Economics Politics

Adam Smith and the Cuts

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The Institute that takes the name of Adam Smith (wholly in vain in my view) has been in the forefront of the expenditure cut propagandists. They have produced, in the guise of impartial analysis, two documents that start with their desired conclusions and proceed by the use of pseudo-logic and misdirection. The great Kirkcaldy moral philosopher and economist will be spinning in his grave if he has had the misfortune of posthumously reading these travesties.

Firstly, the Institute’s co-director, Dr Eamonn Butler has produced a document apparently rather cleverly called ‘Re-booting Government’. In fact, the correct computer analogy would be ‘Re-installing a cheap and cut-down operating system sold to you by a dodgy guy in the local computer repair shop’! It starts with an economic premise that is simply wrong:

While public spending may create public jobs, they come at the expense of private jobs, since the spending has to be paid for either by higher taxation (which makes consumers cut back, raises business costs, and so forces some firms out of business), or by public borrowing (which absorbs the investment funds needed by businesses…

This argument seems to assume that when the government spends money it is somehow burnt-up and disappears, never to be seen again! In fact, of course, the money spent by government re-circulates in the economy in exactly the same way as if it had been spent by business and consumers. If all government revenue was raised as taxation, then the depressive effect of taxation would, all things being equal, simply be matched by the stimulant effect of spending. Public borrowing is simply the difference between the money spent by the government, and what it raises in taxes. If inflation is to be avoided, the total flow of money out of the economy has to match the total flow into it. Generally-speaking, if businesses have viable investment plans, there is no reason why they cannot fund them from bank loans and other sources even if some spare money is being used to purchase government bonds. What determines the ‘correct’ level of government expenditure then, should have nothing to do with the level of taxation and borrowing, but should depend on the extent to which collective provision of particular goods and services is more desirable (for efficiency, equity, or other reasons) than provision by independent suppliers and consumers operating in a competitive environment.

Dr Butler’s dodgy economic thinking naturally leads him to the idea that the deficit must be tackled by spending cuts rather than by tax rises, and he divides his approach to this into three phases: short, medium and long term. His short-term solutions involve indiscriminate freezes and cuts to public sector pay, recruitment, benefits and projects. In this he displays no interest in analysing whether the costs in terms of public sector performance and social solidarity in what is being cut match the benefits, beyond the claim that many programmes and grants were ‘politically-motivated’.

In the medium-term, privatization is suggested, along with the abolition of ‘quangos’ such as the Regional Development Agencies, whose ‘contribution to public life is exceeded by their cost’. Now, there may well be efficiency gains from privatization, and many quangos may indeed no longer (if they ever did) provide benefits exceeding their costs, but this depends on assessment of the merits of each individual case. Privatisation frequently has equity and effectiveness (in terms of wider social goals) losses to match the efficiency gains. On an actual cost-benefit analysis, perhaps new quangos are urgently required to replace the old ones? We don’t know and Butler isn’t going to enlighten us.

He wants to bring ‘private-sector expertise’ into the cost-cutting process. I see no problem with this, if it is about delivering effective and equitable services as efficiently as possible. But it is debatable how much ‘expertise’ can be transferred from the exercise of maximizing revenue and minimizing costs, to the surely more complex and often conflicting imperatives of collective service delivery.

Finally we get to the long-term, where the ‘rebooting’ takes place. Butler says

An effective long-term approach to defeating the deficit and getting public spending under control means re-thinking the purpose of government itself…Government becomes rather like a computer that is overloaded and slowed down by unwanted files and applications; the sensible thing is to save what is essential to save, and then re-boot it.

As I mentioned above, in my experience this sort of improvement needs an operating system re-install, rather than just re-booting! Butler’s more specific proposals are a re-think of the number of government departments; he has little use for the Business department and Culture, Media and Sport departments in particular. He would like to see the quest for cuts as being about reform, rather than finance. He outlines the Canadian approach:

Ministers were each charged with defining what their department was there to achieve. What was its core purpose? Did it really need civil servants to achieve that purpose, or could it be delivered better by private providers, voluntary groups or by the public themselves?

Now, this sounds great. To be honest it seems like the sort of thing that should happen at regular intervals in every organization. But, to be genuine, it has to be an open-ended examination. It may well be that along with the current service provision that is revealed to be unnecessary, ineffective or inequitable, there is potential new service provision would actually be better provided in the public sector! So this makes a nonsense of Butler’s other proposal (fleshed out in another ASI publication), for arbitrary caps on government expenditure, the budget deficit and total debt.

A second document, The Party’s Over, certainly wears its political prejudice on its sleeve, is produced by an investment analyst by the name of Nigel Hawkins, and is equally sketchy in its supporting facts. He scares us by pointing out that the 1976 IMF loan was demanded at a lower deficit level than that for the UK in 2009/2010. In fact circumstances were rather different then than now. Then, a large part of the problem was in shoring up a weak currency, rather than simply funding government debt. Nevertheless, he accepts that, currently, the UK government has had little problem selling its bonds. Contrary to the comments of the coalition government it is likely that the attractiveness of sterling bonds is enhanced rather than weakened by problems in the Eurozone.

Hawkins also raises the spectre of off-balance sheet liabilities such as public sector pension liabilities and PFI contracts. But he simply quotes total liabilities without pointing out the considerable time-spans over which these liabilities are actually due. Despite this, and without any further justification, Hawkins insists that public sector pensions should have reduced benefits and longer periods of employment for eligibility.

Hawkins also remarks on how public expenditure has risen from 1990/91 to 2008/09, but since he fails to factor growth into this, he presents us with just another fairly meaningless big number. Hawkins’ analysis as to why expenditure cuts rather than tax rises should be the primary mode of tackling the deficit rests on the hoary old ‘Laffer Curve principle’, the much abused claim that any tax rise must automatically have a negative effect on economic activity and thus revenue. The real effects of tax changes are in reality much more nuanced, and require individual analysis of their potential costs (and benefits) to economic activity and revenue.

Hawkins’ strategy for carrying out the actual cutting is no better argued, being seemingly based on nothing more than anti-public sector myths and prejudice. His general approach seems to be that if a budget is large, or has grown recently then it is ripe for cutting. There is no genuine analysis of where need is greatest. For example, ‘In respect of social security – by some way, the largest element of public expenditure – the concept of shrinking benefits should be adopted.’, or ‘…it is vital that, like any over-staffed company, the bloated UK public sector employment payroll is tackled – efficiently and fairly.’ But it should be noted that his main point of equity is between the ‘overpaid’ public sector and ‘underpaid’ private sector, while ignoring the huge discrepancies between skill mix and income distribution between the two sectors. Hawkins advocates removing Child Benefit and Tax Credits from those better-off without considering the effects of social solidarity or on the problems of higher marginal tax rates for these groups. For benefits we must look for ‘tighter physical and mental eligibility criteria’ and ‘really deserving claimants’, ignoring the attempts made in this direction already by the Labour government and that no eligibility criteria can ever be perfectly just and so will inevitably catch some genuinely deserving cases in their net.

The NHS employs many, so must be overmanned; it has a large payroll, so its employees must be overpaid. It has a lot of managers, so there must be too many of them, and they are overpaid – apparently. The drugs bill is large, so it too is ‘ripe for cost-cutting measures.’ So goes Hawkins’ logic. No evidence is provided to support these claims. The truth about managers is that they make up 2.7% of the NHS workforce (2006 figures), in comparison to the economy as a whole in which 15% are in managerial positions. A survey conducted in 2003 found that the salaries of chief executives of private sector companies providing public services was on average four times that of NHS chief executives. Much of the need to increase the management structure of the NHS comes from the introduction of ‘business-like’ reforms aimed at introducing market incentives, patient choice and higher utilization of fewer resources – all of which the ASI have vigorously supported in the absence of full privatization. So when Hawkins complains that ‘[m]any Primary Care Trusts are poorly managed…’, is his solution to reduce the number of managers, or to find better ones who would presumably demand higher pay?

Hawkins’ analysis of education, defence and local government expenditure isn’t any more rational. If there are a lot of them, there must be too many. If it costs a lot it must be too much. Programs such as Sure Start are dismissed without any expert analysis of their benefits relative to cost. For others ‘[t]here should be more economic ways of tackling the problem’, but we are not informed what these might be, since it is clear that the author does not know.

Some of Hawkins’ final sallies are toward the devolved administrations of Scotland, Wales and Northern Ireland. The per-capita differences in spending between these and England are ‘anomalies’ with no apparent justification in terms of different needs or geographical features. The Barnett formula (by which Scotland, Wales and Ireland receive equivalent per capita uplifts in funding as for the UK in general) is ‘outdated’, yet no alternative is discussed. He objects to the idea that ‘the UK taxpayer generally – finance the subsidized services that are currently not available outside Scotland.’ Well, he would be right to object to it, if it were true. But it’s nonsense. All subsidized services in Scotland are financed out of the annually fixed block grant. If Scotland opts to use some of this funding to subsidise some services then it cannot pay for others. These are the realities of devolved democracy.

The most shocking, perhaps, of Hawkins’ suggestions is that the UK should renege on its promise to provide 0.7% of GDP for Overseas Aid. I wonder what the author of the Theory of the Moral Sentiments would have made of this abrogation of our obligations to the world’s most deserving of sympathy.

Taken together, these two documents from the Adam Smith Institute are poorly argued, analysis-free and irrationally biased against public sector provision. The man whose detailed analysis produced the work of genius that is The Wealth of Nations would be horrified at their production in his name.

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