Vulcanomics obscures the Tories' real choices

"While the Tories, led by Mr Redwood, fret about how to finance tax cuts, the electorate may become equally concerned come polling day about the absence of real growth in public services."

Vulcanomics has not had a good week. John Redwood's campaign for the premiership was dented from the moment he claimed that he could painlessly cut taxation by pounds 5bn in the first Cabinet meeting under his chairmanship.

Mr Redwood could have argued a case for tax cuts in several different ways. He could have asked for a higher budget deficit, or for a change in the boundary between the state and the private sector. He could even have used the supply-side argument that cuts in the marginal rates of tax would stimulate economic activity so much that tax receipts would not decline. But he did none of these things. Instead, he claimed that his pounds 5bn could be found from cutting waste and bureaucracy in government departments. Woe betide, he said, the minister who failed to mind the petty cash in a Redwood government.

This reliance on squeezing the petty cash to finance tax cuts has a good Thatcherite pedigree. It was a ruse used by the Iron Lady on her way to government in 1979. But while a cut in public spending of pounds 5bn may be only 1.7 per cent of the spending total, it is enormous relative to the Government's total expenditure on bureaucracy and administration.

Indeed, as the Chancellor has noted, Mr Redwood's pounds 5bn is equivalent to one-third of the pounds 15bn spent each year on central government administration (i.e. "Whitehall"). Furthermore, the Treasury already requires all government departments to make efficiency savings of 2-3 per cent each year, which fully offset pay rises for the Civil Service. Although there is clearly a lot of bureaucracy in the health and education services that is not included in the Chancellor's pounds 15bn figure, it is completely implausible to argue that pounds 5bn of administrative savings could be found either quickly or without any dent to services provided to the public.

A Fellow of All Souls is clearly intelligent enough to know all this, so Mr Redwood presumably has some hidden agenda. Most likely, he is reluctant to specify areas in which the public services should be cut, but wants to signal that his administration would be, like Mrs Thatcher's, generally in favour of shrinking the state and cutting the tax burden.

"Waste" in Mr Redwood's lexicon may in fact be a code word for "public services that should instead be provided by the private sector, and charged accordingly". Ever since John Major moved into No 10, there have been dark mutterings from the right of the party that the control of the public purse strings has been much slacker than it was in Mrs Thatcher's day, and that the state has once more been allowed to extend its tentacles. So what does the record show?

Any comparison between public spending trends in different periods must obviously take account of the economic cycle, since it is much easier to hold spending down when the economy is growing fast. The graph tracks the behaviour of real public spending (excluding debt interest) in the first five years of the 1980s economic recovery, and compares this with what has happened in the equivalent period of the present recovery.

The main difference came in the first year following the trough in activity - 1992-93 in the present case, and 1981-82 last time. In 1992-93, the Major government allowed real public spending to rise by 6 per cent, partly as an election-year hand-out, and partly to compensate for the fact that monetary policy could not be used to boost the economy while sterling was in the European exchange rate mechanism.

Since then, however, the public spending increases under Mr Major have been smaller than those at the equivalent stage under Mrs Thatcher, and that remains the case in the plans just re-affirmed for next year. The cumulative growth in real spending in the next two years will be just 0.5 per cent, which is remarkably low for a pre-election period, and does not suggest that overall spending targets have been lax.

In fact, while the Tories - encouraged by Mr Redwood - fret about how to finance tax cuts, the electorate may become equally concerned before polling day comes round about the absence of real growth in the public services. One way round this dilemma would be to go for the "cut and run" option, and simply expand the budget deficit. Economists who are influential on the right of the Conservative Party, such as Patrick Minford, argue for this, though they would not describe it as "cut and run".

Their diagnosis of Britain's current economic condition is quite different from the mainstream view that tends to prevail in the Treasury. They believe that the economy is still working far below its normal capacity, mainly because Thatcherite supply-side reforms (privatisation and labour market deregulation) have transformed the underlying growth rate of that capacity.

The right contends that the inflation threat is therefore minimal, and that the main problem facing the economy is a lack of effective demand, especially with the housing market in its present parlous state. Although their main prescription is for a cut in interest rates, they are also enthusiastic about pre-emptive cuts in marginal tax rates, since they believe that tax cuts will be comfortably financed as the economy expands rapidly. There has been no hint from Mr Redwood that he shares this analysis, but many of his supporters obviously do.

The Minford case is certainly not self-evidently wrong - its author is too intelligent for that, and his forecasts recently have been better than those based on a less optimistic diagnosis of the economy's underlying performance. But his policy prescription is risky, since if he is over- optimistic about the supply side - as has been common in the past at this stage in the cycle - an easing in fiscal and monetary policy would put us straight back into the economic overheating of 1988-89.

Certainly, the financial markets prefer the more cautious strategy they have been getting for the past two years from the Major/Clarke combination. Patience and continued control over public spending will eventually deliver scope for tax cuts, while keeping the budget deficit low as well. As long as the Government keeps the growth in real public spending below the trend growth in gross domestic product (about 2-2.5 per cent per annum), taxes can be cut not once but continuously.

With UK demographic trends much less adverse than those elsewhere in the developed world, the British government will be in better shape to do this than most foreign governments, but it will still involve difficult political decisions about the border between the public and private provision of pensions and welfare services. This could and should have been the economic focus of the Major-Redwood debate, since the two probably have genuinely different views about how far the state should be shrunk to finance tax reductions in the medium term.

Mr Redwood, in seeking to widen his appeal to the centre of his party, has obscured this basic choice by talking about cutting waste and saving the petty cash. In this part of his manifesto, he has convinced no one.