Ryan Bourne is the Head of Public Policy at the Institute of Economic Affairs.
The economic recovery has been bittersweet for the government. Unemployment has fallen dramatically over the past 12 months – from seven per cent to six per cent. GDP growth is still healthy despite significant international headwinds. And yet, the overriding declared mission of the government – deficit reduction – is floundering. Badly.
Last week’s public finance figures should be a wake-up call. In 2013/14, the UK borrowed a total of £97.5 billion. After the first seven months of 2014/15, we’ve already borrowed £64.1 billion. That’s £3.7 billion more than at the same stage 12 months ago. It seems perfectly plausible that for the year as a whole the deficit will be higher than last year. This comes on top of delays to deficit reduction targets seen through this parliament.
Think back to 2010. George Osborne said he wanted to eliminate the structural current deficit – intuitively, the part of the day-to-day deficit that wouldn’t fall away when the economy returned – by 2014/15. Sure, he included weasel-words about it being a ‘rolling target’, ‘within five years’, such that if he didn’t meet it, he wouldn’t be declared a failure. But it was understood by almost everyone to be an ambition to run a structural current surplus by this year.
To do so, he set out spending plans and a range of tax policies which he believed would facilitate that target being met. By 2014/15, the UK would have an overall structural deficit of 0.8 per cent of GDP and would be running a structural current surplus of 0.3 per cent of GDP. In fact, by Budget 2014, the forecasts for 2014/15 were considerably less rosy. We were now predicted to have a structural deficit of 4.5 per cent of GDP and a structural current deficit of 2.9 per cent of GDP.
How had this come about? Did Osborne simply jack in “Plan A”? It depends what you mean. The Chancellor has by-and-large delivered the spending levels and tax rate changes he promised. But most thought Plan A was a “deficit reduction” plan, not a “spending plans” plan. The Chancellor has consistently decided not to pursue more active reductions in government spending in reaction to evidence that his deficit targets are not being met. Specifically, the OBR revised up how big the “structural deficit” was in 2011 after revising down the productive potential of the economy – and the Chancellor decided to sit on his hands.
In fairness to him, it was not an entirely unreasonable reaction. I happen to agree with some left-wing economists that the “structural deficit” is a somewhat ridiculous technocratic construction based on a range of variables which economists have little ability to know with certainty. The structural deficit is determined by using estimates of how far the economy is from its potential, the productive potential in future, and how tax revenues and spending are likely to react to changes in the health of the economy.
inanAs we’ve seen, it is subject to large revisions. The fact that so much emphasis is put on its precise value in public discussion of legitimacy of planned policies is laughable. So the Chancellor was no doubt hoping that the OBR was wrong – and that when the economy did recover, productivity would recover quickly, tax revenues would boom more than expected, the structural deficit would be revised down again and meeting his targets would be much easier.
Except, as we’ve gone on, that hasn’t happened. In fact, using the OBR’s own methodology, the Financial Times journalist Chris Giles has shown that the OBR are probably going to revise up the structural deficit again – to as high as £95.5 billion for 2014/15. Whilst we shouldn’t attach too much commitment to the exact number the OBR machine churns out, the evidence that we have suggests spare capacity in the economy is closing quickly, productivity is still struggling and tax revenues have been nowhere near as responsive to growth as expected. Put these together and it means a need for more restraint – which, if Osborne won’t change his plans ahead of the election, will mean further cuts booted into the future.
It looks, in other words, that Osborne’s plans simply weren’t ever enough to get the job done. In truth, the cuts delivered have always been modest in relation to overall spending. Under the Chancellor overall government spending fell by 1.7 per cent in real terms between 2009/10 and 2013/14. Excluding debt interest payments, this was a fall of 3.9 per cent. Of course, within that, the decision to prioritise certain spending streams such as the NHS, the state pension, and foreign aid, meant that many of the liberal functions of the state – like defence, policing and local government – have taken a big hit. Social protection spending continues to grow, in part because of an ageing population.
Back in 2011, I thought Osborne was wrong not to adjust his spending plans. But I can understand why he didn’t. What has troubled me more, though, is the often unimaginative approach to spending restraint, even on a forward-looking basis. Much low-hanging fruit has now been plucked, and the next government will find itself with much more difficult choices about where the axe will fall. Yet all Osborne’s musings suggest he would simply keep salami slicing in the same unprotected areas in the next parliament until the structural deficit is gone.
Rather than assuming that all of the functions of the state should remain, it would surely be better to think from first principles about what the state should actually do and then work out the funds necessary to deliver those services. In other words, a truly comprehensive spending review is desperately needed – but one which focuses on the functions of government, rather than departments, and one which recognises the cost and demand pressures of the service. I quite like the ConservativeHome manifesto idea of an Affordability Commission – though my own preference would be for a much smaller state per se.
Within this re-examination, political ring-fencing should go. Not that this would necessarily mean severe cuts in all of the existing protected areas, but because allocating a pot and then telling people to get on with it is a bad way of doing policy. That applies to the Annual Managed Expenditure welfare cap that Osborne is imposing, too. Social protection spending keeps rising in the UK, but it makes no sense to just set a pot for working-age welfare (excluding jobseekers’ allowance) irrespective of the needs of the time and then salami slice to meet that target. This may be easier than fundamentally re-assessing eligibility criteria, or developing much-needed supply side reforms in areas like planning to eliminate the need for housing benefit. But in the long-term it will undermine public support for welfare reform, by leading to punitive cost saving measures that do hurt some groups.
A final thought. The Conservative position on pensioners is surely not sustainable. The triple-lock has been an expensive mistake. There is an economic case for linking state pension increases to prices (to maintain purchasing power) or earnings growth (to preserve living standards relative to workers). It is more difficult to justify a policy which links the state pension to whichever is higher. It’s impossible to make the case that a third safety net of a 2.5 per cent rise should be included, too. The fact that earnings growth has been so slow in this parliament, with an inflation spike and now a period where both earnings and inflation are low, means this policy has already been expensive. Both this and the collection of unjustifiable universal pensioner benefits should surely be on the cutting table in the next parliament.
Given the fundamentals then, the story at the Autumn Statement should really be about spending and the scale of restraint necessary for the next government. Unfortunately, with an election around the corner, it’s been suggested it will be instead about announcing pork barrel infrastructure projects for politically important areas of the country. Plus ça change.