A lost decade: counting the opportunity cost of public spending 1999-2008

This Reform report examines the period of public spending increases begun in April 1999 and finishing in March 2008. It shows that the public spending programme has not achieved its stated aims of reformed public services and stronger economic growth. In fact the fiscal consequences of spending and the absence of reform leaves the UK much worse placed to face the challenges of coming years. The UK has missed the opportunity to improve its long term growth potential in benign global conditions.

The spending increase between 1999-00 and 2007-08 is the largest and longest of the last 35 years. The other two periods of growth (as a percentage of GDP) lasted for three or four years (and were associated with recessions). The current period has lasted eight years (in a time of steady growth).

There were four main justifications for these increases. Firstly, that hitherto there had been underinvestment in public services and additional spending could remedy this, in partnership with reform. Secondly, that increases would help drive “endogenous” growth and therefore make Britain more innovative and productive. Thirdly, that public spending was a “good” in itself and would strengthen community ties. Finally, the strong fiscal inheritance meant that funds were available.

The scale of spending increases – and the absence of reform – means that they have acted as a “flash flood” rather than a planned irrigation. Instead much of the spending has resulted in doing the same thing at a higher cost. Unreformed and over-centralised management has not ensured that resources are used productively. Capital has been purchased and then rendered obsolete or underutilised. Staff costs have risen, with less being required in some cases. Entrenched producer interests have not been effectively challenged and consumer preferences are not driving delivery in the way they should.

The ambition of a stronger growth environment has not been realised. Entrepreneurial activity, business start-ups, patents granted and private spending on R D have all declined over the period. The strong growth record over the period is misleading. Between 1999 and 2007, 28 per cent of GDP growth has been generated by the public sector, compared to 1.9 per cent between 1993 and 1998. An expansionary fiscal policy is contributing to inflationary pressures and slowing growth.

Whilst Britain has used the past 10 years of benign economic conditions to expand the country’s “fiscal footprint”, some competitor nations have embarked on significant reform programmes. New economies have emerged with much lower costs and more attractive tax regimes.

The analysis in the preceding chapters gives insight into the policy debates and use of resources in the Government’s first two-and-a-half terms. But its real value is its bearing on the UK’s economic and public sector challenges for coming years. These were well summarised by the Cabinet Secretary, Gus O’Donnell, in a recent speech. On the one hand, the demands for better health, education and other social outcomes will grow. But on the other, the pressure of globalisation will reduce the ability of governments to increase taxation on both labour and capital. He called on the UK government “to do more with less”.

His challenge requires an attitudinal shift by the UK Government and in UK political debate. The UK needs to move beyond the Pavlovian “conditional reflex” of committing more public money when there is a problem. This means maintaining a clear view of a sustainable fiscal footprint whilst reforming public services to deliver more value.

This is a very considerable challenge for the current Government. Since the 2007 Comprehensive Spending Review, Ministers have regularly cited spending increases as an example of commitment and success.

The 2008 Budget is therefore a critical opportunity for the Treasury to regain ground. Its opportunity is to develop policies based on a sustainable fiscal footprint. This would involve driving real reform in the public sector and adopting new attitudes to public spending and taxation. The alternative will see the economic sustainability of public finances diminish further.

There are short term and longer term reasons why a new approach should appeal to the Government. In the short term, greater productivity is a means to solve the problem of high borrowing without the political difficulties of reducing spending or increasing taxation. In the long term, a new relationship between the Government and individual is consistent with the developing characteristics of society.