Why the politics of public spending do matter

Public spending has risen inexorably this century, from little over 10 per cent of GDP to nearly half. Even after 16 years of Conservative governments dedicated to rolling back the frontiers of the state, the public spending ratio stands at over 40 per cent, having risen sharply in the recession of the early 1990s. Must it inevitably go on rising, until the levels considered normal in wartime (or in Scandinavia) become the peacetime norm in Britain?

An interesting new paper, Prospects for Public Spending, Social Market Foundation by Andrew Tyrie, former Treasury adviser to Chancellors Lawson and Major, suggests not. He argues that the forces restraining the growth of public spending have been enormously strengthened by the free movement of capital, now the norm in the developed world. The bond markets impose a strict discipline on policymakers, making it difficult to finance extra spending by government borrowing. As a result, the connection between high spending and high taxes is becoming clearer, and the desire for lower taxes is being harnessed in the cause of public expenditure control.

There is some support for the Tyrie thesis - and some pointers to the future - in recent events. The fiscal position, actual and projected, is better today than was forecast in the March 1993 Budget (the first after the election) and, remarkably, this progress has been achieved mainly by better control over public spending. This is arguably the result of an unnoticed revolution in the conduct of fiscal policy which has improved our governance as much as the highly publicised changes in the conduct of monetary policy. What both changes show is that institutional arrangements can have a huge effect, for better or for worse, on the quality of decisions.

In monetary policy that is obvious. Not long ago changes in interest rates were decided at secret meetings between the Chancellor and the Governor at irregular intervals. There was no framework of published information. Little justification was given for rate changes, and none at all for a decision not to change rates.

Today we have published inflation targets and a quarterly progress report by the Bank of England. There are regular meetings between Chancellor and Governor on the first Wednesday of each month to review progress, and the reasons behind decisions to move or not move interest rates are subsequently published. This openness has given us better decisions, as we saw earlier this month when the good economic reasons for putting interest rates up prevailed over the bad political ones for keeping them down.

Fiscal policy operates on a longer time frame than monetary policy, and there has been a public framework for decision-making ever since medium- term fiscal projections were introduced by Chancellor Howe in 1980. But the existence of that framework did not prevent a massive rise in public borrowing in the 1990 recession. The published targets were missed, and by a large margin.

Since then however there have been two important changes: the unified budget (greatly underestimated) and the EDX committee (almost unknown, except to a few cognoscenti). The unified budget, which presents tax and spending decisions together in a single document, has focused ministers' minds on the connection between tax and spending. In the past the high- profile tax changes announced each spring reflected spending decisions made the previous summer. In politics a week is a long time and six months is forever. The old "spend now, pay later" regime made it too easy to deal with political problems by throwing money at them. The resulting tax demands were far away and hence too heavily discounted.

Under the new arrangements the tax consequences of every spending decision are immediately visible since both are announced on the same occasion. It has concentrated minds wonderfully. The benign effect of the unified budget has powerfully reinforced the other key change: the EDX committee. In the past the spending departments used to gang up on the Treasury and demand money with menaces. In Cabinet the spenders heavily outnumbered the Treasury team, and always had pressing political arguments for higher spending. As a result spending too often drifted upwards.

Under the new arrangement the powerful EDX Cabinet committee, a group of senior ministers chaired by the Chancellor, monitors progress against a spending total approved by Cabinet in advance. As a result all the players enter the spending round knowing that it is no longer a bear-bait (everyone against the Treasury, which can be made to give ground) but a zero-sum game (to decide which of the many urgent spending priorities is actually the most urgent).

Together these two changes to the budget-making process have increased the political weight given to the general aim (low spending, low taxes) at the expense of one-off calls for extra spending. Mr Clarke has used the new machinery to keep his spending colleagues under control.

The success of the unified budget and the EDX committee prompts an obvious question: what other political/institutional changes might help reduce the public spending ratio? Mr Tyrie would like to make the average voter more aware of the size of his tax bill, and more critical of how the money is spent. He has long believed that pay-as-you-earn income tax collection is politically dangerous because it makes paying the tax too painless and leaves us unaware how much is taken from us. He would change this by introducing an annual statement telling us how much tax we pay each year and where it goes, and by requiring the VAT rate to appear on all invoices, receipts, credit card statements, price tags etc.

On the spending side, Mr Tyrie would put more muscle into the fundamental reviews of the spending departments. These reviews, inspired by the zero- based budgeting ideas imported from the US, are conducted under the usual shroud of Whitehall secrecy. Why not publish them? The main difference between public spending and private spending is that public money is wasted out of sheer inertia. We go on giving aid to Hong Kong (richer than we are) or building tanks to fight the Russians (they're on our side now) just because we always have.

Also, typically, there are powerful lobbies on hand to argue that disaster would ensue if we stopped. We need therefore to mobilise the public as a political counterweight to the spending lobbies. Requiring every department to explain and justify in public how it spent its money would make it much harder to keep obsolete spending categories off the public payroll.

Mr Tyrie is a refreshing optimist. He believes the ineluctable rise of the public spending ratio can be reversed. His chart shows that public spending hit a peak in 1976 and has arguably been on a downward trend ever since. (The rise in the early 1990s was partly the cycle and partly a pre-election accident which won't now be repeated.) But keeping the powerful pressures for higher spending in check requires radical and imaginative thinking. Mr Tyrie has made an excellent start but there is a long way to go.

Bill Robinson is a director of the consultancy London Economics