24 October 2008
Public spending is back in fashion as the government attempts to minimise the effects of the recession. Will this new approach aid Gordon Brown's political revival and what will be the impact on next month's Pre-Budget Report? Colin Talbot investigates
Prime Minister Gordon Brown might have donned his superhero outfit and prevented a meltdown in the global financial system, but this has merely averted a financial drama and still left us with an economic crisis. The effects on public finances are likely to be dire.
In November, Chancellor Alistair Darling will present his Pre-Budget Report – but what is a PBR? This is already problematic, as it can take three forms.
The first type does not announce any changes to taxation or spending but merely lays out the framework within which the government will be operating when it does address these issues in next March's Budget. This is a mythical beast that exists only in the rhetoric about how the system is supposed to work. Chancellors have increasingly used the PBR as a mini, and in some cases not so mini, Budget in its own right.
The second sort of PBR is the non-pre-Spending Review one. We have – again, at least in rhetoric – a system of Spending Reviews (sometimes randomly known as Comprehensive Spending Reviews), which fix government spending for three years ahead. These are reviewed every two years (1998, 2000, 2002, 2004) except when it suits not to (2007). If the PBR occurs in a year when the spending envelope and plans are still (officially) fixed by the previous Spending Review, then it should not change the overall spending plans.
Which brings us to the third sort of PBR – the pre-Budget and pre-SR PBR. In these, the chancellor tells us not only what the parameters are for next year's Budget (March) but also next year's SR (July – except when it's in October).
So – if you are still with me (and I'll understand if you're not) – what is this year's PBR? Good question. It could be a combined PBR and PSR or just a plain old PBR. There have been numerous comments in the media that suggest it will be combined – ie, there is going to be another Spending Review next July. But the Treasury has so far failed to inform anyone officially that this is the position (maybe they've just been too busy?)
This is rather important. If the PBR does set out the parameters for spending for 2009 to 2012, this will set the grounds for the political debate about spending in the run up to the general election. If it doesn't, then we could be going into the next election without the (notional) forward spending plan. While this might appear superficially attractive to some in New Labour's ranks – given how constrained the public finances are likely to be – it seems unlikely that this will happen. So, PBR 2008 will, in effect, set one of the crucial terrains for the 2009/10 election.
The Conservatives, it should be noted, have already realised this and scrambled to reposition themselves. They have 'let it be known' that when the parameters for SR 2009 are announced they will not, as they did for SR 2007, sign up to keeping to Labour's projected spending totals. So the public spending battle lines will be drawn in practice by what the chancellor announces in the PBR in November.
So what are Darling's options? Well, he is very unlikely to plan to reduce public spending substantially as a proportion of gross domestic product. The last Spending Review included a small cut in this ratio (of about 0.9%) but a combination of factors would suggest this will be halted, if not reversed. First, now we are all Keynesians again, you don't cut public spending in a recession. If anything, you increase it without increasing taxes – ie, you borrow and spend to help the economy.
Secondly, public spending as a proportion of GDP will increase anyway as the economy slows.
Thirdly, increased costs for unemployment and paying for greater government debt will have to be absorbed unless radical cuts are made to public services.
This is precisely what Margaret Thatcher's government did during the early 1980s economic downturn – and public spending rose to around 48% of GDP for almost half a decade (the long-term average is about 43% – see figure on this page).
The scope for the government to increase borrowing will be somewhat limited by the amount of debt it has had to take on for the banking bail-out, but it is still possible. Current government borrowing is not extremely high in historic terms (it rose much higher under the Tories). The government could even increase overall spending (as a proportion of GDP) to protect public services in the name of 'exceptional circumstances', although it might be politically difficult and cause long-term problems.
The only other possibility is, of course, to raise taxes. While some marginal increases might have seemed possible a few months ago, the unknown extent of the economic downturn makes it very unlikely any government would substantially increase taxes at the moment. In the longer term, however, when the upturn finally arrives, they probably will have to raise taxes – or face creating an ongoing structural deficit in the public finances.
Most likely, Darling will announce some compromise between maintaining current relative levels of spending on public services and increasing government debt to cover the costs of unemployment, borrowing and lower income from taxes. A projection for public spending to rise to between 43% and 45% of GDP is not impossible in the short term.
One certainty, however, is that we will now also enter another round of political competition over 'savings' in the public services – already kicked-off by the Liberal Democrats' claim that they can find £20bn to fund their tax plans. Watch this space for an escalating arms race of grand savings plans.
While for the Opposition parties this is just a game of 'fantasy efficiency savings', for the government – and for public services – it will be all too real, and painful. Government plans announced last year for 3% a year 'value for money' savings across the public sector, all in cash and therefore double the 'Gershon' targets, were already eye-wateringly tight.
To meet such savings, services would almost certainly have to be cut; 3% a year genuine 'efficiency' savings are simply unrealistic. Services and jobs would have to go to meet these targets – it is hard to see this being followed through in a recession. What is more likely is that we'll see a repeat of some of the 'smoke and mirrors' used to claim success in the Gershon efficiency drive.
The Tories are in a particularly hard place on tax and spend – their promise to 'share the proceeds of growth (sic)' between tax cuts and public spending (ie, gradually erode public spending as a proportion of GDP) now looks fanciful, even with some fantasy savings thrown in. They are further hampered by their association with the free market deregulation of the 1980s, which by any objective standards must be seen as a major contributory factor in the current drama.
The political fallout for the government from the financial and economic crisis is much more difficult to judge than the tax and spend issues. Political stocks in Gordon Brown have been see-sawing almost as wildly as the real stock markets. He may have gone from Stalin to Mr Bean, but now he has re-emerged as the Caped Crusader.
Will the voters, once the dust has settled on the financial crisis, stick with what they know and reward Brown for saving the global economy? Or will they blame the government for the ensuing recession and put what's left of their money on the Tories? This is a much more open question than it was only a few weeks ago.
And the picture is complicated by Brown's leadership style. We have been here before – the dynamic, decisive, I-know-best style might be fine during crises, as they were in the early months of Brown's premiership (remember the floods and terrorist attacks). But they become a real handicap when you make mistakes and are unwilling to 'fess up' to them because you are always right (remember the 10p tax rate and the election that wasn't).
Ironically, Brown's global plaudits over his leadership in averting the financial meltdown might well reinforce just the facets of his leadership that brought him near to being ousted only a few weeks ago. That could prove a bit of a problem for him in the future – I wouldn't rush into Brown stocks just yet.
PFoct2008
