Pro-growth economist: Sharing the proceeds of what?

'Pro-growth economist' takes up ConservativeHome's campaign for George Osborne to adopt slower growth in public spending.

When Shadow Chancellor George Osborne MP set out his party’s pledges on public spending in The Times last September, his promise to match Labour’s fiscal plans for three years caught the most attention. The budget was set to rise from £615 billion in 2008 to £674 billion in 2010 – a two per cent annual increase in real terms.

Torn between the party’s economic liberals – who were demanding tax cuts – and an alleged general desire to spend more on public services, the Conservative leadership described their budget as a plan for “sharing the proceeds of growth” – a phrase aimed at pleasing everyone. It meant more money for schools, hospitals and the police for those who prefer higher spending. To people who want a smaller state instead, it was a synonym for less government. After all, if the proceeds of growth were shared between higher absolute spending and lower taxes, the state’s relative share of GDP would fall.

But above that, by committing to Labour’s spending plans the Conservatives wanted to reassure the general public that no “Tory cuts” would happen if elected. No hospital would close, no policeman laid off, no school would suffer. In this sense, it was good politics as it closed a complete angle for political attacks.

Since George Osborne wrote his article, the outlook for the UK economy has darkened, however. The true scale of the Northern Rock disaster is gradually emerging, consumer spending has slowed, and house prices have gone into reverse – and that is without mentioning the big international question marks like the US economy and energy prices. Amid such clouds on the economic horizon, it is unsurprising that many economists have revised downwards their forecasts for this year. Most analysts now believe that we can only expect growth of just below two per cent in 2008. But even this may turn out to be too optimistic if the housing market correction turns out to be more severe than estimated. How growth will look in the years after 2008 is only intelligent guessing.

So where does this leave the Conservatives’ plans to “share the proceeds of growth” and increase public spending by two per cent annually for the next three years?

Well, it is not easy to estimate how the amount of tax revenue will respond to changes in GDP growth, but some things are clear. With an economy slowing to below two per cent growth, the increase in tax revenue could be close to or even below the promised two per cent spending increase. In other words, it would be impossible to “share” the proceeds of growth between tax cuts and spending. Instead, all extra tax revenue would be needed to fund the scheduled spending increase. Besides, the freedom to cut taxes could be further reduced as during economic slowdowns the government’s welfare bill tends to go up.

If these economic circumstances persist for the next three years, pledging to increase real spending by two per cent a year could become really difficult. Worse still, under such conditions “sharing the proceeds of growth” may not be achievable at all in the short run.

Of course, hindsight is easier than foresight. So when George Osborne outlined his fiscal policy he probably believed that economic growth in the following years would make it possible to do both simultaneously: spend more and cut taxes. And of course, this will still be possible in the long run when the economy picks up again.

In the short run, though, and given the changed economic circumstances, it would be worth a thought whether the party should not reconsider its commitments or rephrase them. While it is worth every effort to reassure the public that public services will be maintained and indeed improved under a future Conservative government, it would also be wise to point out that it is not extra money alone that delivers better outcomes. Some improvements may as well be achieved by improving efficiency and cutting waste. The idea that it is enough to throw money at a problem for it to be solved has been tested to destruction – not least by the current government. It is worth reminding the public that spending increases as such are not delivering any positive solutions.

Furthermore, “sharing the proceeds of growth” has always been a nice, if also a little vague formula. It does not set the degree to which growth should be shared between tax cuts and public spending. Unfortunately – and almost by definition – it becomes an impossible task if there is no or only little growth and consequently not much to share. It should be any party’s goal to improve the state of the economy so that eventually there will be proceeds of growth to share again: between better public services and lower taxes.