Spending review 1: Heroic expectations for private sector

The strategy underlying the £81 billion cuts over next four years, announced in the UK Government’s Comprehensive Spending Review last October, is to hope that it will lead to a rapid revival in economic growth powered by a revitalised private sector and a diminished public sector.

The burden of fiscal consolidation is to be borne by spending cuts rather than by increases in taxation. For example, there were additional cuts to the welfare budget which increased to £18 billion compared with the £11 billion indicated in the June budget. Because of our relatively high dependence on welfare spending this will hit Wales disproportionately hard – rising to an extra £963 million a year taken out of the Welsh economy by the end of the period.

Spending Review Special This is the first in a series of four articles we are publishing this week analysing the Comprehensive Spending Review which will determine much of what happens in Welsh public life during 2011. Tomorrow: Steve Thomas, Chief Executive of the Welsh Local Government Association. This article is from the current issue of  The IWA’s journal Agenda, issued three times a year. To receive Agenda and get unlimited access to the IWA’s online archive, click here.

The Government has forecast that 490,000 jobs will be lost in the public sector, and hopes the private sector will take up the slack. Most critics of this strategy accept the need for fiscal consolidation but say spending should be cut more slowly in order to avoid the risk of a double dip recession or, as is more likely, sustained slow economic growth over the coming years. That would lead to continuing high levels of unemployment with the attendant drop in tax take and increase in welfare spending. Such an outcome could undermine the planned reduction in the fiscal deficit. Cutting spending over more than four years is unprecedented. Historically sharp reductions have only lasted twelve to eighteen months.

The Welsh Government’s overall budget for each of the next four years is set out in Table 1. How this will impact on each of the departments – health, education, economic development and so on was made clear by the detailed Welsh budget for 2011-12 published in late November – see here.

Table 1: Welsh Government’s budget 2010-15 – £million real terms after correcting for inflation

	2010-11	2011-12	2012-13	2013-14	2014-15
Revenue	13,445	13,015	12,795	12,602	12,311
Capital	1,674	1,244	1,139	994	1,007
Total	15,119	14,259	13,934	13,597	13,318

Source: Welsh Government

In practice these figures are broadly in line with spending implied in Labour’s 2009 and 2010 UK budgets. Labour planned to cut the Welsh Government’s budget by £500 million a year for each of the coming three years (they did not forecast a fourth year). The plans as announced this October call for a deeper cut in the first year of £860 million in real terms, offset by a smaller reduction of £325 million in the second year. By 2014-15 the Welsh budget will have been cut by £1.8 billion which reflects a continuation of Labour’s plans over the first three years of successive cuts of some £500 million a year. According to the Welsh Government’s own estimate the cut in real terms over the four years is 12 per cent.

The sharp reduction in capital investment of 41 per cent is slightly lower than Labour’s planned 45 per cent reduction in real terms announced in their 2009 UK budget. Thus Labour’s attack on the Conservative-Lib Dem coalition’s plans so far as the Welsh budget is concerned ring a little hollow. In terms of ‘fairness’ it would be naïve to expect Wales to get a fair deal given that the changes to funding of the Welsh Government are determined by the Barnett formula which is a simple and crude arithmetic exercise. The Welsh Liberal Democrats are in the difficult position of defending the cuts for Wales as ‘fair’ whilst condemning the Barnett formula as ‘unfair’.

While attention in Wales is concentrated on the Welsh Government’s budget, nearly 40 per cent of identifiable public expenditure is made through direct payments to people in Wales by the UK Government. Most of this spending is on welfare payments. These include state pensions, invalidity benefit, support for the unemployed, housing allowances and tax credits. Given the planned cuts of £18 billion in the UK welfare budget, significantly higher that planned in the June 2010 budget, this will mean a cut of almost £1 billion a year in the case of Wales, when fully implemented.

While the removal of child tax credits for higher rate taxpayers will, by definition, hit the better off (about £90 million in for Wales), the other welfare cuts of £873 million will be borne by many of the most vulnerable in our society. The impact of these cuts will of course be felt more widely because those on the lowest incomes cannot save but spend most of the money locally on food, clothing and other essential items.

Approximately £1.5 billion a year is spent by the UK Government in Wales in other areas such as public order and economic affairs, shown in Table 2.

Table 2: UK Government spending in Wales – £ million

Public order and safety	627
Economic affairs, including transport	613
Recreation, culture and religion	146
Other	132
Total	1,518

It is not clear how much of this spending will be cut. However, in England police and culture budgets are suffering higher than average cuts and this will be reflected in the monies spent in Wales.

It was noteworthy in the Chancellor’s statement and in the Spending Review documentation that little was said regarding Wales. A number of specific commitments were made for Scotland, including an additional £250 million through the Green Investment Bank for infrastructure investment. In the case of Wales the Severn Barrage and St Athan defence establishment projects were both dropped in the run-up to the Spending Review. A couple of small, local rail improvements were announced but the Review was silent on the proposed electrification of the London to Swansea line. Meanwhile, there were commitments to a high speed rail link from London to Birmingham, Crossrail in London and major improvements to the London underground. Major commitments were to spending on science projects in London, Oxford and Cambridge but none in Wales.

A major Welsh concern has to be the 41 per cent cut capital spending. Wales has already lagged behind the rest of the UK in this area over the last decade. Will the Welsh Government cut capital spending this much or will it boost capital investment at the expense of current spending? Whilst being politically difficult this would be the right thing to do if Wales is to renew and modernise its infrastructure. Another possibility is for the Welsh Government to raise money in the private capital markets for investment in infrastructure such as roads and broadband.

Another concern has to be the impact of the Spending Review on employment. Wales’s share of the 490,000 jobs the UK Government forecasts will be lost in the public sector could be between 25,000 and 35,000. Is there scope for Welsh government at national and local levels to work with the trades unions to reduce the impact of the cuts on employment by trading off pay levels against staffing levels? Wales responded well to the immediate aftermath of the banking crisis with its ProAct and ReAct programmes. Can it do the same now?

If the strategy of the Spending Review works, job losses in the public sector will be off-set by growth in the private sector. But even if this works at a UK level will it work in Wales? Will the skills of former public sector workers match the needs of the private sector? Will the new jobs be created in Wales which has a relatively weak private sector or will they continue to be concentrated in south east England?

Over the past decade most of the growth in private sector employment has been in financial services and construction whilst manufacturing has continued to decline. Wales has traditionally been strong in manufacturing but weak in financial services. These are some of the issues that the Welsh Government has to face as it decides on its spending priorities.