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There is much support across the UK for increased spending on public services. The dire state of many public services requires urgent attention. The state of the justice system and prisons is a disgrace. Hospital waiting lists, GP appointments and dental services all need major improvements. The condition of many roads with winter potholes resulting from decades long lack of resurfacing suggests a drift away from being a first-world economy as does the state of our rivers.
Much of this is blamed on Tory austerity and the Conservative party’s preference for low taxation but this is only partly true. The austerity of the Coalition Government of 2010-15 was much the same as had been planned in Alaister Darling’s final Labour budget in 2010 at the end of Gordon’s Brown’s brief premiership. The real cause of austerity has been the banking crisis of 2008 exacerbated by the Covid pandemic. Both led to huge increases in government borrowing, and subsequent austerity has been an attempt to reduce the mountain of debt built up in both episodes.
The Coalition successfully managed to reduce annual public borrowing from the unprecedently high level of 10% of GDP reached during the banking crisis as revenues plunged. By 2015, annual borrowing had fallen to 4.5% of GDP but the accumulated public debt level had doubled to 80% of GDP. David Cameron’s administration followed by Theresa May’s then continued the austerity with a squeeze on the volume of services, social benefits other than pensions and on public sector pay. The austerity was relaxed in time for the 2019 election but the public finances then endured a huge further hit from Covid. Public borrowing rose to a new post-WW2 record of 12% of GDP and total public debt approached 100% of GDP.
Any post-Covid administration faced a daunting task. As interest rates eventually recovered from their 300-year post-banking crisis lows, debt repayments have soared to 4% of GDP. The high level of total debt essentially puts a limit on future borrowing as Liz Truss found when she attempted to cut taxes without reducing spending. The current Labour government has managed to announce an increase in borrowing, albeit relatively small, through changing the definition of debt to include some offsetting financial assets notably including student debt repayments, pension fund assets and equity in publicly-owned companies such as NatWest. The nervousness of the purchasers of UK Government bonds (half of whom are abroad) was seen in the post-Budget rise in bond yields (which equates with a fall in bond prices) but there has been no major panic. Bond yields are now back to close to the levels of the Liz Truss budget crisis of October 2022 but unlike then, the level of sterling has remained stable because the markets were carefully primed to expect what was coming in the Budget.
While it is easy to agree with the Labour Government that public services need urgent improvement, its proposed £70 billion (2.5% of GDP) increase in public spending, compared with pre-existing Tory plans, may achieve little improvement Much of the spending is front-loaded in the next two years and sudden increases of this sort can easily lead to waste. The much-vaunted (but over-rated) Office of Budget Responsibility (OBR) appears to agree.
The OBR Forecasts
For each Budget and Financial Statement, the OBR obtain government spending plans from the Treasury to generate their forecasts. This time they reported that the Budget would increase current spending by government by £54 billion by 2029 and capital spending (fixed investment) would be £20 billion higher. The OBR also calculated what the increase would be in real terms, i.e. adjusted for inflation. The inflation-adjusted values attempt to measure the extra goods and services generated over the period plus the additional capital stock in the form of hospitals, schools, roads etc.
Amazingly, the OBR projected an increase in real (i.e. inflation-adjusted) current government spending of only £5 billion by 2028/29. This implies that almost all of the additional £54 billion in money terms will be spent on extra public sector jobs and wages without generating much in the way of extra services. The OBR have assumed that the cost of producing the extra government services now rises by 13% up to 2029/30 while last March, before the Budget they assumed this rise would be only around 4%. After several emails to the OBR, we are unclear exactly why the OBR made this important change. Bizarrely, the OBR downplay the use of inflation-adjusted government spending as an indicator of the volume of services provided.
The picture is clouded by the OBR’s parallel prediction that government departmental current spending (RDEL) will rise by £27 billion (7%) in real terms compared with its March report which was based on Tory plans. Since departmental spending constitutes most of government consumption it is puzzling, to say the least, that the inflation-adjusted versions of essentially the same rise in money terms should be so different. The OBR claim that RDEL and government consumption are different concepts but both are just measures of what the government is expected to spend. We can see no reason for using different assumptions for inflation as the OBR do.
The OBR’s also forecast a 500,000 increase in public sector employment by 2029/30 which is 230.000 greater than in their pre-Budget forecast last March. With only a minor increase in the volume of public services this implies a much slower growth in the (already depressed) level of public sector productivity. Real current government consumption per employee is now projected to rise more slowly 0.7% per annum) than in the March forecast (1.1% per annum) which reflected Tory spending plans. This makes some sense if most of the extra spending on current rather than capital outputs is heavily concentrated in the first two years. Previous experience shows that rushed expansions in spending can lead to much feather-bedding and waste. More money may be planned for health and education but unless extra doctors, nurses and teachers can be put in place in effective roles the outcomes may not be as positive as intended. Labour will need to rely on reforms in the NHS and elsewhere to deliver improvements but these were absent from the Budget. Reform is easier said than done and it remains to be seen how successful Labour will prove in improving services with limited additional expenditure.
Secondly, the main increase in real public spending comes not in current spending but in capital spending on infrastructure projects. Here real spending (after allowing for projected inflation) is projected to rise by 6% compared with the fall of 10% projected in the previous (Tory) plans.. Much of this involves catching up with the maintenance of buildings and facilities in health, education and net zero but there are small amounts of extra money for growth related projects. The maintenance may well be necessary but may not do much to increase the volume of services provided to the public especially in the near-term.
Potential Labour voters to pay nothing
The most unsatisfactory aspect of the budget is the way it is financed. The extra £40 billion of taxes and £30 billion of additional borrowing offer little direct pain for most voters, especially for most Labour voters. In this sense, Labour’s offer to voters is the classic something for nothing. Most voters face few new direct or indirect taxes or national insurance contributions. Income taxes will rise because the tax thresholds remain frozen until 2028, but this was already Tory policy and could be quietly adopted by Labour with little or no publicity.
Extra jobs and higher wages for the public sector enables Labour to secure the support of its public sector supporters and its trades unions backers, but unless this can be translated in better health, education and other services the wider public will be disappointed. Few Labour voters will protest at tax rises on farmers, small business owners, or parents with children at private schools. Nor will they object much to higher payments by companies on employer’s national insurance, even if they are vaguely aware that this may come back to bite them through higher prices or lost jobs.
The tax proposals look like a what Alice Thompson in the Times (Nov 6th) calls a ‘Labour class-war’. The farmers and small business-owners are the backbone of the Tory Party in many rural areas. The tax on family farms is especially tendentious. Perhaps half of farming families (as opposed to small-holders) will need to sell land to pay the new inheritance tax. If the land is bought by investors and rented back to farm operators, the character of farming and rural areas will steadily change away from the owner-occupied farms of the 20th century and back to the rented farms of the 19th century. This would be a major cultural change for rural areas and is perhaps an unthought-out and unintended, but nonetheless uncaring, consequence.
Similarly, the imposition of VAT, extra National Insurance and business rates on private schools smacks of class-war since it raises little net income. The decision to impose VAT in January midway through a school year is especially mean. Less well-off parents forced to withdraw their children in mid-year will need to find places in state schools where the most-favoured places have already been allocated.
Economic growth is important
Labour’s pre-election rhetoric that economic growth was the best way to generate the needed tax revenues was correct. What Labour has found in practice is that to avoid their supporters paying any extra tax it has, in the absence of extra growth, had to load the tax on businesses large and small. This is the opposite of encouraging business to invest and grow. Few of their non-tax policies will have enough clout to offset the disincentives imposed through the tax rises and the net effect is likely to be negative for growth.
The OBR suggest that these policies, together with a higher living wage, will provide only a small boost to real GDP in the first couple of years but GDP will be no higher by the next election in 2029. The OBR forecast for GDP partly reflects their assumption of little growth in real government consumption, although the odd way in which the OBR forecast GDP makes the connection between GDP and government consumption less direct than it should be. Instead of forecasting the components of GDP (household consumption, government consumption, investment and trade) and summing these to obtain GDP, the OBR start with assumptions for GDP and then adjust the components to make the forecast add up.
OBR forecasts are based on assumptions about economy-wide productivity and a need to reflect government targets on inflation but in this instance the judgement on the future of GDP is reasonable. In any event, the forecasts generated from a model constructed by my own macro-economic model generates an almost identical result. My expectation is for growth in GDP at a little over 2% per annum from 2025 until the end of the decade with something of a recovery in productivity compared to the last 15 years. This is a relatively benign, even if not particularly exciting, prospect but not one that will be materially changed by the recent Budget except for a minor temporary bounce in the first two years.
How Serious is a Lack of Growth?
Is the failure to stimulate sustained faster growth a serious omission? Many economic commentators including the Financial Times would say yes. Their view, partly formed by their allergic reaction to Brexit, is that the UK is in some sort of terminal decline relative to other major economies. The FT editorial the day after the Budget opined that “Rachel Reves inherited a deeply troubled economy, slow growth, strained public services and high debt”. The FT’s chief economic commentator, Martin Wolf went further on the same day stating that “the dire legacy must not be forgotten. According to the IMF the in 2024 UK GDP per head will be 29% below where it would have been if growth had continued at its 1990-2007 rate”.
Helpfully Wolf produced a chart based on the IMF figures, which is reproduced below. At first glance this chart appears to show the UK under-performing the other G7 economies throughout the period since 2007. On closer inspection it shows something quite different. This is that the trend in UK growth deviated more than in other nations compared with the performance before 2007. This assumes that the rapid growth of the UK prior to 2007, which was due mainly to unsustainable expansion of mortgage and other bank loans, would have continued, essentially forever. This is daft.
Source of data: World Bank
A much better sense of how the UK economy compared with other G7 nations can be seen in the chart below which shows the actual growth of real GDP per head since 1990. The good performance of the UK stands out. Over this 34-year period since the end of the Thatcher decade, the UK economy has grown faster than other G7 nations except for the USA. Recent years may not have been as good as before 2007 but that was an exceptional period in which growth was boosted by unsustainable bank lending. Even the USA has only pulled ahead of the UK since 2016 when the huge fiscal expansion of the Trump-Biden years began. In the USA a large government deficit of 6.5% of GDP opened up after 2016 and is projected to remain for the foreseeable future, leaving the US with a huge and ever-expanding public debt that one day will become unsustainable.
Source of data: World Bank (LCU indicates local currency units ie local currencies
Most major EU economies (except previous laggard Italy) have struggled since 2019 through Covid and beyond, and like them the UK currently has a level of per capita GDP no higher than in 2019. Since the major markets for UK exports are in the struggling EU, slow growth in the UK is likely if not inevitable. While the economic outlook for the next few years looks relatively benign, faster growth at say 3% per annum would be more comfortable and would allow a restoration of high standards in public services without extra borrowing. This will be difficult to achieve if the UK’s major markets in Europe continue to grow slowly, even if President Trump exempts the UK from his proposed tariffs. The UK would need to increase its share of EU and other markets which would require us to become more competitive than themselves. Alternatively, the UK would need to raise its growth in productivity without higher borrowing.
Much will now depend on public sector reforms leading to higher productivity. This could underpin better public services but also release labour for faster growth in the private sector. The Tories presided over a period of declining productivity in the public sector, especially since Covid. We have little idea on how Labour proposes to succeed where the Conservatives failed. This task will prove much more difficult than raising a few tens of billions in tax revenues.
