Monday, 30 March 2015

Getting to thirty eight - Prof Perri 6, Professor in Public Management, School of Business and Management, Queen Mary University of London

When their subject is dominating the general election debate in the media and among ordinary citizens, what could a public management academic possibly complain about?

Well, don’t get me wrong, I'm not bellyaching at all. Democracy doing its job ought to be celebrated, even when the news for the public services is hardly cheering.

But... (and you knew there’d be one...) it’s not at all clear yet that the politicians and journalists are focusing on all the big issues of public management that will really matter during the 2015-2020 parliament. Let’s start with those cuts which will follow the general election, as soon as a government is formed and its budget is prepared.

Here is this week’s chart to reflect upon.

The chart shows three key indicators of the state public finances, all expressed as percentages of gross domestic product (GDP), which – for all that it isn’t very satisfactory – is still the best single indicator that we have of the volume of value-adding activity being produced in the British economy in a given year. To keep the numbers simple, I've used the Guardian’s adjusted versions of Office of National Statistics numbers. Although cash numbers may seem at first easier to understand, it makes sense to show government finances as proportions of national economic activity because that provides a coarse measure of the things available to be taxed. Those percentages are marked on the vertical axis. The horizontal axis shows time. The three indicators are traced all the way back to the year 1964-5, the first year of Harold Wilson’s Labour government. The brown line at the top shows what government spent each year, as a proportion of total economic activity. Next, the blue one shows what government took in, by way of taxes. And finally the grey line at the bottom shows what government spent on interest to service its debts.

Fairly obviously, the size of the gap between the brown and the blue lines is the deficit, and when government is not repaying its accumulated debt, it matters that the distance between the two lines should start to narrow.

There is good news, old news and bad news in this chart.

The grey line is the good news. Indeed, it is better news than it looks. It is well known that the total British government debt, excluding the costs of the bank bail outs, rose very sharply indeed from its historic low in January 2008 when it stood at 35.5% of GDP to around 77% now (at least on the measure used in the UK government accounts; it looks higher if calculated on a basis used by the EU for comparing countries). So the fact that the grey line, showing that cost as a proportion of economic activity of servicing all that extra debt in our chart, has barely ticked up, is very good news. It reflects the fact that British government has been and still is able to borrow at very low interest rates. In the jargon, the “yields” that government has had to pay to those who hold bonds issued by the UK Debt Management office for the Treasury, been low since 2008. Ten year Treasury bills are currently paying around 3%. This is because the markets still think that the British government is good for its debts, at least in the long term. And since 2008, the government has moved a lot of its debt from more expensive short term Treasury bills and replaced them with cheaper to service longer term bonds.

That’s not to say that if the deficit failed to fall further during the next parliament, so adding less to debt until we can start repaying some of it, the grey line would necessarily rise sharply. Of course, further borrowing at levels which the bond markets thought irresponsible would push it. But since even the Labour opposition is proposing to reduce the deficit further during the next parliament and get to a surplus at least on the current account by 2019-20, outright irresponsibility is probably not going to be the fear on the bond markets just yet. Indeed, the grey line suggests that if government thought it good for the economy to undertake at least a few more capital projects on infrastructure, the impact on the cost of servicing the debt incurred might be manageable. After all, the chart shows that as a proportion of GDP, the grey line behaved itself surprisingly well even during the 1960s when the Labour government was still struggling to down wartime debt and during the early 1970s when the Conservative government was facing horrible economic difficulties from oil and coal threatening the integrity of the tax base.

Then the chart shows you old news. The brown line drops from 2010. That’s the effect of the cuts already made, which so far have affected the headline numbers for local government and the police more than they have the NHS, even though hospitals’ difficulties are all over the news right now.

The bad news, though, is that blue line in the middle. It shows receipts from taxes, again as a proportion of GDP.  I could have shown you all sorts of projections of that blue line for the next few years, but I didn’t because I haven’t much confidence in many of them. And the reason that I haven’t is that I’m looking at how the line has behaved over the last few decades.

Why is it bad news? Well, because it’s boring. Very boring. It just doesn’t do a fat lot. There’s nothing dramatic going on there. It has wobbled around between around 32% of the value of national economic activity and 38% in a good year.

But hang on. Since 1964, there’s been plenty of drama in tax. In the 1970s, income tax rates for top earners were extremely high. In fact, they were at 83% for the very highest earners between under the Labour governments between 1974 and 1979. One of the last acts of the Gordon Brown and Alistair Darling regime in 2009-2010 was to introduce an additional higher rate of 50%, which the coalition cut to 45%. In 1976, even the basic rate was at 35%. In 1992, John Major and Norman Lamont reduced the starting rate of income tax for the lowest paid to 20% and in 1999, Tony Blair and Gordon Brown brought it down to 10%. In the early 1970s, when VAT was first introduced to comply with European rules, it was levied at a balmy 8%. It was under Margaret Thatcher and Geoffrey Howe that it went up to 15%. The coalition raised it from 17.5% in 2010 up to its present 20%. In the early 1970s under the Heath government, the standard rate of corporation tax was what would now be regarded as a whopping 52%. It now stands at 21%.

The bad news is this. For all the last fifty years’ of efforts to move tax rates up and down in the hope either of taking more money out of the economy with high rates or else of stimulating more economic activity in the hope that low rates would bring in more receipts through expanding the size of the tax base, receipts have never topped something close to 38% of the value of annual national economic activity.

Put brutally, that is all the next government has to work with, to pay for the public services that sustain civilisation, to service its debts and (eventually) to start paying down the accumulated debt.

But – and here’s the rub – demand for a host of public services will rise during the next parliament, putting big strains on the brown line for expenditure. The current health crisis for which Accident and Emergency services are only the canary in the coalmine is a clear indication that the ageing of the population is pushing demand up much sooner than some commentators had predicted. The gathering environmental problems being created by global warming, ranging from higher rates of flooding through to coastal erosion, are also creating new demands for public expenditure. The next parliament will see significant numbers of people who have been on low and modest incomes now retiring whose occupational pensions will be much smaller than some recent cohorts of retirees have been able to enjoy, and whose ability to supplement those pensions will be limited.

So are the politicians talking about this chart? Well, yes and no. The Conservatives have said that they have no plans for tax rises. It isn’t very clear just exactly what that means, but it’s a fair presumption that they would like to avoid big increases in headline rates. So they will rely on growth, not rates to expand receipts. Their first problem is that growth is slowing.

Their second problem is that, if the British economy is back on its usual cycle, the next parliament could well expect to preside over the start of the next recession, even before the public finances have recovered from the 2008 slump. Since the end of the second world war, if we define a recession as two consecutive quarters of a year in which the value of national economic activity as measured by GDP has shrunk, then the rhythm of recessions looks like this. There were recessions in in 1956, 1961, 1973-4 and also 1975 which we should probably treat together as one recession, 1980-1981, 1990-91, and 2008-9. Of course, misery of other kinds lasted long after each, such as poor unemployment figures or high rates of negative equity in house values, but these are just the years of falling GDP. So the spacing between the end of one and the start of the next is six years, then twelve years, then five years, then nine years, then seventeen years. The gap between 1991 and 2008 was exceptional, and unlikely to repeated, not least because of the effects of the 2008 great recession itself on the world economy and on Britain’s. So realistically, we should prepare for the possibility that the gap between that recession and the next might more somewhere between eight and eleven years. That would put the next one squarely in the lifetime of the government we are about the elect, with some chance that it might at least fall toward the latter part of their time in office. For our chart, this means that the current growth might not be sustained long enough to keep the blue line from wilting and the brown one from perking up dangerously.

Some Labour politicians have hinted that they think that forty or even forty two per cent of GDP might be the sort of terrain they would like to see for government expenditure. If they also mean to keep to their plans for reducing the deficit and getting to a current account surplus by 2020, then Labour would need to get tax receipts up to and preferably above that 38% which has been the best we have seen since the 1960s. The narrow band in which blue line in the chart has moved and the reflections I’ve just offered about the experience of fifty years of moving rates up and down suggests that will be very, very difficult. That’s their first problem.

And Labour’s second problem? Well, it’s the same as the Conservatives second problem – the likelihood of the next recession starting in the next five years.

So what about those government surpluses then? Does the chart show us anything about how to get one? Well, yes, it shows just one period of absolute surplus in the last fifty years. That was in 2000-2001, before Gordon Brown’s 2001 budget started increasing spending on public services to deal with what the Labour government described as the decrepitude they found in 1997 but were prevented from addressing before then by their promise to keep to mid-1990s Conservative chancellor Ken Clarke’s spending plans for the first few years of their time in office. Around the turn of the millennium and despite the “dot com bust”, British GDP was growing by between 2% and 3% a year, but it dipped a little from 2002. The chart above shows that at that time tax receipts had been growing at a healthy clip since around 1994-5.

So can Labour just do all that all over again, then? Well, it’s true that right now economic growth is back, albeit that it’s probably more fragile than it looks. The chart shows that although tax receipts aren’t falling catastrophically, and most recently they have perked up a bit more to the point that in the very short term, some immediate targets might actually be met. But the longer term trend in tax receipts does not show them are not rising at anything like the rate needed even to meet the coalition government’s aspirations for reducing public sector net debt as a proportion of GDP to under seventy per cent by the mid 2020s. Until very recently indeed recovery has been “tax poor” for several reasons. Partly that’s down to widespread low earnings for many of those in work. Partly it’s due to the coalition government’s decision to raise the threshold before income tax gets levied to £10,000, which leaves many on low wages paying little income tax. Some think it may also be due to some expansion in the cash-in-hand economy, but it’s hard to be sure of that. So it looks as though Labour’s hopes rest on some very rapid improvements in earnings which by good luck (for example, with the pound’s behaviour on the foreign exchange markets) don’t harm competitiveness.

But the other part that the chart makes rather too pointedly (the point is downward facing and sharp in 2001) is that the last time we had a surplus, it was not sustained. Labour in 2001 had to meet expectations for better public services, especially in the NHS, on which Tony Blair then felt compelled to promise to meet the European average in public spending as a proportion of GDP. That could certainly happen again.

Moreover, after the election, it’s quite likely that the present boom will subside. The first budget of the new government, announcing the detail of the spending cuts, will depress demand and growth. If there is political uncertainty – for example, if the next government is a minority one – the markets will grow distinctly nervous. A Greek or Ukrainian crisis, Libya falling to extremists or – heaven forfend – a standoff in the Baltic – will certainly bring about a sharp downturn.

The American scholar of government, Francis Fukuyama, talks of the challenge for countries reforming their systems of public management as one of “getting to Denmark” - a symbol of a well-run country with the rule of law, political stability, little corruption and competence in public services. For the government we’re going to elect in May and which is supposed by law to last until 2020, the challenge is not quite that. It’s getting to thirty eight. Oh... and staying there for a good many years, even when the next recession arrives.

[With thanks to Prof Colin Haslam and Prof Brigitte Granville for advice and suggestions]

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