Hamish McRae: This huge experiment has failed

It was the largest peacetime rise in public spending that has ever taken place
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The Independent Online

The focus has shifted. We are not there yet and won't be for some months to come, but some sort of turning point for the economy does seem to be in sight. The problem of public finances, by contrast, looks worse by the day, with even the dire forecasts of Alistair Darling in his Budget now looking far too optimistic.

After the experience of recent months all forecasts have to be taken with a pinch of salt, but it does seem that the economists are at last catching up with the reality and there is widespread agreement that there will be some growth next year before a more solid recovery gets under way in 2011. For what they are worth, the new National Institute numbers out today suggest that UK GDP will grow by 0.9 per cent next year after a figure of minus 4.3 per cent this. Unfortunately that halting recovery will not be enough to stop unemployment peaking at more than 3 million, nearly 10 per cent of the workforce, in 2011.

That pretty much squares with the outlook for other large developed economies. Japan and Germany appear to be particularly hard hit by the collapse in world trade this year and will decline by even more than the UK. It may seem counter-intuitive but it is possible that service-oriented economies such as the US and UK will come through this cycle better than manufacturing-oriented ones such as Germany and Japan.

But, frankly, the differences between the different economies are less remarkable than the similarities. I have not been able to find a single large developed economy that will grow this year. Not one. The only countries that are continuing to grow are the emerging economies, mostly in Asia. As for us, in terms of its relative misery, the UK is pretty much middle of the developed country pack.

Where we are an outlier is not in our growth, or lack of it, but rather in our public finances. These do look much worse than those of any other major European country and probably of any other major developed country, with the possible exception of Japan. The National Institute estimates that borrowing will be around £170bn for both the current financial year and the next one and that far from declining to 5.5 per cent of GDP by 2013-14 as projected in the Budget, it will still be running at 8.6 per cent of GDP.

There are two possible reactions to that. One is to see it as a horror story, with sharp increases in taxation on just about everyone, and sharp cuts to just about all spending programmes. It is a debate as to how the pain should be shared, which government departments will be squeezed, whether there will be a freeze on public pay and so on.

There is bound to be horror and there are bound to be mistakes in the way the correction takes place. The "nice to do" aspects of public spending will have to be sacrificed under the pressure from the "have to do" programmes. But there is another way of approaching the problem which is to see it as an opportunity to reshape government so that it does a better job for us all.

We have had over the past decade the largest increase in public spending that has ever taken place in peacetime. It is also the largest increase that has occurred, proportionate to GDP, of any major economy during that period. So we have in effect been carrying out a huge experiment: to what extent can you improve public services by spending much more money on them. (The tax take, by contrast, has actually declined as a proportion of GDP.)

I think most of us now recognise that this experiment has failed. You can have a debate as to whether public investment had been squeezed too hard in the middle 1990s and during the first two years of the Labour government. You can have a debate about the best way of getting more money into services such as health care and education. But only die-hard ideologues would maintain that this great surge in public spending has brought real value for money and everyone agrees that this process has now come to an end.

If you accept that, you have to ask what we can learn from this failure and how we can use that knowledge to advantage. In short, we have to figure out how to do the business of government better?

In the world of business, companies do this all the time. They face sudden pressures, perhaps from a change in demand, perhaps from a change in technology, perhaps from a change in consumer taste. Sometimes they respond skilfully, sometimes less so, but adapting is normal.

In government, radical change is rarer. Governments are by their nature slower-moving, partly because they have to build political support for their actions and partly because they can run up deficits for a while in way that companies cannot. But there are precedents; this is not entirely a journey without maps. For example, Sweden in the early 1990s faced a fiscal disaster. It also faced a banking crisis that initially cost, relative to Swedish GDP, rather more than the likely cost of the UK banking catastrophes. It set about reforms that preserved the basic welfare state but brought both tax rates and spending down to sustainable levels.

Canada had much the same experience with a budget out of control and the need to cut something like 20 per cent in real terms out of public spending. It now has among the best record coming through this global recession as well as sustaining its place at or close to the top of the human development league table.

Now we know that this will have to be done by the next government. It is not realistic to expect the present Prime Minister to reverse all the policies that he developed or indeed to make any significant changes to them. Weak governments cannot make radical changes even if they want to. But it seems to me to be too limited to think of this just in party political terms. There will have to be new leadership of course but the actual job of reform will be one of those bit-by-bit transformations where getting the detail right will be as important as crunching the big numbers. That will be a job for an awful lot of people, not just the high-heidjins in Westminster and Whitehall.

If you look at surveys of the efficiency of governance, the UK comes in the bottom half of the league – we are not the worst but we are not very good either. Surely we can do better, now we have the spur to make us lift our game.