The public expenditure debate

Public expenditure looks like being one of the major dividing lines between the political parties at the next election. It is, of course, to some extent an artificial debate. Whoever is in office is going to make substantial cuts, probably the most severe since 1945. However, the preference of the Conservatives would be to cut more and increase taxes less and the cuts would probably be directed differently under Labour.

How much has to be cut depends in part on how quickly the economy recovers, boosting tax revenues and reducing benefit payments. There has been some over optimism about recovery when what has happened is that the economy has stopped declining rapidly and is bumping along the bottom. To some extent there has been an inventory cycle effect as stocks that have been run down have had to be replenished.

It is therefore worth noting the OECD forecast of a 4.3 per cent in GDP this year, followed by a flat 2010. Three per cent of output may have been wiped out for ever in OECD countries and perhaps as much as five per cent in the UK.

The required spending cuts will include savage cuts in capital spending and a reduction in public sector manpower. But where will the cuts fall? If reductions are equally shared. departmental spending would fall by nearly 7 per cent in real term in the three years after 2011. If health and overseas aid are spared, most departments would fall by 10 per cent and if schools escape the axe, the reduction would be a massive 13.5 per cent.

Health, education and social security account for about £2 out of £3 spent in the form of public expenditure in the UK? Can these budgets remain sacrosant? Health is beset by the problems of an ageing population and an ever advancing technological frontier. Touching the NHS budget is regarded as political dynamite. However, perhaps there needs to be a debate about what can be afford or whether there is any scope for charging (although that may not raise much in relation to the controversy it would cause).

Is working longer the answer?

Conventional answers to the crisis brought on in the public finances by the recession are some mixture of increasing taxes and cutting public spending, generally more of the latter.

Now in a paper written for the National Institute of Economic and Social Research by Ray Barrell, Ian Husrt and Simon Kirby, it is suggested that each year of additional working life would cut the budget deficit by 1 per cent of GDP after 10 years and in time reduce government debt by 20 per cent of GDP.

Boosting average working lives by three years would pare back the budget deficit by 3 per cent of GDP and cut government debt by 60 per cent of GDP, which the institute estimates is the cost of the current crisis.

Interestingly, compared with earlier recessions, employment among older workers is holding up better than for other age groups. Of course, it may be that the depth of the recession and the impact on their pension pots incentivises them to work longer.

Budget commentary

Britain now faces the challenge of a massive overhang of public debt with public borrowing estimated to soar to £175bn in this financial year with a similar amount to be borrowed next year. Managing that debt involves a combination of tax increases and cuts in public expenditure. This task is not made easier by the fact that corporate and personal tax revenues fall in a recession while payments on unemployment benefits increases.

The Government is going to have to sell far more gilt-edged stock than anticipated and there are doubts about the ability of the market to absorb more than £200bn of gilts, particularly if international investors start to doubt the credibility of the UK economy. One of the ways of retaining that credibility is to show that the UK is fiscally responsible but what that means in practice is pain for UK taxpayers and users of public services.

The damage in terms of the toxic debts of the banks may be greater than the Treasury is allowing for. They have made provisions of up to £60bn for potential losses, but the International Monetary Fund thinks that it may be necessary to make provision for over twice the amount the Government is talking about, in the region of £130bn.

Much of the effort to cut public expenditure rests on ‘efficiency savings’ estimated at £15bn. These have been going on for some years anyway and it is questionable savings of this size can be made. Cutting bureaucracy may seem an attractive way of reducing public spending. But there is a point where it starts to affect citizens. For example, if HM Customs and Revenue are under staffed more mistakes may be made and it may take longer to sort them out.

Making the better off pay more taxes with the new 50 per cent rate and the 45 per cent rate starting this year is also politically attractive, but in reality it often raises very little revenue, particularly given that it is difficult to close off all routes for tax avoidance.

Motorists will be hit with the idea of above inflation rises in petrol duty coming back and the scheme to pay a bounty of £2,000 for scrapping cars over ten years old will only have a marginal effect on the beleaguered motor industry.

It should also be noted that all the Government’s plans rely on a rapid recovery in the economy which many analysts think is unlikely. It’s a hard path ahead.

A spectre is haunting Europe

There is a spectre haunting Europe and it is the spectre of industrial policy. Some of the more ambitious dirigiste aims of President Sarkozy have been tamed by the European Commission, but there is no doubt that interventionism is back in town. I even heard someone argue the other day that the market is finished as a form of social organisation.

Whether politicians and bureaucrats can make better decisions is far from proven: rather the contrary. Those of us who studied industrial policy in the 1970s came to the conclusion that it was a highly dysfunctional form of policy for the following principal reasons:

1. It enables multinational companies to play one country off against another to extract funds (which is why we need an EU state aids policy).
2. It is very difficult to demonstrate 'additionality', i.e. that the additional funds made available lead to investment that would not otherwise occur.
3. It is very difficult for politicians and bureaucrats to pick winners (or 'losers')
4. Often decisions are made on electoral grounds, e.g., the sensitivity of a particular constituency or region.
5. Often investments were replicated in different parts of the country for political reasons when there was no good economic case: steel and aluminium provide good examples.
6. Large companies were generally favoured over smaller countries.
7. Industrial structures were ossified, particularly in terms of over capacity.

The political pressures to 'save jobs' are nevertheless enormous which is why it was encouraging last week to hear Lord Mandelson say that government (or the taxpayer) is not a huge bail out fund.

Capitalism has recurrent crises, but they also have a purgative effect, producing a leaner and fitter economy. In this respect I await one of the first books by a leading political economy academic on the global financial crisis. The Spectre at the Feast by Professor Andrew Gamble FBA of Cambridge University will appear from Palgrave-Macmillan in the next couple of months. Gamble

Who should get help?

Yesterday was a particularly grim one in terms of employment news with big job losses at steel maker Corus. But, given that government funds are constrained, who should get help? Steel unions have asked for the kind of aid that is given to supplement the incomes of those on short-term working in France, Germany and the Netherlands. The UK Government is unwilling to do this, but might give money for 'training'.

Steel workers were complaining yesterday that money is given to 'top hats' but not to 'hard hats'. However, if we learnt one thing from the experience of the 1930s recession in the United States, it is that one doesn't allow banks to collapse.

In fact there may be another bias in the way in which aid is given. Women are losing their jobs faster than men in the recession and women MPs are complaining that too much emphasis is being given on helping male-dominated industries such as finance and motor vehicles, whilst 'soft' industries such as retailing and catering are ignored.

When I used to work on industrial policy, I was struck how many books were written about motor vehicles and steel, but relatively few about food processing. But, of course, food processing is an industry that employs large number of women workers. All the talk about 'real jobs' and 'making things' often conceals an implicit gender bias.

Of course, recurrent major crises of the capitalist system are a reorganisation device out of which it emerges leaner and fitter and able to grow again. Not everyone's job can be saved or subsidised, but the flip side of that is that the pain of recession falls harder on some than on others.