The Comprehensive Spending Review

So, the CSR is out and, as suggested earlier, not as tough as hoped/feared (strike out as desired). This CPS paper demonstrates that the restrained nature of the cuts in financial terms comes about because they are largely cuts to planned future increases (£81 billion), not cuts in actual historical expenditure. To my mind, the government has got it about right overall, not least because implementation will depend on keeping the coalition together. Not much good will come from having another general election right now.

The aim is to bring down public spending from 47% of GDP this year to about 40% in 2015. This latter figure represents the rough historical mean for the last 60 years, whereas the former is unusually high for peacetime. By comparison, the figure was 36% just before Gordon divorced Prudence in 2001. The current projected deficit for 2010 of around 11% has come about chiefly through the collapse of tax receipts in the recession, but the current (September 2010) debt of 57.2% is the result of seven years of imprudent spending, carried out by Labour but often supported by the Tories and LibDems. The deficit itself would be sustainable were not the debt already so high. These figures, rightly, do not include supporting the banks (not only a necessary action but one which is likely to prove an excellent investment in the long term).

For the reduction in spending to occur as a proportion of GDP, the government needs to get an average 2.5%+ growth over the next five years, not an overly unrealistc expectation, but far from a racing certainty since it is somewhat above the long term trend. As ever, world events might conspire to make even this modest growth target unattainable and the Autumn Forecast from the Ernst and Young ITEM Club does not look that promising. Of course, increasing the current level of public spending (as envisaged by some members of the current opposition) would boost growth, but in combination with QE and prolonged low interest rates it would also drive up inflation in 2012 and beyond, potentially nullifying any beneficial effect.

As Roger Bootle in the Daily Telegraph explains, the "cuts" will still be perceived as such, even though government expenditure ("Total Managed Expenditure") will continue rising year on year until 2014-2015 (total 6.17% in cash terms). In fact, the public sector will be decimated, in the proper sense of the term (i.e., a one in ten of the workforce axed), although not "literally", as no doubt some illiterati will claim. Probably, not all of this will be via redundancies. There will be knock on effects in the private sector too, with business lost and business gained. However, despite the financial stringency and even at the nominal projected inflation rate of 2%, government expenditure in real terms will only revert to 2005/2006 levels by 2015. The graph presented by Stephanie Flanders shows the historical situation quite clearly.

The cuts will only reverse half of the real terms rise over the past ten years, bringing the rise in central government expenditure back to trend. The closest historical parallel in Britain is the dash for growth in the mid 1970s and the subsequent IMF inspired pull back.

However, real cuts will occur because: a) the NHS, the Overseas Aid budget and some other areas have been ring-fenced, thus forcing other departments to suffer; b) annual debt interest will increase from £43 billion in 2010 to at least £65 billion by 2015, thus forcing all departments to suffer; c) inflation for government departments will probably be above trend, again forcing all departments to suffer. Altogether, there is an average 19% cut to projected departmental budgets over the next four years, probably similar to what Labour would have done overall, but different in the detail.

The details of the CSR will have to be made clear over the coming months and there will be, no doubt, plenty to complain about, from the loss of local services to the fact that we are still giving a winter fuel allowance to millionaires in the Algarve. All in all, despite the fact that they will bite hard in certain areas, the planned cuts are a modest reponse to a relatively modest problem (there are plenty of countries in a worse state than the UK). Their aim is to prevent that middling sized problem from turning into a big one. Since the government still needs to borrow hugely, it will be keen to keep gilt yields at their current low levels. Whether or not the cuts succeed will depend not only on the usual external economic factors, but also on how much the detailed measures, many as yet unknown, are really thought through and politically viable.