Turn of the Screw

28 Nov 13
A return to economic growth will bring no relief for the public sector. Crushing austerity is here to stay for at least a decade, whoever is in office. So what will this vice-like grip on the finances mean for spending, taxation and service provision?

By Tony Travers | 28 November 2013

A return to economic growth will bring no relief for the public sector. Crushing austerity is here to stay for at least a decade, whoever is in office. So what will this vice-like grip on the finances mean for spending, taxation and service provision?

December cover feature

Economic growth has returned. Against the expectations of many government critics, the UK is now seeing a faster expansion of economic activity than most of the eurozone. Forecasters (oddly named, given that most forecasts appear to react to rather than predict changes in actual growth) are now projecting even higher growth in 2014.  

As he prepares his latest Autumn Statement, Chancellor George Osborne now faces critics who argue that the unexpected growth is of the wrong kind or unsustainable or unbalanced. Of course, they may be right. Or wrong. Despite many years of advanced economic modelling, predicting short-term economic progress remains difficult. There are just too many variables – some of which are, to be fair, more in the realm of psychology than economics. The effect of confidence, in particular, is hard to measure.

But if we assume the economy is set fair for the next two or three years, what does this imply for the future of the public sector? Does a return to growth herald an end to so-called austerity? Of course, we all know the answer to that question.  Regardless of the optimistic growth figures, a vice-like grip on spending looks set to stay in place until at least the early years of the 2020s. 

The UK is most definitely in the early years and not the latter part of a period of severe expenditure constraint. That is, the effort to adjust the nation’s public finances looks likely to continue until 2022 or 2023. At least a decade of further austerity looms ahead. The objective, as the prime minister recently told the Lord Mayor’s banquet, is to build a ‘leaner, more efficient state…. Not just now, but permanently’.

Back in March 2013, the Office for Budget Responsibility forecast that GDP would grow by 0.6% in 2013, 1.8% in 2014 and 2.3% in 2015, with 2.7% and 2.8% in the succeeding years. Underpinned by these numbers, the OBR projected that the deficit would fall as a share of GDP from 7.8% in 2012/13 to 5.5% in 2015/16. By 2017/18, the deficit would be 2.3% of GDP. The implication of this run of figures is that the deficit would finally be eradicated in 2019/20.

The traumatic economic and political impacts of the 2008 financial crash are going to be with us for a long time to come. In much the same way that high inflation in the 1970s and early 1980s has influenced the way the British political class thinks about rising prices, it is surely inevitable that governments will want to sustain balanced budgets once the existing deficit is finally eradicated. Put the other way round, is it likely that a chancellor of the exchequer would want to increase public sector borrowing during a period of economic growth in the early 2020s? Osborne has already made it clear that he would run a budget surplus once the deficit has hit zero.

A Fabian Society commission on the future of public expenditure recently concluded that the government should reduce the deficit slightly more slowly than Osborne’s existing plans, though eradicating the deficit was still the objective. A slightly higher level of public expenditure in the years from 2016/17 to 2019/20 would be consistent with ‘a rise in capital investment; a modest reduction in social security entitlements; “flat” real spending for the health, social care, education and economic budgets; and a 3.5% annual cut for all other departments’.

The Fabian Society report is a bid for spending levels about 1% in real terms above those likely to be set by Osborne. There would also be a possibility of modest tax increases, although these would most likely be achieved by ‘fiscal drag’, that is, by not raising tax allowances and thresholds in line with inflation. The report, from a Left-of-centre think-tank, is modest by any standards. While it is inevitable that other Labour-leaning commentators will call for more radical solutions, it seems likely that the Fabians represent a view close to that of the majority of Labour’s  frontbenchers, including shadow chancellor Ed Balls.

The picture painted in the report is instructive. Future spending plans for the NHS and schools are the same as those pursued by the coalition. Capital spending would rise a bit, but social security expenditure would fall – which is the reverse of what the coalition has achieved. A 3.5% annual cut for other departments would leave the Foreign Office, defence, international development, local government, the police and fire & emergencies facing real-terms cuts of over 10% between 2016/17 and 2019/20.

Councils’ spending will have dropped by about 25% between 2011/12 and 2015/16.  The Fabians’ further 10% cut would leave local authority spending in 2019/20 at least 35% lower in real terms than in 2010/11. By 2019/20, NHS expenditure would have been held flat for nine years. Schools would be in a similar position.  

Osborne has plans to continue with his current approach to spending well beyond 2015 so that he can build up a budget surplus. If, in around 2019, we arrive at the point where the government’s budget is indeed running at a surplus, it is inevitable that public expenditure will have had to drop to around (or somewhat below) the yield of taxes.  That is, UK public expenditure would have to be below 38% of GDP, the medium-term average for taxation, by 2020.

Such a figure would take spending as a proportion of GDP to broadly where it was in the 1950s and again in the late 1980s and, briefly, around 2000 after Labour had committed itself to adhering to Kenneth Clarke’s pre-election spending plans. The Fabian ‘expansionist’ proposals would take public expenditure to 41% of GDP, which is about the average for the middle of the Blair-Brown years, though this would be well below the figures reached by Labour in the late 1970s. And 41% is also well below the levels in, say, France or Sweden.

What will happen should growth stall? If the government’s critics are correct and the UK’s new growth cannot be sustained, there will either need to be cuts in spending to below the Fabian levels or the deficit will start to climb once more. Given the problems haunting the US and eurozone economies, coupled with continuing instability in the Middle East, developed world economies will be lucky indeed if they get to 2020 without another jolt to the economic system. Britain, in addition, is threatened by long term under-investment in energy generation which, notwithstanding Ed Miliband’s threatened price caps, could undermine growth if there were one or more cold winters. Nothing can be taken for granted.

For politicians and public service managers, this medium-term financial planning scenario is not pretty. The government and its Labour Opposition face the need to keep the public sector in a vice, tightening the screw, for another decade.  Even when we get to the 2020s, there will be no way to expand the state faster than GDP growth until and unless taxpayers can be convinced to pay a larger share of their income in tax.

Given the recently developed political orthodoxy that everyone apart from the super-rich is struggling with falling living standards, it is hard to see how mainstream politicians in any party can make a case for average or just-above-average earners to pay more tax. There might just be potential to squeeze the top 5% of earners, though it is worth noting that such a move would catch people earning around £50,000 a year, which is a long way short of ‘top pay’. The truth is, as the Fabian Society’s suggestion that it would be necessary to rely on ‘fiscal drag’ to raise more tax implies, even Left-of-centre think-tankers outside parliament believe there is limited scope for an increase in direct taxation.

In the short-to-medium term, a major programme of public service reforms may drive up costs. Recent publicity suggests it is possible that the NHS and welfare changes, though intended to deliver greater efficiency, might cost the government more than is currently planned (and which must be embedded in existing Treasury figures). On top of this, Office for National Statistics population projections published earlier this month show the UK population rising by 10 million by 2037, with the number of over-80s doubling in this period. In the next 10 years, the UK population is shown rising by over four million: by 400,000 to 500,000 per annum. This rise in population will add to public service demands, especially for older people. ‘Real’ terms means with inflation removed but takes no account of the rising population: per capita spending will drop.

So what, short of unleashing herds of grazing sheep onto municipal grass verges (one of 201 ways to cut costs advocated by the Taxpayers’ Alliance, and endorsed by Communities Secretary Eric Pickles) is to be done? The first conclusion to draw is that the kind of pressures felt by local government, the police, fire and the core civil service will have to continue and spread to other, protected, services. It will become necessary to go beyond the current mix of shaving budgets, putting up charges, contracting out and joint provision. 

Community budget-type policies, which have been significantly resisted by the main spending departments, will have to be put into effect. It is hard to imagine that pooled NHS, schools, welfare, police and council budgets could not lead to major efficiencies. The Treasury will at some point have to assert itself and force the Whitehall baronies to work together.

Second, the public will have to be told that the state cannot pick up most of the new responsibilities that we have come to expect of it. In the health service and social security in particular, new demands will have to be resisted. For some new provision, charging will be required. Subsidies for provision such as railways, universities and the arts are likely to be cut substantially. Defence will be reduced to a ceremonial and border-protection force. The retirement age will have to rise at the rate of one year every three to four years.

Third, there will need to be direct intervention to make people look after themselves more. Public health will have to be freed from accusations of ‘nannying’ and allowed to campaign hard to change costly behaviour. Road safety can save lives and costs.

The public will have to be given incentives, or be required, to insure themselves to cover the costs of domiciliary care.

Let us imagine what, without such radical measures, a number of public services and their infrastructure might look like after 10 years or more with little or no investment. Britain has long had a problem with under-investment in its capital. Our roads, railways, housing and schools are often over-used and at risk of decay. Spending in the years to 2022/23 will inevitably see erosion in the quality and reliability of many public sector assets. Shabby, frayed-at-the-edges, services are perhaps the best we can hope for.

We are probably close to the point where there will need to be a more thought-through examination of the future of taxation and public spending in Britain.  Muddling through has just about worked until now. But the pressure on public expenditure that will last from 2011-12 for more than a decade is without parallel in modern Britain. 

The country will have to decide how much taxation it is willing to pay and which service provision it wishes to make a longer-term priority. The exchange of ideas during a three-week general election campaign every five years really is not sufficient to make the kind of radical policy changes required. Economic growth no longer means Britain can expect a big increase in public expenditure. We may never again see the likes of the post-1945 growth in the scale and scope of the British state.


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

This feature was first published in the December edition of Public Finance magazine



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