3rd August, 2020

David Laws, GK Strategic Advisor – Views on the Spending Review

With the UK and world economy facing unprecedented economic disruption, there has been little peace at Her Majesty’s Treasury for many months now, and the Autumn looks to be just as busy – the Chancellor has promised to deliver a Budget and a multi-year Spending Review, and both (as well as Brexit!) are going to take a great deal of preparation.

The focus of the Budget is likely to be on sustaining and restoring economic growth, in order to prevent a surge in unemployment as the Furlough Scheme ends.  If the economy is sagging again, the Chancellor could consider a reduction in VAT, though the impacts of this might be modest if growth is being suppressed not by consumer incomes but by a second virus surge. Other options include reducing employers national insurance contributions or even (whisper it!) extending the Furlough Scheme for any sectors still “shut down” by COVID-fighting regulations. Extending the Furlough Scheme or “picking sectors” to stay in the scheme are certainly not options the Chancellor wants to adopt, but all bets are off if there is a significant second wave of the virus.

But what about the Spending Review? Given the government is projecting a fiscal deficit this year of mind-boggling size (twice the level of 2009/10, after the financial crisis), you might have thought that the Spending Review would be all about cuts and dividing up the pain. But the Chancellor and Prime Minister don’t want to see a return to austerity – or certainly not yet. They would be worried that spending cuts would drive economic growth back down, and they also appreciate that there is limited appetite for more austerity after ten years of squeezing the public sector. Somewhat surprisingly, therefore, the Chancellor is still planning to set future spending plans (three years worth for current spending, and four for capital spending) in which spending will be rising modestly in real terms – this combination of a massive deficit and higher real spending has only really been experienced previously in war years.

Other than modestly rising real spending, what should we expect from the Review? Well, continued largesse for the NHS and social care, as the government has to write a spending “blank cheque” for COVID related costs and for helping the NHS catch up eventually with the growing backlog of non COVID work. And no doubt there will be significant other public spending pressures from dealing with the pandemic.

But the government can also be expected to use the multi-year settlement to “look beyond” COVID and seek to deliver some of the pledges in its election manifesto. This could include more spending in targeted areas of the education system, perhaps to improve post-16 technical and vocational education and to “level up” opportunity in areas of the country with poor education outcomes. It will also include more infrastructure spending – perhaps targeted towards areas such as the North and Midlands, where the government has both economic and political aspirations. It will be fascinating to see if the Prime Minister’s adviser, Dom Cummings, manages to secure real money and policy substance to back his ambition to spread new science and innovation industries across the country, and out of London and the South-East. How will the government choose to back the “winning sectors” of the future, and can these businesses really be nurtured in the parts of the country that arguably most need the extra investment? And what of the pledge to back the zero carbon businesses of the future? How will that be realised?

The Spending Review also pledges to look at the way in which central government delivers public services and infrastructure. Whitehall civil servants will be looking nervously at what this might mean. Will the civil service be dramatically “re-purposed”? Will more powers be devolved from Whitehall and Westminster?

As well as announcing all the “positives” about extra spending on health, education, science and infrastructure, we need to look at what the government does about some of the more challenging items in the Chancellor’s inbox. Will there be a serious attempt to properly fund social care and to re-consider the split of social care costs between the private and public purse? Will the Chancellor signal a move away from the state pension “triple lock”, which could be very expensive over the next few decades? How can a government so dependent on pensioner votes cut back on future pension related costs?

We also know that in spite of the current growth in public sector wages, the Treasury will want to reduce public sector settlements in 2021 and beyond, to help control public spending and avoid public sector wages moving above those in the private sector. With inflation likely to be very low, private sector wage growth could collapse, requiring some much tougher public sector settlements.

In this year’s Spending Review there will be relatively little of the pain and anguish that have characterised other such reviews since 2010. But with the public sector deficit surging to 15-20% of GDP, the pain cannot be delayed indefinitely. There is a reckoning to come on taxes and spending. But not for now.