Lord Flight was Shadow Chief Secretary to the Treasury from 2001-2004.  He is now chairman of Flight & Partners Recovery Fund.

George Osborne is to be congratulated on having got the economy going again, in contrast to the poor, continuing performance of continental European economies; but there remain five inter-related issues which need to be addressed if economic recovery is to be sustained.

  • We continue to run what is, in effect, a structural budget deficit of £100 billion a year.
  • The UK Savings Rate continues to be far too low.
  • Productivity has not increased for a decade.
  • Pay in the public sector, strata by strata, remains too high in comparison with pay in the private sector.
  • Over half of all households are now receiving more in benefits than they pay in taxes, leaving a minority of middle class tax payers bearing a growing share of the tax bill.

While rising tax revenues with the economy recovering will serve to reduce the budget deficit, this will of itself be sufficient.  In addition to fast-growing debt servicing costs, the public sector deficit, combined with the low Savings Rate, has led to the largest ever UK current account deficit – over five per cent of GNP.  One way or another, this will have to be financed by a mixture of the sale of UK assets to foreigners and mounting foreign owned debt to service.  Taken together, health and welfare expenditure are now running at around £350 billion per annum – close to half of all Government expenditure, which is simply not sustainable in the long term.

I believe we need a private sector Savings Rate averaging around 10 per cent of GNP; it is now around only three per cent.

Productivity growth since 2005 has been virtually zero in net terms.  Manufacturing productivity has grown, but in the service sector productivity has actually declined.   The two inter-relate, because “Savings equal investment” where there has been inadequate investment in the service sector.  Low levels of savings have thus been one cause of zero productivity growth.  It is, moreover, no coincidence that poor productivity performance goes back to Labour’s introduction of tax credits in 2004.  The problem with subsidising employment is that it leads to over-manning in non-growth areas, discourages people from skilling up and so damages productivity.  It also puts downward pressure on wages and interferes with the employment market.  This is precisely what happened in the first 30 years of the nineteenth century under the Speenhamland regime of subsidising employment, when, as has occurred today, the costs of such subsidy also rise inexorably. Tax Credits now cost £29 billion per a year, with housing benefit costing £25 billion – together equal to half the structural deficit.

Since 1997, the Savings Rate has been driven down, in part by the destruction of what was the best pension system in Europe.  This decline has been caused by over burdening final salary schemes, by the tax raid in Gordon Brown’s first budget and by continuous tinkering with the rules.  And with Brown’s major extension of welfare entitlements, a majority of the population sees no point in saving for their retirement years: the State will look after them anyway.

The two main causes of the £100bn structural deficit created by Gordon Brown were the major increases in welfare benefits – such as tax credits – largely designed to “buy votes”, and major increases in public sector pay – this was where much of the increase in health spending has actually gone.

Historically, level by level, public sector pay has been of the order of 10-15 per cent below private sector pay, reflecting better pension provisioning and better security of employment in the former.   Today, public sector pay remains, level by level, some 10-15 per cent above private sector pay.  The Coalition Government promised to address this by freezing public sector pay, yet pay increases in the public sector have regularly outstripped those in the private sector.  Last year, State employees enjoyed an average wage increase of 1.4 per cent, compared with only 0.6 per cent in the private sector.  As pointed out above, part of the reason for the continuing low increases (decreases in real terms) in private sector remuneration has been tax credits – why should employers pay more when the Government tops up wages?  The argument is, moreover, circular in that larger pay increases would serve to be inflationary, unless matched by productivity increases.

Another result of the Brown increases in welfare entitlements and deficit spending has been the number of people who get more in benefits and public services than they pay in tax that is at record levels.  More than half of households now take more from the public purse than they contribute.  This in turn narrows the tax base, and damages the stability of the public finances.  Today, 52 per cent of households (13.8 million families) receive more than they pay in taxes; back in 1977, the figure was only 40 per cent of households, rising to 44 per cent in 2000.

Within the recent Budget was a commitment to cap welfare spending for the years 2015 – 2019 at a level of £119.5 billion rising to £127 billion in 2018/19.  The cap does not, however, include Job Seekers Allowance and its passported housing benefit; Universal Credit payments subject to full conditionality; both basic and additional state pension expenditure; Government transfers such as TV licences for the over 75 year olds and benefits paid from within Departmental Expenditure Limits.  Making the best of the data available, and including some welfare expenditure within regional and local government expenditure, total national welfare spending for 2014/15 will be between £230bn and £240bn.  The caps on expenditure will thus only relate to approximately half of it,

In this whole inter-related area, the truth is that Brown has left his successors with thorny politico/economic problems to address, but public opinion appears to be supportive of the original intent of welfare expenditure – for those in real need. With the economy now recovering impressively, the task of addressing these inter-related problems should now be more easily addressed in political terms  If, however, this is not done, failure will condemn Britain to a low, underlying, sustainable rate of growth.