THE ECONOMIC CHALLENGE TO THE TORIES

John Wood of the Institute of Economic Affairs sees some rough water ahead for the new Go vernmen t.

As the new government is slowly and reluctantly beginning to realise, huge— indeed, hitherto unimaginably huge7-cuts in state spending must be made if the Conservatives are to have any chance. of reconciling their potentially conflicting Policies of lower taxation and lower inflation. That is why the new Chancellor, Sir Geoffrey Howe, in his first speech Promised to make "a substantial start at once" in making economies. It will take many years of economising, however, and countless difficult political struggles will i have to be won, particularly as there s now no way to avoid drastic changes in the scope and financing of the welfare services, which have come to account for over half of government spending, and nearly 30% of national income. The new government would in any case have had to make substantial cuts simply to prevent inflation getting worse. The going i rate s now over 10% and recent behaviour of the money stock suggests that it could rise to 15%—as the former Chancellor, Mr. Healey, has admitted. Then, to reduce inflation rather than just contain it, will require still further cuts. Indeed if the aim is to reduce inflation to zero—and why not?—the share of resources taken by government will have to be drastically brought down. At the same time the government is committed to reducing taxes on incomes—a major political aim, which it dare not fail to achieve.

As if this were not enough, the international context within which British economic policy must take its place is unhelpful. Slower growth is expected, partly because of the rising cost of oil, but more importantly because of the worldwide move back towards balanced budgets, as one country after another, disrupted by decades of inflation, turns away from the horrors of Keynesian deficit financing. The United Kingdom cannot insulate itself from Lui U11U, 4110 SO 101 I114lI reasons, We Chancellor's overriding war aim must be to reduce to nil the Public Sector Borrowing Requirement—or budget deficit in plain language—during his term of office. What that means and the enormity of the problems involved, can best be illustrated by some drastic simplification and a few "order of magnitude calculations". No fine cabinet work here—just rough carpentry.

The pre-budget outlook for the financial year 1979/80 is that on existing policies there will be a P.S.B.R. of about £10 billion —equal to the worst figure ever known. To get rid of this incubus—and thus to avoid generating fresh inflationary pressure— will take several years of stringent financial control. Unfortunately some easy but false optimism is already being generated by the idea of disposing of some of the state's more marketable assets. However admirable the policy may be on its own merits, it would fail to yield anything like £10 billion for the Exchequer, and that for one year only, even if implemented in the most Draconian fashion.

Selling the pictures off the walls

The most attractive 'lot' in what has been dubbed The Sale of the Century is, of course, the state's 51% shareholding in British Petroleum. But City estimates put £2'4 billion as the best figure that is likely to be obtained. Other easily realisable assets include the portfolio of the National Enterprise Board, which has a balance sheet value of £1'4 billion, and the holdings of the British National Oil Corporation, worth perhaps £1/2 billion. Add to this some of the routes operated by British Airways, the National Bus Company, and all the unrelated assets held by the nationalised industries (brickworks, hotels, showrooms) and the land 'banks' built up (but not on) by local authorities, and still the total receipts would probably fall short of £8 billion. Even if some (or for illustrative purposes, all) of the nationalised industries were to be sold back to private hands, the sum that could be obtained for them, when measured on the scale we are using—a £10 billion module— would be quite limited, since only a few of them have the potential to make big profits.

Of course, such a policy of 'selling the pictures off the walls' though effective as a once for all temporary expedient may not only have disturbing consequences for the capital market, but also fails to tackle the essential trouble, which is the apparently unstoppable rise, year by year, in current spending by government. By making a rough and ready classification of all forms of current state spending into three groups, and setting each against our module of £10 billion, some instructive lessons may be learned.

Where should the axe fall?

The hard core of government services, which even extreme adherents of the Manchester school would not wish to see disbanded, costs just over £10 billion. This includes defence, law and order, and public services which can only be provided collectively such as roads, sewage, and facilities for public health. Many of these items are likely to cost more rather than less under a Conservative administration (e.g. the Armed Forces and the police), so there is no scope for savings here.

The next grouping covers all forms of government 'help' and subsidy, and is a measure of the extent of government intervention in the economy. It includes every kind of support to industry, transport and agriculture, including regional policy, and help for 'lame ducks'; money spent on job creation schemes, grants to local government, to parks, libraries, museums and other amenities. Even if all this—and overseas aid—were to be abolished entirely, the saving would only be of the order of £8 billion. It need hardly be said that to withdraw all government spending for these purposes would be quite impossible, except over a period of years.

Which cows are sacred?

So by a process of elimination one comes to the last group, welfare spending, which, simply because it is so large, offers the best scope for economy. In 1978 welfare spending of all kinds cost three and a half times the anticipated £10 billion borrowing requirement—the cost of housing programmes and subsidies alone cost £5 billion. Welfare services have come to account for over half government spending, so for that reason alone, it is here that the Chancellor will have to resolve his conflicting policies. Although some help may be had from elsewhere—the disposal of assets, and the reduction of government subsidies already discussed—the sheer scale of welfare spending makes it the inevitable area for big changes.

A long diversion from the main theme of this article would be needed to explain why welfare is no longer the sacred cow that it once was, and why major reforms in state education, housing and health would be politically popular, rather than unpopular. Discontent with universal, tax financed, collectively provided services has now grown to such an extent that a majority of the population would prefer to contract out of state services and rely on private provision. The Prime Minister's emphasis on the restoration of 'choice', in the debate on the Queen's speech, reflects her awareness of the change of opinion that has taken place. It is a reassessment which will be amply confirmed by the findings of an extensive and authoritative investigation into the welfare services shortly to be published by the Institute of Economic Affairs, under the title 'Overruled on Welfare".

It will still no doubt be asked whether the prospects for Tory economic policy need be quite so bleak as here outlined. Is there no alternative way ahead? One there may be, but only one, which is to gamble on reducing taxes on incomes sufficiently to provoke a massive increase in output. The precedent of 1970-73, which the Tories are unlikely to forget, is unpromising. Mr. Barber's error then, in putting taxation reform before expenditure reform led to disaster, and cannot be repeated. This time expenditure will have to be severely restricted as a necessary condition for success. Further, just to keep a sense of perspective about what is possible, it would require a 10% leap in real output to provide £10 billion of extra resources, and the rate of growth recently has been very slow—between 1973 and 1977 only about 1%.

The real incentive

Nevertheless many experts argue that cuts in income taxes can be made without substantial loss of revenue, particularly on higher incomes. The cost of reducing the highest rate of tax on earned income from 83% to 60% is in any case derisory—onlY £400 million—and incentives would be altered in two ways, both for the better. First, it would be worthwhile to work harder to produce more, and second, it would no longer be worthwhile to work so hard in avoiding and evading taxation. As for lowering taxes more generally, the cost of bringing down the basic rate to 30% is over £1 billion, and if only because the gain will be proportionately less for lower income earners, the impact on output maY also be less dramatic. The critical point to keep hold of, however, is that concessions in taxes must be closely linked with increases in output which can pay for them. That can only underline the importance of encouraging new and better systems of payment, which link reward with results, as is the

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