Elizabeth Truss

Budget 2008: Arresting the fiscal flood

Budget 2008: Arresting the fiscal flood
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The focus of the UK economic debate of recent weeks has been the credit crunch and the evolution of Northern Rock.  Now, however, the Government's plans for fiscal policy will take centre stage.  This week's Budget provides the Chancellor with an opportunity to set out a new approach for government spending, based on the notion of a long term sustainable public spending policy. If this opportunity is missed, it will leave the way clear for the Opposition parties.

A new report published today by the independent think tank Reform argues that the programme of public spending increases begun in April 1999 has been unsuccessful. This period of public sector expansion - the largest and longest spending increase of the last 35 years – has failed to achieve its stated aims; has acted as a weight on the private sector, damaging long-term economic growth; and has left the UK ill-placed to face the challenges of the coming years.

The programme of spending increases was justified on the rationale that public services would be reformed and the UK's productivity would be boosted (the championed post neoclassical endogenous growth theory).  These aims have not been achieved. In contrast to the much needed planned irrigation, there has been a flash flood of increased spending on largely unreformed and inefficient structures.  The ambition of a stronger growth environment has not been realised - entrepreneurial activity, business start ups and private spending on research and development have all declined over the period.

The Government has pointed to strong economic growth during this period, but this picture is misleading.  One new fact in the report bears repetition in the debates this week: 29 per cent of GDP growth from 1999 to 2006 has been generated by public sector expansion.  And while competitor countries have been moving towards fiscal consolidation, the UK has been increasing its “fiscal footprint”.  Public spending is now well above the average for OECD countries, the budget deficit is amongst the largest in the OECD, and the UK has moved from having the fourth lowest gross public debt in the Euro 19 Area to the ninth. The opportunity taken by competitors to reduce their fiscal footprints in a period of benign global economic conditions has been missed by the UK and taxation has risen to fund this.  The UK's position as a leading low-tax economy and strongly competitive country has declined.

In this context, an attitudinal shift as well as a change in policy is needed from the UK Government and in the wider UK political debate.  More than anything, the Pavlovian reflex of committing more public money wherever there is a problem must be discarded.  The Cabinet Secretary, Sir Gus O'Donnell, is commended in the report for his call in a recent speech for the UK Government to start “to do more with less”.  His words show that some Ministers recognise that in a globalised world it will be increasingly hard for governments to raise taxes, and that greater productivity in the public sector will enable reductions in the tax burden, stimulating incentives to work and save and making the UK a more attractive business environment.

The Conservative Party have clearly made significant steps in this direction.  George Osborne has set out his commitment to a "growth rule" of public spending over the cycle.  David Cameron has stated that "the days of big government are numbered".  The recent suggestions of major increases in taxpayer-funded health spending, however, suggest that the Party may still be uncertain about a long term reduction in government.  A greater commitment to reform would enable the Party to lead on the development of a new fiscal policy for the UK and a new relationship between the Government and individual. The Liberal Democrats also have a chance to capitalise on their successful commentary around the Northern Rock affair to focus on the economic competence of the Government's spending policy. Both parties now have an opportunity to challenge the Government on the course of UK fiscal policy at this week's Budget.

Elizabeth Truss is Reform’s Deputy Director and Lucy Parsons is Reform’s Economics Research Officer. 

A Lost Decade: Counting the opportunity cost of  public spending 1999-2008 is available at http://www.reform.co.uk/filestore/pdf/A%20lost%20decade.pdf