Sunday, January 06, 2013
Welfare: the elephant in every room
Posted by David Smith at 09:01 AM
Category: David Smith's other articles

elephant3.bmp

My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Somehow, one senses, the word "triple" is going to feature quite a lot in discussions of the economy in the coming months: the triple-A rating ands the debate over a triple-dip recession..

Some City economists had thought it unlikely gross domestic product will have slipped back in the final quarter of 2012 (which would give the first leg of a triple-dip).

But weak purchasing managers' surveys for construction and services in December have put it back on the agenda - Markit, which prepares the data, expects a 0.2% quarterly GDP fall, and it is always unwise to second guess the Office for National Statistics, which will have its first stab on January 25. More before then.

This week let me look at that other triple, the triple-A rating. Britain’s AAA sovereign rating, having survived until now, is plainly under threat. All three of the main ratings agencies, Standard & Poor’s, Moody’s and Fitch, now have the country on negative watch or negative outlook.

I know what you are thinking. Why should we take any notice of ratings agencies, which have still not redeemed themselves for their performance ahead of the global financial crisis, when they scattered AAA ratings like confetti around securities that turned out to be junk.

The loss of the AAA rating, more likely than not from at least one of the agencies this year, matters less than it did. Had it happened three years ago, when America and France still enjoyed AAA status, it would have emphasised Britain’s particular vulnerability. But it would be a big political event, embarrassing for George Osborne, and reflect genuine concerns about Britain’s public finances.

There are many reasons why you might worry about Britain’s public finances. The loss of the revenue cash cows of the past, including corporation tax revenues from the City and the North Sea, is biting hard.

Weak growth, for reasons mainly not connected with fiscal tightening, is preventing the kind of virtuous circle Britain enjoyed in the 1990s, when a strong upturn under Norman Lamont and Kenneth Clarke resulted in a rapid deficit reduction.

One of the biggest problems, however, and it is not a new one, is welfare. Britain, as the Institute for Fiscal Studies’ excellent A Survey of the UK Benefit System points out, really is a welfare state.

Some 30m people, almost half the population, receive one or more benefit. The bill for all this is more than £200 billion a year, “£3,324 for every man, woman and child in the country”, and the equivalent of 13.5% of GDP and 29% of spending.

Seventy years from Sir William Beveridge’s hugely significant report, which called for the elimination of the “Five Giant Evils” of squalor, ignorance, want, idleness and disease, the welfare state has spread far beyond what he would have envisaged, without eliminating those evils.

Social security spending was just 4% of GDP at the dawn of the welfare state. In 40 years, from the early 1970s, it has risen more than 300% in real terms, double the increase in the size of the economy.

Welfare spending rises in good times and bad. It is hard to think of a period more conducive to control of welfare spending than the Blair years, 1997-2007.

But Labour ignored its welfare reform minister Frank Field’s good ideas. And, without pressures from rising unemployment, spending rose nearly 3% a year in real terms. The welfare state and entitlement culture expanded.

It goes on. So far this fiscal year (April-November) cash spending on net social benefits is up by 5.9% on a year ago, largely because of the 5.2% April uprating of most benefits. Welfare is easily the fastest-growing element of government spending.

Can it be turned around? The coming year is a big one for welfare. 2013-14, the fiscal year that begins in April, will on official forecasts be a rare year in which spending falls in cash terms.

The Office for Budget Responsibility predicts the cost of social security and tax credits will drop from £210.4bn this year to £207.7bn in 2013-14, under the impact of child benefit restrictions, restricting the employment support allowance and limiting to £500 a week total household benefits.

Then it resumes its rise, reaching a projected £230.7bn in 2017-18. That incorporates the 1% limit on annual rises in most working-age benefits for three years, on which parliament will vote on Tuesday.

The 1% limit announced in the autumn statement preserved the so-called automatic stabilisers (not taking money out of the economy when public finances have deteriorated for cyclical reasons) by recycling the cash saved - and more - in extra capital spending and raising the personal tax allowance.

It does not, in itself, represent the kind of far-reaching reform Britain’s welfare state needs. It is not yet clear the plans of Iain Duncan Smith, the work and pensions secretary, which revolve around the new universal credit, do so either.

As with other elements of government spending, we need to re-examine what the country can afford. This does not mean an attack on the poorest, nor should it. It does mean trying to steer the welfare state, for working-age people as well as pensioners, back towards its original purpose. A country in which half of people are on some kind of benefit can never be healthy, even if every attempt to rein it back results in squeals of protests from interest groups.

The 1% limit is a stop-gap. But this week’s vote is nevertheless important. Labour is opposing the change, as it has opposed other cuts, even some of those it set in train when in government.

If the coalition were to be defeated, which looks unlikely, the signal it would send out would be that Britain lacks the political will to tackle the welfare state and deal with the deficit.

Labour would no doubt celebrate the loss of the AAA rating, and the pressure it would put on the government. But something has to give. The fiscal arithmetic requires either further welfare cuts, as Osborne has indicated, or cuts in public services that may be impossible to deliver. This week’s political battle over welfare is the first of many.