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
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.
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.
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.