % lower). Over the course of 2012, the
picture for growth in the UK was bleak, and the economy entered recession in
the first half of the year. Growth was markedly volatile, with an extra bank
holiday in the second quarter of the year being offset by the boost from the London
Olympics contributing to growth of +0.9 % in the third quarter. This was followed by negative growth of -0.3 % in the final quarter of 2012 but the
UK avoided a ‘triple dip’ recession by posting growth of 0.3 % in the first quarter of 2013.
Overall, the UK economy is suffering from a lack of investment and extremely
weak exports coupled with quite resilient imports. The UK’s net investment income also fell sharply in 2012. Growth in 2012 came entirely from
domestic demand, namely, household consumption, with some help from government
expenditure. Investment growth showed positive signs in the first half of the
year but this petered out in the second half, when annual growth was positive,
but very weak.

The government’s
on-going fiscal consolidation plan continues to attract much focus as despite
an adherence to departmental expenditure limits (DELs), borrowing has not
fallen by as much as expected, linked in part to weaker growth. Consequently,
the fiscal deficit remains high. Tax receipts over 2012 were less buoyant than
anticipated, and there was higher spending from the part of government spending
that allows the automatic stabilisers to operate, Annually Managed Expenditure
(AME).

Inflation
has generally been on a downward trend since September 2011, when it peaked at
5.2 %, but in recent
months, the trend has been reversed. Inflation was 2.8 % in both February and March 2013, up from 2.7 % in each of the previous four months
and 2.2 % in September
2012. However, the increase in October was due to a rise in university tuition
fees in England, and utility prices kept inflation from falling in December.
Increases in utility prices were also the main source of the further rise in inflation
in early 2013. Higher inflation curtails household consumption and increases
inflation-linked government expenditure items, thereby leading to rises in AME.
Inflation has now been above the Bank of England’s target of 2 % continuously for three years,
implying negative real interest rates on 10-year government bonds.

Unemployment
has been falling in each quarter since the end of 2011, when it peaked at 8.3 %, to reach 7.8 % in early 2013[5].
Overall, the rate of unemployment for 2012 was 7.9 %. The strength of the labour market has been surprising, given the
weakness in GDP. It can be explained partly by a strong rise in self-employment
and part-time work, and also under-employment. Labour hoarding is less likely
to be the cause the longer this phenomenon continues although the lower price
of labour relative to the price of capital may play a role. Nominal wage growth
was weak throughout 2012, with stubbornly high inflation, so real wage growth
remained negative.

Productivity
growth has been very weak in the UK since the start of the financial crisis. As
well as weak investment, there is evidence of a lack of the economic restructuring
needed to foster competition and innovation in the economy, and it is important
that this does not become entrenched.

Economic
outlook

According
to the 2013 Commission spring forecast, UK GDP growth is forecast at 0.6 % in 2013 and 1.7 % in 2014. Private consumption and investment
should improve gradually over the year, into 2014, as uncertainty fades and
credit constraints ease further. Inflation is set to remain high through 2013,
averaging 2.8 %, before
falling back through 2014 to 2.5 %. The fall in inflation is likely to occur later and to be smaller
than previously forecast, due mainly to higher utility prices. Private consumption
is forecast to grow by 0.8 % and 1.3 %,
and investment is expected to rise by 1.8 % and 4.5 % in
2013 and 2014 respectively. Net exports are not expected to contribute
positively to growth in 2013, as growth in the UK's main export markets remains
weak. Net exports are expected to contribute 0.4 pp. to GDP growth in 2014, with UK exports expanding at a modest
rate as economic activity in the UK’s main trading partners picks up and the
value of sterling remains low. Unemployment may have bottomed out and it is
expected to remain relatively stable over the forecast horizon, averaging 8.0 % in 2013 and 7.9 % in 2014.

The
Commission’s estimates for overall GDP growth are similar to those of the
Office for Budget Responsibility (OBR) outlined in the Convergence Programme (0.6 % and 1.8 % for 2013 and 2014 respectively). The Commission’s forecast of the
expected drivers of growth is similar to that of the OBR, although in 2013 the
Commission forecasts a slightly larger contribution from private consumption,
and a smaller contribution from investment.

The UK NRP
does not directly quantify the likely impact of structural reforms on economic
growth. The macroeconomic scenario in the NRP is based on the forecast produced
by the independent OBR, which does incorporate the OBR’s assessment of the
likely impact of government policies on growth[6].
The OBR has tended to note the upside potential of the government’s structural reform
agenda on growth, but has been cautious about changing its growth forecast significantly
until the impact of reforms is seen in the data. The government has an
extensive reform agenda across financial regulation, spatial planning, education
and welfare, which is relevant and ambitious in its stated aims, but in most
cases, it is not yet fully clear how effective the reforms will be. As headline
indicators related to the CSRs on housing, access to finance and infrastructure
are either stagnant or deteriorating, the approach that the OBR has taken is
appropriate.

2.2.
Challenges

The UK
faces tensions between a need for deleveraging, maintaining financial stability,
and the need to avoid compromising investment and growth. In the short to medium term, fiscal consolidation needs to be
balanced with fairness and growth-promoting investment. To provide the
conditions for sustainable, investment- and export-led growth, the UK also
needs to address the economy’s structural weaknesses, including a lack of
housing supply, a persistently weak net export position, skills gaps, and a
need to renew and upgrade transport and energy infrastructure.

Fiscal
consolidation remains a priority for the UK.
Government debt as a percentage of GDP rose from 56.2 % in 2008-09[7] to 90.7 % in 2012-13[8]. The government is implementing a fiscal consolidation plan that has reduced the deficit from 11.5 % in 2009-10 to 5.6 % in 2012-13, although the 2012-13 deficit would have been approximately
7.6 % without one-off
revenues. The one-offs are a transfer of the Royal Mail
pension fund worth 1.8pp. of GDP, and the sale of the 4G mobile phone licence
spectrum. While the UK government has stuck to its
fiscal consolidation strategy, the structural deficit only improved by 0.3 pp. between 2011-12 and 2012-13. The deficit is now expected to fall more slowly than previously
envisaged, due to weaker medium-term growth prospects. The
deficit is forecast at 6.9 % in 2013-14 and 6.1 % in 2014-15. Total public investment remains low, following sharp
cuts in 2011, and the UK has a challenge to achieve differentiated,
growth-friendly fiscal tightening.

Corporate
debt remains quite high, but investment is low, and many firms are having
difficulty accessing adequate funding for investment. Total private debt stood at 206 % of GDP at the end of 2011,
above the euro area average of 164 %. The stock of UK corporate debt is rather
high yet some firms are having difficulty accessing credit and business
investment remains at very low levels. An unprecedented drop in business
investment after 2007 caused gross fixed capital formation to fall to 14.2 %
of GDP in 2012. This is the third lowest level in the EU-27. More specifically,
the UK has a low level of business expenditure on R&D, which fell from 1.17 %
of GDP in 2001 to 1.09 % in 2011[9].
Business investment has started to pick up slightly, with an annual increase of
4.9 % in 2012, but remains low. Net lending to the corporate sector remained
negative in 2012. While larger firms with strong balance sheets are able to
borrow at a historically low cost, and there are signs of less-than-viable
companies being kept in business through low interest rates and bank
forbearance, many other firms, particularly SMEs, are having difficulty
accessing credit. Access to non-bank lending remains largely restricted to
bigger firms, and competition in the banking industry is still limited.

There
is a continued challenge to deliver the housing that people need, and to ensure
that the housing market and household debt are not a source of macroeconomic
instability. As set out in Box 1, the high level of
household debt constitutes an internal imbalance in the UK economy. Household
deleveraging continued in 2012, but it may not be sustained once the economy
improves and housing transactions return to more normal levels, given that house
prices remain high in the context of a housing shortage and low levels of
residential construction.

The
UK’s persistently weak net export position reflects a lack of external
competitiveness. The UK’s current account position
saw a gradual and structural deterioration from the late 1990s until the onset
of the financial crisis. A large goods trade deficit persisted despite the
depreciation of sterling in 2008, and the net trade outturn for 2012 was surprisingly
poor, driven by weaker net exports and a fall in net investment income. As set
out in Box 1, while some rebalancing of the economy towards external demand is
forecast over the next few years, to make sustained improvements to its goods
trade balance, the UK needs to do more to successfully confront structural
challenges in the areas of transport infrastructure, skills and access to
finance.

The
UK has significant unemployment and underemployment, especially among the young. Unemployment stood at 7.8 % at the start of 2013[10] and is
expected to remain broadly flat through 2012 and 2013. Youth unemployment, at 20.7 %[11], and the
NEETS rate, 14.0 %[12],
are much higher. Growth in private sector employment was surprisingly strong in
the last year, given the weakness of GDP growth. Productivity and real wages
have remained weak. Many people, especially young workers, are in precarious part-time
or temporary jobs. Long-term unemployment was 2.8 % of the working-age
population in Q4 2012[13].

The
UK also faces on-going challenges to improve access to high quality, affordable
childcare, to increase parental employment and to combat poverty. At 17.3 %[14]
the proportion of UK children living in workless households is the second
highest in the EU. A lack of access to suitable, affordable childcare still
discourages many parents from working, or from increasing the number of hours
they work. It is likely that poverty among those of working age will increase
in coming years, due to cuts in the real value of benefits.

The
UK has too many low-skilled workers, and a shortage of workers with
high-quality vocational and technical skills. Despite
some progress in recent years, a significant minority of young people continue
to leave secondary education without the skills and qualifications they need to
compete successfully in the labour market. Early school leaving remains
slightly above the EU average. Vocational education and training policy has
been too focused on basic skills and relatively low-level qualifications, while
the economy increasingly demands more advanced qualifications.

The
UK needs to renew and upgrade its energy and transport infrastructure. The UK needs substantial investment in new electricity generation
capacity by 2020, and has a low share of energy from renewable sources. Regulatory
certainty will be required to facilitate adequate and timely investment. Shortcomings
in the capacity and quality of the UK’s transport networks are a structural
problem for the economy, especially for goods producers, distributors and
exporters. There is currently a significant gap between committed funding,
public and private, and the pipeline of transport investment needs. Unit costs
in transport construction and maintenance also remain high in the UK. The UK also
has a challenge ahead if it is to deliver additional hub airport capacity.

Box 1. Summary of the 2013 in-depth review (IDR) under the
Macroeconomic Imbalances Procedure (MIP)

The second in-depth review of the UK
economy concluded that the UK is experiencing macroeconomic imbalances, which
deserve monitoring and policy action. In particular, macroeconomic developments
in the areas of household debt, linked to the high levels of mortgage debt and
the characteristics of the housing market, as well as unfavourable developments
in external competitiveness, especially as regards goods exports and weak
productivity growth, continue to deserve attention.

The main findings of the review were
the following:

• The UK is confronted with the twin
challenge of sustaining pre-crisis dynamism in service exports and boosting the
underlying drivers of productivity in the industrial sectors to regain the
external competitiveness that was partly eroded in the pre-crisis years. The UK
experienced a large drop in export market shares from 2007 to 2010 and the
trade balance has been negative since 1997, mainly as a result of a chronic
deficit in goods trade. Nevertheless, export volumes have been a modest net
driver of growth in the UK economy in the crisis period. External performance
in 2012 was worse than anticipated, driven by weaker net exports and a fall in
net investment income. The current account is, however, expected to move
towards a more balanced position in the medium term.

• Many of the drivers of the UK’s
persistent trade deficit relate to structural weaknesses that have a disproportionate
impact on capital-intensive sectors and goods producers. As regards transport
infrastructure, there is evidence of shortages in airport and seaport capacity.
Road congestion is a problem, and there are identified investment needs in the
rail network. As regards technical skills, evidence suggests that gaps and
recruitment difficulties persist in manufacturing sectors. Finally, access to
finance is crucial for UK firms seeking to enter or expand in exporting
sectors. Difficulties in accessing finance are a cross-cutting problem at present,
particularly for smaller and younger companies.

• The UK faces tensions between the
needs for deleveraging, maintaining financial stability and the need to avoid compromising
investment and growth. Household debt is currently falling, largely due to low
levels of new mortgage lending, but it is likely to remain at a high level. Low
interest rates and forbearance mask risks associated with a minority of
over-indebted households. The stock of UK corporate debt is quite high and
there are signs of less-than-viable companies being kept in business through
low interest rates and bank forbearance, while other firms are having
difficulty accessing adequate funding for investment.

• A shortage of housing in the UK increases the risk of persistent imbalances related
to high house prices and household debt. There have been attempts to liberalise
the spatial planning laws but the planning system continues to be an important
constraint on the supply of housing, including through tight restrictions on
development in many parts of the country. The UK property tax system combines a
regressive recurring tax (Council Tax) with a progressive transaction tax
(Stamp Duty Land Tax). Council Tax is based on outdated valuations and undeveloped
land with planning permission is not currently subject to recurrent taxes. This
system may not provide adequate incentives to release land and properties onto
the market in a timely way. Most tenants do still not see long-term private
renting as an attractive option, and rental contracts do not typically offer much
security. The preference for home ownership increases the pressure on
households to take on high levels of mortgage debt.

3.
Assessment of policy agenda
3.1.
Fiscal policy and taxation

Budgetary
developments and debt dynamics

The
UK is continuing to implement its fiscal consolidation programme, which is designed
to have the cyclically-adjusted current balance in balance by the end of a
five-year rolling period, currently ending in 2017-18. This fiscal mandate is supplemented by a debt target whereby the
rate as a percentage of GDP should be falling by 2015-16. The UK does not set
an explicit medium term objective (MTO) in its convergence programme, but its
fiscal framework, set up in 2010, is a step towards compliance with the
Stability and Convergence Programmes (SCP) code of conduct, as it is designed
to bring the fiscal position close to balance over the medium term.

The improvement
in the headline balance foreseen in the 2012-13 convergence programme, which
covers the period 2011-12 to 2017-18, is insufficient for correcting the
excessive deficit by the deadline set by the Council on 2 December 2009. The programme, based on forecasts carried out by the UK’s OBR, envisages
an average improvement of approximately 0.9 pp per annum over the six-year
period. The programme projects that the excessive deficit procedure (EDP)
deadline set by the Council on 2 December 2009 of 2014-15 would be missed by
three years and estimates a deficit of 6.0 % of GDP in the deadline year. The convergence programme envisages
that the deficit will fall below 3 % only in 2017-18, three years after the deadline previously
recommended by the Council. On its current estimates, the deficit would fall to
5.2 % in 2015-16, 3.5 % in 2016-17 and 2.3 % in 2017-18.

The
planned deficit path is less favourable in the 2012-13 convergance programme
than it was in the 2011-12 programme. The
difference between the deficit forecasts of the two programmes is accounted for
by certain classification changes, one-off measures and a lower GDP forecast.
Growth had been estimated at 0.8 % in 2012, 2.0 %
in 2013 and 2.7 % in 2014.
These numbers were revised to 0.2 %[15],
0.6 % and 1.8 %, respectively.

The improvement
in the structural balance foreseen in the 2012-13 convergence programme is also
lower than what was recommended by the Council on 2 December 2009. The Council recommended an annual average improvement in the
structural balance[16]
of 1¾ % of GDP to the UK
between 2010-11 and 2014-15. By contrast, the adjusted fiscal effort undertaken
so far since the opening of the EDP (i.e. the three-year period between 2010-11
and 2012-13) averaged at just 1.0 % of GDP per annum. The UK’s nominal deficits imply an annual
average structural effort of 0.7 % over the final two years of the deadline to 2014-15.[17]

In
the Autumn Statement, published in December 2012, the government announced
fiscally neutral measures over the current parliamentary period (to 2015-16) with
increases in capital spending being offset by decreases in current expenditure. A subsequent year of fiscal consolidation to 2017-18 was also added,
following the previous addition of extra years. The main spending measures
introduced in the Autumn Statement were a GBP 5.5 billion (EUR 6.5
billion) capital package and support for long-term private investment to fund
new roads, science infrastructure and free schools, funded by savings from
welfare and departmental expenditure cuts, the creation of a Business Bank to
allocate GBP 1 billion (EUR 1.18 billion) of additional capital for small
firms, mainly those involved in exporting, and an increase of 2.5 % in the basic state pension. The main
taxation measures were a further 1 pp. cut in the main rate of corporation tax to 21 % from April 2014, an increase in the
personal income tax allowance by GBP 235 (EUR 275) to GBP 9 440 (EUR 11 110) from
April 2013, and a cancellation of the 3.02p per litre fuel duty increase that had
been planned for January 2013.

The
2013 Budget, published in March 2013, was also fiscally neutral as the
government continued with its consolidation strategy. The main expenditure items announced were an increase in capital
spending by GBP 3 billion (EUR 3.5 billion) per year from 2015-16, funded by
reductions in current spending, GBP 1.6 billion (EUR 1.9 billion) of funding to
support 11 sectors, including aerospace technology, cars and agri-technology,
as part of an industrial strategy, the introduction of a new housing scheme, ‘Help
to Buy’, designed to support those with small deposits who aspire to purchase a
property, the introduction of a single-tier state pension in 2016-17, the
cancellation of the fuel duty increase planned for September 2013 and a
reduction in beer duty by 1p on a pint of beer. The key taxation measures were
an additional 1pp. cut in the corporation tax rate to 20 % from April 2015, a GBP 2 000 (EUR
2 350) employment allowance to reduce employer national insurance
contributions, an increase in the personal income tax allowance of GBP 560 (EUR
660) to GBP 10 000 (EUR 11 800) in April 2014, and the introduction
of a new tax-free childcare scheme to support working families.

Box 2. Main measures

|| Main budgetary measures ||

|| Revenue || Expenditure ||

|| 2013-14 ||

|| · Corporation tax decrease to 23 % (-0.05 % of GDP) · Increase in personal income tax allowance to GBP 9 440 (EUR 11 100) (-0.07 % of GDP) · Duty changes overall (-0.15 % of GDP) || · Capital package (+0.2 % of GDP) · Help to Buy scheme (+0.07 % of GDP) ||

|| 2014-15 ||

|| · Corporation tax decreases to 21 % (-0.05 % of GDP) · Increase in personal income tax allowance to GBP 10 000 (EUR 11 800) (-0.07 % of GDP) · Employment allowance (-0.09 % of GDP) · Tax avoidance (+0.07 % of GDP) || ||

|| 2015-16 ||

|| · Corporation tax decrease to 20 % (-0.05 % of GDP) || · Capital spending (+0.2 % of GDP) ||

|| 2016-17 ||

|| || · Capital spending (+0.2 % of GDP) ||

|| 2017-18 ||

|| || · Capital spending (+0.2 % of GDP) ||

|| Note: The budgetary impact in the table is the impact reported in the programme, i.e. by the national authorities. A positive sign implies that revenue / expenditure increases as a consequence of this measure. ||

The
convergence programme shows that the deficit is estimated to increase from 5.6 % in 2012-13 to 6.8 % in 2013-14. This increase is due to the fact that two one-off items appear in
the fiscal figures of 2012-13 that account for a reduction of almost 2 pp. in the deficit. These are the
transfer of the Royal Mail pension fund (GBP 28 billion, EUR 33 billion) to the
government accounts and the sale of 4G mobile phone licences (GBP 2.3 billion,
EUR 2.7 billion). The deficit for 2014-15 is estimated at 6.0 %. Both deficits in the convergence programme
are similar to the Commission’s 2013 spring forecast, in which the deficits are
estimated at 6.9 % and 6.1 %, respectively. The difference is due
to the slightly lower growth rate in 2014 of 1.7 %, compared with the convergence programme’s 1.8 %. The outturns for the deficits in
2011-12 and 2012-13 were both lower than in the previous year’s convergence programme,
due to somewhat lower-than-expected borrowing and, for the latter year, the
transfer of the Asset Purchase Facility (APF) from the Bank of England to the
government accounts. The decision to transfer the APF to the general government
accounts entails a reduction in the deficit over a number of years, but a
potential increase in the deficit in subsequent years. As quantitative easing
is unwound, the government would be liable for capital losses related to its bond
holdings.

The
consolidation programme outlined in the Spending Review 2010 and implemented
since then front-loads the taxation measures. At
the end of 2012-13, approximately 70 % of the annual fiscal consolidation planned for the Spending Review
2010 period (from 2010-11 to 2014-15) had been implemented, including 90 % of the planned tax increases and 65 % of the planned expenditure
reductions. For the last two years of the Spending Review period, over 90 %
of the further net consolidation planned is in the form of spending cuts. By
2015-16, the share of spending reductions in the total of consolidation measures
that have been undertaken is foreseen at 80 %.

Box 3. Excessive deficit procedure for the
United Kingdom

On 8 July 2008, the Council decided that an excessive deficit
existed in the United Kingdom. The most recent Council Recommendation under
Art. 126(7) TFEU in conjunction with Article 126(13) thereof was adopted on 2
December 2009. The Council recommended that the UK authorities should put an
end to the present excessive deficit situation by 2014-15.

The United Kingdom authorities should bring the general government
deficit below 3 %
of GDP in a credible and sustainable manner by taking action in a medium-term
framework. Specifically, to this end, the United Kingdom authorities should:
(a) implement the fiscal measures in 2009-10 as planned in the 2009 Budget,
avoiding further measures contributing to the deterioration of public finances,
and start consolidation in 2010-11 in order to bring the deficit below the
reference value by 2014-15;(b) to this end ensure an average annual fiscal
effort of 1¾ % of
GDP between 2010-11 and 2014-15, which should also contribute to bringing the
government gross debt ratio back on a declining path that approaches the
reference value at a satisfactory pace by restoring an adequate level of the
primary surplus; (c) further specify the additional measures that are necessary
to achieve the correction of the excessive deficit by 2014-15, cyclical
conditions permitting, and accelerate the reduction of the deficit if economic
or budgetary conditions turn out better than currently expected. In addition,
the United Kingdom authorities should seize opportunities beyond the fiscal
effort, including from better economic conditions, to accelerate the reduction
of the gross debt ratio back towards the reference valueand ensure that its
revised fiscal framework limits the risks to the adjustment and, after the
excessive deficit has been corrected, underpins sustained budgetary
consolidation. Finally, the Council invited the United Kingdom authorities to
implement reforms with a view to raising potential GDP growth, including
reforms conducive to enhancing the quality of public finances, in particular
those consistent with achieving expenditure efficiency savings.

An overview of the current state of excessive deficit procedures, including additional steps adopted after this finalisation of this Staff
Working Document, is available on: http://ec.europa.eu/economy\_finance/economic\_governance/sgp/deficit/index\_en.htm
(please refer to country sections at the bottom of the page).

The
general government debt ratio has been increasing steadily for more than a
decade, with the largest annual jump taking place between 2008-09 and 2009-10
due to financial interventions in the banking sector. The convergence programme envisages that the debt ratio will peak
above 100 % in 2015-16 and
2016-17 before reversing the trend. The Commission’s spring forecast also
predicts an increasing debt ratio to 2014-15, reaching 98.7 % that year. The slightly higher debt
rate of the Commission forecast is due to the marginally lower than expected
growth rate. This means that the supplementary debt target that was introduced
as part of the new government’s fiscal rules, based on public sector net debt,
is now set to be breached, according to the OBR forecast. The rule aimed to put
debt on a downward trajectory in 2015-16, but it is now unlikely to start
declining until 2017-18. Medium-term debt projections
(see Graph below Table V in annex) indicate that full implementation of the
programme could put debt on a downward path by 2020, although it would still be
above the 60 % of GDP reference value.

Long-term
sustainability

The
United Kingdom does not appear to face a significant risk of fiscal stress in
the short term, but there are some indications of future fiscal sustainability challenges. Sustainability risks appear to be high in the medium and long term.
The latter is influenced by the costs implied by an ageing population. It is
therefore appropriate for the UK to continue to implement measures that reduce
risks to fiscal sustainability in the short term, and to enable government debt
to be reduced. Moreover, containing age-related expenditure growth further
would contribute to the sustainability of public finances in the long term. In
January 2013, the government published a bill to introduce a single-tier
pension in 2016-17. This will end contracting out of the State Second Pension
so that everyone has access to the same pension and pays the same rate of
National Insurance Contributions (NICs). In addition, private social care costs
for the elderly are to be capped at GBP 72 000 (EUR 85 000) per person from
April 2016.

Long-term
expenditure projections for healthcare indicate an expected increase in healthcare
expenditure of 1.1 pps of GDP by 2060. In addition,
while UK life expectancy is slightly above the EU average, infant mortality and
the share of people reporting a long-standing illness or health problem are
above the EU average. The UK has seen a large increase in healthcare funding in
recent years, but the outlook for health spending is tighter in coming years[18]. Efforts could
therefore be pursued in the healthcare sector to improve the productivity and cost-effectiveness
of the system, to avoid reductions in access and to improve the quality of
healthcare. The government’s current plans for health service reform (in NHS
England) entail ambitious targets for efficiency gains that the government
plans to attain via reductions in management and administration staff,
encouraging greater involvement of the private sector and devolving budgets and
decisions down to local areas. Further action could include improving e-health
mechanisms for monitoring activity and quality, performance-related payment, stepping
up information to promote health, and disease prevention[19].

Fiscal
framework

The
UK government introduced a new fiscal framework after taking office in May 2010,
and is currently off-track against its own debt sustainability target. The independent Office for Budget Responsibility (OBR) is tasked
with producing official economic and fiscal forecasts and assessing whether the
chances of the government meeting the fiscal mandate and debt sustainability
rule are greater than 50 %.
In its latest assessment (March 2013 Economic and Fiscal
Outlook), the OBR concluded that the government remains
on course to meet the fiscal mandate. This requires the cyclically-adjusted
current budget to be on track to be in balance by the end of a rolling five-year
forecast period, currently ending in 2017-18. However, the OBR forecasts that
the government will miss the debt sustainability target by two years. The debt
sustainability target requires public sector net debt as a percentage of GDP to
be falling by 2015-16.

The
UK does not set an explicit medium-term objective to comply with the code of
conduct of the Stability and Convergence Programme (SCP). Furthermore, the UK authorities’ definitions of national debt and
deficit targets differ from those in the Maastricht Treaty. The national
deficit target refers to the cyclically-adjusted current account balance,
excluding financial interventions, whereas the excessive deficit procedure
(EDP) deficit is defined as general government net borrowing, including
investment expenditure and interest from swaps and forward rate agreements. The
national authorities’ debt target is defined in net terms, whereas the EDP
refers to gross debt.

The UK’s
most recent Spending Review was published in 2010 and it set out its spending
plans until 2014-15; the next Review will be in June 2013. The Spending Review sets out
multi-annual limits for predictable spending in every department through
Departmental Expenditure Limits (DELs). The remainder of spending, mainly
social security, debt interest payments, public sector pensions and EU
contributions, is classified as Annually Managed Expenditure (AME) and has not
historically been capped in advance. In its 2013 Budget, the government
announced that in future, it will introduce a firm limit on a significant
proportion of AME, including some welfare payments.

Tax
system

Since
the 2012 European Semester, tax measures have been taken in the direction of
the AGS priorities and a 2012 Council Recommendation for the UK to deliver
differentiated, growth-friendly fiscal consolidation. The standard corporate income tax rate has already been reduced by
a total of 5 pp. from 28 %
to 23 % since 2010, and
will be reduced by a further 3 pp. to 20 % by April 2015. In order to promote investment by SMEs, the Annual
Investment Allowance for plant and machinery has been increased for two years
from April 2013, although this follows earlier cuts to investment allowances.
Recent increases in the annual allowance in the personal income tax mean that
2.4 million people have now been taken out of the income tax system. The
government has also introduced measures to combat tax evasion and fraud,
including the UK’s first General Anti-Abuse Rule.

No significant
reforms have been carried out in relation to the property taxation element of
the 2012 Council Recommendation on housing. UK
property tax revenues as a share of GDP (4.2 %) are double the EU average. The UK system combines a regressive
recurring tax (Council Tax) with a progressive transaction tax (Stamp Duty Land
Tax or SDLT). There are two problems with the current Council Tax system. First,
the system is based on outdated property valuations (which are linked to the
price of housing of 1991), and second, it is regressive as households owning property
in the lower valuation bands pay more tax in proportion to the value of their
house than properties in higher valuation bands. Undeveloped land with planning
permission is currently taxed on sale or transfer, but not recurrently on its
annual economic value, which can encourage land value speculation, rather than
timely residential construction.

The UK’s
total tax-to-GDP ratio (36.1 % in 2011) is slightly below the EU-27 weighted average, and there
is scope to raise revenue by broadening the base of existing taxes. While taxation of labour as a share of GDP and the implicit tax
rate on labour are relatively low by EU standards, the UK has high levels of
tax expenditure in relation to personal income tax[20]. In 2010-11,
over half of the GBP 33 billion (EUR 39 billion) allowances for savings into
pension schemes were claimed by higher-rate taxpayers.

The
UK standard VAT rate was increased to 20 % in April 2011 but there is significant scope for reducing the
number of goods and services to which non-standard VAT rates apply. While total UK revenues from VAT are around the EU average, the UK
ranks 22nd in the EU in terms of actual VAT revenues collected as a
percentage of theoretical revenues at standard rates (46.5 % in 2011). The VAT base was widened
very marginally in Budget 2012. The UK currently has a reduced rate of 5 % for domestic gas and electricity and
a limited number of other goods and services. A zero rate applies to a broad
range of goods such as food, books, children’s clothes, water supply and
sewerage services to domestic customers. Though overall UK environmental tax
revenues are above the EU average, the reduced VAT rate for domestic energy
consumption provides a substantial subsidy to fossil fuel consumption, which is
not targeted at low-income households. This has the effect of lessening
pressure to reduce domestic energy consumption (mostly home heating) through
energy efficiency measures. The Mirrlees Review[21] concluded that
a comprehensive broadening of the VAT base would benefit the economy and could
raise a net GBP 3 billion (EUR 5 billion) of tax revenue[22], even after using
the tax-benefit system to compensate households, especially poorer households,
for the increase in their cost of living. The Mirrlees Review also proposes an
alternative reform which is redistributional (i.e. compensates only poorer
households) which would raise a net GBP 10 billion (EUR 11.8 billion). However,
the report points out that this reform could reduce incentives to work.

3.2.
Financial sector

The
UK banking and financial sector has returned to relative stability, but has not
yet fully recovered from the impact of the crisis. The
UK financial sector underwent a period of turmoil because of the 2008 financial
crisis, which led the government to inject public funds into a number of
systemically important UK banks to guarantee their solvency and liquidity.
Despite higher bank capitalisation levels, the flow of credit to the corporate
sector remained negative in 2012, and many SMEs are facing credit constraints. In
2012, the Council Recommendations for the United Kingdom included a CSR
concerning improvements needed in the availability of financing, especially for
SMEs, promoting the non-bank lending channel, and increasing competition in the
banking sector.

The UK
has made some progress on measures taken to address the 2012 CSR on improving
access to finance, non-bank lending and bank competition. The challenge for the financial sector to support private sector
investment and growth more effectively remains. Although the government has put
in place a number of schemes designed to increase lending, net lending to firms
continued to be negative in 2012, while net lending to households remained
depressed[23].
Many firms, especially SMEs, are still having trouble obtaining credit to
finance investment. Post-crisis loan rejection rates for SMEs have increased
markedly compared to the pre-crisis period[24]. It is not clear
when and to what extent private investment will pick-up, so the flow of credit
may remain constrained until broader economic conditions improve. Corporate credit
conditions have improved somewhat since the second half of 2012, but less so
for smaller companies[25].

Monetary
policy has struggled to re-establish the flow of credit, even as it continues
to venture into unconventional territory. In 2012,
the Bank of England activated the Extended Collateral Term Repo Facility,
expanded the quantitative easing programme by GBP 50 billion (EUR 59 billion) to
GBP 375 billion (EUR 440 million) and introduced the Funding for Lending Scheme
(FLS) which seeks to incentivise lending by reducing the funding costs of banks
and building societies. In April 2013, the FLS was extended by one year to
2015, and partially redesigned to incentivise lending to SMEs. Preliminary
evidence suggests that the FLS has contributed to an increase in mortgage
lending, but has so far been less successful in boosting corporate lending,
particularly to SMEs.

The
government has announced or put in place a range of initiatives to promote
access to finance. In December 2012, it pledged GBP
1 billion (EUR 1.18 billion) in capital to a new Business Bank to support the
provision of long-term loans to SMEs via existing financial institutions. While
plans are still under development, the Business Bank will enable the
consolidation of numerous existing initiatives promoting access to finance under
a single institution, which should raise the awareness of SMEs and help them navigate
through the various schemes. The government also published its progress report
on the implementation of the recommendations of the Breedon review on SME
access to non-bank finance in November 2012. Peer-to-peer lending is expanding,
as is supply-chain financing by larger companies and platforms that allow the
exchange of receivables for cash. All these alternatives to bank lending are,
however, still small-scale, and SME funding continues to rely extensively on
bank lending and internal sources.

The
difficulties for many firms in accessing finance appear to be due in part to
the persistent lack of competition in the banking sector. The four main players cover more than 80 % of the market, and there are only tentative signs of other players
increasing their presence in the corporate credit market. The Independent
Commission on Banking recommended the creation of a strong challenger bank
through the divestiture of assets belonging to Lloyds Bank, which is partly
owned by the government. However, the planned divestiture of 632 branches,
which is also required to comply with state aid decisions, has yet to take
place. Also, the government-controlled Royal Bank of Scotland has yet to reach
an agreement with potential buyers that would allow it to meet the branch
divestiture deadline set by state aid rules. The UK authorities have sought to
decrease barriers to entry by easing capital requirements for bank start-ups
and accelerating the authorisation process. Further options to help to increase
bank competition include facilitating access to shared databases and standard
risk models, so as to lower costs for smaller banks, and to introduce full bank
account portability to decrease switching costs.

Current
bank capitalisation levels, though nominally adequate, may not reflect a
sufficiently prudent calculation of risk weights and provisions for expected
losses. The aggregate core tier 1 capital ratio of
the UK banking sector compares favourably with other EU countries, the share of
non-performing loans is relatively small, and credit default swap spreads on UK
banks remain contained. There is, however, evidence of continued bank
forbearance in the post crisis-period, with respect to both corporate and
household debt. Corporate insolvencies have remained low in the UK although
many more companies are making losses. Also, R3, the insolvency industry trade
body, found that a large and rising number companies are only able to pay the
interest on their debt but do not see a prospect of being able to pay back the
principal. Though this provides some immediate support to the economy, it could
store up hidden risks in banks’ balance sheets and delay necessary structural
adjustments in the economy. Proper implementation of the Financial Policy
Committee’s recommendations[26]
on prudent reckoning of bank capital requirements and on addressing identified
capital shortfalls without hindering lending to the economy should help
reinforce the financial stability of the UK banking system.

3.3.
Labour market, education and social policies

Employment
has risen despite the lack of significant GDP growth, productivity growth is
weak, and skills gaps persist. The UK’s flexible
labour market has few large collective bargaining arrangements outside the
public sector, which has seen widespread pay freezes, and very little automatic
wage indexation. Real wages have been falling for three years, which has had a
negative impact on household consumption, but helped to support employment. The
overall unemployment rate is 7.8 %[27]
though youth unemployment and the NEETs[28]
rate remain substantially higher. Many people, especially young workers, are in
precarious and often involuntary part-time or temporary jobs. The challenge of
providing sustainable employment, especially for young people, is complicated
by two factors: the UK has too many low-skilled workers, for whom demand is
falling, and a shortage of workers with high-quality vocational and technical
skills. The UK also faces on-going challenges to improve access to high-quality,
affordable childcare, raise parental employment and combat poverty. The
percentage of the population at risk of poverty or social exclusion fell from
23.1 % in 2010 to 22.7 % in 2011, slightly below the EU
average, but this fall was partly explained by a fall in the poverty threshold
due to falling real median income. In 2012, the Council Recommendations for the
United Kingdom contained CSRs concerning welfare reform, poverty and childcare,
youth employment, and improving vocational education and skills provision.

Employment,
welfare reform and social inclusion

The
UK has made some progress on measures taken to address the 2012 CSR on welfare
reform, poverty and childcare. Early evidence on
the impact of the new Work Programme for the unemployed is disappointing, but
the programme is still at an early stage, and it is essential to provide
appropriate support for those who are likely to find it particularly difficult
to gain employment. The UK authorities have introduced a wide range of policies
to address unemployment, especially youth unemployment, including the Work Programme
and the Youth Contract (discussed below). The Work
Programme was launched in April 2011 and seeks to provide people further from
the labour market with relevant work experience and skills. Early results from
the Work Programme[29] show that the total number of jobs gained
by participants is below target, many of these jobs are part time, and a
significant proportion has not turned out to be sustainable. While the early
evidence is not definitive, it does suggest there is scope for refining the
design and contracting of the Work Programme to improve outcomes for
harder-to-help clients.

The
introduction of Universal Credit in place of existing working age benefits should
be a positive step, with its focus on simplifying benefits and improving work
incentives. Weak work incentives have been a
long-running problem for the UK, particularly the high marginal benefit
withdrawal rates for those moving off benefits into low-paid jobs. Most
means-tested out-of-work benefits and in-work tax credits for working adults
(Income Support, income-related Jobseeker’s Allowance and Employment and
Support Allowance) are to be replaced by a single benefit, Universal Credit, as
set out in the Welfare Reform Act 2012. The new system will allow individuals
to keep more of their income as they move into work, and will introduce a slower
withdrawal rate (65 %) of
benefits when they increase their earnings.

However,
the net impact of Universal Credit on employment will depend on effective
implementation and support services. While improved
incentives for households to accept some work should help to reduce the high
level of workless households, the structure of the new system could induce some
second earners to reduce their hours or to stop work. The government’s stated
intention is to introduce more work search conditionality into Universal Credit
in future, to mitigate these risks, but as yet there are no clear plans for
when or how this might be done. It will also be important to get the delivery
of Universal Credit payments right, as delays and errors could cause severe
short-term poverty and lead to scepticism and risk aversion among people
looking to move off benefits and into work. Universal Credit is currently being
piloted and is due to be rolled out for new claimants in stages from late 2013,
with all existing claimants being transferred to the new system by the end of
2017. The government recognises the implementation risks and has indicated that
it is willing to adapt the timetable if necessary.

Poverty,
including child poverty, is likely to increase due to cuts in real terms in welfare
payments for those of working age. As set out in the
Welfare Benefits Up-rating Act, many working-age benefits and tax credits will
be increased by 1 % a year
from 2013 until 2016. This is below the projected inflation rate so it means
three years of cuts in real terms. Most working-age households receiving state
support will be affected, but the poorest households will see the biggest proportionate
fall in their incomes. A range of other reforms to welfare benefits were also
introduced in April 2013. One element is a benefit cap, being rolled out from
April 2013, which limits maximum weekly benefit payments to GBP 500 (EUR 590) for
families, or GBP 350 (EUR 410) for single adults who do not have children or
whose children do not live with them. This will primarily affect larger
families living in areas with high housing costs. For disabled people who face
additional living costs, Personal Independence Payments will gradually replace
working age Disability Living Allowance. The main reason for cutting benefits
is to make fiscal savings, but these cuts are likely to lead to an increase in poverty
among those of working age. In contrast, the scope, level and uprating of both universal
and means-tested payments to pensioners have been largely exempt from cuts.

The decentralisation
of Council Tax Benefit from April 2013 has added complexity to the benefits
system by creating a range of different systems, which conflicts with the simplification
rationale for Universal Credit[30]. As total funding for working age claimants has been reduced this
reform is likely to contribute to increasing poverty. Local authority
administrative burdens and financial losses associated with Council Tax Benefit
administration and rent collection could also rise.

The UK’s
Social Justice Strategy emphasises a more multi-dimensional approach to
measuring and tackling child poverty, with more focus on enabling services and
prevention. In October 2012, the government also published
the Social Justice Outcomes Framework[31].
This strategy includes an ambitious set of measures to complement those
launched in 2011, the Child Poverty Strategy (on the basis of the Child Poverty
Act 2010), and the Social Mobility Strategy[32]. This approach, with
a focus on prevention, is positive in principle. However, income poverty
remains an important issue, and budgets for wider support services provided at
local level are being reduced.

Childcare
and parental employment

Although the supply of
childcare places has risen in recent years, the cost and availability of
childcare remain as barriers to parental employment. Childcare poses particular problems for second earners in couples,
and for single parents[33].
Currently, childcare costs in the UK are among the highest in the EU. In 2010,
only 4 % of children under
the age of three had full-time places in formal childcare, well below the EU
average of 14 %[34]. The overall
employment rate for single parents, 59.9 %[35],
remains relatively low, and is the main reason why the proportion of children in
workless households in the UK (17.3 %) is the second highest rate in Europe. In 2012, the employment rate was 19.2 pp. higher for single women
aged 25-49 who had no children (80.6 %) than for single women who had children (61.4 %)[36].
Since May 2012, single parents are required to actively seek work when their
youngest child begins full-time education.

The
government is improving the availability of childcare for preschool children,
but recognises that there is still a need to improve access to affordable, high-quality
and adequate childcare services. In January 2013, it published More Great Childcare[37], which sets out a plan of action for delivering high-quality early childhood
education and childcare, with a strong focus on child development to help break
the cycle of disadvantage. In February 2013, the government presented the Children and Families
Bill to Parliament, proposing reforms to boost the number of high-quality,
affordable childcare places. It also aims to introduce child minder agencies to
reverse a decline in registered child minders and to offer more support and
quality control. Budget 2013 announced that tax-free
childcare vouchers will be introduced from autumn 2015, supporting 20 % of childcare costs up to a limit of
GBP 1 200 (EUR 1 410) per child per year. Budget 2013 also announced an
additional GBP 200 million (EUR 235 million) of support, to be phased in from
April 2016, which is equivalent to 85 % of childcare costs, for qualifying households in which a single
parent or both earners in a couple pay income tax. It remains important to
ensure that the benefits of these additional resources are not offset by the
impact of other tax-benefit reforms, in particular for low income households.

Employability
of young people, education and skills

The
UK has made some progress on measures taken to address the CSR on improving the
employability of young people, vocational education and basic skills provision.
Despite some progress in recent years, a
significant proportion of young people still leave secondary education without
the skills and qualifications they need to compete in the labour market[38].
As a result of this persistent record of underachievement, the UK has a large number
of functionally illiterate and innumerate adults, usually with no
qualifications. Young low-skilled workers have seen their job prospects
disproportionately affected by the economic crisis. The unemployment rate of
low-skilled 15-24 year-olds is significantly above the EU average (37.2 % in the UK compared to an EU average
of 30.3 % in 2012). Skills
mismatches are also likely to become more serious in the medium term. The
European Centre for the Development of Vocational Training projects that low
skilled posts could represent only 11 % of total jobs in the UK in 2020, down from 21 % in 2010 (compared with an EU average
of 18 % in 2020 and 23 % in 2010). Although the UK performs
well above the EU average with regard to the tertiary attainment rate,
university applications declined slightly in England for the academic year
2012-2013, following an increase in tuition fees to up to GBP 9 000 (EUR 10
600) per year in England[39].
The government is in the midst of a number of significant education reforms, whose
effects on the economy will be primarily long term.

It
is too early to judge the effectiveness of the Youth Contract. The Youth Contract supports tailored measures addressing youth
unemployment by providing additional apprenticeships, giving financial
incentives to employers taking on young people, and increasing support for the
public employment service, Jobcentre Plus. The Youth Contract will be subject
to an independent evaluation in 2013. The Youth Employment Initiative will
deliver measures targeting young people, including by implementing a Youth
Guarantee[40]
and using ESF funding, and will need to build on the Youth Contract. The
Scottish government has developed a package of measures to support youth
unemployment and SME growth, including a recruitment incentive for employers
taking on job-ready young people aged 16-24 who have had difficulty in securing
employment.

A
number of recent reforms to the apprenticeships system may increase the labour
market relevance of apprenticeships, but there is more to be done. The government has announced or enacted changes to improve the
quality of apprenticeship programmes, including their level and duration, but their
impact will depend on effective implementation. The number of
apprenticeships continues to grow and there is some evidence of a shift to high-level
qualifications. There were 520 600 apprenticeship starts in the 2011-12
academic year (compared to 457 200 in 2010-11), of which 291 300 were
taken up by young people (compared to 275 100 in 2010-2011). There was a 22 % growth in advanced level (Level 3)
apprenticeships and a 68 %
increase in higher-level (Levels 4 and 5) apprenticeships[41]. To make
apprenticeships more focused on high-level skills, from 2013, Level 6
(graduate) and Level 7 (postgraduate) apprenticeships will be available in
subjects including law, accountancy and advanced engineering. In addition, 24
University Technical Colleges (UTCs), a new type of school, set up in
cooperation with employers and universities, will be opened by 2014. These
colleges will teach engineering, business and other practical skills.

Recent
moves to increase employer and local control over skills provision have the
potential to improve the responsiveness of the system to the needs of the
labour market. The Employer Ownership Pilot seeks
to raise business engagement and investment in skills provision by routing
public money directly to employers rather than via providers. Businesses are
invited to set out the public funding they need to support their own investment
in skills, training and apprenticeship opportunities. For 2013-14, the
government has increased the size of the Employer Ownership Pilot from GBP 250
million (EUR 295 million) to GBP 340 million (EUR 400 million). A recent report
from an independent ad-hoc commission, the Richard Review[42], called on
the government to improve the quality of apprenticeships and make them more
focused on the needs of employers. The government endorsed the Richard Review’s
recommendations, which appear to have potential to strengthen the role of
employers in designing an effective apprenticeships system. However, the
qualifications system remains very complex, and this may have an adverse effect
on business involvement in the apprenticeships programme.

Raising the age of compulsory participation in education and
training to 18 by 2015 should help address the UK’s high early school leaving
rate, but this alone will not necessarily endow pupils with the right skills
for the labour market. The UK continues to have slightly
higher levels of early school leavers than the EU average, 13.5 % vs. 12.8 % in 2012, although the proportion has declined by 3.5 pp. since
2007. In England, the government is raising the age of compulsory participation
in education or training, currently 16, to 17 in 2013 and 18 in 2015. This may significantly
reduce early school leaving, but it remains to be seen how far additional time
in education and training alone will give young people the right skills for the
labour market. To deal with the basic skills issue, the government plans to
introduce a new Traineeships programme in England by September 2013. This will
provide 16-24 year-olds lacking the skills and experience they need for the
labour market with a tailor-made package of support to enable them to take up
apprenticeships or other jobs. Traineeships could have a positive impact in the
relatively short term, but will require effective implementation and
monitoring. In Scotland, through the 'Opportunities for All' commitment, the
Government aims at offering a place in education or training to all 16-19 year
olds not already in learning, training or employment.

The
government is also reforming the education system, and this includes reviewing
the national curriculum[43].
At school level, the focus is more on system reform than discrete measures or
initiatives. The government is providing schools
with a Pupil Premium worth GBP 1.25 billion (EUR 1.47 billion) from 2012–13 to
boost the attainment of pupils from deprived backgrounds. A survey by the
official school inspection body (Ofsted) expressed some concern that many schools
were not using the extra funding to target disadvantaged children as envisaged[44].
The measures in the education system to improve the skills of young people have
a long-term nature, so it is too early to assess their impact.

3.4.
Structural measures
promoting growth and competitiveness

There
is significant scope for the UK to raise productivity relative to the best
performing countries. Although UK labour and product
markets are among the least regulated in the EU, and its business environment
is generally favourable, the UK economy has significant structural weaknesses.
The UK’s capital stock and investment rate are low. As set out in Box 1,
the UK’s persistently weak net export position reflects a lack of external
competitiveness. Recent productivity growth has been very weak, and there is
evidence of a lack of restructuring, competition and innovation in the economy.
The UK has a challenge to put the regulatory and financing conditions in place
to renew and upgrade its energy and transport infrastructure, using a mix of
public and private funding sources. Government attempts to boost access to
finance and investment are complicated by high levels of private debt, linked
in large part to the after-effects of a house price boom that occurred in a
context of restricted housing supply. In 2012, the Council Recommendations for
the United Kingdom included CSRs concerning housing supply, and transport and
energy infrastructure.

Spatial
planning reform and housing supply

The
UK has made some progress on measures taken to address the CSR on housing, but
housing completions remain at historic lows and there remains a challenge to
deliver the housing supply the population needs. Residential
investment remains low at 3.2 % of GDP. Overall construction output (not just residential) fell by
5.9 % in the year to 2013
Q1 and is nearly 20 % lower
than the pre-recession peak[45].
Some of the government’s earliest commitments led to further reductions in
housing supply. Government funding for social housing was cut sharply in the
2010 Spending Review. When top-down housing supply targets in Regional Spatial
Strategies were abolished, the number of new dwellings targeted for
construction across the country fell by 272 720[46]. In
contrast, the new National Planning Policy Framework (NPPF), introduced in
2012, aims to increase residential construction through simplifying the spatial
planning system and creating a presumption in favour of sustainable
development. The measures announced in the 2011 Housing Strategy for England[47]
are also being implemented. These include freeing up public sector land and
various financial incentives such as the New Homes Bonus, Community
Infrastructure Levy, Growing Places fund and a Get Britain Building investment
fund. The government also recently announced the liberalisation of planning
rules to allow offices, which have high vacancy rates in much of the country,
to be converted for residential use.

It is
not yet clear to what extent the government’s reforms will increase housing
supply in the medium to long term. Many of the
major housing developers have made it clear to investors that they are
currently focused more on expanding margins than volumes[48].
This could limit the positive impact of policies designed to boost housing
supply in the short to medium term. There is also a lack of effective
competition in the residential construction industry. Much of the impact of the
new planning system will depend on local implementation, and the reforms that
have been made seem to amount to moderate liberalisation overall. There
continue to be tight restrictions on construction around most of the UK’s major
cities and economic growth poles.

The
capacity, efficiency and financial incentives in the planning system could also
be a continuing constraint on residential development. Whether or not decisions on planning applications are timely and
efficient can make a large difference to developers’ risks and returns on
potential residential construction projects. This in turn has an impact on the
quantity and cost of new housing. Planning approvals had been at very low
levels since mid-2008, although there were signs of a pick-up in late 2012[49].
Local authorities are sharply cutting spending on administering the planning
system in response to cuts in their overall budgets, and the government has
decided against allowing local authorities to increase user charges for
planning- and housing-related services to reflect the full cost of the system. Some
70 % of local authorities
now have a plan under the new system but there is still strong local political
opposition to new housing in areas where house prices are high, and the
financial incentives available to local authorities may not be strong enough to
overcome this. The government has threatened to take decision-making powers
away from local authorities that are too slow to make planning decisions or
take an excessively anti-development approach, and this measure may be needed
as a last resort.

There
is also a risk that government interventions that stimulate housing demand more
than supply, in particular Help to Buy, could reflate a housing bubble and
consequently household debt. The level of housing
transactions and loans for new mortgages remains low, held back by a weak
domestic economy, impaired credit markets and a continued lack of affordability.
Early results from the Funding for Lending Scheme, discussed in Section 3.2, suggest
that to date it has largely led to an increase in lending against existing property[50]. In Budget
2013 the government announced the introduction of Help to Buy, which has two
elements, both available for houses costing up to GBP 600 000 (EUR 705 000). First,
from April 2013, the government will provide an equity loan worth up to 20 % of the value of a new-build house, repayable
once the home is sold. Second, from January 2014, the government will provide a
mortgage guarantee to lenders who offer high loan-to-value mortgages (80-95 %) on any house, new or existing. By
facilitating loans for potential buyers who could not otherwise afford to buy a
house, Help to Buy risks leading to the return of imprudent and excessive
mortgage lending and generating a rise in house prices due to state subsidy,
which would further worsen the underlying problem of housing being unaffordable[51]. It could
also lead to contingent liabilities for the Exchequer. However, the details of
how the guarantees will operate and be priced have not yet been announced. The
Scottish government's National Housing Trust initiative also provides
guarantees to stimulate both public and private sector funding for the
provision of rental accommodation.

The
private rented sector in the UK is dominated by short-term, insecure tenancies[52]. Tenancy agreements tend to be set for
a relatively short fixed period, after which they revert to a rolling basis
(running on a week-to-week or month-to-month basis). The notice period for
terminating a tenancy is usually one to six months. One reason for the
flexibility and dominance of short-term tenancies in the private rental market is
that in recent decades, private renting has been seen as a temporary solution.
Most people aim to buy their own house at some point in the future. However, a
combination of high house prices, stretched household finances and more
responsible lending criteria are likely to continue to prevent many middle-income
households from becoming home owners. Private renting could be made a more
attractive and viable long-term alternative to home ownership through the use
of legal frameworks that make longer and more secure rental terms more
appealing to both tenants and landlords, and if the sector became more
professional. The Welsh government will bring forward legislation in 2013 to
develop more secure tenancy arrangements in the rental sector.

Infrastructure

The UK
has made some progress on measures taken to address the CSR on improving
transport and energy infrastructure, but continues to have substantial
infrastructure investment needs. The UK has
shortcomings in its infrastructure[53]
and, while the government recognises the potential for infrastructure
improvements to drive both short- and longer-term growth, the UK continues to
have a significant challenge to secure adequate and cost-effective infrastructure
investment. Around GBP 310 billion (EUR 365 billion) of investment is needed in
energy, roads and the rail network over the duration of the current parliament
and beyond[54].
However, in 2012, total infrastructure spending (public and private) fell[55]. Significant
cuts to publicly-funded infrastructure construction and maintenance have been
made as part of the 2010 Spending Review. The government plans to partially
reverse these cuts. It announced in Budget 2013 that it would increase capital
spending plans by GBP 3 billion (EUR 3.5 billion) a year from 2015-16. The government
also indicated that in Spending Review 2013, it would set out long-term plans up
to 2020-21 for the most economically valuable areas of capital expenditure.
While the cuts made to date have had a negative impact and are not due to be
fully reversed, the government is now taking some positive steps on public
infrastructure spending, though the increases will not come in immediately.
Giving greater certainty and predictability on future capital spending plans
could help to bring down the high unit costs in UK infrastructure, especially
in the transport sector.

Most
infrastructure spending is privately funded, and the government is also seeking
to stimulate increased private investment. In the
2012-15 infrastructure pipeline 65 % of spending is private, 13 % public, and
22 % public/private[56].
The government has introduced a GBP 40 billion (EUR 47 billion) infrastructure
guarantee fund to assist large privately-funded infrastructure projects that
are currently struggling because of adverse credit conditions. The projects can
come from a range of sectors including transport, energy, utilities and
communications. The scheme has received 75 enquiries from project sponsors to
date. Projects with a capital value of around GBP 10 billion (EUR 11.8 billion)
have so far prequalified as potentially eligible for a guarantee. The
government has also stated that it wants to access pension funds and other
private capital to fund infrastructure improvements, including new road
developments and replacements for ageing electricity generating capacity. In
the Autumn Statement 2012, a successor to the Private Finance Initiative (PFI)
initiative was also announced. This will be called PFI 2. The UK needs to be
careful not to repeat the mistakes of past PFI projects and to ensure that the
most cost-effective funding model is used for each project. Audit evidence
suggests the PFI model was a costly way of procuring public infrastructure,
largely because long-term projects were funded at a (higher) private rate of
return than the cost of public borrowing. These initiatives may be beneficial
if they can provide additional investment cost-effectively, which requires
careful design, but few funds have been committed to date and it is too early
to make a clear assessment of their likely impact.

Transport

Transport
infrastructure is of particular importance for the goods-producing sector, an
area in which the UK trade balance is in a persistent and significant deficit. Across different transport modes, the UK has a challenge to identify
additional sources of funding, to bring down high unit costs, and to address
practical regulatory barriers to timely investment. According to the ITF,
investment in transport infrastructure building (all modes) is average at 0.89 % of GDP. In Spending Review 2010,
transport investment was relatively protected in a context of sharp cuts to
overall capital spending.

The
UK’s roads are among the most congested in the EU, and the UK’s ratio of
average road traffic speed to free-flow speed is also one of the lowest in the
EU[57]. According to a recent McKinsey report[58],
road spending had fallen to 50 % of its 1975 levels by 2000, though it has since increased again
and is currently 75 % of
1975 levels. On average roads in England are only
resurfaced once every 58 years, much less frequently than is ideal[59]. The
Government has announced priorities for alleviating congestion and improving
the national road network, but overall road construction and maintenance
spending is being squeezed. There is a particular risk that local authorities,
whose overall budgets are being reduced, will cut spending on highways significantly.
Road maintenance and small projects to deal with bottlenecks are important and
should not be neglected. There is evidence that they tend to have relatively
high economic payoffs compared to other spending, and they have relatively
short lead times if the government can identify additional funding. McKinsey estimate that the UK will need to find up to an extra GBP 2.7
billion (EUR 3.2 billion) annually to fund its road network over the next 20
years if it is to avoid a rise in congestion. There is a case for reprioritising
existing public spending towards roads. The UK could also consider options for
generating additional revenue, for example, through user charging for lorries.

Rapid
growth in rail passenger traffic is leading to congestion on some routes and there
is a need for increased capacity. UK rail passenger
numbers have increased by 70 % since the 1990s (compared to increases of 20 % in Germany, 10 % in Italy and 8 % in France)[60]. Rail freight
also moves a substantial proportion of goods to and from the UK’s sea ports,
which could benefit from better transport connections. In July 2012[61], the
Government announced that over the period 2014-2019, more than GBP 9.4 billion (EUR
11 billion) is to be invested in railway infrastructure, including improvements
to stations, routes (electrification, reopening of routes), rolling stock and
ticketing systems. This represents a decrease from the GBP 11.8 billion (EUR 13.9
billion) earmarked by Government for improvements from 2009-2014. Including
running costs, Network Rail plans to spend GBP 37.5 billion (EUR 44 billion) on
operation and expansion of railways for the period 2014-2019. Network Rail
intends to increase capacity, improve connections, especially for cities in the
North of England, and reduce greenhouse gas emissions per passenger, but their
plans are dependent on passenger demand, government fare policy and efficiency savings.
There have been some difficulties with the process of reletting rail operating
franchises, which also need to be resolved to give the industry the clarity it
needs to plan and invest effectively. The government also announced the
construction of a new high-speed rail line between London and Birmingham and on
to Manchester and Leeds. Construction is due to start in 2017, with a view to
services starting in 2026. There remains considerable scope for the UK rail
industry to cut costs and improve efficiency[62].
The government has recognised this in setting an ambition for the rail industry
to reduce running costs by GBP 3.5 billion (EUR 4.1 billion) by 2019[63]. This could
help mitigate the extent to which high fares rise yet further.

The
UK currently has no clear plan to address looming constraints in airport
capacity. As in most other EU countries, aviation
has been hit by the economic downturn and traffic growth and passenger numbers
have all but stalled. Aviation is taxed more in the UK than in other EU Member
States, through Air Passenger Duty, and UK airline passenger services have some
of the worst market performance indicators[64].
There is, however, a growing need for additional airport capacity in the South
East of the UK. To date, the government does not have a policy to deliver the
additional capacity needed for London to maintain its hub status for long-haul
connections. In September 2012, the government established an Airports
Commission[65]
to conduct an independent assessment of the future of aviation capacity in the
South East, including the possibility of building a third runway at Heathrow.
However, the final report is not due until 2015 and there is scope for the
government to make progress in the interim, given the pressing need for
additional capacity.

Energy,
climate and resource efficiency

The UK
is making good progress towards meeting its Europe 2020 target for greenhouse
gas emissions not covered by the EU-wide EU Emissions Trading Scheme (ETS). In 2011 emissions were 14 % below 2005 levels. Projections based on existing measures suggest
that the UK emissions from non-ETS sectors will be 19 % below 2005 levels by 2020, exceeding the 16 % cut by 2020 required under Europe
2020. The long-term legally binding framework established under the 2008
Climate Change Act, including statutory carbon budgets, continues to drive
emissions reductions and a focus on green growth. In October 2012, a Green
Investment Bank was launched with GBP 3 billion (EUR 3.5 billion) to invest in
the transition to a green economy. The UK housing stock is relatively old and the
government estimate that 38 % of GHG emissions in the UK come from energy
inefficient buildings. The government’s main programme to improve energy
efficiency is the Green Deal, launched in January 2013. It provides households
and landlords with the option of paying back investment costs over time through
energy bills, rather than paying costs upfront.

The
UK ranks 25th out of 27 EU Member States regarding the share of renewable
energy sources in final energy consumption. Under
Directive 2009/28/EC on the promotion of the use of energy from renewable
sources, the UK is committed to reaching a target of 15 % of renewable energy sources in final energy consumption and a 10 %
share of renewable energy in the transport sector by 2020. Currently,
performance on energy from renewable sources is significantly short of the
target. In 2011 the share of renewable energy in gross final energy consumption
was 3.8 %, below the first
interim target set for 2011-2012 (4.1 %). The National Renewable Energy Action Plan outlines the current
and future measures to be deployed to follow the trajectory for developing
renewable energy sources laid down in the Directive and sets sectoral targets. Over
the 2007-2013 programming period, around EUR 433 million or 4.2 % of the ERDF in the UK has been
devoted to renewable energy and energy efficiency. The Commission’s position on
the development of the Partnership Agreement and programmes in the United
Kingdom for the period 2014-2020 states that ESI Funds should support an
increase in the use of all types of renewable energy.

The UK
has an increasingly urgent need for new electricity generating capacity, but
there has been a lot of uncertainty over the prospects for energy investment,
due mainly to regulatory risks. The Energy Bill,
submitted to Parliament in 2012, includes a number of policies intended to set
a clearer long-term framework for investments in low carbon energy generation
and to stimulate green growth. In view of potential generation capacity
shortages in Great Britain in the latter part of this decade, the Energy Bill
introduces an explicit capacity mechanism to address this concern. Electricity
market reform should make a difference in helping to stimulate the GBP 110
billion (EUR 130 billion) of investment needed to renew the UK’s electricity
infrastructure[66].
The Energy Bill also proposes a new long-term feed-in tariff for renewable
electricity generation to replace the existing renewables obligation. Other changes
to support for renewables proposed in 2012 included reduced tariffs for some
renewable generation, and the addition of a new domestic renewable heat
incentive. Given the importance of an effectively-functioning internal energy
market for delivering new investment, it will be very important for the UK to ensure
that detailed measures implemented under the Energy Bill to attract new
investment are fully in line with State aid and internal market rules.

UK
energy networks are being improved to ensure the security of supply and to add
flexibility and reliability to the grid. There are
significant developments in the power transmission grid across the UK to better
integrate generation from renewable sources, such as both on and offshore wind
farms. Further strengthening the electricity grid and interconnections, especially
to mainland Europe, would allow the UK and EU to benefit from the UK’s
significant potential for wind power generation, especially offshore.

Although
the UK has taken reasonable first steps to improve resource efficiency, there
is still room for improvement, especially as regards waste and water management. The UK still landfills almost 50 % of its municipal household waste, in contrast to most other EU
countries, although the government plans to increase the landfill tax. The UK
already recycles or composts almost 40 % of waste, so reaching the 50 % recycling target by 2020 may be possible. Full implementation of
the existing waste legislation could reduce direct and indirect GHG emissions
by an amount equal to 4 % of total 2004 emissions. The current level of water
abstraction is unsustainable, and water scarcity will have impacts not only on
the population, but also on industry and agriculture.

Research
and innovation

Although
the UK scores above the EU average on innovation indicators[67], it has relative weaknesses in R&D investment by firms, the
creation of intellectual assets, SMEs introducing product or process
innovations, and sales of new-to-market or new-to-firm innovations.
Business expenditure on R&D fell from 1.17 % of GDP in 2001 to 1.09 % in 2011[68].
Furthermore, in the last decade, overall expenditure on R&D has averaged
around 1.8 % of GDP, lower
than the EU average of 2.03 %. The UK has not set a national R&D intensity target in
response to the European Council’s request regarding Europe 2020 headline
targets. As part of the 2010 Spending Review, the budget for science was frozen
in cash terms at just over GBP 4.6 billion (EUR 5.4 billion) for the next four
years. This amounts to a cut of some 10 % in real terms over the period. The capital expenditure budget for
science was not protected, although additional commitments to research capital
announced since Spending Review 2010 have reduced the initially planned 44 % cuts considerably[69]. R&D
tax credits continue to be the largest single source of government support for
business R&D[70].

3.5.
Modernisation of public administration

The
UK generally performs well in surveys on the quality and timeliness of public
administration[71]. The government itself has set
ambitious targets to reduce the administrative burden on companies, and to use
e-government tools as much as possible. Regarding regulatory burdens, the one
in, one out target has been replaced by the even more ambitious one in, two
out, to help stem the flow of new regulation. Regarding e-government, the
digital by default principle is being implemented, meaning that online services
will get priority unless there is a good reason to take a different approach[72].

The
UK does, however, have scope to improve public procurement, particularly in facilitating
the participation of SMEs. The UK authorities
estimate that only 12 % of
central government procurement is currently from SMEs, against their target of
25 %. The government is aware
of the issue, but is finding it difficult to overcome strong resistance to the
centralisation of procurement across central government, and to reconcile its
localism agenda with the streamlining and coordination needed to make public
procurement more accessible.

The
UK lacks mechanisms of control and knowledge over state aid granted. Other Member States have introduced relevant procedures such as
transparency mechanisms and bodies in charge of checking eligibility of aid
awards[73].
One of the UK’s main challenges for the successful implementation of the
European Regional Development Fund (ERDF) 2007-2013 Operational Programmes is
the scarcity of funding to match EU funds, especially after the abolition of the
Regional Development Agencies. However, despite these challenging circumstances,
the absorption rate of ERDF in the UK is still acceptable. Around 80 % of resources had been contracted to
operations by the end of 2012.

4.
Overview table

2012 commitments || Summary assessment

Country-specific recommendations (CSRs)

CSR 1: Fully implement the budgetary strategy for the financial year 2012-13 and beyond, supported by sufficiently specified measures, to ensure a timely correction of the excessive deficit in a sustainable manner and the achievement of the structural adjustment effort specified in the Council recommendations under the EDP and to set the high public debt ratio on a sustained downward path. Subject to reinforcing the budgetary strategy for the financial year 2013-14 and beyond, prioritise growth-enhancing expenditure to avoid the risk that a further weakening of the medium-term outlook for growth will negatively impact on the long- term sustainability of public finances. || The UK has made limited progress on measures taken to address the CSR. At 6.4 %, structural borrowing in FY 2012-13 was only 0.3 pp. lower than in 2011-12, despite the UK government sticking to its fiscal consolidation strategy. The deficit is forecast at 6.8 % in 2013-14 and 6.3 % in 2014. Some modest progress has been made on making the structure of consolidation more growth-friendly by shifting spending towards capital budgets.

CSR 2: Address the destabilising impact of high and volatile house prices and high household debt by implementing a comprehensive housing reform programme to increase housing supply and alleviate problems of affordability and the need for state subsidisation of housing. Pursue further reforms to the housing market, including the mortgage and rental markets, financial regulation and property taxation to prevent excessive volatility and distortions in the housing market. || The UK has made some progress on measures taken to address the CSR. Government has reformed the planning system and put in place a number of regulatory and fiscal measures aimed at increasing residential construction, but it is not yet clear how effective these will be in boosting the supply of housing. Both residential construction and new mortgage lending remain low, affected by a weak economy and policy constraints. There is also a risk that recent government interventions that stimulate housing demand more than supply, in particular Help to Buy, could reflate a housing bubble and consequently household debt. This could also further decrease housing affordability. Limited changes to SLDT have been made but no wider reforms to property taxation have been made.

CSR 3: Continue to improve the employability of young people, in particular those not in education, employment or training, including by using the Youth Contract. Ensure that apprenticeship schemes are taken up by more young people, have a sufficient focus on advanced and higher-level skills, and involve more small and medium-sized businesses. Take measures to reduce the high proportion of young people aged 18-24 with very poor basic skills. || The UK has made some progress on measures taken to address the CSR. If implemented effectively, with a proper focus on increasing the quality of apprenticeship programmes, including their level and duration, a number of measures taken may increase the labour market relevance of apprenticeships. The measures in the education system to improve the skill levels and employability of young people have a long-term nature and therefore it is too early to assess their impact.

CSR 4: Step up measures to facilitate the labour market integration of people from jobless households. Ensure that planned welfare reforms do not translate into increased child poverty. Fully implement measures aiming to facilitate access to childcare services. || The UK has made some progress on measures taken to address the CSR. The introduction of Universal Credit will be a positive step, with its focus on benefits simplification and improving work incentives, although the employment impact is likely to depend in part on effective implementation. However reforms to Council Tax benefit appear likely to increase poverty and make the benefits system more complex, partially offsetting the simplification benefits of Universal Credit. Early evidence on the impact of the new flagship Work Programme for the unemployed is disappointing. Relative poverty, including child poverty, fell slightly from 2010 to 2011, due in part to falling real median income. However, poverty is likely to increase in future due to a range of real terms reductions to working age welfare payments that the government is making as part of its fiscal consolidation strategy. Some additions to early years provision are being made but childcare remains expensive and of variable quality.

CSR 5: Further improve the availability of bank and non-bank financing to the private sector, in particular to SMEs. Support competition within the banking sector, in particular through measures to reduce barriers to entry, increase transparency and facilitate switching between banks as recommended by the Independent Commission on Banking and explore ways to improve access to venture and risk capital and other forms of non-bank lending. || The UK has made some progress on measures taken to address the CSR. The government has put in place a number of schemes aimed at increasing lending but net credit trends remained weak throughout 2012. Many firms, notably SMEs, are experiencing difficulties in obtaining credit to finance investment. More coordination and clarity among the different programmes would be beneficial for SMEs. The FLS has contributed to ease bank funding costs and credit conditions, but there is a risk of it being primarily channelled to sectors that are less in need of funding. The government is addressing a number of the recommendations put forth in the Breedon review, but access to non-bank lending remains largely restricted to bigger firms. There remains limited competition in the banking industry, but some actions to tackle barriers to entry have been announced. Lloyds bank and RBS are yet to divest of part of their assets to comply with state aid rules and to facilitate the creation of new challenger banks.

CSR 6: Pursue a long-term strategy for improving the capacity and quality of the UK’s network infrastructure, including measures to address pressures in transport and energy networks by promoting more efficient and robust planning and decision-making processes, and harnessing appropriate public or private financing arrangements. || The UK has made some progress on measures taken to address the CSR. Overall, public investment has fallen and remains relatively low, but there has been some prioritisation of higher value projects. Quality and congestion of transport infrastructure remains a structural weakness affecting the whole economy, and especially goods producing and exporting companies. The rail investment pipeline should help to accommodate the forecast continued increase in rail traffic. The government has announced a lot of initiatives to boost private investment in the road network but most remain aspirational and the UK needs to be careful not to repeat past mistakes. Limited progress has been made in addressing the need for additional hub airport capacity. There has been a lot of uncertainty over the prospects for energy investment, due in part to regulatory risks. UK assessments show an increasing need for new generating capacity, both renewable and non-renewable. The energy bill aims to put in place measures to attract the GBP 110 billion (EUR 130 billion) investment that is needed to replace current generating capacity and upgrade the grid by 2020. The UK should ensure that the detailed measures to attract new investments are fully in line with State aid and internal market rules.

Europe 2020 (national targets and progress)

Employment rate target: No target set in NRP || 73.6 % of the population aged 20-64 was employed in 2011 (unchanged from 73.6 % in 2010). Little progress has been made in contributing to this target in 2012, but the situation has not deteriorated. The UK employment rate is now marginally below the Europe 2020 target of 75 %. In 2012 private sector employment grew sufficiently to offset reductions in public sector employment and the growth of the workforce. To raise employment in the longer term, the UK also faces challenges to increase work incentives and parental employment, to improve access to high-quality, affordable childcare, and to raise skill levels.

R&D target: No target set in NRP || 1.86 % (2009), 1.77 % (2010), 1.77 % (2011). The share of R&D spending in UK GDP is below the EU average of 2.03 %. It has averaged around 1.8 % over the past decade. The trend since 2000 shows an initial fall, a mild recovery from 2005 (peaking in 2009), and a recent decline then stabilisation.

Greenhouse gas (GHG) emissions target: -16 % (compared to 2005 emissions. ETS emissions not covered by this national target) || Change in non-ETS greenhouse gas emissions between 2005 and 2011: -14 %. According to the latest national projections submitted to the Commission and when existing measures are taken into account, the target is expected to be reached: -19 % in 2020 compared to 2005 (with a margin of 3 pps).

Renewable energy target: 15 % Share of renewable energy in all modes of transport: 10 % || Share of renewable energy in gross final energy consumption was 3.8 % in 2011, and 2.9 % in transport[74]. Progress to date was not sufficient to reach the 2011-12 interim trajectory target (4.1 %). To achieve the 2020 target, the UK should urgently finish developing and put in place a coherent, stable and predictable renewable energy support framework.

Indicative national energy efficiency target for 2020: final energy consumption in 2020 of 129.2 Mtoe. This implies reaching a 2020 level of 177.6 Mtoe primary consumption and 157.8 Mtoe final energy consumption. || The United Kingdom has set an indicative national energy efficiency target in accordance with Articles 3 and 24 of the Energy Efficiency Directive (2012/27/EU). It has also expressed it, as required, in terms of an absolute level of primary and final energy consumption in 2020 and has provided information on the basis on which data this has been calculated.

Early school leaving target: No target set in NRP || Early school leaving rate: 14.9 % in 2010; 15.0 % in 2011; 13.5 % in 2012. The early school leaving rate is falling but remains slightly above the EU average (12.9 % in 2012). The government is introducing reforms which should have a significant effect in reducing early school leaving. The age of compulsory participation in education or training is increasing from 16 to 17 in 2013 and 18 in 2015.

Tertiary education target: No target set in NRP || Tertiary attainment rate: 43.0 % in 2010; 45.8 % in 2011; 47.1 % in 2012. The UK tertiary attainment rate has increased significantly from 29 % in 2000, and is well above the EU average (35.5 % in 2012).

Risk of poverty or social exclusion target: Existing numerical targets in the 2010 Child Poverty Act and Child Poverty Strategy 2011-14 || The percentage of the population at risk of poverty or social exclusion was 23.1 % in 2010 and 22.7 % in 2011 (slightly below the EU averages of 23.6 % and 24.2 % respectively). The fall in the indicator from 2010 to 2011 is partly explained by a reduction in the poverty threshold due to falling real median income. Three other relevant social inclusion indicators rose from 2010 to 2011: risk-of-poverty or exclusion of elderly: +0.4 pp.; severe material deprivation: +0.3 pp.; in-work at-risk-of-poverty rate: +1 pp. Although the latest figures show a reduction in the number of children living below the relative poverty threshold, linked to the drop in median income, absolute poverty remained unchanged. Planned real terms reductions in some working age welfare benefits are likely to increase poverty rates.

5.
Annex

Table I.
Macroeconomic indicators

Table II. Comparison of macroeconomic developments and forecasts

Table III. Composition of the budgetary adjustment

Table IV. Debt dynamics

Table V. Sustainability indicators

Table VI. Taxation indicators

Table VII. Financial market indicators

Table VIII. Labour market and social indicators

Table IX. Product markets performance and policy indicators

Table X. Green Growth

[1] COM (2012) 750 final

[2] COM (2012) 751 final

[3] SWD (2013) 125 final. 13 in-depth reviews were published on 10
April 2013. While selected for an in-depth review in the AMR, Cyprus was
ultimately not reviewed under the Macroeconomic Imbalance Procedure in view of
the advanced preparations for a financial assistance programme

[4] As regards social inclusion, last year’s NRP referred to numerical
targets of the Child Poverty Strategy 2011. There is no such reference in this
year’s NRP

[5] November 2012 – January 2013, Eurostat definition. On the national
definition unemployment was 7.9 % in December 2012 – February 2013

[6] See for example Office for Budget Responsibility (2013), Economic
and Fiscal Outlook, March 2013

[7] 20xx-xx
refers to the financial year which starts on 1 April and ends on 31 March

[8] Eurostat-validated EDP data

[9] Eurostat (2013). Provisional figure

[10] November 2012 – January 2013, Eurostat definition

[11] Eurostat data, 2012 Q4

[12] Eurostat data, 2012 Q4

[13] Eurostat definition, 2012 Q4

[14] Children aged 0-17 years living in jobless households, Eurostat
definition

[15] Subsequent revisions to 2012 now estimate growth at 0.3 %

[16] Cyclically-adjusted balance net of one-off and temporary measures,
recalculated by the Commission services on the basis of the information
provided in the programme, using the commonly agreed methodology

[17] Idem

[18] See Office for Budget Responsibility (July 2012) Fiscal
Sustainability Report Table 3.6

[19] See OECD (2013), OECD Economic Surveys – United Kingdom, and
European Commission (2010), Joint Report on Health Systems

[20] OECD (2010), Tax expenditures in OECD Countries

[21] Mirrlees et al (2011), Tax by Design: the Mirrlees Review.
Chapter 9 – Broadening the VAT base

[22] Based on the old 17.5 % rate of VAT. The authors state that
the welfare gain would increase under the new VAT standard rate of 20 %

[23] Bank of England (2013), Trends in Lending, April 2013

[24] See Federation of Small Business (2013) Voice of Small Business
Index Quarter 1, 2013. This recent survey on SME access to bank loans puts
loan rejection rates at approximately 40 %

[25] Bank of England (2013), Credit Conditions Survey 2013 Q1

[26] See the Financial Policy Committee’s statement from its policy
meeting of 19 March 2013

[27] November 2012 – January 2013, Eurostat definition

[28] ‘NEET’ refers to a young person who is not in education,
employment, or training

[29] Department for Work and Pensions (2012), Work Programme evaluation:
Findings from the first phase of qualitative research on programme delivery

[30] Institute for Fiscal Studies (2012), Reforming Council Tax
Benefit, IFS Commentary C123

[31] This framework aims to support future policy by highlighting
priorities, identifying where good progress is being made and where more works
needs to be done

[32] HM Government (2012), Opening Doors, Breaking Barriers: A
Strategy for Social Mobility. Update on progress since April 2011

[33] OECD (2012), OECD Family Database

[34] Eurostat (Formal child care by duration and age group)

[35] Eurostat (Employment rate by sex, age groups, highest level of
education attained and household composition)

[36] Eurostat (Employment rate by sex, age groups, highest level of
education attained and household composition)

[37] Department for Education (2013), More Great Childcare – Raising
Quality and Giving Parents More Choice

[38] Harding, C et al. (2011), 2011 BIS Research Paper Number 57,
Skills for Life Survey: Headline Findings. 28 % of 16-18 year olds are
functionally innumerate and 14 % are functionally illiterate. The figures
for 16-65 year olds are 24 % and 15 % respectively

[39] See UCAS (2012), How have applications for full-time
undergraduate higher education in the UK changed in 2012?

[40] Council Recommendation of 22 April 2013 on establishing a Youth
Guarantee (2013/C 120/01)

[41] In 2011/2012, advanced-level apprenticeships represented 36.1 %
of the total, compared with 33.7 % in 2010/2011, while higher-level
apprenticeships were 0.7 % of the total, as against 0.5 % in
2010/2011

[42] Richard (November 2012), The Richard Review of Apprenticeships

[43] The Department for Education proposed more demanding programmes in
English, mathematics and science

[44] See Ofsted (2012), The Pupil Premium

[45] Office for National Statistics (2013), GDP Preliminary Estimate,
Q1 2013

[46] Morton (2012), Planning for Less: the impact of abolishing
regional planning

[47] HM
Government (November 2011), Laying the Foundations: A housing strategy for
England

[48] Deutsche
Bank (2013), UK Building Sector – What to expect from the Q4 2012 results

[49] Home Builders Federation (2013). New Housing Pipeline, Q4 2012
Report

[50] Bank of England (2013), Trends in Lending, April 2013

[51] See oral evidence from the Office of Budget Responsibility to the
House of Commons Treasury Committee hearing on Budget 2013, 26 March 2013

[52] Shelter (2012), A better deal: Towards more private renting

[53] According to the World Economic Forum, the UK currently ranks 24th
on quality of its overall infrastructure, while France ranks fifth and Germany
ninth. World Economic Forum (2012), The Global Competitiveness Report
2012-13

[54] HM Treasury (2012), National Infrastructure Plan: update 2012

[55] Office for National Statistics (2013), Output in the
Construction Industry, December and Q4 2012

[56] HM Treasury (2013), Infrastructure Pipeline Data 2012

[57] European Commission (2012), Key areas: comparing Member States’
performances, Network industries  —transport

[58] McKinsey (2011), Keeping Britain moving  —The United Kingdom’s
transport infrastructure needs

[59] Asphalt Industry Alliance (2012), Annual Local Authority Road
Maintenance Survey 2012

[60] European Commission (2013), Commission Staff Working Document,
Impact assessment SWD(2013) 10

[61] Department for Transport (2012), High Level Output Specification
(HLOS) 2012: Railways Act 2005 statement

[62] McNulty (2011), Realising the potential of GB rail – Report of
the rail value for money study

[63] Department for Transport (2012), Reforming our Railways: Putting
the Customer First

[64] European Commission (December 2012), 8th Consumer Markets
Scoreboard, DG SANCO

[65] See https://www.gov.uk/government/organisations/airports-commission

[66] Ofgem
(2012), Electricity capacity assessment (Ref: 126/12)

[67] European Commission (2013), Innovation Union Scoreboard 2013

[68] Eurostat
(2013). Provisional figure

[69] Campaign for Science and Engineering (CaSE) (2013), Public
Funding of UK Science and Engineering — March 2013 update

[70] The UK authorities estimate that claims are made for some
two-thirds of all business R&D expenditure and that each GBP 1 of foregone
tax revenue from the R&D tax credit stimulates between GBP 0.47 and GBP
3.37 of R&D investment (UK National Reform Programme 2013)

[71] European
Commission (2012), Excellence in public administration for competitiveness
in EU Member States

[72] Cabinet
Office (2012), Government Digital Strategy

[73] For instance, Estonia recently introduced a public registry of all
State aid awards, including de minimis aid, on the homepage of the Ministry of
Finance (http://www.fin.ee/riigiabi); in Hungary, the State aid Monitoring
Office (http://tvi.kormany.hu/home) is in charge of checking eligibility under
the General Block Exemption Regulation; Slovenia’s Ministry of Finance has put
in place a system of regular monitoring and evaluation of State aid measures          
(http://www.mf.gov.si/en/areas\_of\_work/state\_aid\_monitoring/surveys\_on\_state\_aid\_in\_slovenia/)

[74] Eurostat (April 2013). For 2011, only formally reported biofuels
compliant with Art. 17 and 18 of Directive 2009/28/EC are included)

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