Public sector spending spree

After years of neglect, the public sector is back in the spotlight.

Mrs Thatcher’s first electoral victory in 1979 marked the start of a reduction in the role of government in the economy, largely through privatisation.

A second strand of policy was the reform of services such as health and education, aimed at getting better value for taxpayers. During the Major years, the policy was continued, with more privatisations and, after a marked deterioration in public finances in the early 1990s, the introduction of tight controls on public spending.

The Labour administration has accepted much of what its predecessors did. There have been no renationalisations (Railtrack is an exception) and both the Prime Minister and Chancellor have been pressing for reform across large areas of the public sector. With their commitment to the private finance initiative, this government has extended the concept of privatisation into new territory. Yet this does not mean they have abandoned the public sector to market forces. Services such as healthcare are higher on the agenda than they have been at any time since 1979.

There are several strands to the argument about the role of the government in the economy. At the highest level of aggregation, it is true that public sector spending is rising faster than expected tax revenues and the economy as a whole. This has led to fears of a return to the tax-and-spend policies of the Labour governments of the 1960s and 1970s. From a macroeconomic perspective, funding implications of the ambitious spending plans should not be a problem if Brown’s forecasts for activity are born out.

To prevent a return to the lax fiscal regimes of the 1970s, Brown introduced two rules to ensure stability – the Golden Rule (borrowing to invest) and the Sustainable Investment Rule (public sector net debt to be held at a stable level, ie 40% of GDP). Even allowing for his increased spending and borrowing, the Chancellor will meet his rules. Assuming the economy hits his growth targets, there will be a small current account surplus over the life of the cycle, and public net debt will not exceed 34% of GDP. Questions have, however, been raised about the optimistic forecasts of activity which will make these fiscal numbers work. If activity disappoints, the gap between receipts and spending will widen.

The borrowing figures have been increased twice in the past 12 months because tax revenues have been flatter than projected. For this fiscal year, for example, Brown raised the likely funding gap from £13bn to £27bn between his 2002 and 2003 Budgets. In subsequent years, he expects the borrowing requirement to fall, but this forecast is again sensitive to his growth expectations. If activity is slower than he is predicting, borrowing will be even higher, unless he trims his spending plans.

As the private sector weakens, the government is stepping in to fill the gap. This is basic counter-cyclical spending, a policy pursued by many governments over the last 50 years. It is obvious that, in these circumstances, the government’s share of activity will rise, reflecting fragility elsewhere as much as a boosting of the public sector.

And rising it is. Total employment in the public sector is moving up as the headcount in private businesses comes under pressure. From a peak of 7.5 million in 1979, the number of public sector employees dropped to under five million in 1997 and 1998. It has now turned and, at the end of 2002, the total was up to 5.3 million. In only four of the last 18 months have earnings risen faster in the private sector than in the public. Last year, public sector pay rose by 4.2%, compared with 3.4% in the private, a figure that has widened this year to 5.1% and 3.0% respectively.

Improving public sector services is the overriding objective of Brown’s spending plans. He is aware, however, that paying the same people more money to do the same job is not likely to raise standards in these vital services. That is why the extra funds he has promised are linked to performance targets for each department.

Although hard to measure and enforce, this is at least a recognition by New Labour that the old Labour route of increasing inputs to secure greater output was flawed. The private sector allocates resources via the price mechanism and the discipline of competition. The public sector’s share, on the other hand, has largely been determined by political judgement.

The Chancellor, who clearly believes in public provision of services such as health and education, is trying to introduce an element of accountability.

He might not get it right the first time, but he should be commended for trying.