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Financial wizardry?

Updated Wednesday, 20th October 2010

Alan Shipman, the Open University's lecturer in economics, responds to the October 2010 Spending Review

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The boldest claim in the Spending Review – and the one that will persuade Conservatives that George Osborne has repeated the Thatcher-era feat of making them electable through fiscal austerity – is that he has delivered a bigger deficit reduction over the next five years while cutting public services by less than his Labour predecessors had planned. The magic Chancellor promises to soften the spending cuts and still close the deficit faster.

The smaller drop in main departments’ spending, and continued real increases in the healthcare budget, is achieved in four main ways:


Welfare spending is reduced by more than the previous government planned – by £7bn, 50 per cent more than the inherited scenario. The child benefit cuts (now forecast to save £2.5bn) have hit the headlines because of their likely impact on unsuspecting middle income earners, but the most severe reductions will be to housing benefit, incapacity benefit and support for those out of work.

The government has also opened the way for significant real-terms savings in its welfare obligations by freezing various benefits and tax credits, and deciding to inflation-adjust others using the consumer price index (CPI) rather than the faster-rising retail price index (RPI). Inflation – still well above the Bank of England target – will be allowed to move more households into higher income brackets, increasing their tax obligations and cutting their means-tested entitlements.


The capital budget is reduced more sharply than previously planned, leaving more available for current spending. Although it headlines £20bn for rail expansion and over £1bn in low-carbon projects, the axing of school-rebuilding plans already announced will be followed by major state investment reductions in social housing, the NHS and other areas of education.

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The Review headlines over £1bn in low carbon projects


Larger efficiency savings are envisaged. The coalition believes it can achieve more waste reduction through its Quango cull and a more fundamental reorganisation of central and local government agencies. Local authorities will be forced to find these savings through a real reduction of over 30 per cent in the communities and local government spend between 2010/11 and 2014/15.


Spending departments will pass some of their responsibilities to other agencies: for example, rail companies using fare increases to fund more investment, and the BBC taking over World Service from the Foreign Office. More services are intended to move from public to voluntary sector provision, as the ‘Big Society’ expands to fill the ground vacated by the shrinking state.

Two other factors have enabled the government to claim it can reduce the deficit much faster than its predecessors, while cutting current expenditure less savagely. Since Labour’s last budget in March, economic growth has picked up strongly, and official forecasts (now provided by the independent Office for Budget Responsibility) show recovery continuing at two per cent next year. And, as a result of faster growth, the deficit has fallen faster than the last government was projecting. Faster growth will, if sustained, also raise the value of banking assets acquired by the government during the 2008-9 crisis, which when sold may enable a considerable one-off public debt reduction.

But will June’s emergency budget and October’s spending review lead to faster growth, and convert the targeted deficit reduction into actual debt reduction? The extreme difficulty of reining in state spending at a time of slow growth is confirmed by the Spending Review’s projection that, if all goes according to plan, public spending as a percentage of national income will return only to the level of 2006/7, before the financial crisis hit. And these projections will prove too optimistic if growth falls below official forecasts.

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Unfortunately, the squeezing of state expenditure when households are also tightening their belts – as they absorb higher public service costs out of incomes restrained by a slack job market and shrinking benefits – means it will take a heroic rebound of private-sector investment and job creation to take up the resources released by the public sector and deliver the growth the government expects.

The private sector did, indeed, generate over a million jobs and fuel an economic recovery after the recession of the early 1990s. But then budgets were less tight, spending cuts delivered income-boosting tax reductions more than income-sapping deficit reduction, the global economy was expanding, and the house-price drop had done little lasting damage to the banks.

Plus, new jobs and output after 1993 were mainly generated by financial and business services. In 2010-15, banks and insurers are still severely wounded by their near-death experience and the consequent regulatory tightening, and business services are forecast to be heaviest hit by the coming reductions in public spending. While the government now talks of a revival of manufacturing, domestic demand for its products is set to stay subdued, and exports are hard to revive when finance ministers across Europe are using translations of Osborne’s hymn-sheet.  The more sober economy foretold by the governor of the Bank of England could easily slip from detoxification into dehydration.

Reviewing the spending review

Reactions to George Osborne's statement on how far the nation must tighten its belt:

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