Sunday, 17 November 2013

The State We're In

David Cameron's recent commitment to a "leaner, more efficient state" has been widely interpreted as a promise of permanent austerity, though as he delivered his speech at the Lord Mayor's Banquet, in white tie and tails, a more cynical interpretation would be "tax cuts for the rich". This pre-election manoeuvring has also revived the idea that the size of the state is a policy differentiator and we may be faced with a clear choice in 2015: Labour offering more state, the Tories offering less, and the LibDems pitching for the "don't know, best leave it as it is" vote. The voice of neoliberalism, i.e. Martin Kettle in The Guardian, is sceptical about these promises: "No modern political party in this country has a very clear answer to the question of what size the state should be".

This is an odd claim because the evidence of history is that the parties largely agree that it should be around 40% of GDP, and have done since WW2. Though there are real differences between the parties in respect of priorities and delivery, the overall level of public expenditure is more a matter of agreement than disagreement. It has fluctuated over the last 50 years, broadly in the 38-45% range, with troughs and peaks around 35 and 50%, however this fluctuation is mainly driven by the economic cycle and secular trends, rather than by government policy. In recessions, a fall in GDP causes the percentage to increase as the numerator (public spending) cannot contract as quickly as the denominator (GDP). This is amplified by counter-cyclical "automatic stabilisers", such as increased spending on benefits as more people become unemployed or lose income. Conversely, when GDP growth picks up, public spending's share of national output tends to drop. By their very nature, public services do not quickly expand or contract in real terms, despite the threats and promises of politicians.

Substantial policy-driven change to public spending usually means transferring economic activity between the public and private sectors. Changes to expenditure levels, whether cuts or investment drives, have only a marginal impact at the aggregate level. Between 1966 and 1986 public spending as a share of GDP was consistently a bit above 40%. Between 1986 and 2007 it was consistently a bit below. The main factor in this shift was the change in housing policy, which moved construction activity from the public to the private sector, followed by the privatisation of state industries and local authority services such as transport. Between 1997 and 2007, the share of GDP rose from 37% to 39%, having first dipped to 35% in 2000, reflecting the initial constraint and subsequent expansion of public services under New Labour. The aftermath of the 2008 crash saw this jump to 46% by 2010, reflecting both the absorption of the banks into the public sector and the counter-cyclical effects of the recession.

In 1978, public sector workers totalled 7 million. By 1998 this was down to 5.2 million. The number increased to 5.8 million during Labour's expansion of public services in the early 00s (mainly in health and education), with a further jump to 6 million as a result of the bank nationalisations in 2008, however it has begun to decline again (partly because sixth-form and FE colleges were recategorised as private sector in 2012) and is now at 5.7 million. With the return of the banks to the private sector, in addition to ongoing cuts in services and the privatisation of Royal Mail, that figure will probably drop close to 5 million later this decade. Measured against the total population, that is a decline from 12% to 8% since 1978, but it's important to remember that this reduction is largely a product of privatisation in the 1980s, while around half of the likely drop this decade will probably be down to shifts between sectors rather than absolute cuts.

The "doom" narrative of public spending assumes that we face an ever-increasing level of expenditure on health, social care and pensions due to an ageing population. This is over-stated, in part because of the way reporting of this expenditure has changed over time. As an area becomes more politically salient, government tends to split it out - e.g. pensions were separated out from general welfare spending in the early 90s. Similarly, a lot of expenditure that would have been classed as "general" or "local government" in years gone by has been absorbed into the larger departmental budgets, due to a mixture of centralisation and political opportunism. In some cases this has been done informally, for example cuts in local authority care budgets have led to increased demands on the NHS. The chart below shows the composition over time.

Excluding the big ticket items, the underlying trend in public expenditure has actually been downwards, from 25% to 18% over 60 years, a decline wholly attributable to cuts in defence expenditure, from a post-war high of 11.2% in 1952 to a pre-crash trough of 2.6% in 2007. While demography has increased the total cost of pensions, and put pressure on health, it has also eased pressure on education, which peaked at 6.5% in 1975 (the end of the postwar baby-boom), dropped to under 5% for most of the 80s and 90s, and only got back above 5% after 2004. Welfare other than pensions took a step-up in the late 70s and early 80s as a result of the recession and longer-term deindustrialisation. It has not stepped back since, despite the real value of benefits being severely reduced. We now have an underlying trend rate of 6%, peaking at 8% in recessions. To put this in perspective, the reserve army of labour now costs more than twice the entire defence establishment.

UK public spending and the size of the state is broadly in line with our peers in Europe. This reflects a common approach to fiscal policy, i.e. tax and spend, despite a varied approach to service provision, from nationalised providers (like the NHS) through non-profit social enterprises to for-profit private suppliers. In contrast, the US state is about 10% smaller, as a percentage of GDP, which reflects the public sector's greater absence from health, pensions and education. It's important to note here that the difference relates to the sectoral categorisation of similar services, not a fundamental difference in the composition of the economy. The small state rhetoric of the right claims that by reducing public spending we will encourage more productive activity in the private sector, but the evidence is that advanced economies just end up producing the same goods and services mix. Public health workers become private health workers, not export-oriented manufacturers.

In practice, the scale of public spending only changes through large-scale privatisation, i.e. the state stepping out of provision both in respect of tax and spend. When this occurs, it usually proceeds at a relatively slow pace, which means it depends on cross-party consensus. House building is a case in point. The current lack of affordable homes is as much the product of New Labour's desertion of local authority building as it is of the Tories' "Right To Buy" policy in the 80s. But such sectoral shifts, in either direction, are rare. Most public sector "reform" concerns outsourcing (and occasionally insourcing). The neoliberal strategy is not to "privatise", in the literal sense of that word, but to transfer the economic control of public services to privileged private sector corporations. In other words, the state is used to guarantee funding through taxation while rent-extraction and profiteering is placed outside public scrutiny. A G4S or Serco contract does not change the overall share of GDP.

The real significance of David Cameron's speech was not the content but the audience, i.e. the City of London. He isn't promising tax cuts - that's for later. What he is promising is that under an outright Tory government more contracts will be awarded to private corporations for the provision of public services, and that the nationalised banks will be returned to the private sector once all risks have been mopped up by the public purse. The timing of the speech, 18 months ahead of the next general election, reflects the need to get commitments on donations from those who will benefit from these policies. A leaner state means a fatter City.

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