Shaping up to slow growth

16 July 2012

Reform roundtable seminar on “Shaping up to slow growth.” Introduced by Vicky Pryce, Senior Managing Director, FTI Consulting

Pressure on living standards and Government spending on public services is likely to continue. This does not mean the UK necessarily faces a “lost decade,” as by playing its cards right the UK could create a stronger and fairer economy. But this will require tough decisions. Government will have no other option than to give a higher priority than it has in the past to those types of public spending that increase growth potential. This might be at the expense of politically protected spending that does less for growth.

To explore these issues in greater detail Reform recently held a Reformer lunch on “Shaping up to slow growth” with Vicky Pryce, Senior Managing Director, FTI Consulting, and former senior government economic adviser. This event was the third in a series of “austerity debates” and was held under the Chatham House rule. Vicky Pryce spoke in a personal capacity.

The discussion highlighted that the current economic conditions provide opportunities as well as challenges. The key is to use current challenges as a platform for making changes that raise the long term competitiveness of the economy and radically transform public services. It is important not to waste the crisis.

The starting point for these changes must be realistic forecasts of the economy’s growth prospects. There is a concern that the forecasts of the Office for Budget Responsibility are too optimistic. Overoptimistic forecasts make the task of rescuing the public finances appear easier than is really the case and could weaken the commitment to the changes that need to be made. Overoptimistic forecasts, and a Treasury that continues to move the goal posts, could also give the markets reason to pause. Hard won credibility in the eyes of the markets can be easily lost.

The global outlook provides one reason for concern around the shorter term outlook for the UK’s growth prospects. There are worries over growth in China and the USA and the Eurozone will continue to have a negative impact on the UK. There is uncertainty over the degree of the negative impact from the Eurozone. Scenarios range from one country defaulting to multiple defaults and the breakup of the currency zone (which would be the most serious for growth and weaken the outlook for some time to come).

As well as a greater realism around growth forecasts there is a need to rethink the role of the state. It is an often cited cliché, but politically tough choices need to be made. Greater emphasis must be given to capital spending by reducing spending on popular but less productive areas. There is a need to revise budgets such as health, education, defence and international aid. Change should not stop with budgets. There is no fixed relationship between inputs (budgets), outputs (services provided) and outcomes (impacts on the community), so services should be reformed to provide better outcomes with fewer inputs. A radical transformation in the ways that public services are provided is needed.

The NHS was discussed as an area for further reform. Although health reform can be politically hard it is nonetheless essential. The NHS absorbs around 10 per cent of the economy and not only impacts on health outcomes but fiscal and economic ones too (consider, for example, the impact of the service on labour markets). Yet the NHS is subject to few competitive pressures and is resistant to redesign. Internationally, health is an industry that is undergoing significant change with technological developments meaning reliance on the acute sector can fall, but resistance to change in the NHS means opportunities to use capital expenditure to generate operational savings are being missed.

Greater use of capital expenditure can be attractive as the Government currently has a low cost of borrowing. Markets may accept an increase in borrowing if it generates good returns or increased rates of growth. Spending on infrastructure is sometimes seen as satisfying this test, although this depends on how the money on infrastructure is spent. There is little long run benefit to the economy from an unused airport or a bridge to nowhere.

The debate on infrastructure highlights the importance of procurement skills in government. Concerns with the contracts negotiated for Private Finance Initiative projects illustrate existing worries over these skills. Increasing infrastructure spending while also requiring this spending to contribute to a broader set of objectives (such as supporting domestic supply chains) risks pushing this capability past breaking point.

Improving growth should not be seen as simply a task for government. The private sector must be central to efforts to improve growth. There are concerns that the private sector is being held back by problems of financing. The finance sector is also an important sector in its own right. Ways to get this sector to not only expand lending (in a sustainable way) but to also grow (again in a sustainable way) need consideration.

Politically a challenge in improving the long run growth potential of the economy is that there is often a lag between introducing the right policy and getting results. The Government needs a strong nerve, which highlights the importance of leadership and a unified Cabinet. Vested interests will often oppose reform and use “growth” to defend short term positions. It is important to distinguish between initiatives that may lead to a short term bubble, or simply postpone the inevitable, and those that lift the long run growth potential of the economy. This requires the Government to be clear about the immediate outlook for the economy and what the public should expect from public spending and services. For this to happen the Government should hold a new spending review now, not in 2014 or the next Parliament.

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