Bill Jamieson: Spending squeeze means more pain

Economist Paul Krugman is cited to justify the case for more spending and borrowing. Picture: Getty
Economist Paul Krugman is cited to justify the case for more spending and borrowing. Picture: Getty
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WANTED urgently to drive Scotland’s economy: a big fiscal boost via higher capital spending and infrastructure projects. But looming ahead: a severe and unrelenting public spending squeeze.

This is the conflict at the heart of two major forecasts for Scotland’s economy: the Fraser of Allander (FoA) Institute assessment and a paper on long-term budget projections from Fiscal Affairs Scotland (FAS).

We are fortunate in having two such detailed and forensic analyses to hand. In combination they provide the Holyrood administration and Scotland’s business community with plenty of fact and much with which to contend: how can the upturn be sustained in the face of the most challenging period yet for public expenditure?

The good news is that, for the time being, growth in employment, investment and GDP is set to continue, albeit at a more modest pace than forecast by FoA in June.

And some comfort can be taken that, after a long series of forecasts highly sceptical about recovery when not in outright denial, FoA has come to recognise a substantial improvement in our fortunes.

“We can conclude that elements of a balanced recovery are falling into place,” it writes.

Hallelujah for the doubter that now sees an upturn that its previous analyses deemed was impossible. Quite why FoA got its previous forecasts so wrong and we have been enjoying an upturn without a fiscal boost of the type it regularly recommends is not examined.

But let’s mark the admission of improvement: Scottish GDP growth in the first half of this year, it observes, “was somewhat faster than previously forecast”. Its GDP forecast for 2014 is now 2.7 per cent, revised up from its previous 2.5 per cent in June. For 2015, it is maintaining its previous forecast of 2.2 per cent, though for 2016 it has trimmed its forecast from 2.4 per cent to 2.1 per cent, largely reflecting the continuing weakness of the Eurozone economies.

Production and manufacturing continue to be the major sectors exhibiting the fastest growth over 2014-16. On job creation, it has made a slight upward revision to its forecasts for 2014 but further downward adjustments for 2015 and 2016. Its central forecast is that net jobs will increase by 46,560 in 2014, 41,600 in 2015 and 48,900 in 2016. This year it expects nearly 40,000 service sector jobs to be created, with around 2,100 added in production.

And it sees unemployment on the International Labour Organisation measure falling to 124,700 (5.3 per cent) by the year-end, down again to 5.2 per cent next year and to fall again to 5 per cent by the end of 2016.

Now all of this comes with caveats: net trade has been consistently negative for three quarters and prospects for sustained investment spending depend on the growth of domestic demand and household spending in particular.

And “in the light of slowing growth, the risks of secular stagnation… there is a strong case that government, and the UK government in particular, should invest more in infrastructure in and for Scotland”.

Here Professor Paul Krugman, relentless champion of government largesse, is once more invoked to justify the case for more spending and borrowing, even though there has been no “secular stagnation” and instead we have been enjoying an upturn with squeezed spending and lower borrowing.

“Debt-financed projects,” FoA writes, “could have large output effects without increasing the debt-to-GDP ratio, if clearly identified infrastructure needs are met through efficient investment.”

Even assuming the condition of “efficient” investment delivering growth improvement is met, it is 
not just the abstract debt ratio we have to worry about but the very real and growing burden of debt interest, already sucking more than £50 billion out of government coffers every year.

And it is this relentless growth in the burden of debt servicing that dictates further spending constraint to bear down on our deficit and debt.

The implications, as Fiscal Affairs Scotland well sets out, are grim. At present, it notes, both Scotland and the UK are roughly halfway through the series of annual budget reductions to take the UK back to a balanced budget. For the first decade of the new Scottish Parliament the Scottish budget rose in real terms by around 5 per cent a year. But the second decade of the parliament coincided with a likely real-terms fall in its budget of around 2 per cent a year.

The baseline forecast of FAS, going from 2009-10 to 2018-19, incorporates spending projections used by the UK Office for Budget Responsibility. This results in an overall cash-terms cut to the Scottish budget of just over 4 per cent and a real-terms cut of almost 20 per cent over this period.

At present (2014-15), the real-terms cut since 2009-10 stands at 10 per cent. The profile of cuts over the full nine years is: two years of deep cuts, followed by four years of milder cuts (where we currently sit), followed by the prospect of three more years of deep cuts.

While most of the intended cuts to the capital budget in Scotland happened in the first two years of austerity (ie, in 2010-11 and 2011-12), for spending on day-to-day services the biggest cuts are still to come. Continued protection of the NHS budget will result in the cuts to non-protected areas being over 50 per cent higher than the average – that is nearer 30 per cent over the full period.

A spending squeeze of this intensity will stretch the limits of political acceptability. Indeed, it is likely that these deficit reduction targets ahead of the May election will be modified and stretched over a longer period. The problem is not that governments don’t know what has to be done; they just don’t know how to be voted into government to do it.

For the time being, business will have to contend with uncertainty over continuing government contracts but with the consolation of a bias towards capital spend, low inflation – and rock-bottom interest rates well into next year. «