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Chancellor feels his own squeeze

This Wednesday, UK chancellor George Osborne will present his Autumn Statement and his first comprehensive review of government spending since an all-Tory government was installed after elections in May. He is likely to come across as less triumphant than that recent election victory presaged. A whole store of problems rather suddenly confronts the man in charge of the UK government’s finances.

First, his own self-imposed target of an overall budget surplus by the end of the decade has just become a bit more remote. Chris Giles has the reporting: tax revenues are suddenly slipping below projections, and could mean additional public borrowing of some £10bn this year — entirely undoing the £10bn budget surplus planned for 2019/2020 unless something makes up the lost ground.

(With the deficit at an unthreatening 4 per cent of GDP, and the public debt to GDP ratio stable and sustainable, why the chancellor aims for a surplus in the first place is a mystery, but that’s where we are.)

A briefing from the Institute of Fiscal Studies gives the details on which taxes have fallen short and where spending has overshot (in particular investment — which is a good thing for the economy, even if the overspend may be bad in Osborne’s economic philosophy). The IFS analysis also points to a second problem for the chancellor, again of his own making. If the political backlash against his attempt to cut tax credits for low-paid workers forces him to reconsider, he needs to find other welfare cuts instead — or butt up against a cap on total welfare spending which he himself put into law.

That’s not all. Even if Osborne gets his way both on the deficit path and tax credits cuts (or other welfare cuts to stay within the cap), the meaning of his fiscal trajectory is coming into view for the public in a way that it had not before. The Resolution Foundation has calculated that, given the various commitments made by the government, the worst-hit departments will face real-term budget cuts of 30 per cent in the next four years. Given that many of those budgets were already slashed in the previous parliament, the cumulative cuts since 2010 could reach 75 per cent in some cases.

These and other stunning numbers are presented in a longer Resolution Foundation briefing that gives the clearest available summary of how Britain’s public finances will have changed beyond recognition by 2020. While there is an attempt to bring government spending as a share of GDP to the lowest levels seen since the second world war, the true revolution is in what the government spends its money on. As the graphic below shows, the share spent on health has increased enormously, while other public services have been squeezed.

While service provision has been squeezed, transfer spending (welfare benefits) has not — but largely because pensions have been left unscathed whereas benefits for younger people are being cut to the bone. The Resolution Foundation is quite right that it is these changing shares of spending, as much as or more than the amount of spending overall, that are fundamentally reshaping the state. A similar point is brought out in a different context by Jedediah Purdy’s historically perceptive essay on Bernie Sanders and the pedigree of the term “socialism” in US politics. Purdy reminds us that after Ronald Reagan came to power the state “did not in fact shrink, thanks largely to military spending and retirement benefits” — but that shift in spending would reshape both the economic and the political relationship between the government and the governed.

So, on Wednesday, watch how the chancellor manoeuvres against the increasingly worried public understanding of where his fiscal trajectory is leading the country, and how he refines his promises on the deficit path, the welfare cap and the make-up of state service provision. Beyond Wednesday, consider how the economy deals with the consequences. The chancellor must be praying that his crypto-Scandinavian push for higher minimum wages to enhance productivity will bear early fruit; and that those arguing the 21st-century state needs to be bigger than in the 20th, are wrong.

Live Free Lunch

Don’t forget that the chancellor’s spending review forms the topic for a live Free Lunch on December 2: Martin Sandbu leads a conversation with Paul Johnson of the Institute for Fiscal Studies on the future of Britain’s public finances after the Autumn Statement. Tickets here.

Other readables

  • Jared Bernstein usefully goes through the different ways one can analyse a minimum-wage increase: in some models, it hurts employment, in others it increases employment as well as wages. This is an important and under-appreciated point. As Dani Rodrik points out in his new book Economics Rules, economics usually has a collection of models that may give different answers to different questions. To say categorically that “economics proves” that minimum wages reduce employment or rent controls shrink the housing supply — which many economists do, as Rodrik also documents — is to display ignorance of the richness of economics itself.
  • The US jobs market may be creating more jobs than it is losing, but the gross numbers of hires by new companies and jobs lost from those closing have both fallen significantly since the crisis. That could be one reason for very slow productivity growth, since it means labour is not shifting into new activities as fast as before.

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