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Public Spending: Whom Should we Believe?

As the year draws to a close, the economy continues to hog the headlines, and it’s likely to do so until the 2015 general election. Fresh battle lines have been drawn over the main parties’ spending plans. Labour, if returned to power, now promises to cut the deficit every year of the next parliament. The Conservatives, at least since the Chancellor’s autumn statement in early December, have been ‘accused’ of cutting more than is necessary for ‘ideological’ reasons. Britain, it is alleged, will be returned to the hair shirt levels of the 1930s. The line, perpetrated by the media, is evocative of dole queues, cloth caps and a country scarred by unemployment.

It is not only the political spin that is misleading. One look at the historic data reveals that the Chancellor’s official spending plans would bring us nowhere near the spending levels of the 1930s, even when expressed as a share of GDP. Public spending levels for this country remained well under c. 30 per cent of GDP throughout most of the 1920s and 1930s. Moreover, what is not widely known is that, if measured on a more accurate basis than that used officially today, public spending is likely to represent an even higher proportion of GDP than is officially reported.

Today, in a new Politeia Commentary, David B. Smith shows that the changes to accounting procedures and the measures officially used to report public spending ratios tend to underestimate levels of public spending. In particular, the new European rules which have just come into force (ESA 2010) make a like for like comparison difficult to establish. To this problem must be added the further complication of what is, or is not, included by government for calculating public spending.

He recommends a more accurate basis for measuring public spending. In this new and compelling analysis he gives a picture of the government’s spending plans which shows how far they are from the 1930s. Taking the chancellor’s current proposals, UK public spending in 2020 will be 11 per cent higher than in 1938 when the pre-war re-armament programme was already well under way.

This finding may take the sting out of Labour’s attack, but it does not at all vindicate the Chancellor. The evidence is that the UK would be in a better economic situation if public spending and taxes fell more, and more quickly, than is planned. Other successful western economies, such as Switzerland and Australia, often enjoy far better public services than those for which UK tax payers pay too dearly. If Mr Osborne is to be criticised, it should not be because his plans will return Britain to the 1930s. They will not. Rather, it is because he must be more ambitious, if the UK economy is to compete globally.

As David B. Smith explains in his Commentary: This is not the place to attempt to assess the realism of Mr Osborne’s projections. However using the macroeconomic forecasting model described in ‘The UK Government Spending Ratio: Will it Return to the 1930s?’ general government spending is expected to be some 39.4% of the new definition of market price GDP (45.5% on the factor cost measure) in 2019-20 rather than the officially projected 35.1%, while Public Sector Net Borrowing (PSNB) is expected to be around £50bn, or some 2.2% of ESA-2010 market-price GDP, rather than the £23bn PSNB surplus for which the Chancellor is aiming. This projected borrowing ratio for 2019-20 would probably be sustainable, even if it might be disappointing, and our longer-term forecasts show a further diminution subsequently. However, that achievement relies on holding the growth in the volume of general government current expenditure to plus 1% per annum, which is roughly what has happened since 2010 (i.e., there have been no overall cuts in practice). Click Here to read David B. Smith’s ‘The UK Government Spending Ratio: Will it Return to the 1930s?’

*Dr Sheila Lawlor is Director of Politeia
*David B Smith is a member of the IEAs Shadow Monetary Policy Committee and has been Visiting Professor, Derby Business School. He is a co-author of Politeia’s The Financial Sector and the UK Economy: The Danger of Over-Regulation (2013) and the author of Crisis Management? – How British banks should face the future.

David B. Smith

David B. Smith is a City economist who worked as a macroeconomic modeller and economic forecaster, predominantly in banks (including the Bank of England) and security houses (1968-2006). He maintains his own macroeconomic forecasting model at Beacon Economic Forecasting. His Politeia publications include Britain's Taxable Capacity: Has it Reached the Upper Limit? (2020), The Brexit Settlement and UK Taxes (2018) and Banking on Recovery: Towards an accountable, stable financial sector (as co-author, 2016).

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