Efficiency savings won’t stop tax rises or spending cuts

When I posted my 2015 Dilemma diagram just before Christmas, a few people responded by asking, ‘what about efficiency savings’? If we can simply make the public sector more efficient, we can maintain services, keep taxes low-ish and still reduce the deficit, or so the story goes.

The 2015 spending/taxation/borrowing dilemma

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There is little argument about the need for greater efficiency in the public sector. It was to emphasise this point that I started banging on about the UK’s tough spending choices in the first place. For at least the next ten years, even as the economy recovers, the public sector will be under pressure to reduce its costs. Real-terms budget cuts and the drive for greater efficiency will be the defining feature of many public servants’ careers. There are some in the public sector who think the current squeeze is temporary. You still hear people say ‘when this is all over’ or ‘when things get back to normal’. Things won’t get back to how they were before the recession, though. The days of increasing public service budgets won’t come back. The relentless push for efficiency savings will become normal. That’s a given.

But efficiency savings alone won’t prevent further cuts and tax increases in the next parliament. The gap between revenue and spending is just too big. This summer, the Institute for Fiscal Studies calculated that a tax increase of £25 billion would be needed to prevent further cuts after 2015. The Resolution Foundation put the figure slightly higher at just over £26 billion.

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Efficiency, and especially public sector efficiency, is a difficult thing to measure. The ONS compiles figures on productivity across all sectors, as does the Institute for Fiscal Studies. Productivity and efficiency are not quite the same thing but they tend to be used interchangeably by politicians and journalists and, for the purposes of this argument, they are close enough. (If you want to get your head around public sector productivity, this handy guide from the LSE and these FAQs from the Office for National Statistics are useful.)

According to the IFS, productivity in the economy as a whole increased by 2.3 percent in the decade before the recession. The Bank of England put it at 2.4 between 1998 and 2004. The OBR predicts 2.2 percent for the next decade or so. But that disguises some differences between sectors. Manufacturing productivity increased at somewhere around 4.5 percent, private sector services were closer to 2 percent. (See this KPMG report Page 20.) Public sector productivity barely moved at all between 1997 and 2010, according to the ONS, with recent gains cancelling out previous losses. The IFS is a little more positive. For reasons it gives in Chapter 3 of its Green Budget, it estimates public sector productivity improvement at 0.7 percent per year between 1998 and 2008.

Since the recession, productivity in the UK has crashed. The IFS reckons it fell by 1 percent per year between 2008 and 2012. Over the same period, the public sector held up reasonably well, improving productivity by 0.3 percent. Given that the public sector over-achieved on its spending cuts last year, that figure might look slightly better when more recent data become available.

The general picture, then, is that manufacturing improves productivity at almost twice the rate of the service sector and the public sector struggles to do so at even half the rate of private sector services. There are a number of reasons for this, which I wrote about at length a couple of years ago (here, here and here) and summarised here. It’s also worth remembering that not all of the private sector’s productivity increases come about because of improvements in existing organisations. Some of it is due to new organisations replacing old ones that have gone out of business. The private sector can, effectively, rip it up and start again in a way that the public sector can’t.

Let’s assume, though, that sustained year-on-year productivity improvements, well in excess of anything achieved so far, are possible in the public sector. What if the public sector could do what the whole economy averaged in the decade before the recession? 2.3 percent is a convenient figure to work with because the IFS has already done some calculations for us.

After the Autumn Statement, the IFS said that reducing the public service cuts to 2.3 percent per year after 2015 would require welfare cuts or tax rises of £12 billion. In other words, then, if you could make efficiency savings of a similar size, you’d still need £12 billion in taxes to cover the shortfall, if you wanted to maintain your public services.

So even if we imagine efficiency savings at the Kool-Aid end of optimism, we would still need more tax rises or cuts to public services after the next election.

But it’s actually more complicated than that because the cuts are not evenly spread. By protecting the budgets of two of the highest spending services, the level of cuts must increase for all the rest. By quite a lot. As this IFS chart shows, the relatively modest (compared to what’s planned for later in the decade) 2.1 percent cut planned for public service spending in the year of the election, translates into some big numbers for the unprotected areas once health and education have been ring-fenced.

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These come on top of big budget reductions since 2010. As the overall percentage of cuts rises over the second half of the decade, the level of cuts to the unprotected areas will be huge.

Couldn’t this be solved by asking the NHS to make savings too? Yes but the NHS needs its savings just to enable it to manage within its ring-fenced budget. Health costs rise faster than inflation and, according to the IMF and OBR, will probably outstrip economic growth over the next 15 years (see previous posts) which means that, even with a slight real-terms budget increase, the NHS has to make efficiency savings just to maintain its current level of service. Here, too, there are problems. After getting off to a good start, NHS productivity improvement has stalled. Recent reports from the National Audit Office, the Kings Fund and the Nuffield Trust suggest that the initial savings came from relatively easy wins and future gains will be much harder.

IFS Director Paul Johnson said something similar about the rest of the public sector:

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.

Even if public sector organisations could manage 2.3 percent productivity improvement per year, then, it still wouldn’t be anywhere near enough to cover the planned cuts to their funding. Achieving even that would mean tripling the rate of productivity gains achieved by the public sector in the past. Efficiency gains may make some difference over the next few years but it won’t be anywhere near enough. To prevent cuts to services, something else will have to give. 

There is some great work going on in the public sector at the moment. Most people working in it know that they will need to keep finding new ways to do more for the same or the same for less. Let’s not kid ourselves that these new efficiencies will remove the need for service cuts, tax increases or extra borrowing, though. The problem is much bigger than that.

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11 Responses to Efficiency savings won’t stop tax rises or spending cuts

  1. Pingback: Efficiency savings won’t stop tax rises or spending cuts - Rick - Member Blogs - HR Blogs - HR Space from Personnel Today and Xpert HR

  2. forlornehope says:

    The key point is the “rip it up and start again” that you mention. Culling local general hospitals and replacing them with regional units and very local “cottage hospitals” will give improved treatment and big cost savings. It’s only the scurrilous behaviour of MPs more concerned with the health of their majorities than the health of patients that is stopping this (the health service unions and professional bodies aren’t any better). There is still a long way to go in cutting the educational bureaucracy and concentrating spending in the schools. Again, the vested interests are in the way. When that happens in the private sector the companies either reform or close down. As a for instance, when energy was privatised it transpired that the power stations were not 30% overmanned but could run safely and efficiently with only 30% of the staff that the CEGB thought necessary. There’s lots to go for if sufficiently radical approaches are on the table.

  3. Sage Vals says:

    The solution may lie in a constant year-on-year search for efficiency savings over many years. Spending reviews must become part of the culture in the public sector (and private for that matter) not just an ad-hoc response to economic or political crises. A “”permanent revolution” if you will. At the very least, politicians and senior managers must always ask “how much?” before embarking on new initiatives. And there should be no incentives for “empire building”, but rather for more efficiencies/ higher productivity each year. Hard bit is to persuade voters not to let politicians buy their votes simply by throwing money about on new initiatives, however good they might sound…

  4. TickyW says:

    Anecdotal evidence, I know, but when I had a temporary job in my local authority, I was taken to one side by the boss and told that If I continued to work at the same pace then she would have to lose two members of staff (!).

    Although I recognise the need for efficiency/productivity improvements in the public sector (especially in local authorities), the solution that dare not speak its name is tax increases. More council tax bands for example. Perhaps alongside the introduction of a Land Value Tax. And yes, the re-introduction of the 50% income tax band and the introduction of a 60% band too.

    Otherwise the country is doomed. DOOMED, I tell ye

  5. DJK says:

    Be careful of the rip it up and start again approach. Academy schools (or whatever they’re called this week) are a case in point. They have much higher per capita costs than LEA schools because the central govt pols who run them are anxious for them to be seen to succeed.

  6. GCS says:

    DJK, what is the evidence that academies have “much higher per capita costs than LEA schools”?

  7. Dipper says:

    I really like this blog. It makes me feel I’m not mad. The budget deficit of £120B per year (or to put it another way, £10,000 per year for a family of 5) has been consistent over the last few years without any sign of change. This sum of money seems to me to be absolutely massive – so big that its pretty much the only modern political fact anyone needs to know; everything else is just noise. The reason for this predicament is that our collective expectations of the standard living we wish to enjoy outstrips our ability to generate the money to pay for it. In short, as a nation in competition with others, we are crap.

    This blog starts from the same viewpoint and discusses quantitatively the options, and invariably ends up at the only logical conclusions – more tax, public sector cuts, and still we will all be poorer.

    I like the improvements in public sector threads and will take the link to Portsmouth Council into the large financial institution in which I work. Realistically though, as Rick says, these changes will have no direct effect on the challenge of the deficit. They may however have an indirect effect in that it fosters a change in culture towards genuine effectiveness and competitiveness, and may help lift the dead weight of top-down management-by-targets that is slowly but surely destroying the productive capability of this country.

  8. Big Bill says:

    Ah, you do know that the privately-owned banks, the government through the Treasury and the Bank of England can all create money out of thin air, right? Also that we use fiat currency these days, not commodity backed currency like we used to decades ago? Fiat currency is best described as being backed by the uses it’s put to, so, create new money and we all go for a drink with it, that gets us inflation. We pissed it away, didn’t do anything of value with it. Who’d respect that? Create new money and build a chain of pubs with it, create proportionate wealth with the new money in other words, and there’s new money circulating in the economy without there being inflationary consequences. The idea we’re somehow short of a resource we can conjure from thin air is absurd. We’re not, and we never can be.

  9. There is a major flaw in that three circle alleged dilemma. It’s the assumption in the orange circle that the deficit has to be “eliminated” by 2019 (or indeed any other year).

    Continuous year after year deficits are actually an inevitable consequence of the 2% inflation target. Reason is that given X% inflation, the monetary base and national debt will shrink in real terms at X%pa. And on the assumption that those two are to remain constant relative to GDP in the long term, they have to be topped up. And they can only be topped up via a deficit.

    And the historical fact is that over the very long term (i.e. a century or more), the debt has remained roughly constant relative to GDP.

    Plus if there’s any economic growth, that adds to the size of the necessary deficit. In fact, and plucking numbers out of thin air, if inflation is 2%pa and growth is 2%pa and the base and debt are equal to 50% of GDP then according to my calculations, the deficit needs to be 2% of GDP ((2%+2%)x50%).

    And that’s just the first reason for the “eliminate the deficit” being a nonsensical assumption. A second reason is as follows.

    If a continuous rise in the debt/GDP ratio for the next 5 years proves necessary so as to achieve full employment, what does it matter? As long as real or inflation adjusted rate of interest on that debt remains at zero or is negative, no one should be bothered. And if creditors start demanding a higher rate of interest in the debt, then stick two fingers up at them and print money instead.

    And if anyone responds to that by mentioning inflation, then they’re just displaying their ignorance: if a deficit is required so as to deal with excess unemployment, a rise in demand stemming from a money supply increase won’t be inflationary.

  10. John Dowdle says:

    When I was elected as a local Councillor in 1995, the universal mantra then was efficiency savings. Nothing appears to have changed in 20 years. We still hear this same refrain every year. Someone – I think Einstein – once defined stupidity as doing the same thing over and over again but expecting different outcomes. Basically, then, what we are really suffering from is stupid government. Clearly, no one wants to see waste like the £40 million written-off by Chris Grayling’s department, as well as other substantial sums frittered away by central and local government. Perhaps the real solution is for central government to just stop interfering in local government and the economy generally, as the results continue to reveal their innate stupidity.

    • Dipper says:

      “The first target is always efficiency savings, however these are always overestimated and are never achieved.”

      My father used to tell me this regularly when ever the subject of efficiency savings came up. He himself had been told this as a geography university student in the late 40’s/early 50’s.

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