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The Prime Minister is, apparently, intending to introduce a “Fiscal Responsibility Act” to tackle Britain’s scandalously bad public sector finances. Well, I suppose, better late than never and I await the details with great interest. I also await the next Pre-Budget Report, which will include the Treasury’s latest economic forecasts and projections for the public finances. In particular, I shall be interested to see whether the Chancellor amends his target for “balancing the budget”.

In the April Budget, Chancellor Darling’s projections included the objective of balancing the “cyclically-adjusted current budget” by financial year 2017/18 (FY2017) and contained plans for fiscal tightening vis-à-vis the 2008 Budget. Specific measures have been announced that will deliver about half of the projected tightening.

Putting aside the issue of whether the public sector finances have deteriorated even faster than expected in the Budget, which they probably have, there is the matter of the wisdom of having so distant a target for balancing the budget. But if a less distant target is picked then the tightening will, of course, have to be even more stringent. According to my calculations, if a target of zero public borrowing by FY2015 is chosen for illustrative purposes, another £70-90 billion of fiscal tightening would be required over the period FY2010 to FY2015.

This tightening can, of course, be met by raising taxes, cutting spending or a judicious combination of the two. Bearing in mind the inevitable damage to competitiveness and incentives from higher taxes, it will come as no surprise that I believe the emphasis should be on spending cuts – and large ones at that. It should, however, be noted that the background to this path of fiscal consolidation will not be benign.

The cost of servicing public debt will rise reflecting the ballooning debt levels, and the spending of local authorities and the NHS will be squeezed by commitments they have made under PFI as well as the ageing population. In addition, there is the enormous burden of public sector unfunded pensions. According to the British-North American Committee (BNAC) Britain’s unfunded pension liability, at £1.18 trillion, amounts to 85% of annual GDP. The ratio is 28% and 27% respectively in the US and Canada, where the majority of public sector schemes are now funded.

The scale of the public finances problem is horrendous and underlines how Gordon Brown, as Chancellor, skirted every looming problem facing the country – preferring instead crowd-pleasing and public-sector-expanding spending stunts. Alas, the country will be paying for his irresponsible stewardship of the economy and the nation’s finances for years to come.

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IEA Regulation Fellow

Ruth Lea is currently Economic Adviser and Director of Arbuthnot Banking Group and Director of Global Vision. She is also a Governor of the London School of Economics. Ruth is the author of many papers on economic matters and writes regularly for the press. She was Director of the Centre for Policy Studies between 2004 and 2007 and Head of the Policy Unit at the Institute of Directors (IoD) between 1995 and 2003. Prior to the IoD, she was the Economics Editor at ITN. And prior to ITN, she worked in the City for six years. Prior to joining Mitsubishi Bank in 1988, she spent sixteen years in the Civil Service in the Treasury, the Department of Trade and Industry, the Central Statistical Office and the Civil Service College.

10 thoughts on “Public spending cuts will be very painful”

  1. Posted 29/09/2009 at 10:25 | Permalink

    It depends what one means by ‘painful’. Government spending always has an opportunity cost (even if financed by borrowing). When the spending cuts take place, all the things that the government would have stopped us from having by spending too much we will be able to have! Just as the public sector slowly but surely (and quietly) crowded out the private sector, when spending is cut, the private sector will, once again, be able to expand.

  2. Posted 29/09/2009 at 10:25 | Permalink

    It depends what one means by ‘painful’. Government spending always has an opportunity cost (even if financed by borrowing). When the spending cuts take place, all the things that the government would have stopped us from having by spending too much we will be able to have! Just as the public sector slowly but surely (and quietly) crowded out the private sector, when spending is cut, the private sector will, once again, be able to expand.

  3. Posted 29/09/2009 at 12:48 | Permalink

    Painful, yes, but for whom?

    Govt spending has crept up from 36% of GDP ten years ago to over 50% now. At the same time, the number of taxpayer funded jobs has crept up from six to eight million (and there were far too many ten years ago). If half the totally non-productive people in the public sector got proper jobs, you could cut the average tax bill per worker by about £5,000 each (dividing a smaller cost by a larger number of workers).

    Also, what Philip says.

  4. Posted 29/09/2009 at 12:48 | Permalink

    Painful, yes, but for whom?

    Govt spending has crept up from 36% of GDP ten years ago to over 50% now. At the same time, the number of taxpayer funded jobs has crept up from six to eight million (and there were far too many ten years ago). If half the totally non-productive people in the public sector got proper jobs, you could cut the average tax bill per worker by about £5,000 each (dividing a smaller cost by a larger number of workers).

    Also, what Philip says.

  5. Posted 30/09/2009 at 11:18 | Permalink

    These figures are indeed ghastly, but much of this debt is “owed” by ourselves as taxpayers to ourselves as investors. What proportion is owed abroad? And how does that relate to UK residents’ asset holdings in other countries’ government debt?

    Public sector pensions liability – both state pensions and pensions for PS employees – are not debts which are ever going to be called in as lump sums, so this sort of presentation, while scary, is a bit misleading as well. It is also difficult to grasp for the normal person – the sums are so huge. They might usefully be projected as future pensions in payment as a proportion of GDP, or as the tax liability of those in work in the future in £££s.

  6. Posted 30/09/2009 at 11:18 | Permalink

    These figures are indeed ghastly, but much of this debt is “owed” by ourselves as taxpayers to ourselves as investors. What proportion is owed abroad? And how does that relate to UK residents’ asset holdings in other countries’ government debt?

    Public sector pensions liability – both state pensions and pensions for PS employees – are not debts which are ever going to be called in as lump sums, so this sort of presentation, while scary, is a bit misleading as well. It is also difficult to grasp for the normal person – the sums are so huge. They might usefully be projected as future pensions in payment as a proportion of GDP, or as the tax liability of those in work in the future in £££s.

  7. Posted 30/09/2009 at 11:24 | Permalink

    Taking a different angle – Gordon Brown’s speech yesterday was a classic piece of political evasion, planning yet more spending and no real mention of cuts at all – just those elusive “efficiency savings” once more.

    I am very sceptical of the prospects for significant cuts in public spending. I don’t think politicians of any party have the stomach for them. I anticipate much higher (probably disguised) taxation and the return of inflation over the next decade.

  8. Posted 30/09/2009 at 11:24 | Permalink

    Taking a different angle – Gordon Brown’s speech yesterday was a classic piece of political evasion, planning yet more spending and no real mention of cuts at all – just those elusive “efficiency savings” once more.

    I am very sceptical of the prospects for significant cuts in public spending. I don’t think politicians of any party have the stomach for them. I anticipate much higher (probably disguised) taxation and the return of inflation over the next decade.

  9. Posted 06/10/2009 at 08:32 | Permalink

    Those commenting on the deficit should clarify two FUNDAMENTALLY DIFFERENT reasons for the deficit. First, households are saving as never before. This should ring alarm bells in any economist’s brain: Keynes’s “paradox of thrift”. I.e. unless the government / central bank machine not only runs a deficit, but prints the money concerned, unemployment will soar. That part of the deficit is desirable.

    Second, there is “deficit” in the form of govt borrowing instead of taxing. This is a farce, because (contrary to common percention) it does NOT enable us to “consume now and pay later” – as is the case where a household borrows. I expand on this at http://govtdebt.blogspot.com/

  10. Posted 06/10/2009 at 08:32 | Permalink

    Those commenting on the deficit should clarify two FUNDAMENTALLY DIFFERENT reasons for the deficit. First, households are saving as never before. This should ring alarm bells in any economist’s brain: Keynes’s “paradox of thrift”. I.e. unless the government / central bank machine not only runs a deficit, but prints the money concerned, unemployment will soar. That part of the deficit is desirable.

    Second, there is “deficit” in the form of govt borrowing instead of taxing. This is a farce, because (contrary to common percention) it does NOT enable us to “consume now and pay later” – as is the case where a household borrows. I expand on this at http://govtdebt.blogspot.com/

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