Month: February 2011

The following letter from Dr Roy Spendlove (Miscellaneous Projects) to Dame Lucy Doolittle  (Director of Unit for co-ordinating cross cutting initiatives and partnerships)has come into my possession. It shows latest civil service thinking on the cuts.

Dear Lucy,

               I felt it was time I reported to you on the progress we are making in explaining the realities of public spending to the new Ministers and the Treasury. As you appreciate, many official colleagues felt the spending envelope was too tight and would require various adjustments, programme by programme.

                 The government as a whole wisely signed up to presenting the £90 billion a year cash increase in current spending over the five years as a large cut. As Ministers are now finding out, the cash increase will entail substantial and difficult reductions in various areas, and some redundancies.  The demands for cash for the EU budget, the Euro loans, overseas aid, health reform and benefit reform will eat up what extra cash is available.

              Ministers have now accepted that they were too hasty in considering the sale of forest leases. The new work on protecting biodiversity and woodland access may require an additional estimate  for the Forestry Commission. Ministers also accepted that it made no sense to be too parsimonious on school sport facilities, and have revised that measure.

                    At Work and Pensions they have accepted advice to delay the reform of benefits until 2013, and to implement it over the election years 2013-17  assuming a 2015 election. This we felt would ensure moderation in implementation, and leave time for the large computerisation programme it entails. . Ministers have also opted for a guarantee that there will be no cash losers, which means we need to budget for the higher costs of change accordingly.

                     At Defence Ministers agree that in order to meet the tough totals there do need to be redundancies, rather than  relying on natural wastage. Officials pointed out that if you rely on leavers you do not necessarily keep the structure of forces you want. This does entail more difficult decisions and higher cost. The email sackings were an unfortunate error which highlighted the difficulties of the spending policy.

                      Ministers have decided to put some more money into charities and the Big Society, following the insensitive  decision by many Councils to cut their grants to worthwhile causes as part of their response to the spending squeeze.  The government willingly advanced a substantial sum to Ireland, which equalled the budget savings for 2010-11, reminding Ministers how events can alter strategies very quickly.

                       We should warn Ministers that the health reforms also require substantial new computer systems to make them work. The new purchasing consortia need to provide professional back-up to the GPs and need to be properly staffed and tasked.  The GPs will not take kindly to these changes if they feel preparation has been poor, or budgets pinched, not allowing them the full support they will need to take on these new areas of activity. I am sure Ministers will come round to the view that it is worthwhile spending more here to bring about a better outcome.

                       I will of course alert you to any other areas of potential trouble before they arise. The more we look at it, the more we feel the settlement was unrealistically tight and may in later years need to be relaxed. Given the limits placed on the budgets there will be further issues that arise that entail unpopular decisions. As we have seen with the forests, lobby groups are strong and active, so we need to be ever vigilant. There remain issues over the 2013 reduction of Child Benefit that could be worthwhile revisiting soon.  I do hope you can get these messages over to the Treasury.

Yours

Roy

 

                  Most agree that fighting the last war often leaves you wrongly equipped for what might come next. There is also a futility about trying to refight the last war if you have already lost it. However much you try, the past result remains.

                  The Bank of England specialise in doing too much too late. The Bank recommended membership of the Exchange Rate Mechanism, which gave us boom and bust and ended with the ignominious exit of the UK from the Mechanism.  Our interest rates were treble the level needed and were throttling the UK economy.

           The Bank in 2004-7 encouraged and allowed a massive explosion of credit, failing to raise interest rates soon enough or fast enough to restrain the banks. It ignored both opposition political parties who warned that credit was out of control.

                  In 2007 to early 2009 the Bank kept rates too high for too long, starved the markets of liquidity, and helped bring the banks into the Credit Crunch. The Bank ignored those of us who told them to slash rates and make more money available to the money markets. At one point the politicians rightly took the decision out of the Bank’s hands by reaching international agreement for lower rates. In 2010 the Bank failed to raise rates to prevent the inflation which is now very predictably hitting us. I called for higher rates more than a year ago to head off the inflation we now have.  

                So now the Bank is in a difficult place. Most people read the G0vernor’s letter on inflation to mean two or three increases in rates this year, starting in May. It is difficult to see the logic of these, given all that the Bank has said about why it didn’t bother to raise rates a year ago when the inflation was a forecast, not a reality. Higher sterling is the only way to bring current inflation down a bit, and that requires monetary action yesterday, not in May.

                  The problem is greater now, because the strong worldwide recovery which we have been experiencing is about to be slowed by tougher monetary action elsewhere. Brazil has a 11% interest rate. India and China have raised their rates to 6% and may go higher.  China is seeking to cut the rate of growth of money and bank credit. Even the USA will probably stop printing money by misdsummer and will be thinking of interest rate rises.  The world monetary climate will get cooler later this year, which will in due course take some of the heat out of commodity prices. It will also come at the price of slower worldwide growth.

                 UK money growth remains low. There is the chance that higher prices will not lead to substantially higher wages, particularly if the public sector sticks to its stated policy of a two year pay freeze. The recovery which should resume this quarter after the poor end to 2010 will encounter more headwinds from the global position, and from the sensible decision to slow the rate of growth of public borrowing.

                  The answer is that you cannot mend the UK economy just by moving interest rates. If the Bank is eventually going to raise rates, help savers and have a stronger pound, at the same time it needs to sort out the commercial banks. It becomes their regulator shortly. It needs to understand that current banking regulation is pro cyclical. It is making recovery more difficult, just as surely as it stoked the credit boom by reinforcing that destructive cycle. If it wants lower inflation and more growth it cannot just raise interest rates.

                  The Bank’s latest forecast is for inflation to stay well above target for 2011. The Bank rightly reminds us that commercial banks need to refinance around £400-500 billion of  their borrowings this year. Official rates are well out of line with market rates. The Bank shows us that the typical personal loan costs 10% and a 90% mortgage 6%. Meanwhile money growth is sluggish, credit restricted for small and medium sized companies according to the Bank, and GDP still around 5% below early 2008 levels.

 

                    Yesterday the No to AV campaign claimed that the referendum to change the voting system would cost taxpayers £250 million. This was an eye catching claim.  It did not cheer up many who want public spending brought under control without damaging important services. The cost of the referendum joined overseas aid to more successful countries, and the growing EU budget, on the list of  spending many would like to cut.

                    As it happened the government yesterday brought a Money Resolution to the Commons on the very subject of the referendum. It seemed an ideal opportunity to test out the No to AV claims.  Would it really cost as much as £250 million to hold the count on this item on the same day as local elections? Could it be done more cheaply?

                  The government’s Money proposal was a minor technical matter. They had already secured agreement to the general expenditure. The Minister asked to defend this proposal was unable to tell the House how much the AV referendum would cost. He told us the latest change would reduce the cost, but was unwilling to share with us how much it take off the bill and what the new cost would be. Labour agreed with the government’s motion, so there was no point in dividing the House on it. It was not a good  moment for Parliamentary democracy. Parliament’s strength emerged from a tussle to control the state’s spending and taxing.

                    We learn that the No to AV campaign has less money from donors to spend than the pro AV campaign, and that it is now behind in the polls. Both sides in this argument are going to find it difficult to grab the attention of the public. I do not find my email b ox jammed with messages for and against a change in the voting system. Parliament seems to be spending money on something which is not top of the public’s concerns. MPs are finding it difficult to galavanise electors, or even to explain how the AV system works.

 

              Inflation is well set around the world. At least most commentators now recognise this, and have stepped away from telling us the main  threat was deflation. The large increases in food prices which lax money policy has triggered have had one unexpected result – it has helped fuel the anger of the crowds taking to the streets in a succession of dictatorships. Inflation in India and Brazil has led to much higher interest rates in an effort to cool things down.

              This week China has reported her inflation up to 4.9%. The Chinese authorities who allowed a big monetary expansion to ward off the effects of the western Credit Crash have been taking strong action to curb the price rises. Interest rates are over 6% and the banks are required to lodge a lot of money with the Central Bank to restrict their lending.  

               Today the Uk is likely to report that our RPI inflation is now higher than China’s published figure. Our official interest rates remain at 0.5%, almost 5% below the RPI inflation rate. The UK authorities will take no action to tackle it.

              There are some important differences between China and the UK. The UK is heavily in debt, whilst China has record levels of reserves and investments in overseas bonds and Treasury instruments. China is growing quickly, whilst last quarter the UK did not grow at all. Chinese banks are still  lending plenty of money despite all the efforts of the Chinese authorities to rein them in, whilst UK banks are unable to lend much owing to the new regulations and the aftermath of  the crash.

              The Uk authorities are banking on China succeeding in slowing things down, and taking some of the heat out of commodity markets. Meanwhile the US keeps printing dollars. Some of those will continue to find their way into  commodity speculation. The more the US presses the monetary accelerator, the more China, Brazil and India have to put on the monetary brakes. It’s not a great system.

 

                  A government needs both strategy and tactics. A sensible government, if it makes a tactical error, will quickly apologise, adjust and move on. If a government makes a serious strategic error – like John Major’s ERM decision or Gordon Brown’s boom and bust policy-  it is likely to be terminal for that government.

                 Recently there have been criticisms of the Coalition government’s approach to school sports, to selling woods, to funding charities and to supporting debt counselling, among other issues. Most of these are tactical issues arising from the strategic decision to cut the deficit. The government has changed in response to criticism in each case.

                  The underlying strategic judgement that public spending needs to be brought under some control is correct. The spin that the cuts are going to far larger than the overall figures imply may reflect the public view of some individual cuts which will be unpopular. What matters is that the government develops a flair for controlling public spending better without doing damage to cherished front line services. Given the numbers this should be easy. Given the politics of dealing with so many quangos and Councils, it will be difficult. Setting out the true cash spending  figures in each case might help explain it to the undecided or neutral.

                      The government has three main strategic aims. The first is to bring the deficit down by a large increase in tax revenues and better control over spending increases.The second is to reform public services. The third is to implement its Big Society vision.

                       These three strategic aims have the advantage that they do all largely  pull in the same direction. Welfare reform could result in much lower bills if many more people get jobs. Getting people back to work rests on the very same economic recovery that higher tax revenues rest on. If the Big Society arrives to delegate power to local groups and to front line public service employees, it could help deliver better value public service and be part of public service reform.

                      The latest challenge to the approach is  for opponents to claim that public service reform and the development of localism and the Big Society all require substantial injections of Whitehall cash. The government  has to reject this convincingly and show it is not true. Otherwise public service reform and Big Society growth get in the way of deficit reduction.

                          A few tactical retreats or changes shows flexibility. Too many will create a sense of weakness. If you lose too many tactical battles you end up losing the strategy that led to them.To see through spending control and service reform, the government has to judge its battles well and win them.

 

             Some contributors have written in to say they think the answer to the prisoners’ votes issue is for the UK to pull out of the Convention and settle its own ideas in Parliament. The piece I wrote did not express my view, but sought to say what I think the government will do, and what Parliament might then do. I often use this site to provide commentary and forecasts. Sometimes I give my own personal view, but I think the site needs to do more than that to make it a wide ranging forum. Contributors should know by now that I do think Parliament should make these decisions, but that does not mean it is about to happen in the pure way many would like.

       Some have written in to say the west has been hypocritical in welcoming the success of people power in Egypt when the west has in the past supported the old regime, and still supports other regimes in the  Middle East that are far from democratic. Western countries do not think they should be trying to topple all undemocratic regimes. They accept the need to get on with a variety of different styles and types of government, and to usually leave how a country is governed to the people who live in that country. There is nothing hypocritical about welcoming changes to governments that go in the direction we favour, without having worked to bring that about.

 

          The Prime Minister has said he wants to explain the Big Society idea better. He has appointed a couple of Big Society advocates to spread the word.

         The good news for him is that the Big Society is alive and well. I take it to mean that the public good can be furthered by private and voluntary action, as well as by state programmes. The UK has a long and proud tradition of charitable work. It has a great history of private sector companies taking responsibility for many vital services, from the supply of bread to the discovery and manufacture of pharmaceuticals. It has many charities involved in caring for the sick and lonely, assisting the poor and disabled, and helping families in distress.

         The left wishes to argue that much of the private sector is solely motivated by profit or self interest, which they think rules out that sector doing good for others. Where they accept that charities, mutuals and not for profit companies have a role, they usually judge their social purpose and their effectiveness by how much public money they attract.

        One of the absurdities of the New Labour era was the support or creation of third sector charities and other institutions that spent considerable time and money on raising money in the form of grants from different branches of government. Such a body was said to have mixed funding if it received cash from a Council or two, from a quango or two and from central government. It is such bodies that are now finding life more difficult, as all parts of government review their policy on financing external bodies. True charities have always raised all or most of their money from outside government, so they will not be adversely affected by public  spending controls.

         The test of the Big Society idea over the next four years is this. Will there be more mutuals, more charitable giving and activity? Will groups of public sector employees set up their own institutions to further the public good?  Will there be new or more ways of joint working, and better ways of furthering the public good by private means?

 

        Well done to the people of Egypt. They have swept away a dictatorship. They now need to ensure the army understands the new reality, and is prepared to pave the way for free elections and a new kind of government.

       Meanwhile, the wave of popular protest is heady and spreading. Satellite TV and the world wide web make it impossible for other dictators to keep the lid on the message from Cairo. Today attention moves to Algeria. Many undemocratic   regimes need to rethink their strategies for understanding and handling public opinion.

 

                 How much more inflation will it take to get the Monetary Policy Committee to notice it? The recent producer price numbers show increases of more than 13% in the costs industry is incurring, and inflation of output prices by almost 5%.  As a contributor to this site has asked, what is the point of the MPC other than to prevent this kind of thing happening?

               The Bank’s defence is that it cannot be expected to offset increases in world commodity prices, including oil, metal and food. It sees these increases as outside their control, and assumes they will subside as quickly as they came about. The Bank slides over the role of weaker sterling in increasing our prices, ignores the fact that other western countries facing similar increases in world commodity prices are not experiencing the same increases in their general price level, and glosses over the period of  more than a year now when they have been saying this is temporary.

             I have a further worry. Maybe these commodity price rises will come to an end when the US stops printing dollars, and as the Chinese and Indian monetary tightening has more impact. The UK, however, faces structural price rises in energy costs in the years ahead, as it brings in the full carbon price regime and more expensive ways of generating electricity. The whole of western Europe faces higher costs of doing business, as the regulators introduce many more ways to make manufacturing in the EU dearer.

          The UK government wants to rebalance the UK economy, placing greater emphasis on making things. Last year we imported £96 billion more goods than we exported, so there is plenty of scope to do so. British business could both sell more abroad, and replace more of the imports with domestic production.

               Quite often people think the difficulty in the UK is relatively high wages. For much modern manufacturing wage cost is not the main issue. Processes are highly automated. It is the costs of bought in materials and energy that are more important. Location decisions rest on transport, power and access to materials, as well as the ability to recruit a good workforce.

              To bring about the transformation of the UK economy the government seeks, with bigger and stronger industry spread out around the country, business needs access to plenty of good value power, good transport for exports and imports, and access to plentiful capital to buy the plant and machinery needed.

             There is more to be done in all these fields. A local company recently asked me to intervene with the power utility to get access to the amounts of power they needed – and that was not process industry burning large amounts of energy.

             Hitting our carbon taregts by exporting more of our energy intensive industry to places where energy is cheaper neither saves the planet nor transforms our economy.

             The deficit reduction measures are already having an impact on real incomes, as this year all the strain has been taken by the private sector through a series of tax increases. Next year the slower rate of growth of current public spending does bring some areas of reduction, to offset the more rapid growth in the preferred programmes. The degree to which the cuts do damage depends entirely on how the public sector manages the change from rapid growth in cash spending to slower growth in cash spending.