Economics: More promises – making the case for public sector cost cutting

The fact that there has to be a general election by the first week in June next year gave this autumn’s party conference season some extra spice. The economy is obviously high on the three major parties’ agendas, the debate about future government tax and spending policies a central theme. Business secretary Lord Mandelson went as far as to describe the next election as a ‘change election’, warning that if his party was not prepared to embrace change, voters would turn to one which did.

It is easy to understand why public sector finances might become one of the defining issues of the election campaign. Chancellor Alistair Darling announced in his April 2009 Budget that in the current fiscal year, the government’s deficit will be £175bn. This comes after seven years of smaller deficits, at a time in the economic cycle when conventional economic wisdom would have expected surpluses.

Forget that. This year’s net borrowing is equivalent to 12% of GDP while, for the first time, the figure has exceeded £100bn. The obvious consequence is that national debt will rise, from under 30% in 2001-02, well beyond Gordon Brown’s sustainable 40%, to 76% by 2013. This is even higher than in the bad old days of Jim Callaghan and Denis Healey in the 1970s and makes nonsense of New Labour’s claim to fiscal prudence. A coherent exit strategy implies substantial tax increases, swingeing spending cuts or a combination of both. Neither route will be popular, both will be painful, and the political battle will be for policy credibility.

That said, Darling’s current position is a defensible one. The simple principle that everyone’s expenditure is someone else’s income means fiscal easing is an obvious policy lever to pull when the economy turns down. The amount of his borrowing reflects both the damage the recession did to his accounts and his inheritance of spending and borrowing. No fair-minded person would point an accusing finger at the Chancellor and blame him for these dreadful figures. But you might hope he would say more about how we get out of the mess.

Of course, compared with some of our major competitors, it is not such a mess as some quarters of the British press imply. And because interest rates are so low, servicing the debt is expected to account for only 4% of government spending this year. This is a much smaller proportion than in the early 1990s when John Major’s government spent more on debt interest than on education because interest rates were so much higher. But even this 4% is money that cannot be used for tax cuts, hospitals or improving the infrastructure. It represents the cost of past failures.

Questioning the role of government, however, goes beyond arguments about lowering the tax burden or maintaining frontline public services. There is a need to ask what governments should do in a modern economy, how much that should reasonably cost and what is the most efficient way of raising the money. Governments generally do what governments have always done, then add a bit more. They very rarely ask if everything that is done needs to be done, and should be done by the public sector.

The size of the government now is raising all the 1970s issues about ‘crowding out’ the private sector, for labour and for finance, with the result that earnings and interest rates could be pushed up. The alleged ‘comfort zone’ offered by the public sector is a disincentive for workers to go back to the private sector when activity picks up, leading perhaps to more off-shoring or out-sourcing of jobs.

As dependency in the UK increases (people at either end of the age range dependent on a smaller proportion of the population in the labour force), each worker has to create more wealth than their predecessors to support them, so in other words, productivity has to be higher. There is a lot of evidence that productivity levels and the rate of productivity growth are lower in the public than private sectors, and so the increasing employment in public services, however socially worthwhile, does not produce the same economic gain.

And in a modern global economy, the UK needs to be perceived as ‘a good place to do business’. We need to attract the inward investment in key sectors to underpin the productive base of the economy. The burden of corporate taxation is an important component in the location decisions of major multinationals that are spoilt for choice.

All three parties seem to have accepted the need for cutting government spending, but only when conditions allow it. It would be counter-productive to reduce the public sector if the private sector is still in the doldrums. But expectations have to be kept in check. Much government spending is planned well in advance and immediate cuts cannot be introduced. There are also areas that seem untouchable.

Spending on social protection, health, education, public order, defence and debt interest accounts for 80% of government spending, thus reduces the scope for quick action. And, of course, once in office, the business of government gets in the way of longer-term thinking. Making the case will be easier than implementing it.