Welsh Government must confront coalition’s sado-masochism

Public finances in Wales took another blow from George Osborne last week, though not, perhaps, as bad a one as feared. The budget in Wales was cut by 1.8 per cent for the period 2015-16 over 2014-15 after accounting for expected inflation. That compares with a real cut of 2.7 per cent across all UK government departments.

The Welsh resource (that is, current spending) budget in two years time is expected to be about £13.6 billion, much as it is this year and indeed as it was in 2010 in cash terms, implying continuing real cuts when inflation is taken into account.

Wales’ position was partially protected because the Chancellor protected the main areas of devolved expenditure and the Barnett formula transmits that protection into the Welsh block grant. Health spending in England is scheduled to be flat in real terms (up a fractional 0.1 per cent), while education spending falls by just 1 per cent. Other government departments took hits in the range 5-10 per cent. The third biggest devolved area though, feeding the block grant, is spending on local government and that got caned with a whopping 10 per cent decline.

That cut recreated an anomaly that we have been seeing in recent years. While the Welsh allocation fell 1.8 per cent, those of Scotland and Northern Ireland fell only 1.5 per cent. For Barnett purposes local government is wholly devolved to Wales so it gets 100 per cent of the cut in local government finance. However in Scotland and Northern Ireland, unlike Wales, business rates are devolved and, by a quirk of the formula, that means local authority spending is only partially devolved (the rest being financed by their own business rates). So only a part of the local authority spending cut falls on them.

If it is hard to make sense of that, don’t try too hard – it doesn’t really make sense.  The Silk Commission has recommended devolution of business rates to Wales but we still await the UK government’s response to its own Commission’s first report. Full devolution of business rates will be advantageous as long as cuts persist. On current government policies, persist they will.

The coalition government set out aiming to cut public spending by 9.1 per cent in real terms to balance the so-called structural deficit and hoped to have done so by the time of the 2015 election. However, the stagnation of the economy has seen tax receipts undershoot and benefit payments for unemployment and the like rise. If implemented, the latest cuts will mean spending is down by some 6.5 per cent by 2015-16 and the deficit continuing. If economic growth is only what the Office of Budget projects, another 2.5 per cent cut will be needed by 2017-18. The prospect of austerity therefore stretches some five years into the future.

The prospect is not really ameliorated by the Chancellor’s talk of a boost to infrastructure. Capital budgets are being cut too – by a planned 21 per cent between 2011 and 2018. In 2015-16 the planned cut is a real 1.7 per cent. Any increase in spending on some infrastructure will require robbing Peter to pay Paul.

There is a strong case for saying this is sado-masochism designed more to shrink the state than restore its finances. Leaving aside financial transactions flowing from bank bailouts, UK government debt is now 75 per cent of GDP – lower than its historical average. Coming out of both the Napoleonic and the Second World Wars it was 250 per cent and both those eras saw rapid growth that solved any incipient problem.

When Harold Macmillan told the British people that they had never had it so good in 1959, government debt was still 150 per cent of GDP, twice its current level. Yes, a deficit of 7 per cent or so, as the government is currently running, is not sustainable. But economic growth would bring it down faster than austerity and stagnation, as the United States has been demonstrating.

However, it is a hard task for politicians to explain to people that trying to cut borrowing quickly does not necessarily solve a borrowing problem. Labour in London has decided it is beyond them. In search of electoral credibility they have signed up to austerity too so we look like being stuck with it whoever wins the next election.

That confronts the Welsh government with a stark problem. With its older demographics and less healthy population Wales faces even worse pressures on public finances than the UK as a whole. For example, almost 45 per cent of Welsh Government current spending is on health and that proportion is rising inexorably as the population ages and more expensive drug treatments become available. Urgent reforms to the pattern of health provision in Wales and a much better integration with social care are required if rising costs are to be brought under control.  Yet the public resists any change to hospital provision and opposition politicians – and even the odd government minister – play politics with the issue. We are heading for a situation where health gobbles up fully half the entire budget to the detriment of other services.

The cuts in capital spending also limit the ability of the Welsh Government – even with EU funds – to make the key investments that could move the Welsh economy forward and arrest the process of relative decline. The Government has introduced some unorthodox initiatives to try and plug the investment gap. Wales currently has some of the best minor roads in the UK partly as a result of a programme using local authorities to borrow the cash for road maintenance and improvement with central support. A similar initiative is keeping the 21^st Century Schools replacement programme afloat and there are plans to support social housing using the borrowing powers of housing associations.

However, all methods of borrowing by the back door still result in debts that have to be serviced. And there’s the rub. Having shown some appetite for borrowing to maintain or increase infrastructure development, Ministers now have to worry about whether their resource budgets will stand the strain of extra debt servicing in the years ahead. With cherished programmes and ambitions facing the chopper, it is harder for politicians to take a longer view and commit to projects that will make further calls on their budgets some years down the line.

And yet… while there’s little virtue in building infrastructure just for the sake of spending money, Wales has to find ways to transform the prospects for its economy and the delivery of key public services. It is a tall order and surely impossible without big investments and without taking some calculated risks.