The RSA and Social Market Foundation report Fiscal Fallout got very little coverage this week. There were reports in the Guardian, the Telegraph and Public Finance but, if it made the TV or radio news, I must have blinked and missed it.
This is a pity because, as Matthew Taylor said, it is far more important than most of the hullaballoo that’s been making headlines this week:
Given the importance of the research’s conclusions, I predict with total confidence that its contents are more important to you than the question of George Entwistle’s payoff.
What’s the big news? The RSA and SMF have crunched OBR figures together with growth projections and concluded that, to meet its deficit reduction targets, the government will have to cut a further £48bn from public spending by 2017-18. That’s on top of the cuts already announced!
The reasons are that the economy hasn’t grown as much as the government assumed it would when it wrote the 2010 spending review. Therefore, tax revenues have not recovered and benefit payments have remained high.
What is supposed to happen during a recovery is that companies recover, unemployment falls, tax revenues rise and benefit payments fall. This reduces the government’s need to borrow. Increases in GDP give the added benefit of making the public deficit and debt look smaller.
Alas, this hasn’t happened. A couple of years ago, there were fears of a jobless recovery. Instead, what we seem to have had is a recovery-free job increase. Unemployment has fallen but growth has remained flat (at best) for the past two years. The tax revenues have barely moved from where they were a year ago and, if anything, in recent months they may even have fallen. The cost of welfare is rising as low wages force many of those in-work to claim benefits.
It’s not hard to see what’s going on here. The rising army of part-timers and self-employed odd-jobbers might be keeping the unemployment figures low but they are not earning enough to pay much tax. In some cases, they are not even earning enough to keep themselves off benefits.
Not only does a recovery-free job increase not do much for the public finances, it also, say the authors of Fiscal Fallout, has worrying implications for the country’s ability to bounce back:
There has been a fall in average hours worked as the proportion of part-time workers in the labour force has increased. This partly explains the fall in productivity per worker, but doesn’t account for the entire drop. While output per worker is 3.7% lower than immediately prior to the 2008 recession, output per hour is only 2.5% lower.a However, even output on a per hour basis has been falling recently, suggesting that there are other factors limiting productivity of the UK economy.
A recent ONS analysis of the issue has suggested a number of potential factors that may have reduced productivity.b These include:
- The 2008–09 recession adversely affected high-productivity sectors of the economy, such as manufacturing;
- Lags in the response by firms to lower demand, as some businesses decide to ‘hoard’ skilled staff in anticipation of the economy picking up;
- The impact of the downturn in lending on firms. This may in turn be reducing firms’ investment in capital and innovation, damaging productivity;
- Over-exuberance in the financial sector pre-recession resulting in capital being diverted to areas with less potential for returns;
- The loss of human capital, as those who have been unemployed for a long period of time lose skills.
a. Office for National Statistics, The Productivity Conundrum, Explanations and Preliminary Analysis, October 2012 (http:// http://www.ons.gov.uk/ons/dcp171766_283259.pdf)
Some of these, like the hoarding of labour, might be temporary, but others, like the reduction in investment and innovation and the degradation of skills, suggest that the economy may have run out of oomph.
The report continues:
This is profoundly important for two reasons. First, the economy has less far to bounce back, so we may be permanently poorer than we thought we were. Second, together with higher borrowing, it means that even more public spending cuts or tax rises than those announced to date will be required to return the public finances to structural balance within five years.
Anaemic growth will, as I’ve said before, have serious implications for public finances.
Fiscal Fallout concludes that, if the government persists with its strategy of reducing deficit by spending cuts, it will need a further £48bn worth of cuts in the next spending round, on top on the £81bn proposed in the current one.
Assuming the government sticks to its plan for reducing the benefits bill by £10.5bn (which also assumes a certain amount of cost reduction due to growth but let’s not over-complicate things) that leaves £37bn in cuts to public services. Fiscal Fallout calculates that this will be a real terms cut of 11 percent over the three years 2014–15 to 2017–18.
But that 11 percent is unlikely to be spread evenly across the board. Fiscal Fallout concludes that, if the government continues with its policy of protecting health, international aid and, to an extent, education, the cuts required from other departments would average 23 percent. Because health and education are so large a proportion of public spending, protecting them transfers a massive burden to everywhere else.
If these cuts are combined with those in the current spending round, the implications for the other public services are huge. Some departments would end up with budgets nearly half the size they were in 2010.
The reports gives some examples of what this might mean:
Ministry of Justice
- Halving spending on the National Offender Management Service – i.e. prisons and probations budget; or
- Cutting over 80% of the Legal Services Commission – i.e. the legal aid budget.
Department of Work and Pensions
- More than halving combined spending on Jobcentre Plus and employment programmes; or
- Cutting departmental operating costs and housing benefit and council tax administration costs by around 90%.
- Cutting over a third of crime and policing spend; or
- Cutting spend on the UK Border Agency and the Office for Security and Counter-Terrorism by around 90%.
The report doesn’t get into specifics about the impact on local government, but remarks:
At a local level, the fiscal impact of rising demand is daunting. The Local Government Association have estimated that the cost of meeting rising demand for statutory services such as adult care and waste could leave local government with a funding gap of £16.5 billion by 2019–20. Assuming that social care and waste costs are met in full, this means that other services would have to be cut by 66 per cent.3 None of this takes account of the further cuts identified as necessary by the SMF after 2014–15. Birmingham City Council has given a stark illustration of the impact of these cuts on the UK’s second largest city, warning that some £600 million of cuts could result in ‘the end of local government as we know it’.
On top of all this, there is the near-certain increase in social costs as a result of demographic change:
Responding to growing and changing demand: the impact of demographic change will be profound and is well known to policymakers. The OBR, for example, estimates that health spending alone will rise by 2.4 percentage points of GDP between 2015-16 and 2016-61.1 Research commissioned for the 2020 Public Services Commission from Professor Howard Glennerster of the London School of Economics predicted that an additional 6 per cent of GDP would need to be spent on public services by 2030 to meet the social costs of an ageing society and to maintain existing cross-party social policy commitments.
According to PwC, that amounts to another £20bn in tax rises or spending cuts, plus an increase in the retirement age, sometime in the next decade.
Anyone who thinks that efficiency savings or the salami-slicing of budgets is going to solve this is living in cloud cuckoo land. As is anyone who thinks public services will get back to normal when the recession is over.
Here’s Matthew Taylor again:
Reading the RSA/SMF report has enabled me to put my finger on the ambivalence I feel about a whole range of government polices – such as free schools and police commissioners – which I don’t actively oppose but which also feel somehow misguided. The answer is that the scope and credible impact of these policies is utterly out of proportion to the strategic challenge government now faces. The leader of any organisation facing Whitehall’s scale of crisis would deal ruthlessly with ideas which did not seem powerfully relevant to core strategic needs. But instead it seems that Number Ten seems positively to encourage these irrelevancies, perhaps in the hope they will distract people.
Tinkering with the state isn’t good enough any more and neither is a laissez-faire just-cut-spending-and-see-what-happens approach. Even if a Labour government is elected in 2015, the problem won’t go away. OK, some of the targets might shift but the underlying debt problem will remain. Whoever is running the country at the end of this decade will have very little room to manoeuvre.
As some politicians are at last starting to recognise, a fiscal gap of this size means that a complete re-design of services and entitlements will be needed. And soon. As I keep saying, the task of this decade is to design a state which can cope with the next one. If we fail to do that, we will be living with the consequences long after everyone has forgotten who George Entwhistle was.