Hard Times for Public Services

Whoever is in power at Westminster, public services are facing hard times over the next few years.

The public finances are shifting from chronic problems to acute crisis as income dries up and demands increase. Before the current crisis the public finances almost certainly already had a structural deficit build-in. Although this was not huge, it was leading to public net debt steadily rising. The annual and total levels were, by historic standards, still low – previous Tory governments had far larger levels of cumulative public debt. But they were increasing at a time in the economic cycle when they probably should have been going in the other direction.

However, all that has now been made largely irrelevant by the scale of the current crisis. The numbers are eye-watering (as Robert Peston would say)

Total government exposure in propping up the financial system is around £600bn – or roughly an entire year’s public spending. Most of this is relatively safe and some, such as the investments in bank shares, may even make money for the Treasury in the long run. But in the short term the risks for public finances are huge, if of low probability, and some money has been actually spent as opposed to simply being promised as guarantees.

The economic crisis triggered by the financial melt-down is also costing. Spending on unemployment – direct benefits as well as extra help to industry and individuals – will increase sharply. Anti-cyclical spending is also set to rise as capital projects are brought forward and new ones created to off-set lack of demand in the private sector. All this extra spending either has to come from existing budgets elsewhere or from borrowing.

The extent of public sector borrowing increase really is now dramatic – public sector net cumulative debt is set to rise to around a trillion pounds or, put another way, to jump from around 40% of annual GDP to nearly 60%. This is historically high in British terms but not so large compared to other large, advanced, countries. Still – it is a qualitative step change in public sector indebtedness that will have implications for years, if not decades, to come – including for public services. More of public income will have to go on debt servicing and less will be available for public services.

To illustrate how big an impact this will have, it is important to understand what has happened in recent years. The received wisdom has been that New Labour has been pouring unprecedented amounts into public spending and, especially according to the right-wing press, taxing us all at huge rates to pay for it. This is simply not true.

New Labour’s public spending record is actually pretty average, in fact it is below average. For past the four and half decades (1963-2010) public spending will have averaged 42.5% of GDP – Labour’s average from 1997-2010 is only 40%. This partly because in the first couple of years of New Labour Gordon Brown scored a record – he got public spending down to only 36% of GDP – the lowest in the past 45 years! Whilst levels are now forecast to rise above average – hitting 44% – New Labour is not and has not been spending unprecedented amounts of taxpayers money.

So why has it felt like they have – especially for those working in public services? The answer is simple – and illustrates just how hard times are about to get.  Whilst the government has not been spending historic levels of money in general, it has been able to focus more of what it does spend on public services.

That is because during the early noughties two things happened: first, the government reduced public debt to near zero and consequently had to pay out far less on repayments and interest, which it was able to redirect to services. Second, unemployment and its costs also fell dramatically, again freeing resources to go into services. Both of these are now reversing – public debt is set to reach stratospheric levels and unemployment could well get back to early 1980s levels – both of which means that although we’ll be spending 44% of GDP far less of it will go into services. The affects are already going to be dire and they could get a whole lot worse.

In the so-called ‘Pre Budget Report’ (PBR) last December the government forecast the real growth in public spending would slow to just over 1% per year. When you factor in real levels of inflation and increasing demand, the spending in many services will in effect fall. And if certain highly politically sensitive areas like health and education are protected, others will suffer more.

And these are all based on the Government’s wildly optimistic assumptions about the duration and depth of the current recession. According to the PBR the British economy will experience what I called (in evidence to the Treasury Select Committee) “live cat bounce” – we will be in and out so quick you’d hardly notice. This is, to put it mildly, unlikely and the consequences for tax receipts could prove disastrous, putting even more pressure on spending. [Since I wrote this tax receipts were reported to have fallen by £7bn in January alone]

If there is an election and the Conservatives win, then things will get a whole lot bleaker for public services. David Cameron and George Osborne are promising to prioritise reducing public sector debt. On my calculations even to just stop the rise in cumulative public debt over the next 3-year spending cycle, they would have to slash 5% in real terms, or around £250bn, from public spending. This is roughly the equivalent of abolishing Wales and Scotland. And that would be to merely halt the growth in public debt.

Gordon Brown is right about one thing – this is indeed a global crisis. What happens to British public services will only partially be determined on these islands – what happens to the world economy will have by far the bigger impact. If the global economy does not go into synchronized recession and starts to bounce back, then the British economy may well get pulled back too. But even in this happy event, public services are in for hard times for the foreseeable future. Just how hard remains to be seen.

[This article appears in the Spring 2009 edition of Update, the latest bulletin of the Herbert Simon Institute. It was written before the latest changes to public sector finances which incorporate the debts associated with the bank bail-outs.]

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