I was out of the country when the Office for Budget Responsibility published its Fiscal Sustainability Report, so I have a vaguely plausible excuse for missing it. That said, it sounds like it didn’t attract much comment. As you might expect, the FT and a couple of others covered it but, as Michael says, there wasn’t the usual hullabaloo. Which is surprising because its long-term forecast of public debt was worse than the one in the last report eighteen months ago. A lot worse.
The reaction to this, or lack of it, is a sign of how far politics has shifted in the past couple of years. A few years ago, The Debt was the biggest story around but Brexit has eclipsed it and with the OBR’s report being released on the same day as Theresa May’s speech it was never going to get much of a look in.
But, as Michael says, if, as most newspapers insisted every year, the level of debt forecast by the OBR was ‘unsustainable’, then this new projection must be super-plus-unsustainable!
So what has made the OBR debt forecast so much worse? Has there been a sudden deterioration in public finances?
As you can see from Michael’s’ chart, the public debt is a little higher than where the OBR thought it would be 18 months ago, mainly because tax revenues continued to disappoint. But that isn’t the main reason for the change. What is behind the soaraway debt forecast is a change in the way the OBR has assessed the likely increase in health costs.
This is not due to the ageing population, which the OBR factored into its previous estimates, but to other factors such as increasing demand and healthcare costs rising faster than inflation. These assumptions were set out in a report last September, Fiscal sustainability and public spending on health, which would have formed part of last year’s FSR had it not been cancelled because of Brexit. The report notes that, even before the pressures of an ageing population, healthcare spending rose more quickly than GDP in most developed countries.
Michael illustrates the point with an example from the BBC’s Hospital series:
The BBC series “Hospital” that’s running at the moment has some great examples of this. For example in Episode 5, 18 year-old Deborah is saved because new developments mean that sickle-cell disease can be cured with a bone-marrow transplant from a donor who is only a 50% match rather than as previously requiring a 100% match. This means that of all the young people with sickle-cell, more can now be treated and will be treated, pushing up spending. Though the state can put into the other side of the balance the prospect of a healthy tax-paying life for Deborah! At the other end of the age-spectrum, the programme showed new procedures for heart-valve replacement for people who are too old and frail for traditional open-heart surgery, increasing the proportion of people within an already increasing pool who can be treated (and thus doubly increasing the number of operations that could take place).
In other words, because we can, we will. As more procedures become possible, more people will want them. Today a professor will sit on the breakfast TV sofa describing a new operation, tomorrow people will be beating on their GP’s doors demanding it. In a health service free at the point of use, innovation doesn’t reduce cost, it increases it.
Add to this the relatively high cost of medical equipment and of wages in healthcare. As the OBR comments:
Health care is a relatively labour intensive sector. For example, the King’s Fund found that staff accounted for around 70 per cent of a typical hospital’s total costs and that this proportion had grown over time.10 Cost and price pressures have generally been stronger in the health sector than in the rest of the economy, while productivity growth has tended to be lower. According to the so-called ‘Baumol cost disease’ theory, real wages in the health care sector have to keep pace with the rest of the economy in order to attract and retain staff, but slower productivity growth means that additional input would be needed to achieve the required improvement in care per person. As a result, the cost of health services will rise relative to other sectors of the economy.
Taking all this into account, much of the rise in health are costs in recent years hasn’t had as much to do with an ageing population as the headlines might suggest. For example, during the last financial year much of the increase in spending was due to other factors.
Once you add in these extra cost pressures, the projections for health spending go through the roof. In the chart below, the green line is based on the assumptions the OBR used in its previous forecasts. The Central projection is the one used in calculating the increase in debt shown on Michael’s chart above. Even the ‘lower cost pressures’ scenario is still higher than the OBR’s previous forecasts.
Now of course, these are only projections and these days it’s deeply unfashionable to take economic forecasts at all seriously. Who knows what will happen to the economy a decade or so from now? Nevertheless, what the FSR does show is just how sensitive the UK’s fiscal position is to changes in healthcare spending. Even before the most recent report, healthcare spending was the variable with the most impact on the UK’s debt trajectory. It dwarfs everything else, be it pensions, immigration or changes in interest rates. As Michael says, even the various migration scenarios don’t have anywhere near the same impact as the change to health spending.
Even if the OBR is only half right it is highly likely that healthcare spending will outgrow the economy from sometime early in the next decade. It is unlikely that efficiency savings will do much to mitigate this. The National Audit Office has expressed doubt about the ability of the NHS to deliver the sort of productivity improvements that would be needed to offset its financial problems and has suggested that some of the efficiency targets might even have made things worse.
Unless people are willing to accept rationing or to pay for more healthcare at the point of use, the only way to stop the NHS either falling over or pushing the fiscal deficit ever higher is for us all to start paying more tax.
Chris Giles reckons now is a good time for the chancellor to come clean with us about this:
Since Mr Hammond wants to leave big tax reform until his Autumn Budget, he can nevertheless use the evidence of strain in public services to prepare voters for paying higher taxes in future. Naturally this is difficult. The Conservative government was elected on a promise not to raise income tax, national insurance or VAT rates, but if it can ditch a manifesto promise to keep Britain in the EU single market, it can also think again about how best to fund public services.
As the Social Market Foundation said in their report on health funding just before Christmas, people see healthcare as the top public spending priority and have done so fairly consistently for the last three decades.
If anything is going to persuade the public of the need for tax increases, it is the pressure on NHS finances and the need to keep it properly funded into the next decade. Given recent developments and the worsening of NHS trust finances, it might be a good idea to have an honest conversation with the voters sooner rather than later.