Despite deep cuts, Britain’s public finances have veered off course by Andrew Miller writer at large for the economist.
WHEN George Osborne, the chancellor of the exchequer, rises to deliver his annual autumn statement on December 3rd, he could be forgiven a mild sense of satisfaction. British consumers are spending strongly. Firms, buoyed by consumers’ confidence, are at last investing. Britain seems to be free from Europe’s economic woes. Yet when it comes to his flagship economic policy—deficit reduction—Mr Osborne will probably deliver bad news: once again, he is missing his borrowing targets. The cumulative effect of such failures is that Britain is less than half-way to closing its structural deficit, despite the government planning in 2010 for the job to be all but done by now (see chart 1).
The problem is not an aversion to wielding the knife. Since 2010, government departments have seen their budgets trimmed by an average of 8%. That number obscures much deeper cuts in some departments, necessitated by government protection for the budgets for schools, the National Health Service (NHS) and international aid. The hardest-hit departments—including local government, justice and the foreign office—have faced eye-watering reductions of over 25%. The communities budget is down 45% (see chart 2).
Even departments within the ring-fence have faced a squeeze. Demographic pressures from a growing and ageing population mean purse-strings are tighter despite real-terms spending being maintained. This problem is particularly acute in the NHS, whose budget has crept up in real terms, but which still faces an £8 billion ($13 billion) annual shortfall in funding by 2020 (even after a £22 billion efficiency programme). Holding NHS spending to its 2010-11 level would imply a 9% fall in age-adjusted spending per person by 2018-19, notes Carl Emmerson of the Institute for Fiscal Studies, a think-tank.
About a fifth of the tightening has come from lower welfare spending on working-age people. Benefits were indexed to a less generous measure of inflation and then capped at 1% per year. Reforms to housing benefit, child benefit and disability living allowance have chipped in, too.
To his credit, Mr Osborne has more or less delivered on his 2010 spending plan. His woes are caused by weak tax receipts. In the early years of the parliament, receipts sagged as growth missed forecasts. This led to the date of structural-deficit elimination being postponed, first to 2016-17 and now to 2018-19. Now growth is back, but the Treasury has found itself shut out of the party. A higher tax allowance for the low-paid has meant that the legions of low-paid jobs the recovery has created have not much benefited the exchequer.
If departments outside the ring-fence are to bear the burden of the remaining austerity, further cuts of around 21% will be necessary. The plan for this lacks specifics; departments have agreed their budgets only until 2015-16.
The easiest cuts have already been implemented. A two-year freeze on public-sector pay followed by a 1% cap has helped trim budgets. This will be harder to repeat if the private sector begins to see pay growth, reckons Mr Emmerson. Neither will departments be able to repeat big one-off projects. For instance, the business department’s hefty 22% cut was aided by a huge reduction in the teaching grant to universities, as part of the coalition’s reforms to tuition fees.
Some would have the government raise taxes instead. Wisely, Mr Osborne has declined to rule this out completely, but further tax rises are not part of his current plan. The chancellor front-loaded his tax-rises early in the parliament, most notably raising VAT, but ever since has focused on spending.
The challenge could get harder still. Britain’s growth has not been export-led, but the turbulent euro zone could drag down the economy. David Cameron, the prime minister, frets about global weakness.
Technicalities matter, too. The government targets the structural deficit, after smoothing out the transient effects of the economic cycle. The higher the gap between the economy’s output potential and what it currently produces, the more of the deficit is seen as cyclical, and the easier the chancellor’s job becomes. But this gap is tricky to pin down. In March, when the Office for Budget Responsibility’s latest forecast was produced, it assumed an output gap of 1.4%. Yet private-sector estimates varied wildly, from as high as 5% to as low as negative 1.6% (implying an overheating economy operating above capacity).
Despite the tricky and uncertain path ahead, politicians have not shied away from committing to finishing the job. With his Conservative Party hat on, Mr Osborne says he will aim to balance the overall budget (economic cycle or none) by 2020. Yet he is light on specifics, other than a promised two-year freeze on working-age welfare. His proposals for tax cuts will make things harder. Labour would seek to balance the current budget, which excludes investment spending, but it too would rather talk about new spending pledges than austerity.
Mr Osborne can afford to be vague. The Conservatives have led Labour in polls on economic management for most of the parliament; in recent polls their lead on this issue reached 16 points. Labour has no such leeway, but would not gain much from specifying cuts, given the Tories’ lead on the economy. Whoever wins next year’s election will have more than just a celebratory hangover to worry about.