Spending Review 2010 - Treasury Contents

Written evidence submitted by Reform

  Thank you for your letter dated 22 October in which you invited Reform to submit written evidence to an urgent inquiry on the Spending Review by the Treasury Committee. Your letter highlighted three questions of particular interest. These are:

    — The manner in which the Spending Review was conducted and, in particular, the decision-making process.

    — The decision to ring-fence and partially ring-fence particular areas of public spending.

    — The impact of the Spending Review on the long-term growth potential of the UK economy.

  This letter gives Reform's full response but in summary:

    — The Government did not go anywhere near far enough to engage the public in the Review and to spark a frank debate about the future of public spending. The comparison with Canada is instructive.

    — The decision to ring-fence budgets is a mistake. It sends a message to public service managers that they are protected from the need to reform and deliver efficiency. In fact there is very strong evidence of inefficiency in, for example, the NHS and the schools budgets.

    — The elimination of the deficit within one Parliament will have very positive impacts on the long-term growth potential of the UK economy. Without the elimination of the deficit, growth will be undermined because rising public debt and rising interest payments will drive up taxes.

    This letter discusses each of these questions in turn. Background material outlining Reform's work on the Spending Review is also included as an attachment to this letter. This background material includes:

    Reform's alternative Emergency Budget, titled Budget 2010: Taking the Tough Choices.[12] This Budget contains forewords by Rt Hon Paul Martin, former Canadian Minister of Finance and Prime Minister, and Hon Ruth Richardson, former New Zealand Finance Minister.

    — A copy of the transcripts from Reform's four post-election conferences on welfare, education, public services and the deficit and health.[13] These transcripts, the Reform commentary on the Coalition's first hundred days and a summary of the transcripts are contained in the document titled The First Hundred Days.

    — A copy of the notes from a public lecture given by Hon Ruth Richardson, former New Zealand Minister of Finance, on her experience with fiscal consolidation in New Zealand and lessons for the United Kingdom.

    — A collection of blog posts written by Reform authors and posted on the Spectator Coffeehouse website in the document titled Your Guide to the Spending Review.

    — A copy of Reform's recent welfare report, The Money-Go-Round, which outlines how money could be saved in the government's largest budget and which includes a discussion on the interaction between spending on transfers (AME) and Departmental Spending Limits.

    — A copy of the PowerPoint slides of a public presentation (on 13 October so prior to the Spending Review announcements) given by Reform staff on what the Spending Review should contain.

The manner in which the Spending Review was conducted and, in particular, the decision-making process

  Reform supports the Government's initiative in aiming to conduct the Spending Review in a collaborative manner, with a period of engagement with the public, the public sector and policy experts over the summer. However, Reform believes that this process did not go far enough in engaging the public and sparking honest debate about the magnitude and general nature of the budget actions that are needed.

  A contrast can be made with the reforms in Canada in the 1990s. As Rt Hon Paul Martin noted in his foreword to the Reform alternative Budget, when the new government was elected at the end of November 1993 Canada's deficit and debt-to-GDP ratios were, with the sole exception of Italy, by far the worst of the G7. In 1998, the deficit had been eliminated and the debt ratio was dropping.

  The approach taken to engaging the Canadian public in the development of this consolidation (particularly the 1995 Budget) has been outlined by Rt Hon Paul Martin.[14] He highlighted that an open budget process should engage the public (experts, interest groups and average citizens) in dialogue on "the adequacy of our targets, the prudence of our assumptions, and the potential fiscal measures themselves."

  In Canada this included a consultation process that began more than four months before Budget day and included the release of major background papers and public hearings by the Finance Committee of the House of Commons. This stimulated an outpouring of detailed mock budgets by various interest groups, media columnists and individual citizens. It is Rt Hon Paul Martin's view that this consultation "contributed importantly to creating reasonable expectations as to the magnitude and general nature of the budget actions that were needed."

  Reform set out to spark honest debate about the budget actions needed through team members' attendance at Spending Review events organized by the BBC and others in London, Norwich, West Bromwich and Ipswich. Reform also held an independent event in Staffordshire titled Can Cannock Cope? Showcasing local champions and public sector reform in Cannock Chase. This discussion on public services and the economy included the leaders of public services and businesses and an audience of 100 people.[15]

  A key finding from the Cannock Chase event was that local people were not fully aware of the difficult decisions that lay ahead and that local leaders (while being optimistic that the necessary savings could be achieved) had not sufficiently considered where savings should be made aside from obvious efficiency gains. The Reform event was the first time that many of the local leaders had met each other and thus provided a starting point for dialogue. Reform's view is that events along these lines should have been undertaken much more widely.

The decision to ring-fence and partially ring-fence particular areas of public spending

  This decision is a mistake at a number of levels.

  Above all it sends a message to the decision-makers in health, schools and the other ring-fenced budgets that they are insulated from the need to deliver reform and efficiency. This is tragic in the light of the evidence of inefficiency in these budgets, brought forward by the Audit Commission, the National Audit Office and Reform amongst others. Conversely the greatest reform energy in the current Government lies in policing where the pressure for lower spending has been amongst the greatest.

  Ring-fencing violates the principle that changes in the Budget should reflect the performance (or value) of the spending in different areas. Low value spending should be cut first—no matter what budget it falls within. Otherwise more valuable spending will be sacrificed to protect less valuable spending.

  To give just one example. Cutting an extra pound of spending from, say, community services to protect a pound of spending on health will only maximise the national interest if the pound of health spending provides greater value than the pound of spending on community services. It is highly debatable that this is true for every single pound of health spending.

  Health is the major departmental budget that has been ring-fenced. However, this budget absorbed 40% of the increase in inputs across the whole public sector between 1997 and 2007. This service has also performed poorly in terms of productivity[16] and has not provided the improvement in clinical outcomes that should have been hoped for.

  Lastly, by ring-fencing areas of spending the government fails to take a consistent approach to consolidation. This lack of consistency encourages groups to lobby for exemptions. The Government will find it hard to justify its reductions in Child Benefits and other benefits, for example, while it is protecting the universal benefits for wealthy pensioners such as the Winter Fuel Allowance.[17]

The impact of the Spending Review on the long-term growth potential of the UK economy

  Reform believes that the Government is correct to set out a target for reducing the deficit in one parliamentary term. Both Canada and New Zealand in the 1990s turned around their deficits within one term. In the Emergency Budget the Coalition won fiscal credibility (and breathing space from international financial markets) by setting a similar goal. Failing to now follow through on this goal would damage the government's credibility and reputation in the eyes of international markets.

  There is, not unsurprisingly, debate on the likely economic effects of a fiscal consolidation. These debates are unlikely to be quickly resolved. But we can say six things securely, based on our work over the last several years:

  1.  consolidation has worked for countries in similar circumstances. We have discussed the results of consolidation with figures from countries like Canada and New Zealand. Ireland is sometimes used as a case against consolidation but the view of Colm McCarthy, Chair of the Irish Special Group on Public Service Numbers and Expenditure,[18] is that while the Irish economy is going through a hard time things would have been even harder if they had not have taken their recent actions (as the cost of financing their deficit would have been higher). Problems with the Irish economy stem from a public finance system that was too pro-cyclical and from not having an independent currency. The problem is not consolidation.

  2.  Second, the UK went into the global financial crisis in a weak position, compared to not only Europe but also the rest of the world. The Government was running deficits even when the economy was experiencing strong growth. Household savings rates were low.

  3.  The comparisons with debt levels following World War Two are anachronistic given the very different age profile of the population then and now. High debt levels and an expensive welfare state may have been affordable (although perhaps not wise) when the working age population was young and growing but in the face of an ageing population this is not the case.

  4.  There are strong arguments for moving quickly. The costs of government entitlements in health and pensions are rising. The longer policy makers wait to reform these systems the higher the costs of change will be.

  5.  The consolidation process, run properly, should encourage policy makers to focus on the quality of public spending rather than just the quantity.

  6.  By reducing the need for tax increases, consolidation will improve the business environment which is crucial for growth. Encouraging private sector growth is an important route to reducing the output gap. Economic research on the Great Depression, for example, highlights that rather than purely being a failure in markets, policies that reduced competition and labour market flexibility made the Depression longer and more severe. Similar arguments have been made in relation to Japan's lost decade of economic growth.

November 2010

12   This alternative Budget outlines Reform's recommended targets and timeframe for eliminating the deficit, broad analysis of the economic and fiscal strategy that should underline government intervention in different policy areas, proposed measures to eliminate the deficit and an assessment of the effect of these measures on the government's fiscal aggregates. Back

13   Speakers at these conferences included (in speaking order) Rt Hon Iain Duncan Smith MP, Douglas Carswell MP, Steve Webb MP, Rt Hon Yvette Cooper MP, Rt Hon Lord Knight of Weymouth, Nick Gibb MP, Rt Hon Francis Maude MP, Bernard Jenkin MP, Rt Hon Margaret Hodge MBE MP, Hon Sir Roger Douglas MP, Cllr Colin Barrow CBE, Dr Phillip Lee MP, Simon Burns MP, Rt Hon Stephen Dorrell MP and Rt Hon Lord Warner of Brockley. Back

14   Martin, P. (1996), `The Canadian Experience in Reducing Budget Deficits and Debt,' Economic Review, Federal Reserve Bank of Kansas City, p. 22. Back

15   Local leaders who attended were Philip Atkins, Leader, Staffordshire County Council; Aidan Burley MP, MP for Cannock Chase; Sheila Brown OBE, Founder, Newlife Foundation for Disabled Children; Stephen Brown, CEO of Cannock Chase District Council; Mark Ellse, Principal, Chase Academy; Dr Lynne Hulme, Cannock Chase Consortium Commission; Douglas Paxton, Deputy Chief Constable of Staffordshire Police; Stuart Poynor, CEO, South Staffordshire Primary Care Trust; and CF Pritchard, Director, Pritchard & Associations Ltd. Back

16   The Office of National Statistics' analysis of productivity has shown that public sector productivity has declined on average 0.3% a year between 1997 and 2007. Private sector productivity, in contrast, rose 22.8% over the same period. These averages across sectors hide the relatively performance of spending in different areas-and in this respect health spending has performed particularly poorly. The NHS has lagged behind the rest of the public sector for delivering value for money. Back

17   Close to 90% of spending on the Winter Fuel Allowance goes to people who are not in fuel poverty. Back

18   See the transcript of Colm McCarthy's comments to a Reform conference on public services and the deficit on p 126 of The First Hundred Days. Back

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Prepared 26 November 2010