Axe Wednesday: The future starts here

Today's cuts are about more than just today's problems. Hamish McRae on why they signal a new era of lower ambitions for government and a shrinking public sector

So it has come to this. The bright ambitions of the previous government that it could spend money both to fix problems at home and to strut a role on the global stage have hit the hard reality of huge debts. We were told yesterday of the implications for defence; today we get the bigger picture of government spending on everything else.

You can look at this in two ways. You can see it as a course correction, a violent one to be sure, but one essentially made necessary by past errors. This is the idea that we have to get back on track, that doing so will be painful, but that when we do all will be hunky dory. Or you can see it as something quite new, the early stumbling stages along a path towards redefining the role of government itself – what the state in a Western society does for its citizens, and what it does not or indeed cannot do.

Both views are valid enough but I suspect that in 10 or 20 years' time we will see the events of today more in terms of the latter and more dynamic perspective.

Some numbers. During the past 25-30 years government tax revenues have peaked at around 38 per cent of GDP. Governments of both main parties have sometimes sought to increase the tax take a little but have not succeeded, usually because an economic slowdown cut receipts. But spending has hovered around 40 per cent of GDP, rising at present to some 48 per cent of GDP – hence the present gap of 11-12 per cent of GDP. Let's say, to keep things simple, that half of that gap will correct itself as the economy comes back to its full potential output. That still leaves another 6 per cent of GDP as the so-called structural deficit, that has to be eliminated. That is share of GDP, not share of public spending, so the cuts in the latter have to be much bigger, say 12-15 per cent of spending. Since more money has to be set aside for extra interest and since some programmes, such as the NHS, are going on growing, the other cuts have to be bigger still.

Now you can have a debate about the speed at which spending plans are being cut, about their economic and social implications, about the balance of the priorities, about the extent to which any government might be able to push taxation higher than the levels achieved during the past generation. (Actually the Coalition does seem to be trying to do that and it will be interesting to see whether it succeeds.) But you cannot get away from the basic maths. As that insouciant note left by the previous government's chief secretary to the Treasury, Liam Byrne, to his successor said: "I am afraid to tell you there is no money left."

Actually you can make a decent case that even after these cuts, the Government will still have massive funds to deploy. On these plans actual spending, adjusted for inflation, will in 2015-16 be a little below the level of this year but spending will still be higher than it was in 2009. The government of any large developed country has access to funds on a scale that no multinational company, however big, could contemplate.

But so too are the demands on it. These demands that we as voters and taxpayers impose are set to grow inexorably in the coming years. This is partly the result of demographic change. The rising proportion of retirees relative to people of working age means that each worker will have to pay more tax simply to keep pensions steady in real terms. If pensions are to be increased in line with earnings, then an even larger chunk of the earners' salaries will have to be recycled to pensioners.

It is also the result of changing preferences about how we as a society spend our money. We want better healthcare; we want, or at least ought to want, to be better educated. But these are services funded largely by the state.

It gets worse. It has proved relatively easy to increase productivity in manufacturing and in some private sector services such as supermarkets. But it is much harder to increase productivity in schools and hospitals. If you skimp on staff you are liable to skimp on service.

This is not to claim that there is no fat in public services to be cut, for there is clearly huge waste. Insofar as government productivity can be measured, the Office for National Statistics calculates that productivity may have fallen during the Labour government. That is dreadful, for it means the costs of the public sector have been a big drag on living standards in the economy as a whole. But we should not kid ourselves that it is easy to increase public sector efficiency, for many of the things it does need boots on the ground.

So government, here in the UK but actually everywhere in the developed world, will have to try to do more, but do it with less. But it can't. That is why these spending cuts will, I think, come to be seen as a first stage of a wider retreat. It will start to shed some responsibilities: indeed it is already starting to do so. Welfare and social housing are two clear areas where the Coalition will step back, and we will learn much, much more today.

Look forward 10 years and the pressures will be greater still: our workforce will probably be falling in size; the retired baby boomers will need more care; we will all have to save more for ourselves and rely less on the state; and I am afraid those debts will still be there. This is not a terrible prospect, for we will still be lucky to live in a decent democracy. But it will be a world of diminished ambitions, for politicians as for the rest of us. And it starts today.