The myth of spending cuts

This article was first published in the December issue of Fund Strategy.

Of all the confusing areas of economics one of the most bewildering is public spending. Despite its centrality to public debate in Britain most people probably shrug their shoulders when they hear it being discussed. Yet its profile is likely to get higher still with the Autumn Statement and next year’s election.

It is not that it is inherently that complicated. The problem is that some basic distinctions get muddled. Sometimes there is deliberate obfuscation on the part of politicians and experts debating the subject. So, in the interests of clarifying a key subject, there follows some key points to bear in mind.

Let us start by taking public spending as a whole – rather than dividing it into constituent parts. There is a pervasive assumption that the Thatcherite wing of the Conservative party wants to slash it and Labour wants it to remain high.

That premise does not stand up to critical scrutiny. Those who want to examine the question in more detail are fortunate to have comprehensive data freely available at: http://www.ukpublicspending.co.uk/ There is also further information on the Office for Budget Responsibility (http://budgetresponsibility.org.uk/ ) and HM Treasury (https://www.gov.uk/government/organisations/hm-treasury ) websites.

One way to measure public spending in real terms over time is to look at it as a proportion of GDP. There was clearly a huge surge in spending during the second world war but in recent decades there has been no clear trend either way. Spending has risen and fallen with the economic cycle but it has fluctuated around roughly the same level.

For example, public spending for 2014 is forecast at about 43.5% of GDP according to www.ukpublicspending.co.uk. That is about the same level as in 1967 and 1968. In the meantime it fell as low as 34% in 1989 and rose as high as 48% in 1975. In other words, despite all the talk of Thatcherism and neo-liberalism there has been no clear trend towards cutting public spending. Indeed one of the sharpest falls, over five percentage points in four years, came during the Labour government of the late 1970s.

However, if spending is measured on an inflation-adjusted basis and per head basis (taking into account the rising population) the trend looks more like one of steady increase. Spending per head in 2013 (the latest available figure) is calculated at just over £10,000 in constant 2005 pounds. That is not far off twice the level in real terms as when Margaret Thatcher became prime minister in 1979.

Both sets of figures beg the question of why there is so much talk about spending cuts. It is clear from the record that, whatever the rhetoric, spending is stubbornly resistant to such initiatives over the long term.

A closer look at the figures over the last few years helps explain recent developments. In 2008, with the economy going into recession, public spending surged. According to the OBR’s figures it increased from 39.9% of GDP in 2007-08 to a peak of 45.3% in 2009-10 (see graph). This was under a Labour government but it is likely that more-or-less the same would have happened under the Conservatives.

The forecasts for the coming years are even more striking. The OBR forecasts public spending to be at 40.2% of GDP in 2016-17 – that is higher than it was in 2007-08 despite all the talk of cuts. It is also worth noting that public spending is forecast to rise this year in real terms compared with last year. Public spending is only being cut relative to its recent, artificially inflated, peak.

So all the figures on total spending show without doubt there is no trend towards a shrinking state. On the contrary, it looks certain that government will continue to play a huge role in society and in the economy. The claim that Britain is a free market – if that is taken to mean a minimal role for he state – is contradicted by the data. It may or may not be a desirable goal but it is certainly not what exists at present nor is it on the agenda for the foreseeable future.

If spending is not being cut in real terms it begs the question of why it is being so widely discussed. One answer is that spending is falling in certain areas even if aggregate cuts are small.

Take the estimated spending of £731bn in the 2015 fiscal year as an example. The Government has said it is going to protect health spending (about 18% of the total), education* (12%) and overseas aid (1.5%).

There are also large areas of spending which are not classified as departmental spending such as debt interest payments (7%), pensions (20%) and welfare benefits (15%).

That means there are areas which are suffering substantial cuts, such as local government spending, but there are others which are not being cut at all. The cuts get most of the attention but such a one-sided focus provides a grossly misleading picture of the overall trend.

It is high time that debate on the subject was better informed.

* School spending in particular is protected.