UK: Getting growth going - GOVERNMENT HAS NO TIME TO SIT BACK.

UK: Getting growth going - GOVERNMENT HAS NO TIME TO SIT BACK. - Tony Banks, the Labour MP, once said of John Smith that if he was a double-glazing salesman every house in the country would boast a new set of windows. As it turned out, even Smith's techn

by David Smith.
Last Updated: 31 Aug 2010

Tony Banks, the Labour MP, once said of John Smith that if he was a double-glazing salesman every house in the country would boast a new set of windows. As it turned out, even Smith's technique could not win enough customers for Labour's tax plans and, on present evidence, it will be four or five years before he has another opportunity. The general point, however, stands. Deals that sound very attractive at the time soon begin to look dubious when the hidden extras appear.

Nowhere is this more true than in the matter of public finances. The Treasury's projection of a £28-billion 1992-3 public sector borrowing requirement, rising to £32 billion in 1993-4, concentrated the minds of the financial markets on the alarming deterioration in the Government's financial position. And yet this did not prevent the two main protagonists in the general election campaign offering competing visions of largesse - in higher public spending, tax cuts or both.

Now the realists can take over and the reality is that the Treasury, in its determination to bring public sector borrowing under control, will be doing what comes naturally - clamping down hard on public spending. As for tax cuts, what politician needs them in the first half of a parliament?

In 1979 the Conservative government pledged to achieve cuts in public expenditure. And certainly, in the popular mind, such cuts took place. The facts, however, tell a different story. From 1979 until the mid-'80s, public spending growth, after allowing for inflation, exceeded 2% a year. The target of securing actual reductions in public spending gave way to the ambition of reducing the share of such spending in gross domestic product. In other words, public spending could grow as long as it grew at a slower rate than the rest of the economy. Ironically, as soon as the target of achieving cuts was abandoned, there were two years, 1987-8 and 1988-9, when public spending fell, by 0.1% and 2.5% respectively. But this was because of public expenditure savings which accrued from rapidly falling unemployment. Falling unemployment, by producing big savings in transfer payments from government to the private sector, notably unemployment benefits and other social security payments - is easily the best recipe for taming the public expenditure leviathan.

In the next few months the "dry" chief secretary to the Treasury, Michael Portillo, will attempt to do what the Thatcher government failed to achieve in its early years. Portillo's task is made easier by the fact that the biggest Whitehall budget, that of the DSS, is under the control of the equally arid Peter Lilley.

When a government is spending some £250 billion a year in total, there is clearly scope for savings. There is, however, only so much a determined chief secretary can do. In the 1970s and '80s, those public spending cuts that were achieved (within an increasing total) fell disproportionately on capital spending. The infrastructure suffered, to the detriment of the economy's productive potential.

There are, in addition, so many sacred cows that make large-scale savings difficult, if not impossible. The NHS faces almost limitless demands, exacerbated by an ageing population and the advances in medical science. Education spending has similarly become, if not sacrosanct, an area certainly where cutters tread warily.

The clues to successful control of public spending are to be found in the experience of the 1980s. During the first half of the decade the government failed because the forces of slow growth pushed up the demands on state resources. But in the second half of the decade, public spending was brought under control, largely as a side-effect of strong economic growth, just at the time such growth was swelling tax revenues. The result was a repayment of public sector debt.

It is not difficult to see why strong economic growth can have the effect of reducing public spending. Prosperity brings with it a greater likelihood that people will opt for private sector provision in areas like health and education. The greater that prosperity the more likely the culture of welfare-dependency will disappear. Growth is, therefore, the vital ingredient in controlling public spending, and by generating substantial increases in tax revenues, in restoring the public finances to health. The Treasury clearly recognises this. Its medium-term projections show the Government returning towards a balanced budget by about 1996-7, with room even for some modest tax cuts at the end of the period. But its central assumption, crucially, is for economic growth of 3.5% a year from 1993 onwards - not quite a boom but certainly a very robust performance.

The alternative, as shown in the chart, is that growth will be much slower than this. If growth in the first half of the '90s is similar to the performance of the first half of the '80s, then serious problems lie ahead. Not only will borrowing return to the levels of the mid-'70s, but the Government will face deeply disappointed expectations. Not only will meaningful increases in public spending be unaffordable, but the Government will have to abandon its intended progress towards a 20p in the pound basic rate of tax.

The slower the growth rate, the more the Government will be seen to have reneged on its promises. And the more difficult - with the European exchange rate mechanism - will it be to do anything about it. Often, recently-elected governments can sit back and wait for economic growth to come through. This one needs to get growth back on stream, and fast.

(Chart not included.)

David Smith is economics editor of The Sunday Times.

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