Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday, 14 September 2014

Shrinking the State

More on George Osborne’s plans, courtesy of the OBR’s latest publication. (Campaigning for a UK Fiscal Council was one of my better calls - just imagine if you had to rely on today’s government for this kind of information.)

Consider three points in time: 2001/2 (when the UK budget was last in balance, and still largely reflecting the actions of the previous Conservative government), 2007/8 (pre-recession, under Labour), and 2018/9, when George Osborne also intends us to be back in balance. The first chart actually comes from the OBR’s historical database, which only covers the broad aggregates. (It would be fantastic if this database could include more disaggregated information.)

This shows total government receipts (taxes) and expenditure (spending) as a percent of GDP. The two lines meet at the start and end. In 2007/8 we had a budget deficit of 2.6% of GDP. At the time that seemed a bit on the high side: something between 1.5% and 2% would have kept the debt to GDP ratio constant. (Budget balance implies a falling debt to GDP ratio.) For this post the point to note was that the Labour government chose to use this fiscal loosening to increase spending rather than cut taxes.

The Conservative government plans to do the reverse. So does that mean that it is just trying to undo the increase that occurred under Labour? The answer is no, and this is where the OBR’s latest report comes into its own.

Their chart shows how we get from the deficit of 2007/8 to the small surplus of 2018/9. (There is, as I note here, no good macroeconomic reason to aim for a surplus.) The cuts in spending are not just the size of the 2007/8 deficit - they are much larger for two main reasons: higher debt interest and higher ‘welfare’ spending. The reason for the higher debt interest is straightforward: debt is much higher because of the recession (and to a small extent the fiscal stimulus in 2009). Although academics often assume that higher debt interest is paid for by raising taxes, a more ‘neutral’ approach would be to raise taxes and cut government spending. Osborne plans to just cut spending.

The increase in welfare payments is probably not what you might think it is. The report’s Table 5.7 shows it is not higher unemployment benefits or income support: by 2018/9 unemployment benefit is the same as in 2007/8, and income support is 0.5% lower as a share of GDP (which is the main reason why poverty will increase over the next five years). Housing benefit is 0.3% higher as a share of GDP (partly reflecting depressed real earnings), but the main reason is the state pension, which is almost 1% higher as a share of GDP. This represents both an increased ‘caseload’ (more pensioners) and a more generous value of pensions themselves. Although the numbers suggest that here too Osborne plans to pay for this additional spending by cutting the size of government, he has indicated that he hopes to reduce this increase in welfare payments by some, as yet undeclared, means.

So this is why the reduction in the size of the state planned for 2018/9 is much more than reversing Labour’s increase: in fact, if welfare cannot be cut further, to decrease its size to “probably to the lowest share of GDP since 1938” (p128). In this particular respect, therefore, this government plans to go well beyond anything Margaret Thatcher ever attempted. I suspect when some people write that this Conservative party is more right wing than any since the war, many reading think this is hyperbole. On this metric at least, it is simply fact.  


  1. (i) " the reduction in the size of the state planned for 2018/9 is much more than reversing Labour’s increase: in fact, if welfare cannot be cut further, to decrease its size to “probably to the lowest share of GDP since 1938” (p128)"

    If by 'the state' people only meant public services, your claim would be right. But nobody in ordinary discourse does mean that.

    The reason expenditure on public services is going to be lower as a percentage of GDP than at any time since 1938 is not attributable to the private sector taking up a larger slice of GDP.

    State spending has been lower than 38% of GDP on many occasions (as low as 34% in the dark rightwing days of, errr, 2001.)

    The fall in the share of public services is caused by the increase of the share of welfare spending and interest payments. If the Tories really were the evil rightwingers you claim, it seems a bit surprising that their 'austerity' involves running such a large ongoing deficit (hence increase in interest) and increase in welfare spend.

    In fact, this is just part of a long term trend: welfare spending will continue to increase as a share of GDP whoever wins as will the level of debt (and hence interest). Public services will get a smaller share of the cake (which we can only hope continues to grow).

    It is the fact that we have an ageing population (hence welfare increase) and burgeoning interest cost that makes me rather less sanguine about public finances than you are.

    (ii) That said, the Tory fiscal plan for 2015-2020 are so tight as to be wholly implausible. They cannot be believed. They are just there to paint Labour into a corner post election defeat. Labour's plans (by contrast) are so open textured as to be completely meaningless.

    (iii) Posts like this one need to be held back. In 4 days time Scotland may vote to be independent. If they do, all projections like this are valueless.

  2. I think, on a political point, you are right and wrong to say that " this government plans to go well beyond anything Margaret Thatcher ever attempted."

    For those who have looked into what 'Victorian Values' meant when it was used in Thatcher's first parliament, it looked back nostalgically to the interwar years, not to any period of 'Victorian Britain'.

    I see this brand of Powell-Joseph-Thatcher Conservatism as thoroughly consistent. Consistent in its duplicitousness and in its cruelty.

    Oh for an election in which only graduates could vote.

    1. I should add that the 'Big Society' was 'Victorian Values' rebadged for a party that still wanted interwar levels of taxation and social immobility, but which gave some wriggle room, as it were, for a Party which seemed incapable of 'going back to basics' when it came to marital faithfulness. It is more Lord Chesterfield than Thomas Arnold.

  3. As recent examples of countries with budgets in surplus include Germany, Switzerland and Singapore, might it be that macroeconomic theory is in conflict with simple common sense?

  4. I got referred here by Huffington Post and this is an excellent blog. Useful for referencing too. Simon Wren-Lewis, you may be interested to read my economic article here


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