Belfast Telegraph

Sunday 28 December 2014

Sean O'Grady: The Treasury is in a tight spot – and this time it can't rely on Keynes

The party's over. That was the central, if implicit, message from the Chancellor's statement. The years of plenty when the public sector could expect to see large real-term increases in funding are now behind us.



Ironically, the Labour government is now set to increase public spending by less than the national income as a whole is forecast to rise – thus "sharing the proceeds of growth" between public and private sectors, to borrow the Tories recent slogan.



Total public spending will rise from £589bn in 2007-2008 to £678 bn in 2010-2011, an average increase of 2.1 per cent per year in real terms. Thus, public spending, as a proportion of the national income, hit its peak under this government at 42 per cent last year, and there it pretty much stays way into the future, with public spending still accounting for 41.6 per cent of the national income by 2011.



Taking a long view, that is not such an unusually large number. From the early 1960s to the middle 1990s governments of all hues watched the state spend more and more of our money on our behalf, peaking at a 50 per cent ratio in 1975-76. By more recent standards, however, it is a markedly rising trend, higher than at any time in Labour's first two terms.



So how is Mr Darling going to pay for his continuing largesse? He will tax a bit and borrow some more. Net taxes and national insurance contributions – the bulk of conventional taxation – are set to rise from 36.7 per cent of the national income last year to 37.6 per cent of GDP in 2012. Taking into account EU transfers and other items, they'll peak at 40.2 per cent in the same year.



Again that's on the high side by recent historical standards. That, however, may not be such a problem as Mr Darling plans to borrow. It isn't that Mr Darling has entirely abandoned prudence to her fate. At least, on his estimates the Exchequer will be looking to borrow small amounts by international standards.



Even these smallish increments – £38bn, £36bn, £31bn, £28bn over the next few years add up, and they add up so much that the Government will be extremely lucky not to break its "sustainable investment rule", to keep the total net debt of the nation below 40 per cent of the GDP. It is going to be very tight at any rate: the projection is that the net debt will peak at 38.9 per cent of national income in 2010-11.



However, perhaps with their political antennae re-energised by the general election that never was, ministers seem to be redoubling their efforts to ensure that they get the maximum political bang for their public spending bucks. The Comprehensive Spending Review highlights areas that are to receive the bulk of what money there is, and a quick glance at the tables reveals the winners and losers.



Top of the pile is the cause championed by Mr Brown, his predecessor and this newspaper – Africa and international development, which sees its budget jump by 11 per cent per annum in real terms.



Health spending is set to increase by 4 per cent a year in real terms, about a half of its more recent rises, but still respectable enough. Spending has very roughly doubled in the last eight years or so, and it will crest the £100bn per annum mark in 2008-09. The NHS will see its resources increasing from around £90bn in 2007-08 to £110bn by 2010-11.



Derek Wanless, author of the various reports the Government has used to justify its large expansion in NHS spending, has suggested that a real-term increase of around 4.4 per cent was needed to keep pace with the needs of the service, given advances in medical technology, NHS inflation and the changing demographic of the nation.



Nonetheless, we are clearly at the end of the era that began when Mr Blair plonked himself on the sofa opposite Sir David Frost in January 2000 and told his television audience for the first time – apparently including the then chancellor – that he wanted to take British health spending up to the European average. It was a quite dramatic announcement that heralded hikes in national insurance and other taxes to pay for a vast increase in manpower, pay and associated reforms. Productivity gains have been less than expected.



While Mr Brown declared in his leadership manifesto that his "priority" was the NHS, he also declared that his "passion" was education. Here too, the Chancellor has responded to his bosses' wishes. The Department of Children, Schools and Families will see 3.1 per cent annual real-term growth and its ex-education department sibling the Department of Innovation, Universities and Skills sees a less munificent 2.2 per cent. Transport and the fight against terrorism will also get more money.



Losers? Cuts in real-term spending are going to be endured at the Chancellor's Department (down 4.9 per cent per annum), the Northern Ireland Office (down 1.9 per cent), Work and pensions (down 5.6 per cent) and the Law Officer's Department (down 3.2 per cent). Plus there is the usual forecast of savings on debt interest and from efficiencies and waste elimination.



Sometimes the best way to look at the public finances is to ask where the numbers ought to be rather than where they are. From that perspective, as the former Conservative Chancellor Kenneth Clarke told the Today programme, the Government ought to be running huge budget surpluses rather than the significant deficits of recent years.



Thus, while the Government's failure to hit its borrowing targets is yet again a matter for some concern, the discrepancy between official target and official outcome is not perhaps as large as that between either or both of those figures and the notional figure of where we "ought" to be now, without the intervention of the years of plenty in Labour's second term, which, of course, the Government does not publish.



Why does this matter? When the economy last suffered a downturn, after the dot-com bust in 2000 and the terror attacks of 11 September, the Government was able to use public spending to make up the shortfall when consumer confidence and business investment dried up. It could do so because it had kept public spending under tight control and had been running budget surpluses.



This classic Keynesian response was thus at least affordable. With the Bank of England interest rate cuts they helped avoid a recession. Should we be in for a downturn worse than Mr Darling foresees now, then that fiscal "headroom" will no longer be there.



Mr Darling is in a tight corner, and could find his stay at the Treasury growing progressively less comfortable.



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