Public spending reform could make Labour radical in power

Perhaps they will succeed where Mrs Thatcher failed, given that the alternative - more public squalor and more private provision of key services - is so unappealing

The aspect of the shadow Chancellor Gordon Brown's speech earlier this week that got the least attention in the headlines could turn out to be the most important and distinctive contribution of New Labour to the management of the economy - namely its ambitious plans to restructure public spending.

Tax pledges make the best tinder to feed the fires of the election campaign, so Mr Brown's promises not to increase the basic or top rate of income tax and not to extend the VAT base - and whether these pledges meant taxes would have to rise in other ways - were the natural focus of interest in his speech. But Labour's tax policy is dictated by two things: the unsatisfactory state of the public finances, and the fact that the Conservatives have successfully turned income tax rates into a political totem. Between the too-high government borrowing requirement and the painful memories of the "tax bombshell" in the last election campaign, there is not much room for manoeuvre on taxation.

On the other hand, there were signs of strategic rather than tactical thinking in Mr Brown's comments on public spending. He committed a Labour government to the existing departmental spending plans in the current financial year and to the existing grand total in 1998/99. At one level this was simply another signal that Labour has definitively abandoned its foolish old idea that the answer to every problem is for the government to spend more money on it. And at this level some of the party's supporters are miffed - what is the point of a Labour government if it is not going to spend more on things that matter?

This reaction is understandable. To many people on the left of the political spectrum it seems obvious that Britain is suffering from what the eminent economist John Kenneth Galbraith diagnosed as private affluence and public squalour. Public services are straining at the seams because of a shortage of cash. This is especially obvious in areas such as education, for any parent of children in the state sector knows at first hand about crumbling buildings, shortages of books and the brain drain of good teachers because of inadequate pay.

The trouble is that other demands on the public purse have siphoned off resources. The biggest of these has been welfare - the growth of the pension and social security budget. As the chart shows, the welfare share of total public spending has climbed steadily. For government expenditure to have grown as we would have liked on health and education too, tax revenues would have had to increase by far more than they have. As it is, even with the squeeze on frontline services, excessive government borrowing has doubled the national debt, made debt interest payments the fourth biggest item of expenditure and left macroeconomic management at the mercy of financial market reactions.

Addressing public spending is therefore an imperative for whoever wins the election. Now, this all sounds very much like the Conservatives' message, but the present Government's approach to expenditure cuts has been to tell every department to shave a certain proportion off its budget. Exceptions have depended on short-run political pressures. As Pam Meadows, director of the Policy Studies Institute, argued in a recent paper, no householder or business would try to cut costs across the board like that. Rather, they would axe certain areas of spending altogether - cut out holidays, say, or pull out of one particular unprofitable market.

Mr Brown signalled this week that Labour will try this approach in the public sector. It will try to switch money from low- to high-priority areas. A "Comprehensive Spending Review" would start immediately after the election to implement a switch of resources away from welfare and towards education. "Central to Labour's medium-term approach to public spending must be a radical reform of the welfare state," the shadow Chancellor announced.

The traditional annual spending round will not take place this year if Labour does win the election. Instead, Mr Brown said, the Cabinet's public expenditure committee, known as EDX, and senior Treasury officials would work on the strategic review which it would start to implement the following year.

There is plentiful academic support for a radical review of priorities. According to Pam Meadows: "The principle is a sound one. Where I'm sceptical is whether you can do it sufficiently quickly to do everything else you want as well."

The Institute for Fiscal Studies also backs the idea in principle. In its Green Budget with investment bank Goldman Sachs last October, it noted that control of public spending had seen social security grow at the expense of health and education. As "superior" goods, demand for health and education services will grow faster the more prosperous we become. The IFS concluded that the only alternative to radical reform was the creeping privatisation of health and education, with people spending their own money to top up increasingly inadequate state provision.

The International Monetary Fund has been weighing into the debate about the future role of government with a series of working papers. One of the most recent assesses the radical public sector reforms in New Zealand. These have included the introduction of commercial-style accounts into the public sector. New Zealand has replaced numerical fiscal targets with a set of five principles of sound finance (see box). A key institutional element of the reforms has been the creation of a cabinet committee which makes the trade-offs between competing priorities.

According to the IMF, this experiment has been a resounding success. The deficit and debt have fallen. Departments have greater freedom to manage, and attention has switched from what government spends to what it gets for the money.

Mr Brown gave the Labour Party's plans a left-wing gloss in his speech, citing Aneurin Bevan's observation that "the religion of socialism is the language of priorities". But his underlying message about the need to go back to the drawing board on public expenditure is one that probably commands wider agreement, from academic experts and even from Conservatives.

The difficulty, of course, is that to get there, you wouldn't want to start from here. No economist really believes the current spending plans are realistic, and any government is likely to overshoot them. Going beyond meeting tough plans to restructure spending will then involve slashing and axeing entire social security spending programmes. Perhaps New Labour will succeed where Mrs Thatcher failed, given that the alternative - more public squalor and more private provision of key services - is so unappealing. If it does, a Labour government will be far more radical than its fiscal orthodoxy suggests.