:
CONHDENTIAL # #
3
to situations whereby plans ran up against internally generated constraints. On being asked for an example he said that he had been told by the Education Department on his previous visit that some of their ideas and plans had been frustrated by the inability to obtain financial approval. It was explained to Mr. Smith that it was unlikely that the constraints had been any of the budget guidelines; it was more probably that the limitation had been normal questioning by Finance Branch of the proposals (Mr. Smith accepted that the proper role for the Finance Branch was to query proposals put to it). Mr. Smith's attention was again drawn to paragraph 92 of the 1977/78 budget speech where the Financial Secretary had said "... none of these guidelines is absolute and there are no substitute for common-sense, acceptance of economic reality, recognition of social needs, imaginative decision-making and a continuing emphasis on cost-effectiveness and cost-efficiency".
(o) Size of the Public Sector
8.
PAS(ES)D said that he had explained to Mr. Smith that this year's budget speech clearly allowed for further growth of the public sector relative to the economy as a whole. He pointed out that the Financial Secretary had explained currently the public sector was expected to be about 17% of GDP and his cautionary guideline of 20% left considerable room for growth. This view was repeated in the Financial Secretary's statement that a useful guideline for the public sector in real terms was 10% p.a. and given the economy's trend growth rate of 7% this implied an increasing share for the public sector. PAS(ES)D asked Mr. Smith whether as an economist he would agree that it was defensible to include the MTR in the public sector and that this would legitimately show a very substantial growth in the public sector over the past 7 years. Mr. Smith was not able to make any commitment on this but did say that the views of the previous Secretary of State on public expenditure had been explained by him during his previous visit and in particular that he (the late Secretary of State) saw a strong case for public expenditure to increase in real terms. Mr. Smith was asked if he agreed that the budget statements were not in conflict the late Secretary of State's view as expressed by Mr. Smith.
9.
On behalf of the FCO, Mr. Smith reserved their position of the question of budgetary policy.
THE ECONOMY
10.
Mr. Smith said that he had discussed the current state of the economy with PAS (ES)D and Senior Economist as well as the export and GDP forecasts. He noted that the original forecasts may turn out to be too high. He in addition recognised and welcomed the statistical developments and information feeding system established whereby the FCO was informed of developments in the economy. He said that he had also discussed with SMA and DS (MA) the future of the Hong Kong dollar.
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/P.4