A damp squib - the real focus should be on supply-side reform

Ryan Bourne, Head of Economic Research at the Centre for Policy Studies discusses the spending review and how the focus should be on supply-side reform.

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The Chancellor today confirmed that government spending in 2015/16 will be £745 billion. According to the revenue projections of Budget 2013, this would leave us still with a deficit that year of around £90 billion, compared with the expected £20 billion for that year forecast way back in 2010.

It’s in this context that today’s Spending Review should be seen. There is plenty of work still to do in closing the deficit. And it’s important to state what today actually was. Today the Chancellor was setting out the composition of the £11.5 billion package of savings from departmental spending, necessary in 2015/16 to meet the existing expenditure plans. It was not announcing new, unplanned cuts. It was simply announcing where spending was allocated within the existing envelope. In other words, it is merely part of the fiscal consolidation programme which is now in the correct stage of trying to cut current expenditure– thought by economists to be a drag on medium-term growth.

Many of the details of the plans were fairly predictable. The Government had already imposed ring-fences on the NHS, aid, and schools, alongside the triple-lock on the state pension. This, combined with the fact that the Liberal Democrats were only willing to trade more working-age welfare cuts with higher taxes on the rich meant that we were only dealing with a certain proportion of departmental expenditure today. So, inevitably, some of the remaining departments like Transport, DCLG, Justice, Defra, and Work and Pensions all saw circa 10% cuts in their resource budgets for 2015/16. BIS and the Home Office saw smaller cuts of around 6%. Ring-fencing so much means cutting deeply in departments which have already cut deeply is inevitable. It looks doubtful, however, whether this ring-fencing will be sustainable in the next Parliament, without a fundamental re-consideration of what the state actually does. Salami slicing only gets so far.

In facts, it’s worth noting that if bond yields continue rising, then by 2015/16 some of these cuts will have been for nothing. The Budget, for example, said that every 1 percentage point increase in interest rates will increase debt interest payments by £4.4 billion by 2015/16. So keep an eye on the bond markets in the coming year!

There was lots of talk, as always, about capital expenditure, but there was no new money allocated today. Public sector gross investment was announced in the Budget to be £50.4 billion for 2015/16 and that remained unchanged. Some individual departments (transport, BIS and DECC) saw their capital budgets increased relative to their 2014/15 plans, but other departments such as DCMS and DCLG saw their capital budgets slashed. There was much talk of course of the importance of ‘infrastructure’ and its effects on growth, but many seem discuss this in terms of the short-term and direct effects. What ultimately matters is its effects on our long-run condition: investing in the wrong type of infrastructure (expensive energy and high-speed rail) might even perturb our growth potential.

Reforms to public sector pay and welfare – with more stringent work requirements, an overall control of Annual Managed Expenditure (though excluding the huge State Pension, but now including pensioner benefits) and reforming pay in the public sector so it is more based on performance, are of course welcome small steps to better control of the public finances. The significant administration savings being delivered by Frances Maude are also noteworthy.

Overall though it was difficult not to be underwhelmed by today’s statement. Not only was this not really a significant statement (as it seems to have been billed by the media), but there was scant mention in George Osborne’s speech about what the Government should be focusing all of its attention on: raising the growth rate of the economy. Growth ultimately comes from the ingenuity of us. Announcing the details of restaint you have already announced is all well and good. But as Mark rightly highlighted this morning: tax reform to get incentives right, deregulation, and getting out of the way to allow private sector delivery of infrastructure and home-building would all do far more to create the conditions for the entrepreneurship and innovation which we need than any of the measures discussed today.

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Date Added: Wednesday 26th June 2013