Neil O'Brien: If we want smaller government, we will have to think big

Neil O'Brien is Director of Policy Exchange.  Follow him on Twitter.

Public spending in Britain rocketed from consuming just over a third of our national income in 2000 to just under half in 2010 - from 36% to 48%. In other words, we are right back to where we were before Mrs Thatcher. The coalition aims to get the state share of spending back down to 40% by 2016. But that means it will still be higher after the cuts than it was during most of the Blair years (1997-2004). So we are not heading for some small-state paradise once this is over.

Could the government go further?  Over the long term I think it can, and must.  Economic research in react years has shown a clear link between higher public spending and slow growth. Our large but inefficient state is one reason the UK has been so comprehensively outclassed by our international competitors over the last couple of decades.  At the same time many people feel crushed by the rising cost of living. Anything the government could do that would allow sustainable reductions in income tax, VAT, fuel duty and council tax would help a lot.  

Most of the big things that need to be done are long term, and are hard to quantify the benefits of in the short term cashflow. It is less about closing down wasteful little projects (desirable though that is), and more about doing big things that help growth, make government more efficient, and reduce dependency on the state. So here are some big ways we could reduce the burden of taxation over time.

• Introduce conditional welfare.  IDS has successfully passed the welfare reform bill, and is planning to simplify the benefit system to improve the financial incentives to work.  But there is a whole other side to welfare reform which now needs his attention.  The best way to cut welfare spending is obviously to get people off benefits and into work. 

Policy Exchange is part of the way through a major series of reports on how to make the system more conditional.  Step one is to improve the way job centres work, to identify those who might get stuck on benefits at a much earlier stage.  Step two is to ask more of claimants, by making job search more intensive (at the moment some people spend only a few minutes a day looking for work, and “reading the paper” can count as looking for work).  Step three is the targeted use of workfare to move those who have got stuck on benefits into work. 

These techniques have worked in many other counties, like Canada, Australia, the US and Germany.  For example, the state of Wisconsin managed to drive down the number of claimants by 90% at one point.  We should deploy some of the same ideas here. Total benefit spend, excluding pensions, is over £100 billion (1/7th of government spending).The average family on Incapacity Benefit get about £10,000 a year in benefits, and a household on Income support about £13,000. There are about four and a half million people on the main out of work benefits. So the savings from reducing worklessness are potentially vast – not just billions, but tens of billions. 

• Digitise public services.  The DWP spends six billion pounds a year on administration alone.  The cost of processing a benefits claim online, is roughly one hundredth the cost of the usual paper based way.  Yet only a tiny proportion of claims are made online (15% for Jobseekers allowance, just 1% for state pensions).  Whether it is paying tax, making NHS appointments, getting passports, or registering marriages, there are a zillion public sector paper-and-office bureaucracies that could mostly disappear. And services could be better too. Trials of “virtual courts” suggest great potential to speed up our expensive, creaking courts. Martha Lane Fox’s report on making public services “digital by default” suggested that pushing most transactions online could save £1 billion a year.

• Allow for-profit providers and mutuals to provide schools.  The private sector already provides state funded education services for pre-school children, pupils over 16, pupils with special needs, and also runs a few schools and provides billions worth of services to schools.  But ideological opponents fight tooth and nail against private firms being allowed to own schools.  If this ban were relaxed the private sector could come in with cash and expertise. With increasing demand for places, the private sector could take the pressure off the DWP’s capital budget.  At present the capital budget is 5 billion a year, and opening a new free school costs about 5 million a time.  In Sweden 64% of free schools have been provided by the private sector – so the potential to either save money or have more free schools is big.

• Co-location to save on capital spending in education (“use it well or lose it”).  While there is a chronic shortage of good school places, there is a lot of spare space in underperforming schools. Policy Exchange analysis undertaken in 2011 found there to be 53 secondary schools running more than half empty. 225 schools (7% of the total) are more than a third empty. Almost all are poor GCSE performers.  Why not learn from the US and allow “co-location”?  Failing schools could give up some of their buildings to new providers and free schools, saving capital spending again.

• Reduce the cost of childcare through deregulation - and cut growth in subsidies.  Over the last 15 years governments have pumped more and more subsidies into childcare, while simultaneously regulating providers more and more heavily (with staff to pupil ratios, requirements to study for degree-level qualifications and so on).  With the government now spending at least £5 billion on childcare, the potential for deregulation to save the state money (as well as parents) is large. We’re working on this at the moment.  

• Privatise more prisons.  The operational cost of HM Prison Service is around £2.3 billion a year, and average private sector running costs are (according to the CBI) between 10-15 per cent lower (excluding staff pensions).  The Ministry of Justice should aim to have tendered out 50 prisons by 2015 - another 41 prisons on top of the 9 they’re already market-testing.

• Replace community sentences with effective work orders.  Community sentences are widely regarded as a joke. Half are not even fully completed.  Why not replace them with tougher “work orders.”  Research shows that more punitive options are also more effective. This wouldn’t save money in the short term, but if more criminals could be deterred at an earlier stage, fewer would end up in expensive prison places (costing £45,000 a year).

• More outsourcing and civilianisation in the police.  Over the last decade spending on the police went up by a quarter in real terms to £14.5 billion, while detections rose very little. Taxpayers have spent at least £500m since 2006 in extra employment costs for over 7,000 police officers who have a uniform, but who are hidden away in back offices rather than policing. They could be replaced with civilian staff who are on average 60% cheaper. More outsourcing, control of overtime and greater use of civilians in back office roles have great potential to reduce costs in policing.  In the case of the police, it will not be up to the government to make these savings, but the elected police commissioners, who we will be voting in this autumn. 

• Introducing a cap in the value of social housing.  The total stock of social housing is worth around £400 billion. About 4% becomes vacant each year. Polls show that people don’t support the idea that people should be given council houses that are more expensive than the average in their area, or houses in expensive areas.  The government could sell off the most expensive houses in inner city areas.  It could use the money to build new housing elsewhere and boost growth.  Or it could say that people have to move out of social housing if they are very high earners (say with a household income of £80,000-100,000).  The Hills Report on social housing found that about a fifth of people in social housing are in the top half of the income distribution (even a percent or two of the top 20% of earners are in social housing – people like Bob Crow or Frank Dobson).  While we don’t want to punish achievement, very high earners don’t need social housing.

• Building more housing to reduce the cost of government.  The cost of housing is included in everything you buy, and the same is true for government. If the cost of housing hadn’t trebled since 1995, government would have been able to spend a lot less on staff. (The public sector pay bill amounted to £182 billion in 2009, representing 30% of all government expenditure) In the UK rents and mortgages are made more expensive by restrictions on supply which are unusually tight compared to our competitors.  The current plans for reform of planning don’t do enough to break from the socialist-style planning that Local Authorities currently attempt.  If we are going to get down the price we need a system which properly mediates between developers and those affected by development. Government should consider replacing bungs to councils with statutory cash compensation for those directly affected by development.

• Reducing the cost of going green. Government is making it unnecessarily expensive to go green, wasting resources by specifying the use of uncompetitive technologies, rather than letting the market operate. (Huge subsidies for wind and other renewables are a classic example). Picking winners in this way will cost the average household in Britain a total of £400 a year by 2020 – the equivalent to 2.5p on VAT. And the £400 is not the total cost of climate policy but just the additional cost imposed because the government subsidises expensive renewables such as offshore wind, rather than cheaper ways of reducing carbon emissions.

• Ending national pay bargaining.  Paying all public sector workers the same, regardless of whether they live in an expensive area or a cheap one is unfair and wasteful, and holds back the struggling regions of the UK.  Government acknowledges the problem to some extent by introducing sticking plasters like “London weighting” – but there is no weighting for other expensive cities and areas.  The average public sector worker is paid 9% more than an equivalent person in the private sector (before taking into account more generous pensions in the public sector).  But in some regions (Scotland, Wales, the North East) the difference is nearly twice as high. Ending one-size-fits-all pay would save money over time by bringing the public sector into line with the private sector.  I would suggest though, that the money saved should remain in those regions rather than being clawed back to the centre.  Reducing the cost of public services in poorer regions could release funds to, say, reduce taxes in lagging areas.  Much more importantly the end of national pay bargaining could open the way to proper pay for individual performance in the public sector.  If we could pay public servants based on how hard they work and how good they are, rather than how long they have been in the job, then overall public sector productivity would rocket and costs would fall back.

There are a million other things the government could do.  It could reform subsidy-consuming utilities like the railways.  It could uprate court fines. It could do more to reform public sector pensions. But that’s probably enough for now.

Britain today reminds me a bit of that BBC programme “Restoration”, in which brilliant, historic buildings are rescued from collapsing, and made beautiful again. Though things are pretty terrible right now, the UK has great potential.  And everywhere you look, the potential for government to do more with less is vast.