Is the state shrinking?

Almost as soon as the austerity thing started, right-ish commentators started complaining that the government was not really planning any significant spending cuts. Here’s John Redwood barely a month after the Coalition took office.

Allister Heath made a similar complaint in the Telegraph in January and again just before the budget:

If he [The Chancellor] wants to cut public spending, why is he reducing total expenditure by just 3.4 per cent between 2010-11 and 2018-19?

Going by the OBR data, I make it 3.9 percent in real terms but that might just be due to recent changes in the forecast. Over eight years, though, it doesn’t sound like a huge amount.

On the other hand, left-ish commentators tell us we are facing an unprecedented shrinking of the state.

So who’s right? Is the state shrinking or what?

That all depends what you mean by ‘shrinking’.

In terms of raw numbers, it is extremely rare for any government to reduce its spending in a single year, let alone over the course of a parliament. Certainly no government since the end of the Second World War has spent less in its last year than in its first.

When you take inflation into account, though, there have been periods of spending cuts under previous governments. In comparison, the overall total planned by George Osborne doesn’t look that much worse than some of the spending reductions we have seen in the recent past.

TME Real Terms

Source: OBR Public Finances Databank

Taking the same data relative to GDP, the cuts look steeper but they still only take public spending back to 2002 levels.

TME percent GDP
Source: OBR Public Finances Databank

At first glance, none of this looks particularly apocalyptic. Whatever measure you use, the state-shrinkage seems fairly modest, taking us back to somewhere between the early and mid-2000s, more or less undoing the Blair-Brown public spending rises but hardly a fundamental rolling back of the state. That’s what is irritating the right-ish commentators. They want more. A lot more.

But here is where the problems start. Firstly, the population isn’t the same as it was in the mid 2000s. It contains a lot more old people who receive state pensions and associated benefits. Furthermore, this ageing population makes greater demands on public services like health and social care.

Secondly, the labour market is weak. Average wages are set to remain low for the next few years. People in low pay, zero hours contracts and precarious self-employment don’t deliver much tax revenue and a lot of them rely on benefits. Over the next few years, despite modest economic growth, in-work benefits and pensions will keep up the pressure on welfare spending.

The result of this increased pressure on public finances is a shift in state spending away from public services and towards welfare and debt repayments.

The effect of this was neatly illustrated by the IFS in these two charts showing the changing composition of public spending. Look what happens to the purple and yellow lines. The purple line, Annually Managed Expenditure (AME), is mostly social security and the debt repayments, now rising as a result of running big deficits. This is set to increase at about the same rate as the economy grows. If overall public spending is flat and AME increases, the amount left for public services (DEL) must reduce.

Screen Shot 2013-06-27 at 16.39.14
Screen Shot 2013-06-27 at 16.41.45

This chart from the OBR’s March Economic and Fiscal Outlook shows the tipping point happening this year. From now on, AME will make up the greater proportion of public spending, so public service funding must fall if the government’s deficit reduction target is to be met.

Screen Shot 2014-04-01 at 10.34.11

The effects of this are clear in the next chart. In OBR-speak, public service spending splits between revenue spending (PSCE in RDEL) and capital spending (PSGI in CDEL), the darkest blue segments on the chart. Most deficit reduction comes from cuts to spending on public services and, especially, from PSCE in RDEL, which is the funding for the day-to-day running of public services. It’s only towards the end of the decade that reduced welfare payments start to make a contribution and even these projections assumes that the welfare cap is successful.

Screen Shot 2014-04-01 at 10.41.50

I’m surprised no-one has done this but couldn’t find any long-term inflation-adjusted figures for RDEL. I also couldn’t find anything showing public service spending per capita. I dug the figures out from previous OBR reports, then applied the same deflator the OBR used in its overall public spending projections.

Public Spending & Population 2009-2019

(Projected figures in blue)

Public Spending Per Capita

Sources: TME: OBR Public Finances Databank; RDEL, OBR Economic and Fiscal Outlook – Table 4.17; Population, ONS population projections.

Day to day spending graph

According to the government’s plans, then, while overall public spending reduces by 3.9 percent between 2010-11 and 2018-19, per capita day-to-day spending on public services falls by around 28 percent over the same period. Economic and demographic pressures on public finances translate what looks like a relatively modest cut into a very big one.

Within this depleted spending pot, some budgets are protected. As this OBR graph shows, if spending on health, education and international development stays more or less constant, by 2018-19 there won’t be a lot left for everything else.

Screen Shot 2014-03-27 at 19.47.26

It is unlikely that health or education spending will reduce significantly, given the pressures on both. The IFS reckons that the NHS needs a real-terms increase on 1.2 percent per year just to keep pace with demographic change. Even with its protected budget, therefore, the service is beginning to struggle.

The result of all this is some pretty big cuts to most other departments. According to the IFS, the implication of protecting health and education is that cuts to other areas of spending will need to average 36.6 percent. (See IFS Green Budget Chapter 2.) This will hit local government particularly hard.

So, is the state shrinking? Well if you look at the overall figures, it’s not shrinking by much, but the numbers for public service spending tell a different story.

Public spending cuts – 2010-11 to 2018-19

Summary Public spending

As you look into the detail of public service spending, what starts off looking like a fairly small cut gets much bigger. If these spending plans are carried through to 2019, some parts of the state will not so much shrink as disappear completely.

It will need someone with more time than me to dig out the data and work out when a government last spent as little as £3,899 per head, at today’s prices, on day-to-day public services. My guess, just looking at the IFS graphs, is that it must have been some time in the 1990s, when we had a much younger society placing less demand on services like health and social care.

Of course, these are only plans. It may be that economic growth delivers higher revenues, or the next government increases borrowing and taxes. It may be that the spending cuts won’t be as severe. That said, taxes would have to rise significantly to prevent any further cuts after 2015.

Whatever the headline figures might say, though, state provision is shrinking and is set to continue to do so until 2019. Fiscal, economic and demographic factors magnify what looks like a modest spending cut to a point where the squeeze on some parts of the public sector becomes severe. According to the government’s published plans, a 3.9 percent overall spending cut will become a 28 percent public service cut. This is the brutal arithmetic of public spending.

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7 Responses to Is the state shrinking?

  1. Two thoughts.

    Firstly, low average wages means corporations can accumulate – and repatriate – money with less need for capital investment. Is there a link between depressed UK wages and the recent reversal in relative returns on investment into and out of the UK?

    Secondly. In a world of outsourcing, will the shrunken state also become a misshapen state, as contractual liabilities trump public need? Perhaps a more immediate problem in local government.

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  3. Dave Timoney says:

    The state isn’t shrinking. The underlying trend is for state-managed spending to be about 40% of GDP. This has been pretty consistent since 1945. The only major change in the total level was the transfer to the private sector in the 1980s of house-building, nationalised industries and transport. This was a one-off “adjustment” that is unlikely to be repeated (the Royal Mail was chicken-feed in comparison). The major compositional change has been the growth of welfare (mostly pensions), however this was largely offset by a decline in defence spending, and there is still scope for this to continue, contra the demographic doom-mongers (making UK defence spending proportionate to the size of our economy would allow for a 15% increase in NHS funding).

    The neoliberal orthodoxy is often described as “stealth privatisation”, but that is misleading due to the ambiguity of the latter term – it’s not actually transferring economic activity from the public to the private sector, as was done with housebuilding. In practice, what we see is continued state control of revenue-raising and expenditure prioritisation, allied with contracted-out service provision to privileged corporations (Serco, G4S, Capita etc). The critique of Redwood and Heath is that the state should step out of certain public good sectors altogether, thus enabling tax cuts and promoting an elective “free market”. This is ultimately a dispute between big capital and small capital.

    Your point about the changing composition of public expenditure highlights another aspect of this business/government stitch-up. It is no coincidence that the areas relatively proctected, chiefly health and education, are also those where central government control over contracting is strongest and is being further strengthened. This means that there will continue to be pressure from business (ideologised as “raising standards”) to expand these areas as others shrink, leading to no overall change in the size of the state as a percentage of GDP, but a significant increase in the margin of rents extracted.

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