As I write this, we are now only a day and a bit away from one of the biggest fiscal events in our lifetimes – the coalition government’s Comprehensive Spending Review (CSR). Having inherited an admittedly large deficit from the old Labour Government, the ConDems have been busy over the past weeks and months arguing about where the axe should fall, and why their department is special and should be excluded. It’s a bit like NIMBY-ism in the Westminster Village.
Press reports about the potential scale of the changes have focused on the oft-repeated figure of cuts averaging around 25%, but possibly reaching as much as 40% for some departments. In no small part, that reflects the early decision by the government to ring-fence health spending and international development – which together account for around a third of departmental spending. Recent reports that education may be spared the full brunt of the belt-tightening only compound this problem.
However, these stories could be yet another indication that the new government is every bit as adept at political spinning as previous administrations. Tomorrow’s CSR will set out where the axe will fall, and which departments will bear most of the pain. But, actually, we already know what the broad envelope for spending is – because the Office for Budget Responsibility (OBR) set that out back in June, following the Budget. And, digging into the figures in some detail, things might not be quite as bad as they seem, at least in terms of how normal people think about spending.
Economists, however, are clearly not normal, and when we talk about government spending, we tend to scale it by the size of the economy – department budgets are often referred to as a percentage of GDP. This is generally fine, but it is worth recognising that GDP changes over time, particular over the four-year period to the financial year of 2014/5 (FY14/15) that the CSR will cover. What’s more, government spending is typically scaled by nominal GDP – so it’s not just underlying growth in the economy that will affect the figures, but inflation as well. And we all know inflation is set to remain elevated over the near term – above target, but not really high – because VAT is going up to 20% at the start of next year.
All of this means that the underlying assumption behind the CSR is that the cash economy – nominal GDP – grows by 28% between FY09/10 and FY14/15. This kind of increase clearly takes some of the pressure off any target to cut spending as a share of GDP. And, in fact, this is precisely what it does. Digging into the detail of the OBR forecasts, total managed expenditure – jargonistic shorthand for all government spending – is actually set to increase by just over 10%, in cash terms, between FY09/10 and FY14/15. Overall, government spending will not be cut at all.
However, this spending profile still implies painful choices for ministers. Much of the increase in spending reflects things like higher state pension costs, higher spending on unemployment benefits, and larger interest payments on the rising national debt, although the latter in particular is often overstated. Overall, spending on these types of ‘non-discretionary’ items, as civil servants sometimes call them, is set to rocket by 34% between FY09/10 and FY14/15. Clearly, that doesn’t leave much room for anything else.
Investment will bear the brunt of the cuts. Gross public spending on our national infrastructure will fall by over a third, in cash terms, in the five years to FY14/15. Business groups are genuinely worried that this level of spending will not be enough to maintain existing transport structures, amongst other things, potentially hindering the recovery. Unfortunately, investment is only around a tenth of public spending, so departmental budgets will be hit as well. But after crunching the numbers, it turns out that, even after ring-fencing health, the average decline in departmental budgets may only have to be around 7%-10%, in cash terms, in order for the government to meet the OBR’s spending envelope.
Ten per cent cuts will clearly still hurt, even spread over four years – people will lose jobs, and there is still a big question mark about whether the private sector will be able to generate enough jobs to take up the slack in the short term. But cuts of this magnitude are clearly easier to manage than slashing all public spending by a quarter. Of course, politicians are infamous for leaking bad news early, and then trying to grab the high ground when they magically manage to do better than – or at least not as poorly as – everyone expected. And this time, it looks like the ConDems may just about pull it off.