Sleepwalking into tomorrow’s state

IFS director Paul Johnson reckons the June spending review is going to be bloody. George Osborne will have to tell us where the next round of spending cuts will fall. That’s the cuts on top of the cuts he’s already made.

These will come on top of substantial cuts to departmental spending over the period of this parliament. And, at 2.8 per cent, the cut pencilled in for 2015-16 is greater than the average annual cut over this parliament.

What looks unavoidable, given these constraints, is that by the end of 2015-16 a group of departments—the home office, ministry of justice and local government, among others—will have seen budget cuts of as much as 30 per cent since the beginning of this parliament.

Not only is public service spending as a whole falling further than at any time in living memory, but its composition is changing. There is a major redistribution within that spending pot towards health and away from pretty much everything else.

There’s more:

But that is not the whole public spending story. So far we have been looking only at public service spending, which is falling. But total public spending is not. What’s the difference? The difference is what is known in government as Annually Managed Expenditure (AME), made up largely of spending on social security, pensions and debt interest.

This component of total spending continues to rise. Indeed it looks as if AME spending will, for the first time, form a majority of government spending after 2015. Roughly speaking, for every pound saved on departmental spending, an extra pound is being spent in AME. Why is that? Well obviously as debt levels rise the amount the government has to spend on debt interest rises. Spending on benefits, especially on pensioner benefits, also continues to rise, as does spending on public service pensions.

As fast as the government cuts departmental spending (DEL), Annually Managed Expenditure (AME) rises. Total public spending therefore remains roughly the same.

AME is made up of the less predictable elements of public spending. It is being driven up by welfare payments – to the unemployed, to pensioners and to those employed in the UK’s precarious low-wage economy.

Having risen during the recession, the welfare bill is expected to fall from next year as the economy improves, though the level of in-work benefits remains stubbornly high.

Does that mean things will get easier for the chancellor? Not really because debt interest, the other big component of AME is set to rise, hence the purple AME line on the graph keeps on going up.

Using government figures, the Social Market Foundation (SMF) calculates that the slight fall in working-age benefit costs will be more than offset by the increase in pension and debt interest payments:

Is there much the government can do about this? The SMF thinks not, because so much of the welfare bill is structural, due to an ageing society and rising housing costs, rather than cyclical, due to the poor state of the labour market.

7 Percentages indicate proportion of welfare accounted for by different benefits; * indicates biggest contributors to recent rises in AME 

Given that the government has pledged to protect education, overseas aid and health, any spending cuts will therefore fall disproportionately on departmental spending, plus any bits of welfare that the chancellor thinks he can get away with cutting.

Coming on top of the current squeeze, the next round of cuts could well see the end of some public services. A 30 percent cut in the space of six years means that some parts of government, especially local authorities, will struggle.

Not that things will be great for the so-called protected departments. NHS costs rise faster than inflation and an ageing population will make increasing demands. Even with ring-fenced spending, some A&E units are already close to collapse and, according to emails seen by the HSJ, is about to be bailed out with emergency funding. It is unlikely that this will be the last time.

What about efficiency savings? Well we already know that the savings needed are way beyond what could reasonably be expected to come from efficiency measures. And in any case, says Johnson, in local government, much of it has already been done:

Additional cuts in some areas of government spending will bite very hard. To the extent that there was low hanging fruit to pluck in local government, the police and other services, it is likely to be gone by 2015. The consequences for both the real quality of public services and the way in which they are organised are likely to be considerable.

Is this likely to get any better if Labour win the next election? Don’t hold your breath. The combined costs of healthcare, pensions, welfare and debt interest are eating into departmental spending. The only way to prevent further cuts would be to reduce welfare spending, which is difficult, if not impossible, or raise taxes. This IFS graph neatly illustrates the dilemma.

The IFS reckons that the next government will have to increase income tax by 3p in the pound just to avoid further cuts. That’s not to reverse this government’s cuts and put things back to how they were, it’s simply to avoid having to cut any more. (Its other options would be to borrow more or print money, both of which would be controversial, to say the least, and come with risks that I don’t have space to go into here.)

What the IFS and a few others have spotted, but which politicians and the media don’t seem to be talking about, is that this amounts to a de-facto reconfiguration of the state. We are about to pass the point at which spending on welfare and debt interest exceeds spending on public services. Furthermore, an ever-increasing amounts of the depleted spending on public services is being directed towards health.

The focus of government spending is shifting towards healthcare and welfare (mostly pensions) and away from just about everything else. This is only to be expected in a country with an ageing population. But there has been very little discussion about what we might have to give up as a result. Sports centres? Libraries? Street lighting?

Last week, based on the projected funding cuts, the Local Government Association produced a model budget for a typical unitary authority towards the end of this decade.

This sees the closure of leisure centres and museums and cuts to bus services. The removal of funding for the voluntary sector could be significant too. No-one can be sure what the impact of this might be but if charities stop working with alcoholics and drug addicts, many of them are likely to end up in A&E as a last resort, stretching the system even further.

The logical conclusion of all this that there are some things the state will have to stop doing because it just won’t have the capacity. This is something that will affect almost all of us yet there has been little public debate about it. Politicians and the media work themselves and the public up into a frenzy about all sorts of things that don’t really have that much impact on most people’s lives, while the reconfiguration of the state is likely to take place all around us without most of us realising what is going on. Until suddenly we notice that the sports centre has closed, the road hasn’t been fixed this winter, the buses have stopped running and the side streets are all dark. Maybe then we will wonder why we spent the 2010s arguing about immigration, gay marriage and the EU.

Hat Tip: Michael Carty for pointing me to Paul Johnson’s Prospect article.

Update 21 May

Paul Johnson was in the FT yesterday.

Because national income has taken such a bashing, public spending this year will, at 44 per cent, be higher as a proportion of national income than in any pre-recession year since the mid-1980s. Even in plans as set out, it will still in 2018 take up the same share of national income as it did in 2003-04, halfway through the last government’s second term.

That is an important point to grasp. The cuts being faced across the public services are real and they are deep. Yet they will serve only to return the size of the state to something like its long-run average. They are doing something else as well though. They are changing the shape of the state.

The choices that are being made mean that while the public sector will take the same share of national income in 2018 as it did a decade and a half earlier, it will be much more focused on health and pensions – and of course debt interest.

He’s right. It is an important point. As I’ve said before, the government’s ‘state-shrinking’ plans simply return us to the normal (as in non-recession) public spending level of around 39 percent of GDP. The trouble is, thanks to increased spending on pensions, healthcare and debt interest, 39 percent of GDP won’t leave as much for public services as it did in the mid-2000s.

This is an important difference between the Shrink-The-State argument and what I (thanks to Adil Abrar) call the Peak State argument. Cuts to spending on public services will be necessary even without the state shrinking below its long-term average. Either that or spending will have to rise to a new normal which means higher taxes.

Whatever happens, Paul Johnson is right to say that we face tough choices and that we need a broader debate about all this. It’s not happening though. Apparently, our politicians have more important things to worry about.

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