New analysis: Should savings shift from investment to consumption?

April 17, 2015 12:11 PM

All of the major parties have committed to financial restraint in their manifestos and at face value this is welcome.

Labour is proud of its “Zero-Based Review” which has “identified savings [they] will make through reforming government bureaucracies, devolving power and services… and redesigning public services”. The Conservatives argue that “the job isn’t finished”, calling for a further £30 billion of savings, which the Lib Dems largely echo, saying that they must “finish the job of sorting out the UK’s public finances”.

The renewed focus on financial credibility is no doubt a response to the looming election. However, it is useful to look at the past to show where savings should be made in the future. So, how far have the coalition’s cuts actually gone? Where have they been made? And how long-term are the reductions?

The Office for Budget Responsibility’s public finances databank shows that, in real terms, government spending has come down.

 

After adjusting for inflation, total managed expenditure in 2014-15 will be £20 billion lower than in 2009-10 while current receipts have grown by £55 billion. This explains why the deficit has shrunk - although not as fast as George Osborne predicted. In his 2010 emergency budget, the chancellor’s forecast for the 2014-15 deficit was just £37 billion in cash terms, compared to the £90 billion he actually borrowed.

This £20 billion overall reduction, however, came entirely through trimming capital spending. Current expenditure in 2014-15 is estimated to be exactly the same in real terms as five years earlier. Meanwhile, gross investment will be £20 billion less. As such, there is an argument that savings have been made in the “wrong” parts of the budget. The cumulative effect, from 2009-10, of the difference between actual spending and a real terms freeze has been a gross investment budget reduction of over £90 billion and £28 billion more on current expenditure. While factors such as an aging population, growing school registers and rapidly rising debt interest costs mean that reductions in discretionary spending have been made, they do not change the fact that capital spending has been cut proportionately much more than current spending.

During the parliament, gross investment has fallen to less than ten per cent of total managed expenditure and it is forecast to stay at around this level until 2019-20. 

This chart shows that since 1946-47, gross investment has fallen from a peak of 26 per cent of total spending in 1967-68 to less than 10 per cent now (the historical average is 15 per cent). It is possible that in the recent past (including the last five years) we have underinvested or overspent in the current budget. In either case, we may have achieved the wrong balance and the danger is that a lack of investment will hinder our economic growth in the future.

Data from the Treasury’s Public Spending Statistical Analyses shows how total departmental resource budgets have been relatively sheltered.

Despite the total resource budgets being considerably larger, they have experienced much smaller relative reductions than the capital budgets. This is not to say that the capital budgets should have been ring-fenced - but questions need to be asked about the balance between capital and resource savings.

The reason that politicians have shied away from making savings in current expenditure is quite likely because people notice if their money stops flowing or their day-to-day services are scrapped or curtailed. By contrast, capital projects tend not to have existing beneficiaries as their absence is often the status quo. As such, it is often much more politically achievable to reduce investment and capital budgets than current expenditure and resource budgets.    

Consider welfare expenditure, the largest item on the public spending ledger.

There were sharp rises in the three years to 2012-13, followed by a fall in 2013-14. But in 2014-15 total welfare expenditure is forecast to be £208 billion – approximately the same as 2009-10 levels despite the growing economy, falling unemployment and the enormous deficit we faced in 2009-10. Welfare spending typifies the difficulties faced when trying to reduce current expenditure because it is so directly felt by the individual when there is a change.

Continuing dishonesty from politicians masks the unsatisfying nature of this approach. For example, Labour’s manifesto pledged to “invest in 20,000 more nurses, 8,000 more GPs and 3,000 more midwives”. More nurses and doctors may or may not be wise. But hiring them is consumption and calling it investment does little more than mislead the public.

Public spending projects can be worthwhile and can contribute to economic growth. New transport capacity and IT projects to modernise government services, for example, can cut the cost of doing business and generally make life more pleasant in the future. But capital spending is no panacea. Projects can be wasteful, such as the “Building Schools for the Future” programme or the failed NHS National Programme for IT. And dubious grand economic claims are often made for white elephants like HS2 to cover up unimpressive business cases.

Nonetheless, there is some consensus that the best way to reduce spending is to focus on current spending where the impact on economic growth (and ultimately prosperity) is weaker and often negative.  The next government will have to implement serious savings if it wants to bring down the deficit in a way that will improve growth prospects while delivering the tax cutting reform we desperately need.

The TaxPayers’ Alliance, however, have made that easier for them. In our Spending Plan, published in March, we laid out 41 specific, deliverable and costed policy measures. Politicians should read them and then either adopt them or make it clear what they’ll cut, how much they’ll borrow or whose taxes they’ll hike instead.

Unfortunately, the manifestos presented by the major parties largely do not meet this basic requirement.

 

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