They’ve only just begun…

Rachel Reeves certainly isn’t the first Chancellor to turn to financiers for line-by-line scrutiny of public expenditure, as she is reported to be doing, as she fires the starting gun on next Spring’s Spending Review.

Back in 1931, Philip Snowden turned to Sir George May – a retired “man from the Pru” –  to identify potential squeezes and cuts. May’s recommendations, including a 10 per cent cut to unemployment benefits, proved too much to swallow for the Second Labour Government, and precipitated its downfall. A much happier precedent is provided by 2002, when Gordon Brown turned to the former NatWest boss Derek Wanless to advise him on exactly how big a cheque he would need to write to bring the NHS up to spec, a process that led to a very big cheque and significantly improved health service performance.

So does Spending Review 2025 look more like likely to rerun May’s austerity or Wanless’s largesse? For once history is neither repeating or rhyming as the broad plans for overall spending that emerged from the forecasts and decisions of the recent Budget represent a blend of good and bad news, all shot through with a whole lot of uncertainty.

Good news on investment

Perhaps the most important element under the good news at the Autumn Budget was on public investment where the Spending Review must now settle how to allocate the roughly £100 billion unlocked at the Budget (Figure 1) as a result of creative change to a new target for debt that recognises financial assets as well as liabilities. Admittedly, much of this ‘extra’ money is merely compensating for the inherited Conservative plans to squeeze public investment’s share in the economy, but the opportunity to direct where it goes is nonetheless a major chance to be seized. Our Economy 2030 inquiry pinpointed the types of public investment that could do most to spur overall growth. Particularly important here are things like transport and housing in Britain’s giant but economically under-performing cities outside of London. Making our big cities – like Birmingham and Manchester – great places to work will attract the people needed to make them humming hubs of the service industries. This, as RF’s ongoing work on trade underlines, represent the UK’s most plausible route to a prosperous future.

Figure 1 Investment spending was boosted by £100 billion at the Autumn Budget

Less good news on services

The news on day-to-day public service spending is less bright, which might seem paradoxical given that the recent Budget pencilled-in their biggest one-off uplift in resources in a generation, over the next two years. Positive as this development undoubtedly is, it has to be weighed against many pressing negatives, including a ravenously resource-hungry NHS, the creaking or even crumbling condition of services such as the courts and the prisons, and wildly unrealistic inherited plans for a fresh bout of spending squeezes. Putting everything together means, as Figure 2 shows, that those ‘unprotected’ areas are actually in line for cuts of just over £8 billion.

Figure 2 ‘Unprotected’ departments are set for cuts of £8 billion a year after 2025-26

Can these sorts of savings be found without an unacceptable toll on citizens’ experience? Well, 5 per cent savings on around £500 billion would easily cover the problem, but 5 per cent is far from trivial in the current fiscal environment. It would certainly be handy if Reeves’ band of bankers were to spot superfluous items of spending that had somehow evaded the eyes of officials during the long years of austerity. But it would be unwise to hold your breath. Then there is the competing – and increasingly desperate – need to support some of the lowest living standards more directly than through public services, for example by restoring the broken link between housing benefits and rental costs, and axing the two-child welfare limit. Failure to take these measures will likely mean allowing poverty to drift up, but paying for them inevitably uses up any resources that it might otherwise be hoped could ‘top up’ those public service plans.

Known unknowables

Beyond all the news, good and bad, there is a huge amount of uncertainty to deal with. Economic forecasts are always clouded in it, but there are special problems just now because problems dogging one of the most important official datasets are creating significant doubts about where things stand in the economic present. The Labour Force Survey may be failing to count as many as a million British workers. If there are more workers producing than we have been assuming, then the average productivity of each could be correspondingly lower than we had assumed.

Even if that were the case, it isn’t clear how the Office for Budget Responsibility (OBR) would react, but if it were to darken its forecasts for productivity growth then projections for future output and revenue would automatically sink in tandem, making all the Spending Review arithmetic worse.

Indeed, even before we confront any such adjustment, a modest increase in interest rate expectations from those at the time of the Autumn Budget, may well have already wiped out some of the small margin for error the Chancellor had pencilled in for meeting her new fiscal rules. Having so recently rewritten those rules she will be desperate to avoid either breaking them or being required to rewrite them again.

That ugly choice will either crystalise or dissipate across three moments: new OBR forecasts in March; the Spending Review itself in June; and another full Budget in the Autumn. The March forecasts should really be a formality but could become a serious headache if the economic news is unhelpful at a time when the Government is already running budgetary policy close to the wire set by its fiscal framework. Were the OBR to suggest the Reeves’ new rules could be broken, one response would involve a ‘mini’ Spring Statement to tighten policy or, in plainer parlance, to write previously unplanned cuts into the Spending Review. That sounds horrible, but then so too does following October’s stiff tax rises with another round, something the Chancellor has come close to ruling out.

Spirits of growth

In sum, the fiscal and broader economic environment is laced with traps for a government planning a strategically crucial Spending Review. Some of those traps are simply beyond its control. But one big thing isn’t: namely, confidence. Anxious businesses and consumers can always rapidly depress demand, growth and the immediate revenues coming into the Exchequer. Their spirits will lift, potentially creating a virtuous cycle of investment and expansion, if they believe that sustained growth is on the way. This puts the onus on the Government not just to back, but also to talk about, those growth-boosting public investments which should be the absolute centrepiece of the coming Spending Review.