Sunday, June 14, 2009
Tories must tackle public sector blight
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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Had things gone a bit differently for Gordon Brown in the past few days, this could have been the first column of the election campaign. How much would we have known about Conservative economic policy? Not enough. So, armed with a speech that George Osborne, the shadow chancellor, gave last week, called A New British Economic Model, let me fill in one or two gaps.

I will deal first with what we do know. More evidence has emerged in the past week that the recession is coming to an end. Indeed, if the National Institute of Economic and Social Research (NIESR) is right, the trough was in March, even earlier than implied by the purchasing managers' surveys described here last week.

For statistical reasons, even on the NIESR figures it is quite likely we will see another fall in gross domestic product in this quarter, or at best a flat picture (its estimate for monthly GDP in May was fractionally below the first-quarter average). Unemployment figures this week will dampen optimism, though they will lag the upturn.

Even so, Osborne's team are working on the basis that the election will not be about a government and an economy mired in recession but about which party has the best policies for the recovery.

They are assuming, in other words, that the economy avoids a relapse next winter and that they will be facing a government which will claim that its prompt actions, particularly on the banking rescues, pulled the economy out of a tailspin arising from the biggest financial shock since the Great Depression, and returned it to growth.

What is more, though voters may not be inclined to give Brown a hearing, Labour will have a point. On the evidence so far, Britain will have had a recession both shorter than usual and not as deep, in terms of the peak-to-trough fall, as the first Thatcher recession of the early 1980s. So the economic debate will be an interesting one.

What we also know is that the public finances, tax and spending, will be at the heart of the election argument. Here, of course, Labour has a poor story to tell.

Two things happened last week. Andrew Lansley, the shadow health secretary, tried to be a bit too clever in an interview on the BBC Today programme and embarrassed his party. Lansley's comments were not, as one Tory aide put it, "on the grid". It was not intended he would be so candid, though the arithmetic behind his comments was straightforward.

The Institute for Fiscal Studies says the government's plans imply a cash freeze on departments for three years from 2011, after debt interest and other unavoidables. Allowing for inflation this becomes a 2.3% annual real-terms cut, 7% over three years.

If health, Lansley's brief, escapes real cuts, other departments have to bear the brunt and that gives the 10% real cut over three years he told radio listeners about, spoiling a few Tory breakfasts. More on that in a moment.

The other noteworthy development was the publication by the Office for National Statistics of new productivity estimates for the public sector. These showed that, despite a small improvement lately, productivity has fallen most years in the past decade. Calculating output is not easy, but the ONS thinks the average public-sector worker's output in 2007 was 3.2% lower than in 1998.
Contrast that with the private or "market" sector. Over the same period, again according to the ONS, market-sector productivity rose 22.8%. The difference between the two sectors is striking.

What does this mean? A great deal. By my rough calculations, if public-sector productivity had matched the private sector, we could have had the same level of public service but for almost 100 billion less than the 670 billion the government intends spending this year. We would still have a public-borrowing problem but it would pale into insignificance in comparison with the one we have.

Though Lansley was not meant to blurt out any figures, Conservative thinking is clear. The public sector has to be squeezed hard but the saving grace, at least as far as services are concerned, is that this squeeze will generate significant improvements in productivity and efficiency.

On this, the Tories are in tune with official thinking. The Treasury was always uncomfortable with being the instrument of Brown's spending largesse. Decades of experience had etched on its institutional memory the belief that the best way of achieving public-sector efficiencies was to starve departments of funds.

Given that this is in prospect whichever party wins the election, it is clear that only big improvements in productivity growth, to the kind of rates recorded by the private sector in recent years, will prevent drastic reductions in the provision of public services. Even with those improvements the "feast to famine" contrast will be stark.

If the Tories are elected next year, or sooner, they will not be content with the squeeze starting in 2011. A spring 2010 election would be followed by an emergency budget which, as well as tax increases with a strong environmental edge, would aim at "in-year" cuts in public spending in 2010-11, to rein back a planned 4.5% real rise in current outlays. If Labour defied the polls and held on it would also take emergency action, though I suspect with the emphasis on tax.

The Conservatives need to go further in reforming the public sector than merely relying on eyewateringly tight budgets. Party aides insist they are drawing on experts who know about these things. Osborne has said a lot about the process by which a Tory government would manage the public finances, including a new Office for Budget Responsibility, but has not said enough yet about which areas the state may have to withdraw from completely if government is to be put back on a sound footing.

What else do we know? A Tory government would look for new ways to fund essential infrastructure spending, including nuclear power, a high-speed rail network, a smart electricity grid and investment in carbon capture and storage. Osborne sees government enabling such investment rather than paying for it.

He has been talking to Mervyn King, the Bank of England governor, and Lord Turner of the Financial Services Authority (FSA) and is inclined to give the Bank more supervisory power at the FSA's expense. He wants to set up a "son of 3i", similar to the old Industrial and Commercial Finance Corporation, to fill the funding gap faced by new businesses. Gradually, we are finding out more.

Osborne is aware, however, that he will stand or fall on his ability to set out a coherent strategy for the public finances. That will not be easy, but it is probably the most straightforward agenda in politics.

PS: The Treasury has been cautious about going to town on the "recession is over" optimism prompted by the purchasing managers' surveys and then the NIESR. Liam Byrne, the new Treasury chief secretary, said in the Commons he was not prepared to give a "running commentary" on the forecast. Such language is normally for when the news is worse than expected. Alistair Darling says he is "confident but also cautious".

Why the caution? Politically, ministers know they are on a hiding to nothing if they talk up the economy while unemployment is rising and businesses are failing. They know voters do not look at the details of economic statistics and surveys. Having been attacked repeatedly for excessive optimism about prospects, Darling can afford to be patient while independent forecasters move their predictions nearer to his.

There is another reason. Dave Ramsden, the Treasury's chief economist, was around in the Norman Lamont era of the early 1990s. If the former chancellor did not invent green shoots, he popularised them. And he was lambasted for extolling green shoots in the autumn of 1991 that were genuine but withered over the winter. Once bitten, twice shy.

From The Sunday Times, June 14 2009