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Picture 32Gurmaj Dhillon is a former Treasury official who recently served as an
adviser to the Conservatives on police reform and youth justice policy.
He is on the Conservative approved parliamentary candidates' list.

In this article I will seek to make the case that:

  1. An ‘early and greater’ approach to fiscal consolidation is needed to restore the public finances back to health;
  2. We should adopt a two-pronged approach: re-focusing public spending towards frontline public services; and applying the concept of GDP-targeting to public spending, while redefining the provision of welfare support; and
  3. This approach should help to manage risks both around the process of economic recovery and the UK’s sovereign debt rating.

The political debate on how to restore the public finances back to health has largely focused on the timing and scale of reductions in public spending on one hand, and measures to stimulate private enterprise on the other. This has driven scrutiny of activity, headcount and pay across the public sector and publicly-funded bodies, and barriers to business growth and job creation in the private sector.

Advocates for ‘earlier and greater’ intervention on public spending (including the Conservatives) argue that this approach will help to both reduce the growing burden of public debt and stimulate private enterprise through reductions in corporate taxation (accompanied by a deregulatory agenda). Proponents of ‘later and gradual’ intervention (including Labour) point to the fragile nature of the anticipated recovery, arguing that shortfalls in banking credit and private consumption require that that government maintains demand in the economy, as individuals and businesses repair their respective balance sheets.

Although there is validity in the latter position, this is qualified by the hardening of sovereign risk around the UK’s widening budget deficits and public sector debt burden, while the ‘earlier and greater’ camp has not adequately explained how a constrained spending envelope may produce more effective returns. The Conservatives intend to pursue better value-for-money through a performance-based funding model, applied across the range of public services and building on the payment-by-results health reform.  However, this still obliges a more sophisticated analysis of how public spending contributes to GDP-growth and downstream tax revenues, which in turn determine the sustainability of the public finances. This prompts the incorporation of GDP-targeting into public expenditure decisions, with the underlying concept summarized below.

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Translating this analysis into practical policy will be essential to support the ‘early and greater’ agenda while avoiding risks to the anticipated recovery. There would be two principal strands: differentiating between frontline public services and the wider public sector, which implies stripping-out activity/ spending assessed as peripheral to priority public services; and re-focusing public spending towards those sectors contributing to higher GDP-returns, while redefining welfare support around the genuinely vulnerable.

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Why emphasize GDP-targeting? Focusing public spending on activity which offered a stronger GDP-return would improve the self-financing aspect of public expenditure, by mitigating the long-term implications for general taxation and therefore reducing the net long-term carry-cost of public expenditure for the wider economy. Implicit in all long-term public finance affordability calculations is a feedback effect from government expenditure (particularly investment) on GDP and therefore tax receipts, and thus ultimately the overall share of GDP taken in tax over the longer-term. The underlying point is that the affordability of public expenditure plans is a function of how much is spent, what the money is spent on and the return on such spending.

Why emphasize welfare alongside GDP-return? Firstly, this would allow us to redefine the concept of need within the current economic environment, and to accordingly restructure the provision of welfare support (e.g. adjusting the universality of certain benefits). Secondly, it would help focus policy interventions towards those groups which display a high-cost/ high-harm fiscal profile, thereby improving their human capital potential. For example, in areas such as family welfare and youth justice, early intervention should produce greater downstream savings by reducing ongoing ‘negative’ demand for certain public services.

Clearly the refocusing of public expenditure along these lines would imply a shortfall towards currently publicly-funded activities. How might this gap be bridged? There are four principal options: the deletion, drawback or outsourcing of public sector activity and associated spending (e.g. freeze on public sector pay and headcount); increasing non-corporate taxation (e.g. VAT or personal income tax); using pricing mechanisms to manage service demand (e.g. road-user pricing, elective surgery); or attaching more conditionality to service entitlements (e.g. tying welfare benefits to employability and civic behaviour).

This proposal would also imply reform of the current fiscal rule set and treatment of public debt, which as they stand do not prioritise economic growth. The ideal set of fiscal rules would not only ensure that the proceeds of future growth were shared but also that these proceeds were maximised in the first place, implying a more rational approach to decisions about what it is/ is not legitimate for government to borrow for. On public debt, the challenge would be to identify those components that were ‘performing’ in terms of being self-financing. Currently, no distinction is drawn between public debt that is supported by a distinct revenue stream and that which is not – both are treated as equal, whereas they are worlds apart in terms of generating growth.

In parallel, we need to consider the central budgetary framework used to allocate public resources. For example, this approach highlights the potential value for the creation of a cross-departmental Productivity Fund, deployment of which would be conditional on clear evidence that the projects or initiatives boosted GDP-returns sufficiently to avoid a negative impact on the public finances, and the budget for which might be sourced through horizontal cuts to departmental expenditure.

This framework could feed into our campaigning platform, to counter Labour’s claims that they are best-placed to manage the country out of recession. For example, the current Government’s plans for a 50% cash cut in capital investment up to 2013-14 would present severe downside risks to future economic growth, as would their recent announcement on £500 million cuts to the higher education budget.

Taken together with a narrative of “Meeting the Challenge of Change” (which I outlined in this previous article), this approach should allow us to combine a hard-headed statement of action based on current realities, together with an optimistic vision of how such action can pave the way for a more prosperous future.

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