Pitiless austerity? Your exam starts now

THIS month’s rapid succession of big global summits – the Group of Eight in Washington, Nato in Chicago and the European Council in Brussels – has seen world leaders struggle to avoid admitting the glaring truth that two grand post-Cold War projects, Europe’s single currency and the war on terror, are both in very deep trouble.

Here at home we have happily or reluctantly, according to your view, already abandoned our domestic millennial vision, the ‘third way’ of lavish public spending bankrolled by a buoyant economy. We waved goodbye to all that on day one of the Coalition: May 11, 2010. Didn’t we? Put it this way, you might have been puzzled by the lengthy list of real or proposed exceptions in this age of swingeing cuts – in-vitro fertilisation for older women, parent-education vouchers, assorted road schemes, huge waste over aircraft carriers, new broadband connections and so forth. Perhaps all this pork barrel activity did not fit your idea of pitiless austerity.

The Bank of England might have part of the solution to the puzzle: the cuts are less swingeing than claimed.

In a sub-section of this month’s quarterly inflation report, the Bank explained that public spending cuts were not always what they seemed.

Because the State tends to provide services that are free at the point of delivery, there is no obvious price that can be used to adjust Government spending for inflation.

For about a quarter of public expenditure, a price index is concocted and for another small segment the supposed inflation rate is calculated using the cost of the labour and materials involved.

This slice of Government spending in nominal terms – not adjusted for inflation – shrank by 2.8 per cent in 2011. Adjusted by this somewhat wonky inflation measure, the shrinkage was 3.7 per cent.

But for at least two-thirds of public outlays, including big spenders health and education, the ‘inflation rate’ is calculated using ‘indicators of output’.

Thus better exam results are taken as evidence of higher output in education, lowering the ‘real’ cost per unit of teaching. For this two-thirds segment of public spending, there was a smaller gap between the nominal and real change in 2011 – up 2.1 per cent for the former and 1.9 per cent for the latter.

Given that NHS and schools budgets are ring-fenced from both cuts and inflation, the rise in nominal terms is understandable. More alarming is the realterms increase, however rough and ready the inflation measure used to figure it out.

As the Bank notes, real-term rises feed into growth numbers. So either public spending is more incontinent than we thought, or, if the spending figures are unreliable, growth is even lower. Reassuring, isn’t it?

Read more on this subject at atkinsonblog.dailymail.co.uk.