UK Government's optimism bias about public spending is closer to 'optimism madness' – John McLaren

The Chancellor elected to cut national insurance while at the same time maintaining unrealistically austere spending plans. Alongside that came another ‘push for productivity’, this time in the public sector, to help relieve the squeeze.

Such efficiency drives are announced on a regular basis, always accompanied by great claims over what can be achieved but little reporting back on their actual success, which speaks volumes about their effectiveness. At this rate, we can expect a ‘bonfire of the quangos’ at the next fiscal event.

Record tax burden

Labour, for its part, found itself denied future funds for NHS reform and breakfast clubs as the Tory government copied some of its, previously repellent, policies, like abolishing non-dom tax status. The response from Labour has been muted, although as Paul Johnson, of the Institute for Fiscal Studies, noted post-Budget, “who cares about £2 billion” in the grand scheme of things.

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Essentially both parties face the same problem – a tax burden rising to record levels alongside public services under chronic strain. This means that whoever forms the next UK Government will need to spend more on public services but there is no sign of how this can be done without raising the tax burden further. How did we get here? There have been two main drivers, one long term and one short term.

The long-term shock has been the near-disappearance of productivity gains, which drive real growth, rising tax returns and rising wages. This has been connected to the Great Recession of around 2009 but was already starting to have an impact before that. Brexit didn’t help but it explains only a small part of the productivity slowdown.

READ MORE: IFS accuse both main parties of ‘conspiracy of silence’ over public spending

As a result, tax revenues have been unusually constrained. In terms of the future, the latest Office for Budget Responsibility outlook for productivity remains relatively subdued but may still be overly optimistic, at close to one per cent a year, compared to a post-2007 average of nearer 0.5 per cent. Such a margin may look small but cumulatively that’s a big difference.

War in Ukraine

The short-term shock was Covid. This hugely elevated spending in some areas but spending was then cut back before the impacts on the NHS, courts and schools, et al, had been fully dealt with. This left slightly raised spending budgets but alongside a considerable backlog of patients awaiting treatment and court cases.

The combined effect of such circumstances has resulted in a raft of public services that need serious amounts of extra investment in order to be fit for purpose. First, in light of the war in Ukraine, defence spending needs to be raised, with senior military figures claiming it should reach the equivalent of three per cent of GDP.

Second, the NHS blatantly needs more money – in the short term to avoid cuts and reduce waiting lists and in the longer term to fund the ambitious NHS workforce plan (for England). Third, spending to reach net zero, even in the medium term, will require many billions extra a year, over at least a decade, as outlined by the Scottish Fiscal Commission, the National Infrastructure Commission and the Electricity System Operator.

Fourth, a variety of policies are needed, involving the provision of mental health resources, childcare provision, training and more, to help deal with the internationally exceptional rise in the number of economically inactive citizens, many of them suffering from long-term mental and behavioural disorders.

Fifth, investment is necessary to deal with the lack of capacity around courts, prisons and the processing of immigration requests. You could easily add to this list: a lack of effective funding in relation to Levelling Up – witness last week’s report by the House of Commons Public Accounts Committee; shortfalls for dealing with transport infrastructure depletion; insufficient public housing; and even fixing pot holes. The current funding plans exhibit such a degree of ‘optimism bias’ that it is closer to optimism madness.

Yousaf’s unrealistic LSE speech

The productivity squeeze alone would have meant it was hard to keep public spending high enough to maintain the quality and quantity of services expected but Covid blew such hopes out of the water. So we have to start again in terms of outlining a credible fiscal plan and be honest with the public over what is affordable and at what cost.

And talking of unrealistic, the First Minister’s speech at the London School of Economics on the economic benefits of independence referenced a number of organisations, including the National Institute of Economic and Social Research and the Financial Times, in setting out his case. The only trouble being that in almost every case such bodies’ analysis of independence is that it would come at an economic and, in particular, fiscal cost.

So while his calculations based on NIESR figures suggest that leaving the EU had cost the Scottish Budget £1.6 billion (£1.2 billion according to the NIESR), most independent analysis of the cost of Scotland leaving the UK put the budgetary cost alone, ie excluding any longer term economic impact, at over £10 billion, depending on the state of erratic North Sea revenues. So again we’re faced with a politician basing their future finances on an unsustainable, unsupported analysis of the situation.

All of this will come to some sort of head soon, as there will have to be a medium-term strategy before the end of the year in order to set departmental budgets for 2025-26 onwards. Another fudge could, and probably will, be undertaken then, but how long can we continue planning on the edge of breakdown?

John McLaren is a political economist who has worked in the Treasury, the Scottish Office and for a variety of economic think tanks