Spending to forget, by Tony Travers

6 Nov 08
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07 November 2008

Suddenly Keynes' classic remedy for recession is back in fashion. But will pumping money into public sector building and infrastructure projects save the economy or merely store up problems for future generations of taxpayers? Tony Travers investigates

Few historical figures have been brought back from the dead as abruptly as John Maynard Keynes. Having in recent years justified little more than a short section in economics textbooks, he has now become the saviour of the UK economy. Apart from 16 economists writing to the Sunday Telegraph, we are all Keynesians now.

The sudden arrival of neo-Keynesians in politics should not come as a surprise. Senior government ministers and their shadows will have learned just enough about Keynes' General theory of employment, interest and money to remember that when the country goes into recession there is a case for counter-cyclical public investments to push up aggregate demand within the economy, thus bringing back into operation labour and capital that would otherwise stand idle. The fact that there has not been a serious downturn in Britain since the early 1990s has meant that state action of this kind has not been seen as necessary.

'Dry' or 'Thatcherite' economists, who oppose government intervention, would doubtless now argue that from 2002 onwards Gordon Brown – as chancellor – was pumping an already fast-growing economy with public money. It was most definitely not 'Keynesian' to increase public borrowing to push up state spending as a proportion of gross domestic product while the economy was growing at or around 2%–3%. Keynes' work would have suggested putting up tax and/or reducing government investment in those circumstances.

In fact, Brown kept spending. Taxation only started to rise when the Treasury ran out of additional borrowing. It is instructive to compare the disconnect at central government level between the capacity to spend and the need to tax. Brown was able to move from a £12bn budget surplus in 1999/2000 to a planned deficit of £43bn in 2008/09. Put another way, the government was able to spend an extra £55bn on public services without changing the tax burden. No wonder it was popular.

It is now predicted that outturn public borrowing in 2008/09 will be in the (admittedly broad) range of £75bn to £100bn. The jump from £43bn to the new number will be accounted for by a number of factors, including the bail-out of the banks, falling tax revenues and increasing unemployment costs. Chancellor Alistair Darling's Pre-Budget Report will doubtless make an heroic guess at the likely totals for public sector borrowing in 2008/09 and 2009/10. But, the truth is, no one can really know where the economy will end up in the next few years.

Darling used a speech in the City of London last week to defend the idea of pushing up borrowing during a recession. But he did not spell out whether he meant to add new items to the existing planned total of expenditure. 'Allowing' borrowing to rise at a time when tax income will fall and social security will automatically increase is not a particularly dramatic commitment. The real test for the chancellor's Keynesian credentials will be if he agrees to bring forward a series of infrastructure and housing projects as a deliberate boost to the fast-slowing economy.

Thus far, all we have seen is a few ideas pushed into the newspapers, although it remains unclear whether or not the originators of these rumours had an articulated plan. As a result of these stories, public authorities have been rushing forward like Oliver Twist with their demands for nourishment.

Guess who recently wrote the following: 'We had the thrill of driving over one of those big things last year in our 30ft mobile home. It really is very big indeed. It is the Hoover Dam, a colossal concrete cathedral to Keynesian economics, still braced against the Colorado river, still delivering electricity, and built from 1931 to 1935, at the height (or in the depths) of the Depression.'

Answer: Boris Johnson, mayor of London. Apart from the fascinating idea of Boris and family steering a huge caravan over a massive environmentally sustainable electricity turbine, here we have the most senior Conservative in office in Britain explicitly proposing a Keynesian solution to our economic problems. He wants Crossrail started and the Tube upgrades fully funded. Manchester would doubtless like additional Metrolink lines, while virtually every council in Britain has road improvement schemes ready to go.

There will be only a tiny period of opportunity for schemes of this kind. The need to be careful with the nation's finances in the longer term will limit the government's capacity to push up spending or borrowing too far. Darling has spoken of the possibility of bringing forward projects from 2010/11 into 2009/10. But the way this tentative promise was made suggests any additional spending next year will be marginal and, more importantly, the overall spending total for the three-year period covered by the 2007 Spending Review will, broadly, be adhered to.

Looking at recent announcements about public spending on infrastructure projects, the evidence for a consistent approach across Whitehall is mixed. The Olympic Games, which has the advantage of being 'in progress', has had some elements cut to keep its spending within its £9.3bn budget. The proposed press centre was the most recent casualty. Last week, the rail regulator sliced £2.4bn off the money Network Rail said it needed to deliver projects from 2009 to 2014. London Underground is locked in a struggle with the Department for Transport for additional money to upgrade the Tube system to the level the government originally signed up for in the public-private partnership.

If a Keynes-inspired boost is required, it will have to struggle with in-built mechanisms within British government that are designed to slow down projects and reduce their cost. The Treasury has evolved a series of procedures that are intended to stop projects moving ahead too quickly and then to squeeze them for 'efficiency' savings. As taxpayers, we should give thanks for this approach. But if a short, sharp, stimulus to the economy is needed, it will be necessary to override the blockages to immediate spending. So, don't count any Keynesian chickens before they hatch. An uplift in expenditure will be difficult to bring about and would probably only mean starting 2010/11 projects a few months early. Moreover, once this short-term increase has occurred, a long dark night of minimal spending increases lies ahead. It is inevitable that public expenditure totals for 2011/12 onwards, that is those that will be published in next year's Spending Review, will grow much more slowly than in the past decade.

State spending will rise as a proportion of the economy during the years 2008/09 to 2010/11, possibly to 45% or more of GDP. Borrowing is predicted to increase to £100bn or more this year and as much again in 2009/10. From 2011/12 onwards, even the health service and schools are likely to face year-on-year cash increases in their spending of only 3%–4%. Local government will almost certainly be squeezed even harder, with cash rises of 1.5%–3% a year or less.

These conditions will put pressure on councils, health authorities, schools and the police to find annual efficiency savings of 3% or more. It is also likely that there will be further Whitehall demands for more multi-authority purchasing and wider use of pooled services. If public services face up to a decade of funding constraint, the only way to reduce the perception of relentless 'cuts' will be a radical approach to delivery and joint provision of support services.

Britain is entering an extraordinary and difficult period of public expenditure control and, in many spheres, there will be reductions. The nearest parallel for what is to come is a grim amalgam of the mid-1970s (oil price shock, inflation, International Monetary Fund-induced spending cuts) and the early-1990s (inflation, negative equity, recession). Looking back on these periods, when Keynes's influence was probably stronger than today, there was little evidence of any significant jump in infrastructure investment.

Because of low or negative growth during these earlier periods of economic decline, public spending as a share of GDP rose to more than 48% in the early 1980s and almost 45% in 1992/93. Something like this will happen again in 2009/10 and 2010/11. If history is a guide, such high percentages of public spending will almost immediately produce political pressure for a major reduction in the scale of the state.

The need to increase tax will become clear once the early stages of the recession are over. It is this inevitability that prodded the 16 'dry' economists into action to oppose any further increase in public spending, even for benign, Keynesian, reasons. All additional borrowing becomes a charge on future taxpayers. The letter-writing economists clearly believe that the longer-term impact of higher taxes will be to depress economic growth. It is the above debate that will currently be taking place in the Treasury as the chancellor plans for his Pre-Budget Report. How much additional spending and borrowing is acceptable in the short term to bolster the flagging economy? This question is even more pressing now it is widely acknowledged that the Bank of England has held interest rates too high for too long. Even if rates now plunge towards the 1% level set last week in the US, the damage to the economy might already have been done.

Politicians, public service managers and trades unions now need to adjust themselves to a world that will be vastly more challenging than the golden years from 2000 to 2007. Instead of new programmes of spending, new employees and the hope of better-than-average pay rises, there will now be up to a decade of cutbacks, reduced employment and pay battles. There will also be a growing awareness of the cost and generosity of public sector pensions. Expect an assault on the concept of final-salary pensions across Whitehall, the NHS and local government.

All this potential woe and gloom points to the need for public services to stress their growing importance to a population that will have to get used to unemployment, lower incomes and a loss of confidence. Local authorities in particular can provide leadership at such a time. Where new programmes of help are being put in place, it is vital that people know what is being done. Councils are already working with local partners on an array of other matters. Coping with the recession would be a good subject for Local Area Agreement action.

Britain has survived sharp economic downturns in the past. It is still unlikely that anything as severe or long term as the Great Depression will take place during the years ahead. In the next two years, there is a chance for a final public spending 'push' to improve facilities and infrastructure for the longer term. New enterprises will emerge from the ashes of bankrupt ones and there will be opportunities for public service innovation.

As for Keynes, his name will be used by council leaders, health service officials, transport operators and school head teachers as economic justification for their next big project. Social and affordable housing, interestingly, is probably the easiest way to get public resources into vital projects quickly. Construction companies, developers and housing associations stand ready to deliver as many homes as can possibly be built in the next three years.

In the end, however, any short-term investments in public infrastructure will have only a small impact on the worsening recession. It will take at least two years for reasonable growth to return, and possibly longer. The rediscovery of Keynes is the beginning of the end of the beginning.

Tony Travers is the director of the Greater London Group at the London School of Economics

PFnov2008

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