Lean times ahead
Austerity is with us for 50 years
For those finding parliamentary Brexit manoeuvres a sorry, depressing spectacle, the Office for Budget Responsibility’s (OBR) annual “fiscal sustainability report” this week hardly provided light relief. Its publication was drowned out by rows over customs unions and medicines agencies. Yet it spelt out the defining challenge of our time – a trend much more economically and politically significant than the consequences of our post-brexit relationship with the EU.
The OBR projects that the net UK government debt-to-gdp ratio would rocket from 86pc of GDP to more than 280pc over the next five decades, on unchanged policies. Annual net interest payments would jump from 1.8pc of GDP to 11.6pc of GDP, with the budget deficit ballooning to more than 20pc of GDP (more than double the Conservative inheritance from Labour).
Steps will no doubt be taken to ensure this doesn’t occur. But the central premise of the OBR’S work is clear: despite deficit reduction since 2010, the public finances today remain firmly on an unsustainable long-term path. For all the promises of “ending austerity” from Jeremy Corbyn’s Labour Party, this means continued strain on taxes and spending levels for the foreseeable future.
Too much focus has been put on the already-accumulated debt and the short-term task of normalising deficit levels. But governments have made commitments to future generations that are unlikely to be fulfilled. An ageing population means the cost of providing healthcare, social care and the state pension at current levels, or needs, will rise significantly. This puts severe pressure on pay-as-you-go systems, which rely on birth rates high enough to produce more taxpayers, life expectancy not continually rising, and the cost of providing healthcare not forever outpacing economic growth.
The OBR thinks adverse public finance conditions on all three of these means combined spending on health, social care, the state pension, and other pensioner benefits could grow from 14.2pc of GDP to 24pc of GDP by 2067-68. Yes, there’s a great deal of uncertainty about projections so far into the future. There are key unknowns in the form of productivity growth, healthcare costs, migration patterns, birth and death rates, and much else. But even playing around with reasonable-sounding scenarios provides little comfort. All show debt levels spiralling. This sustained pressure will be the defining feature of the politics of the next generation. Even the Corbynistas cannot deny the mathematical realities.
In previous periods of high debt, governments have sought to inflate away the problem. Yet these liabilities do not lend themselves to that option. Right now the state pension is more than inflation-proofed via the “triplelock”. Health and social care demands, meanwhile, are real needs, not financial transfers whose value can be eroded. Nor could one foresee any government simply reneging entirely on the promises it has made, not least because the elderly are the most reliable voters, ensuring such an approach would be political suicide.
Attempting to get debt back down to historic levels (say, 40pc of GDP) while protecting all this age-related spending would be extremely tough. This would require further permanent tax rises or spending cuts equivalent to 5.2pc of GDP from 2022 onwards. That’s £124bn, or around a quarter of all other spending excluding debt interest. With the public seemingly weary of further fiscal restraint, such a package would surely be politically undeliverable in the near future.
Any delay or further spending increases, as we would surely expect under a Corbyn government, would worsen this baseline, necessitating bigger cuts in the longer term to achieve any given debt level. Labour intimates that its spending pledges would be funded via tax rises, but with the tax burden already at its highest level since the mid-eighties, it’s difficult to imagine the public shouldering tax rises for both huge new commitments and those necessary today to meet the demographic challenge.
Inward migration of working-age taxpayers could ease the pressure. The OBR thinks high levels of immigration would shave off about 30pc of GDP from the level of forecast debt by 206768. But, again, public opinion favours greater control of migrant numbers, and this only goes a limited way to solving the bigger problem anyway.
The most likely long-term outcome, by elimination, is a continual austerity setting. By this, I mean sustained focus on the public finances, with politicians obliged to “fund” any new spending commitments, modestly raise taxes whenever they feel they can get away with it, cut spending on non-agerelated areas and offer incremental reforms to the state pension and NHS to try to bring debt down.
We can already see the form this might take. The Government for some time has flirted with the idea of a hypothecated NHS tax. If the Tories had won a majority in the last election, they were planning to water down the triple-lock (increasing the state pension by the higher of inflation, earnings growth, or 2.5pc each year) to a double-lock, jettisoning the 2.5pc backstop. A future government will no doubt move back to simply linking the annual uprating to one of earnings or prices. The Government could well consider limited charging for certain NHS services and further acceleration of the state pension age too, particularly as people work and stay fitter for longer. Efforts to extend working lives or generate more robust productivity growth through supplyside reforms could help, too.
The key point, though, is that far from being over as a central feature of politics, this unprecedented public finance challenge will see the need for fiscal conservatism to again provide the backdrop for policy debates. Bar a miracle growth boom, we aren’t at the beginning of the end of austerity, but merely the end of the beginning.
‘Governments have made commitments to future generations that are unlikely to be fulfilled’