Public spending can hold an economy back

Warwick Lightfoot is publishing “Sorry we have no money: Britain’s economic problem” (Searching Finances 2010) to argue the case that any country which allows public spending to go above 35% of National Income will grow less quickly and will be less well off than one which keeps control of its public spending. His wish to see our current proportion of public spending much lower is shared by all three political parties, though none of them have yet been so bold as to propose his resting place of 35%.

He quotes sources to suggest that the increases in public spending under the last Labour government cut the UK growth rate by between 0.5% and 1% each year. He reminds us of the Bacon and Eltis thesis from the 1970s, which stated clearly than excessively high levels of public spending in relation to National Income can hold an economy back, damage its abiltiy to generate jobs and serve customers in the private sector, and undermines the tax base. It leads to the problem of “too few producers”. High levels of public spending imply high levels of taxation and borrowing, which is just deferred taxation. This in turn undermines competitiveness, persuades people to set up business elsewhere or puts them off setting up altogether, and makes it diffiicutllt for established companies to compete well.

Mr Lightfoot reminds his readers that public spending in the UK grew at an annual rate of 10.7% in cash terms between 1970 and 1996. In the lower inflation era that followed Labour pushed public spending up by 6.3% a year. The present government wishes to slow the pace to 2.1% a year growth in 2009-15. During this long period public spending as a percentage of National Income has fluctuated as widely as 36% and 50%. The highest percentages have been reached during downturns. The best growth rates have often been achieved with the lower proportions of public spending.

The book reminds us that past recoveries have taken place against a background of cutting back on the size and cost of the public sector. The private sector has in the past more than made up the running when this is occurring. In the 1980s the large privatisation programme trimmed total public spending, allowing debt repayment to occur. It also shifted substantial activity from the less productive public sector to a more efficient private sector.

In the last decade the large increases in public spending have been accompanied by declines in productivity. This has increased the drag on UK output and incomes from the surge in public sector employment. Mr Lightfoot thinks economies can become worryingly inflexible and unable to generate jobs and prosperity if public spending rises too high. He fears we have reached that point in some of the UK regions.

This is an interesting and timely book. No elected politician will nail his colours to the mast of public spending at 35% of National Income (as it almost reached in the early Labour years) for fear of Labour playing their usual trick of spelling out lurid cuts to get there. All main party politicians are signed up to Mr Lightfoot’s direction of travel, so they should look at his book to understand a little more why it might be good idea to cut the proportion of public spending in National Income. It is, of course, best done by growing the economy rather than by big cuts – exactly the course this government wishes to see, given its plans to carry on increasing cash public spending.

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26 Comments

  1. P Haynes
    Posted September 22, 2010 at 8:41 am | Permalink

    People can spend their own money directly on what they actually want or need.

    Alternatively the government can snatch this money off them and spend what is left (after collection and administration costs) on something the Government thinks might be good for them or more likely thinks might encourage them to vote for them.

    How can anyone think the second route is better than the first other than for a few basic services such as defence and law and order?

    • Stuart Fairney
      Posted September 23, 2010 at 12:01 pm | Permalink

      That is one of the best and most simple explanations of the small state position I have seen.

  2. Amanda
    Posted September 22, 2010 at 9:32 am | Permalink

    If 'parties' are frightened of the public sector then they need to start educating the public on why public sector spending is not a good idea; and why private people keeping more of their own money is a good idea. I think the body with the public educating remit has the initials BBC – so the Coalition needs to either ensure they are educating the public. Or, if they will not, withdraw their funding and spread it across organizations who will.

    Labour have created a monster in the public sector, and as we are seeming the public sector unions, quangos, bodies eg police and media eg BBC will put up a huge fight to hang on to their spoils – and the rest of us can go hang in their book..

    The fact they use 'the poor' as a cover for their greed is disgraceful. The poor would be better off learning to stand on their own feet. In addition, let's distinguish between the 'worthy poor' eg old people, disabled, and the feckless eg men in Newcastle who have 10 children with 10 different women, most of whom are on benefits. Will someone ask the 'poor's champions', why we should fund the sexual habits of such people? To the detriment of our own family lives !!

  3. Stuart Fairney
    Posted September 22, 2010 at 9:43 am | Permalink

    This is true so far as it goes, but we still seem wedded to the high-tax big-state concept in principle, you seem to be arguing for it to be a bit smaller.

    Where is the true radicalism? Why not start again by saying "Okay, law & order, plus tanks to protect us from the French, what else is essential?"

    Again, we are failed by parties who seem to argue that the state should be variously 35% to 42% of GDP and that nationalised health, education and TV and subsidies all round are untouchable, Fiat currency and debt spending is the only choice, we need lots and lots of politicians, impressive growth is 2% not the 10% China achieves, EU membership is good and non-negotiable (when they dare to argue it).

    Where are the capitalists and libertarians? Patrician conservatives and failed socialists offer no substantive change or difference and we really really do not need a repeat of the indistinguishable Heath/Wilson 1970's from Cameron Clegg and Milli

  4. John Moss
    Posted September 22, 2010 at 9:46 am | Permalink

    My personal perspective is that, international competition aside, When the state takes more of what you earn than you are are left with, then things have gone too far. Labour crossed thi sline with the introduction of the 50p rate, which couped with the uncapped 2% of NI means the state gets more than half of your income.

    Labour's 50p rate hopefully will not survive long, but we must not forget the hidden tax of National Insurance, or the imputed tax on dividends which affects small business owners as well as investors in larger corporations.

    Merging NI in to income tax for employees and having a single rate of tax above a generous amount of free pay would simplify matters enormously, as would paying dividends gross and taxing the recipients. This sort of simplification is another way of attracting economic activity as the cost of doing business is reduced.

    • waramess
      Posted September 23, 2010 at 11:38 am | Permalink

      Don't forget VAT or excise duty. In all they take on average 53 percent whatever misleading stats they produce to prove otherwise.

      And your hope that it will not survive long? The coagulation have just announced that VAT will rise to 20 percent so it would seem you are correct

      • John Moss
        Posted September 25, 2010 at 11:20 am | Permalink

        I think it is perfectly fair to use the tax system to discourage people from smoking and drinking alcohol. I would prefer driving were taxed less, but generally taxing spending at least allows some element of choice to the taxpayer.

        I favour the extension of multiple VAT rates, with lower rates on things you want to encourage, like improving and extending homes and re-fitting comercial buildings with more efficient kit – and higher rates on luxury items like high value cars, electronics and luxury food and drink. They do this in France with little fuss and we do it here, though bizarrely charge less for energy use.

        I hope the 50p income tax rate goes soon along with the bonus tax and that business Corporation Tax rates are redcued quickly. I also hope income tax falls, through increasing the free pay element, especially if this is combined with meaningful welfare reform.

        The signs are there that these things will not happen for five years, which is a pity. If all the Coalition deliver is cuts and high taxes, then they will be thrown out for a Labour Governemnt in 2015 which will return us to penury in no time.

  5. Nick
    Posted September 22, 2010 at 9:54 am | Permalink

    Were you not arguing that you were increasing spending over the next five years?

    ie. You're making the problem worse.

    • waramess
      Posted September 23, 2010 at 11:33 am | Permalink

      You are right, it's a puzzle, isn't it? And then the first thing the coagulation do on taking office is raise VAT to 20 percent and then to confirm they would keep the 50 percent tax rate and then to threaten a tax on banks bonuses.

      I wouldn't mind if it was all going to a charity but no, it is all going on more government spending.

      Our right wingers seem to be deserting in droves. Why, I wonder.

      • Stuart Fairney
        Posted September 24, 2010 at 6:41 am | Permalink

        It's because we don't want the patrician butskillism that's on offer from people like Cameron and our esteemed business secretary who seems to think that capitalism does not offer choice !!

        Setting aside the historical echoes, does anyone know of a nearby tea party because it's as plain as the nose on your face that the tories aren't going to offer any significant change, much less sack the ridiculous Cable and there are stil some of us who believe in capitalism.

  6. Mike Stallard
    Posted September 22, 2010 at 10:34 am | Permalink

    I watch Dragons' Den a lot. How many times do they say: "There is nothing in this for me. Therefore, I'm out."
    This is quite obvious: if the government takes all your profit and then plans (wrongly) what is going to happen, business men and ladies will surely say: "What is in this for me?"
    And, it is URGENT too.
    B*****er Labour!

  7. waramess
    Posted September 22, 2010 at 10:38 am | Permalink

    Low public spending returns resources to the private sector who are best placed to expand the economy. You know this so I have to puzzle why you say in the closing paragraph cut the proportion of public spending…………best done by growing the economy…………exactly the course this government wishes to see, given its plans to carry on increasing cash public spending.

    This all sounds a bit Keynesian to me. Cut the proportion of public spending through growing the economy by an increase in government cash spending. Why not just boost public spending and grow your way out of trouble ala Balls.

    It is just wrong to encourage the coalition to think that small cuts are going to do the trick or to spend the rest of their tenure worrying about how the opposition will respond to cuts.

    There are many reasons to suppose our economy will shrink permanently if nothing is done and then we are done for.

    The only answer is to return resources to the private sector as rapidly as possible and the only way to do this is through cuts in government infrastructure; either the hard way or through more privatisations

  8. Norman
    Posted September 22, 2010 at 10:40 am | Permalink

    I think this is the message the coalition needs to get out. At the moment the coalition appears directionless and is leaving an open door for Labour to push on (when they get a leader and he gets his feet under the table).

    All the talk is of cuts but the reasons given for cutting government expenditure are that we are spending more than we are gaining in tax and are running at a deficit. The impression one is given is that the coalition fundamentally believes that government spending is good, it's just a pity Labour went a little bit too far but if we tax a little more here, spend a little less there, and let inflation eat away a little of our wealth we'll soon be back on an even keel and the spending colussus can rumble on his merry way.

    This leaves the open door for Labour to say (with justification) 'If you agree government spending is good, why are you cutting so savagely when we are a long way from defaulting?' to which the coalition gives no credible answer.

  9. Norman
    Posted September 22, 2010 at 10:41 am | Permalink

    Sorry for second post, the comment was too long for one comment.

    Would that the answer was 'We are overtaxing our population, the sheer size of the public sector is stifling the private sector and government is simply far too large and needs cut back' but I guess that answer is just too 'nasty' for our media savvy leaders to contemplate.

    As an aside, I believe a commission was set up by one of the US Houses in the 80's to look at this question, how much of GDP should government spend. Can't remember if Friedman was chair or simply a member and the final figure also escapes me but I recall it was around 20% or so. Shows how far along the road to statism we are that no politician in the UK would even countenance a figure as low (or high, depending on your viewpoint) of 35%.

  10. Will J
    Posted September 22, 2010 at 10:59 am | Permalink

    Interesting that omitted from the reasons why high public spending slows growth is that it saps talent and energy from the private sector. Every talented person employed in the public sector is one not being employed in the private sector; every energetic person being paid handsomely by the state is one not looking for gaps in the market. I realise that this is only part of the explanation, but it shouldn't be overlooked. Reducing the size of the state is, among other things, about freeing up talent and energy for private enterprise.

  11. forthurst
    Posted September 22, 2010 at 12:06 pm | Permalink

    Is it not rather dangerous to calibrate the effiiciency of the economy by a reference to a single measurement? Undoubtedly, the private sector has far more incentive to engage in efficient expenditure. The public sector has two major deficiencies when set against the private sector: firstly, it has no bottom line, and second, there is a ministerial incentive to spend money in order to attach figures to 'initiatives'. These two issues can combine when consultancies sell expensive and unnecessary bespoken computer systems to departments whose problems would best be resolved by far better organisation and management rather than the imposition of expensive solutions for which there was no demand from service providers.

    But allowing the private sector to grow at the expense of the public sector cannot be construed a panacea: it is essential that those areas that grow should add value to the economy. Manufacturing, particularly for export needs to be encouraged, a swathe of activities involving financial manipulation which enriches a few at the expense of the many needs to be severely constrained through the legal and taxation systems. If we are to succeed we need to rediscover the roots of our original entrepreneurial rise and pre-eminance and ensure that the infrastrucure including education would support it. There is no such thing as a post-industrial society only a failed economy.

  12. Dave Cherling
    Posted September 22, 2010 at 12:15 pm | Permalink

    Why 35%? If it follows that less is more why not go for 25%? That would massively curtail politicians ability to cause trouble.
    The reason more public spending is bad for growth is that it does not produce anything. Labour expected to make the country wealthier by increasing it which is the same as trying to increase your family income by repainting your lounge. It makes things look better but has no other effect except to cost you money.
    As for all parties being signed up for cuts- no. They all talk the talk but, as you suggest, just hope that growth saves them from making hard decisions. The only real cuts I've heard of so far are to housing benefit which targets the poorest (maybe in the hope that they are Labour voters?).

    • Stuart Fairney
      Posted September 23, 2010 at 11:59 am | Permalink

      "That would massively curtail politicians ability to cause trouble"

      Yes indeed, P J O'Rourke observes that giving polticians money and power is like giving teenage boys whisky and car keys

  13. James Strachan
    Posted September 22, 2010 at 3:00 pm | Permalink

    You can read the same diagnosis from C. Northcote Parkinson.

    See the chapter "The Limits of Taxation" within the book "The Law and the Profits".

  14. Neil Craig
    Posted September 22, 2010 at 4:42 pm | Permalink

    I think it would be good politics for elected politicians to name a % of GNP they would like to bring government spending down to. Opponents would thus be forced to de facto admit they want a higher (or lower) figure (or endorse cuts to a non-credible extent which would also alienate their own activists). Such very limited polling as has been done suggests people would like it to be around 20%. Presumably they don't actually realise how high it is. If the Tories said they wanted to go for 40% the other parties would be stuck further away from the "centre ground" of public opinion than them Indeed on that figure about 80% of people could be expected to be with or to the "right" of the Conservatives..

    In the public interest I also think it would be better to shift the ground of debate onto the principle of how much rather than dealing with individual cases which can always be more emotive.

    I doubt if 35% is a particularly magic figure at which government turns inefficient. In the Victorian era it was as low as 6% of GNP. .

  15. Brian Tomkinson
    Posted September 22, 2010 at 6:39 pm | Permalink

    JR: "His wish to see our current proportion of public spending much lower is shared by all three political parties"

    Are you sure? I don't think Labour want to see public spending much lower and, as Nick Clegg said in his conference speech, after 5 years of coalition government and "difficult cuts" state spending will be 41% of national income – quite some way above 35% I would say. I hope politicians do read this book and conclude that despite generations of believing otherwise they are not the best people to spend other people's money but I'm not confident they will.

  16. Daedalus
    Posted September 22, 2010 at 9:02 pm | Permalink

    Personally I would like to see public spending below 30% by 2025, which is when I retire, if I’m lucky. That would mean a REAL task for this coalition for this parliament. If we managed to get people back to work in real jobs there would no need for the amount of Social Security payments we currently make. No money should be paid to recipients of SS, it should be all in vouchers for the sort of food people need rather than want, no ciggies no alcohol. Tax, flat rate no bands no exemptions including charity payments, no minimum wage for places like Middlesbrough, Gateshead, Hull or Liverpool; get people into jobs. Make it easy for companies to start up in the depressed North, I know what it’s like, I live here. God I could go on but!!!!!!!!! I’ll be buzzing again and the wife won’t talk to me.

    • Andrew Johnson
      Posted September 23, 2010 at 10:11 am | Permalink

      Good points well made, to which I would add one more. Why do the good people of the North abandon their usual commonsense and keep voting Labour, when that party, in and out of power, has not given priority to recreating the jobs, wealth and influence the North once had?

      • Daedalus
        Posted September 23, 2010 at 9:21 pm | Permalink

        Having been born just north of Liverpool and apart from13 years when I was in the merchant navy working abroad, I have alway worked in the north, minus 1 year in London. I have always voted conservative, unless liberal might have spoilt the vote (once). I have constantly pointed out the error in voting labour and in my local even ordinary "working men" electricians, plumbers, decorators do not vote labour. Some of my neighbours "champagne socialists" dentists, opticians, teachers, real dual income proffesional families had vote labour posters in the gardens in 97. The other ones in my local who voted labour are the welfare recipients who can afford to go to the pub, funnily enought they where the ones who complained most about the smoking ban.
        I have pointed out more times than I can remember that the tories bring wealth and the possibilty of you making a good living, labour leave you in dept and with less jobs!!!!!!!!!!

  17. G Haynes
    Posted September 23, 2010 at 8:23 am | Permalink

    35% seem rather high but who could sensibly argue with the general principle? Tax avoidance far from being immoral as the Chief Secretary to the Treasury seems to believe is thus clearly a great force for good.

    It enables funds to be spent or invested directly and efficiently by the taxpayers on worthwhile things tax payers actually want rather than indirectly and inefficiently by the state on largely pointless ones.

    Worse of all is the all too common situation, where the state "invests" in pointless QUANGOS. These are usually staffed by highly paid and pensioned friends of the powers that be who then spend their time causing pointless inconvenience, form filling, licence fees and expense to productive industry. Thus rendering these industries uncompetitive ultimately putting them out of business.

  18. jedibeeftrix
    Posted September 27, 2010 at 11:12 pm | Permalink

    "Warwick Lightfoot is publishing “Sorry we have no money: Britain’s economic problem” (Searching Finances 2010) to argue the case that any country which allows public spending to go above 35% of National Income will grow less quickly and will be less well off than one which keeps control of its public spending."

    This is a message that needs to be absorbed, understood, and accepted much more widely. If we wish to reach the year 2050 with an GDP/capita of circa $80,000 (25%above France and Germany according to Cargegie) and do without the 'helping' hand of of rampant inflation then we will require a tax regime that collects somewhere between 35% and 40% of GDP, not 45% plus.

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    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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