Debt Disaster and Public Service Reform

Over the last few weeks, many parallels have been drawn between the Chancellor of the Exchequer’s Budget position and previous occasions when there has been a black hole in public finances such as 1976, 1981 and 1992. However, the combination of problems facing the current Chancellor of the Exchequer is probably unique.

The starting point is that official government borrowing, which excludes a number of important items, will rise to at least 12% of GDP over the next year or so. The last time government borrowing was threateningly high was in 1993 when it peaked at around 8% of national income. Norman Lamont was in a tight squeeze in the 1992 Budget but the problems facing Alistair Darling are much worse. The 1992 deficit was mainly recession-induced and closed as the economy recovered, whereas about half of the deficit today is structural and will not go away when the recession ends. If we include public sector pension costs, properly calculated, the structural budget deficit today is probably about 10% of national income.

In 1981, Geoffrey Howe was facing a particularly grim combination of circumstances. Like today, government borrowing was not just due to recession but caused by general government overspending. The government was also finding it increasingly difficult to sell bonds to fund its debt. However, in 1981, the level of borrowing was only about one third of today’s level and some prudent – though painful – measures were able to restore the situation within a few years.

In 1976 borrowing was around 6% of GDP – again much of it a permanent feature caused by high structural government spending. But there were some relatively easy pickings for the Chancellor at that time in trying to sort out the UK’s economic situation. For example, there were revenues to be gained from privatisations and North Sea oil, which benefited the Exchequer even before the 1979 Thatcher government.

The situation faced by Alistair Darling is truly dire. If we express borrowing in relation to the tax take, then one in every four pounds that the government spends next year will be borrowed, even if we ignore hidden public sector pension costs. Imagine running a business or a hospital on that basis. As has been noted, there will be a yawning gap in the finances even when the economy recovers.

The financial position cannot be restored through big tax increases. Planned taxes rises for the rich will yield relatively small amounts of income. It could take tax increases equivalent to a cut in disposable income of about 10% across the whole population to close the deficit even under the implausible assumption that economic growth were not affected by such a tax increase.

If the deficit is to be closed over the next decade, the emphasis will fall on a spending squeeze. Despite Alistair Darling’s promise to protect health and education, three factors suggest a squeeze for years to come. Firstly, pay in the public sector has risen rapidly. Last year pay in the public sector rose by 5% more than in the private sector and this cannot continue. Secondly, employment in the public sector has also increased dramatically over the last eight years and, again, this cannot continue because it is part of the reason for the structural budget deficit. Thirdly, public sector pensions are going to be an increasing burden. The absence of reform in this field will cause problems not just for taxpayers but for public sector budget holders: because public sector pensions are, by and large, paid out of current budgets the increasing cash cost of pensions will lead to pressure for savings under other budget lines.

This is a potentially depressing environment in which many public sector workers are likely to find themselves. Arguably, public service reform is the only solution. Rather than battling year after year to reduce spending, public sector workers might find it advantageous and liberating to embrace radical reform and privatisation – for example through education vouchers and genuine consumer choice in healthcare. Having the opportunity and freedom to do better with less money might just be more fulfilling than an annual round of budget meetings in every school and hospital looking at how 2.5% can be sliced off here and £50,000 can be saved there.

See also:
Living with Leviathan