Stephen King: The truth about spending cuts

The major parties have deliberately ducked the issue of their fiscal priorities

I can make all sorts of promises. I can promise to stop biting my nails, for example. Indeed, I have made this particular promise with ritual frequency over the last 30 years. But, I'm ashamed to say, I have never managed to stick to my pledge. For a manicurist, I would be a nightmare.

The more I've made this promise, the less credible it becomes. My wife now knows that, whatever my stated intentions, I will fail to deliver. My commitment is not taken seriously.

As we head towards the general election, the major political parties are busily making their own promises. Common to all of them is their pledge to reduce Britain's budget deficit. At an estimated £166.5bn or 11.8 per cent of national income in the current fiscal year, the deficit is, to say the least, uncomfortably large. To put this latest estimate in context, Britain's borrowing amounted to 7 per cent of GDP in 1975/76, prompting a series of political crises. Labour backbenchers rejected their own party's spending plans, Harold Wilson resigned in March 1976 and, later that year, Dennis Healey had to go to the IMF, cap in hand, to be rescued from the country's earlier excesses.

Fine words are one thing but, as we all know, actions speak louder. The great shame about the forthcoming election is that the electorate will be none the wiser about the key fiscal priorities under Labour or the Conservatives because each of the major parties has deliberately ducked the issue.

The main area of disagreement lies in the timing of fiscal consolidation. The Conservatives are promising more or less immediate action to bring down the deficit. Should George Osborne become chancellor, he will hold an emergency Budget within 50 days of the general election. He has no intention of waiting around because he believes the UK's AAA credit rating is under threat. A downgrade could drive gilt yields higher, thereby raising the cost of borrowing for the Government and, hence, for taxpayers.

Labour's leaders, in contrast, don't want to do too much, too soon. The recovery is fragile. Wearing their Keynesian hats, they worry that aggressive near-term fiscal consolidation could throw the UK economy back into recession. On this view, it's far better for the UK to remain on life support for a little longer. Alistair Darling is promising a taste of fiscal consolidation after the election, but the really hard work, according to last week's Budget, won't really start until the 2011/12 fiscal year.

The debate ahead of the general election is, thus, focusing on the timing, rather than the detail, of budget cuts. Should cuts begin in 2010 or later in 2011? Given that we're in the process of electing a government for the next four or five years, this is depressingly myopic, even more so because economists themselves can't agree on the answer. For some, the key worry is the possibility of a Greek-style rise in the UK's borrowing costs, threatening the recovery. For others, the worry is a premature tightening of fiscal policy, again threatening the recovery. To ask the electorate to make a political decision on the back of a debate which even the supposed experts cannot resolve seems almost farcical.

There is, however, a good reason why the debate has descended to this. None of the political parties is prepared to admit the full truth. Instead, we hear claim and counter-claim about the need to protect frontline services. The nearest we've got to some degree of honesty has been from Mr Darling who, to his credit, admitted last week that Labour's planned spending cuts, if implemented, will prove to be "deeper and tougher" than those achieved by Margaret Thatcher's government in the early-1980s (his candour suggests he is relatively relaxed about the forces of hell). Mr Darling is planning to increase spending in real terms (adjusted for inflation) by 0.4 per cent per year against a background of relatively upbeat assumptions for economic growth. On the basis of these numbers, the UK budget deficit falls to £74bn by 2014-15, or 4.0 per cent of national income.

But what are the chances of Labour delivering on its promise? From 1979 through to 1997, under successive Conservative governments, public spending increased in real terms at a rate of 1.5 per cent per year, more than three times faster than Labour is now proposing. Since 1997, when Labour returned to power, public spending has increased at a rate of 3.2 per cent in real terms, and that includes the early years when Gordon Brown, then the chancellor of the exchequer, stuck to the austerity plans conjured up by Ken Clarke, his Tory predecessor. Since 2000, public spending has increased at a rate of 4.3 per cent per year. So, if we are to believe Labour, 2011 will mark the beginnings of a period of austerity with little modern-day precedent.

Then we have the Tories' promises. David Cameron pledges to cut the deficit but not the NHS. What does this mean? Taken literally, I suppose it implies there will be no real cuts in NHS spending. That, however, is a rather shallow promise. In the 18 years following Mrs Thatcher's election in 1979, the Tories increased health spending at a 3.1 per cent annual rate in real terms. Under Labour, it has increased at a remarkable 6.3 per cent annual rate.

Wastage aside, there are good reasons why health spending rises over time. As life expectancy rises, so we tend to suffer from diseases which are more costly to treat: fewer people drop dead of heart attacks in their 50s, more succumb to cancers requiring intensive treatment in their 70s and 80s. Put another way, the demand for health services tends to expand at a faster rate than the economy as a whole. Unless the Tories can resist this pressure, they will be forced to make swingeing cuts in other areas. The Tories claim they can deliver many of these through efficiency savings. However, governments which attempt fiscal consolidation through these alone are fooling themselves and their electorates. Credible consolidation typically involves pain, no matter how many efficiency savings are delivered. Just look at Ireland and Greece.

If spending cuts cannot be found, we'll either end up with a budget deficit far bigger than any of the political parties is prepared to admit or, alternatively, Britain is about to face major tax increases. Sadly, neither Labour nor the Conservatives are prepared to engage in this debate ahead of the election. Yet both know that, post-election, they will be attempting to deliver spending cuts the likes of which have not been seen in many a year. Mrs Thatcher managed to keep spending under control in the late-1980s against the background of an unusually strong economy. With the UK only slowly emerging from a massive economic crisis, life will not be so easy in the years ahead. Promising cuts is easy. Delivering them is tough, politically damaging and, without the help of a prevailing economic wind, sometimes near enough impossible.

stephen.king@hsbcib.com

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