Last week, Ed Miliband gave a speech outlining his response to the Chancellor’s Autumn Statement. It was an attempt to repair the damage caused by his disastrous conference speech and to reduce the Conservative lead in the polls for economic credibility.
In his speech, Miliband accepted that deficit reduction was necessary for economic stability. He went on to argue that “there is no path to growth and prosperity for working people which does not tackle the deficit.” Rising debt, he said, would crowd out investment and lead to unacceptably high interest payments.
Unfortunately, that was as good as it got. According to Miliband, the spending cuts which the Chancellor outlined threaten the NHS and other public services. Moreover, the sensible point that Miliband made on the need to grow productivity was rather lost when he then implied that it would only grow if public spending did too. Unfortunately, whilst he tried to sound tougher on the deficit, his proposals fell disappointingly short of the task.
The blogger Flip Chart Rick has argued that the spending cuts outlined in the OBR’s Economic and Fiscal Outlook are simply infeasible without causing terrible destruction. He has put together three charts that he thinks Miliband should have used instead of talking about 1930s spending levels.
I disagree with Rick. I think that whilst it will certainly be difficult, spending cuts in the next Parliament are both necessary and feasible.
1. Debt interest payments are rising to unacceptably high levels
Central government debt interest payments are rising in absolute terms, as a percentage of GDP and as a percentage of total government spending. Even under the Conservative plans, debt interest payments will rise from £48.1bn in 2014/15 to £64.8bn in 2019/20. Net payments which take into account the fact that the Government owns quite a lot of its own debt through QE will rise by £24 billion from 2014/15 to 2019/20. As a percentage of total managed expenditure, (i.e. total government spending) debt interest payments will rise from 6.5% in 2014/15 to 8.3% in 2019/20. This is more than we spend on education and justice put together.
This should make us angry because debt interest payments are a dead-weight loss. Every extra penny the state pays in debt interest is a penny not going to fund services or cut taxes. It should also make us want to cut borrowing sooner rather than later. Delaying deficit reduction or maintaining a balance only on the current budget (i.e. still running a deficit) means higher borrowing and a greater vulnerability to future bond market shocks; both of which will mean higher debt interest payments.
Treasury analysis, based on this year’s Budget, forecasts that running a 1.4% deficit every year would lead to a total public sector net debt of £500bn higher by 2035/36 compared to a 1% annual surplus. The OBR estimates that a 1% increase in Gilt rates would lead to £13bn extra in debt interest payments from 2015 to 2020. If Miliband wants to borrow more he should explain by how much more he is prepared to see future spending eaten up by the interest on the debts of the past.
2. Spending cuts are easier when real incomes are rising
Flip Chart Rick also argues that the spending cuts of the size which have been outlined would be essentially impossible to implement. However, spending on day-to-day public services (RDEL) would leave it in real terms at the same point as it was in 2002/03 and on a per capita basis it would be the same as 2001/02. Spending the same amount on day to day public services in real terms per person as we did under Tony Blair surely does not herald the end of times.
Rick seems to counter this by saying that “an ageing population means the number of people needing help from the state is increasing.” However, the two budgets which would most likely see upward pressure from an ageing population are the NHS and pensions; both of which are protected. Demographic change is, for example, quite unlikely to make cutting spending on non-protected budgets such as the Home Office or the Department for Business much more difficult.
Real per capita RDEL was £5,650 in 2009/10 and this has already been cut by 13% to reach £4,910 in 2014/15. It is projected to fall another 21% to reach £3,880 in 2019/20. As Giles Wilkes would point out, a similar percentage cut in spending is harder when starting from a lower base. However, there are many reasons not to be so nervous about the outlook for spending and deficits.
Firstly, the polling shows that the spending cuts which have taken place so far have had little impact on the public’s views on the quality of services. Secondly, the current aim is to run an absolute surplus in the last two years of the next Parliament but there is not an explicit commitment to the specific £23 billion figure which the OBR forecasts in 2019/20. This means that the 21% cut in real per capita RDEL is probably higher than will be necessary anyway. Further cuts in welfare spending to offset falls in departmental spending add to this view.
Perhaps most importantly, is that when people feel better off, spending cuts are less painful. The OBR forecasts that real household disposable income per person will have increased by just over 1% between 2010 and 2015. They also project that it will increase by just under 6% during the next five years. If disposable incomes do rise in such a way, the demand on public services should recede and spending cuts of a similar magnitude should become easier to implement.
3. There is still scope for more spending cuts
Economic defeatism, the view that reform is impossible, that welfare budgets must rise and that government spending can never be cut by the levels required, seems to be misplaced considering the progress so far. When Gordon Brown predicted armaggedon before the last election if there were spending cuts, he was wrong then and the defeatists will be wrong now.
We should of course start from the assumption that it is preferable to deliver the same services for £780 billion in 2020 instead of £840 billion. We should also recognise that like in all large organisations, waste in the public sector is not just a static phenomenon which can be cut once and forever eliminated. More efficiency savings can still be found as many councils report themselves.
Indeed, the impact on local authorities has been cited as one area in which spending cuts could be destructive. The trouble is that public opinion on the quality of local services has not particularly fallen and that local authorities have in aggregate been building up their financial reserves not running them down.
As shown in the Economic and Fiscal Outlook, the OBR expects that even with the real terms cuts to come (total current local authority spending will stay flat in nominal terms at £151.5bn from 2014/15 to 2019/20), councils will continue to build up their reserves.
Local authority current reserves in England relative to net current expenditure
A fact which is not well known is that government departments have actually underspent relative to the limits given to them by the Treasury. Page 147 of the Economic and Fiscal Outlook shows that total departmental spending in 2013/14 was £4.6 billion less than planned and it is expected to be another £2.5 billion less in 2014/15.
When Miliband warns that the planned spending cuts in the next Parliament will lead to the disintegration of services, he should remember that the spending cuts in this Parliament have been more than achieved so far without such deterioration.
The forecast cuts in departmental spending of course imply more than just efficiency savings and greater creativity from local authorities. Yet, it is the severity of the fiscal situation which is driving and embedding reform across the public sector. Do we really think that we would be considering the radical proposals recently suggested by Francis Maude or Sir Bernard Hogan-Howe if there was not the pressure to cut the deficit? Even if we would consider such reforms to cut the cost of government, would we be pressing ahead with such vigour?
There is a clear need to cut the deficit. The spending cuts outlined in the OBR’s latest report will not be easy to do it but they are both feasible and necessary.