Running out of road on austerity

Next Wednesday will see the occasion of the annual UK parliamentary set piece otherwise known as the presentation of the annual budget. The principle of parliamentary approval of the budget plans date back to the late seventeenth century when the nation’s finances were squandered once too often by a spendthrift monarch. The final straw came during the reign of Charles II in 1667, whose navy was laid up due to a lack of funds and which was subsequently caught unawares by a Dutch raid.

Budget presentations in their current form began in the early eighteenth century, with the word budget itself derived from the French "bougette", which was the little bag from which the Chancellor of the Exchequer would reveal his plans. Incidentally, this explains why the Chancellor "opens" his Budget. The UK is just one of a handful of countries whose fiscal year begins in April (of which Japan is the only one not a former British colony) reflecting the historical fact that when the economy was primarily based on agriculture land tax was collected in April, hence budgets are held in spring.

Over the years the budget became one of the main parliamentary events of the year although its importance in recent years has dwindled somewhat. Nonetheless, it provides us with a good opportunity to focus on the state of UK government finances and fiscal policy. The good news from a macro perspective is that the budget deficit has fallen sharply, from a peak of 10.1% of GDP in FY 2009-10 to an expected 3% in 2016-17 (it reached exactly 3% in calendar 2016, chart). The previous policy of targeting a surplus by the latter part of this decade has been abandoned in favour of a rule which requires reducing the structural deficit below 2% of GDP by 2020-21 and ensuring that the debt-to-GDP is on a downward trajectory ratio by the end of this parliament – both of which seem highly achievable.

But the fiscal improvement has come at a significant cost. Total managed expenditure (the sum of public sector current expenditure, net investment and depreciation) fell from a peak of 45.3% of GDP in 2009-10 – the highest since the mid-1970s – to current levels just below 40%. At the same time, receipts have risen by less than 1% of GDP which is a clear indication of the extent to which the squeeze on public finances has come from spending cuts. Additional spending cuts are already baked in thanks to measures taken by former Chancellor George Osborne. One of the measures which most worries me is the reduction in central government grants to local authorities, which by 2019-20 are set to fall by 80% relative to 2008 levels. This is without a doubt the key reason why local authorities are having to cut frontline services, and I remain of the view that this savage austerity was one of the reasons why the electorate voted to stick two fingers up to the government last June.

Former minister David Laws has already warned that the UK is “reaching the socially acceptable limits to public sector austerity,” and the Institute for Government reported last week that public services are reaching a breaking point (here). It suggests that whilst “the 2010 Spending review was largely successful” in achieving its objectives, “the Government is struggling to successfully implement the 2015 Spending review … [with] clear signs of mounting pressures in public services.” Newspaper headlines over the winter have highlighted the strains on the NHS and the IfG notes other areas where strains on public services are mounting. The report makes four key points which the Chancellor ought to take note of when framing his budget plan: The government:

• is failing to develop alternative strategies despite the clear warning signs in the data
• is continuing to pursue approaches that are no longer working
• is being forced into emergency actions in response to public concern
• is providing emergency cash to bail out deeply troubled services.

In other words, austerity has gone as far as it can. Moreover, there has been no recognition from the UK government (or, for that matter, from most European governments) that fiscal multipliers have proven to be far higher than expected before the financial crisis. Fiscal austerity has had a bigger adverse impact on European growth than policymakers expected. Undoubtedly Chancellor Hammond will point out that the UK has been one of the better performing growth economies in recent years. But that is not how it feels to many people outside the south east of England. Employment growth has been very strong in the last four years but real wages remain below pre-crisis levels. Workers have priced themselves back into a job but their position feels a lot more precarious than it once did.

I am not convinced that Mr Hammond is going to substantively address these concerns next week. His is a government which has an ideological conviction that deficit reduction is an end in itself. But it is not: After all, it’s not government money – it’s ours and we hand it over to the government to facilitate the running of the state. The government thus has a duty to use that money to manage the economy in the best interests of its citizens. And despite the evidence from the macro numbers, I remain as convinced today as I was in 2008, that fiscal policy has a key role to play in helping to make life better for taxpayers.