Will the coalition government have the guts to cut spending sufficiently to avert economic catastrophe?

As I write this column, students are marching down the street outside chanting “revolution, revolution”. In the past few weeks, they’ve trashed a police vehicle and thrown objects at the Prince of Wales’ car. The object of their invective? A reduction in student grants – a subsidy which to them had become an entitlement. Faced with the most severe fiscal crisis in a generation, the Lib-Con coalition government has no option but to take on the entitled classes. But it’s not clear that it has the will to go far enough.

In October, the government issued a Comprehensive Spending Review that was widely touted as ushering in dramatic spending cuts. In reality, most government departments will merely face reductions in increases. A few, notably the Department for International Development and the National Health Service, will get substantial budget increases. Overall spending is set to rise from £326.6bn in 2010-11 to £328.9bn in 2014-15.

Nevertheless, the review claims that real spending will fall by 8.3 per cent over 5 years. How can this be? In a word: inflation. The problem with this approach is that it raises the cost of borrowing – since purchasers of government bonds will demand a higher yield to compensate for the falling value of the nominal sum invested. And if the cost of borrowing rises, the national debt will increase at a higher rate. It is forecast to rise to over £1 trillion in 2011 – more than 60 per cent of GDP.

The government already officially owes the equivalent of £33,500 for every employed person in Britain. But this figure ignores the massive amounts that will become due to cover pensions and healthcare for Britain’s ageing population.

This precarious situation is spelt out brilliantly in a recent study by Miles Saltiel called On Borrowed Time (Adam Smith Institute), which lays the blame squarely on excessive state involvement in the supply of healthcare, education, welfare and pensions. In its attempt to supply these services, the state has taken on vast unfunded liabilities.

If the British government were a private company and had to declare these liabilities on its balance sheet, it would effectively be insolvent. Only its ability to coerce UK residents and businesses into paying taxes has enabled the government to continue as long as it has.

But taxpayers will put up with only so much pain before they revolt. And revolt they have: faced with rising taxes, many wealthy individuals have been moving to more congenial settings, such as Switzerland, the Channel Islands and of course the Cayman Islands. Those who have not moved have arranged the structure of their family offices in such a way as to minimise their exposure to the UK authorities.

The problem is that the student protests are highly visible, whereas the tax revolt is largely invisible (at least to the television cameras). In many cases, governments will respond to the more visible protest, while ignoring the less visible one. Fortunately, at least in this case, the UK government has stuck to its guns, facing down the student protesters and continuing with its plans to cut their subsidies. If the government wants to stop the exit of wealth and expertise from the country, it will now have to address the less visible problem.

Saltiel argues that the underlying premise of state provision – offsetting everyday risk – no longer pertains. Private markets exist that enable people to purchase insurance against risks to health and employment. Meanwhile, highly liquid asset markets enable people to save for potential future out-of-pocket expenditures on healthcare, education and so on. Moreover, people in the UK are far wealthier than when the Victorians developed the state system.

Europeans have become inured to low rates of economic growth as a result of their overbearing governments. But the massive unfunded liabilities are slowing rates further, with stagflation just around the corner.

If the UK is to avoid the problems that have so beset other insolvent European countries, from Greece to Ireland, the government would be well advised to follow Saltiel’s proposal, shifting its role from insurer of first resort to insurer of last resort. By so doing, education and healthcare can be converted from liabilities to net assets of around £310bn, or approximately 40 per cent of GDP.

Privatising pensions, healthcare, education and welfare, while continuing to offer catastrophic insurance for the genuinely impecunious, would dramatically reduce current and future government liabilities, enabling the UK to lower taxes and thereby attract wealth and talent from across the world.

By pursuing such a bold policy, Britain’s government could shift the country to a permanently higher rate of economic growth, through investment in innovation and associated productivity improvements. But it will take guts to pursue such a strategy.

Having shown willingness to take on the entitled classes in the case of higher education, the government now must tackle the powerful unions that control primary and secondary education, as well as healthcare. As Saltiel notes, “The coalition’s current plans, however painful, just aren’t enough, and threaten the next parliament with fiscal conditions undesirable to borrowers.” That is an understatement. Failure in this battle will permanently reduce the wealth and health of the people of Britain.

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Julian Morris

Julian graduated from the University of Edinburgh with a Masters in economics. Graduate studies at University College London, Cambridge University and the University of Westminster resulted in two further masters’ degrees and a Graduate Diploma in Law (equivalent to the academic component of a JD). 

Julian is the author of dozens of scholarly articles on issues ranging from the morality of free trade to the regulation of the Internet, although his academic research has focused primarily on the relationship between institutions, economic development and environmental protection. He has also edited several books and co-edits, with Indur Goklany, the Electronic Journal of Sustainable Development (www.ejsd.org).  

Julian is also a visiting professor in the Department of International Studies at the University of Buckingham (UK). Before joining Reason, he was executive director of International Policy Network (www.policynetwork.net), a London-based think tank which he co-founded. Before that, he ran the environment and technology programme at the Institute of Economic Affairs, also in London. 

Julian Morris

Vice President, Research
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