Spending Review PSA targets crucial to Browns reforms, by Tom Clark and Christine Frayne

18 Jul 02
The Spending Review has confirmed what many expected: large increases in resources for many public services. The Budget had already told us how far the overall spending envelope would grow, and laid out a very generous settlement for the NHS with avera.

19 July 2002

The Spending Review has confirmed what many expected: large increases in resources for many public services. The Budget had already told us how far the overall spending envelope would grow, and laid out a very generous settlement for the NHS – with average real increases of 7.4% per year through until 2006.

This week's statement from the chancellor announced the other big winners. Education gets an average real spending growth of 5.8% over the next three years, international development gains 8.1% and transport receives 8.4%. There were also more modest increases for defence (1.2%), the environment (2.7%) and housing (4.1%).

The rise in spending over the next three years will be paid for by increased borrowing and higher tax receipts, as outlined in April's Budget. Tax revenues are set to go up by £8bn a year between now and 2005/06, mainly from the rise in National Insurance due in April 2003.

These increases accentuate the need to reassure the public that they are getting value for money. Alongside the extra resources, Gordon Brown outlined fresh government targets and mechanisms designed to secure public sector efficiency and allay some possible concerns.

Measuring public service performance has become a central political issue, starting under John Major, with his Citizen's Charter, and taken a stage further by Labour. Targets for waiting lists and class sizes featured prominently in the 1997 election campaign, while the 1998 Comprehensive Spending Review used new Public Service Agreements to link extra funding to a plethora of performance indicators.

But targets bring their own problems. They are chosen as quantifiable proxies (for example, waiting lists) for the more nebulous things that the government and the public actually care about (such as overall NHS quality). But a waiting list target could mean that NHS managers focus their attention on cutting waiting lists at the expense of everything else, and actually end up reducing quality.

Economists have long talked about 'Goodhart's Law': when a measure becomes a target, it ceases to be a good measure.

This concern may be the reason for the government's recent shift in emphasis from target-setting to selecting the right target. While waiting lists were heralded as the central measure of NHS progress in Labour's first Parliament, a more holistic approach is taken now.

The number of targets is also falling: the July 2000 Spending Review had 160 – a reduction from the 300 in the July 1998 Review. This year's Spending Review had fewer again at 130. Whether these new targets have struck the right balance between simplicity and accountability on the one hand, and comprehensiveness and non-distortion on the other can only be judged over time.

This move away from reliance on crude targets has been accelerated by the announcement in the Spending Review of new public service auditing institutions. Yet even if the measurement of public service quality improves, the issue of how to tackle failing services must still be addressed. Cutting the budgets of under-performers might create the right incentives to achieve high standards, but could also reduce the quality of services for people who already use poor services.

Some of the non-budgetary incentives unveiled by the chancellor for public sector managers – such as the threat of takeover for failing agencies, and enhanced freedom for the successful ones – attempt to address this dilemma.

To put UK public spending in context, it is interesting to ask how we compare internationally both before and after Labour started its significant spending increases. In 2000, the UK government spent 37.0% of GDP, which was more than the US (29.9%) and Japan (36.6%), but less than the big three continental countries – Germany (43.3%), Italy (44.4%) and France (51.0%).

The increases between 2000 and 2006 will mean that the government spends an extra 3.7% of GDP. If other countries' spending remains constant then we will overtake Canada (37.7%) but other than that, our mid-table position in the Group of Seven tax-and-spend league will be unaffected.

Perhaps the most significant potential issue that the Spending Review had little to say on was the government's commitment to reduce child poverty by a quarter by 2004. New tax credits already pencilled in for next year should help, but the provision for benefit increases after that date is modest.

And, as we have argued before in Public Finance, it is very likely that only rapid increases in benefit rates will help substantially to cut child poverty. Small increases are needed just to ensure that the poorest children 'stand still' and do not fall behind those in working families whose wages will increase over time.

Tom Clark and Christine Frayne are research economists at the Institute for Fiscal Studies


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