On the scope for cutting public spending

Currently, the major political parties in Britain seem to agree that some cuts in public spending are required in order to help bring the soaring, post credit-crunch, budget deficit under control. However they are reluctant to indicate exactly what they will cut and are also reluctant to imply that any major cuts will be made this year (let alone this side of the election which must be held by the summer). The most you tend to get is the mention of a few specific items adding up to at most a few billion (a small percentage of total spending).

This reluctance is understandable. For much of the time since 1997, if a party (usually the Tories) talked about spending cuts, especially if they start attaching figures to the desired levels of cut,  their opponents (usually the government or the Labour party) will ask how many doctors, nurses, teachers, policemen, schools or hospitals will be scrapped, or claiming it will lead to some scary number of them being scrapped, as if any significant cuts in public spending must necessarily hit frontline public services. The political tactic is to suggest to voters that any cuts must entail fewer schools, hospitals, doctors, teachers, etc, and thus those proposing cuts will endanger the services voters care about.

John Redwood, writing in the Telegraph, suggests that actually there may be more scope for cuts that don’t impact public services than debates on this issue usually acknowledge:

The good news is cutting public spending is technically easy when you look at just how much needless and wasteful spending there is.

Anyone saying you can cut without sacking a single nurse, doctor, teacher or uniformed person is usually ridiculed, but it is true.

Out of the 6 million state employees, only around 1 million are these essential front line workers.

Over the last few years public sector efficiency has failed to rise, whilst private sector efficiency regularly rises by 2.5% a year or more.

It is possible to do more for less in the public sector, by applying some of the disciplines of the well run office, shop or factory.

Further support for suggesting there is scope for cutting public spending without touching frontline services can be found in a graph on page 12 of the 2009 Pre-Budget Report. It lists the £676 billion worth of projected public spending for 2009/2010 broken down into the following categories:

  • Social protection £190 billion.
  • Personal social services £29 billion.
  • Health £119 billion.
  • Transport £23 billion.
  • Education £88 billion.
  • Defence £38 billion.
  • Industry, agriculture and employment £21 billion.
  • Housing and environment £30 billion.
  • Public order and safety £36 billion.
  • Debt interest £30 billion.
  • Other £72 billion.

I.e. there is £72 billion worth, over 10% of the total, being spent in addition to the budgets for education, health, industry, the environment, transport, public order and safety, social protection, personal social services, defence, housing and even the payment of  debt interest.

How much of this spending is necessary? Could we not make cuts here without harming front line services? This depends on what the £72 billion is being spent on. The notes in the chart explain: “Other expenditure includes general public services (including international services); recreation, culture, and religion; public service pensions; plus spending yet to be allocated and some accounting adjustments.”

I wonder how much of spending on recreation, culture and religion is really necessary?

What “general public services” are left after you factor the public services covered in the other major categories of spending?

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Have world poverty and inequality fallen since the 1970s?

This article suggests so:

Between 1970 and 2006, the global poverty rate has been cut by nearly three quarters. The percentage of the world population living on less than $1 a day (in PPP-adjusted 2000 dollars) went from 26.8% in 1970 to 5.4% in 2006 (Figure 1).

Although world population has increased by about 80% over this time (World Bank 2009), the number of people below the $1 a day poverty line has shrunk by nearly 64%, from 967 million in 1970 to 350 million in 2006. In the past 36 years, there has never been a moment with more than 1 billion people in poverty, and barring a catastrophe, there will never be such a moment in the future history of the world.

And later:

We can compute not only the world poverty rates and the poverty rates of any country or region, but also other statistics related to the distribution of income. For instance, we can compute the world gini coefficient, a measure of world inequality, for every year between 1970 and 2006. We show that world inequality measured by the gini fell from 67.6 to 61.2 (Figure 3), and similar declines in inequality can be shown for other inequality statistics, such as the mean logarithmic deviation, the Theil Index, and the Atkinson family of inequality indices.

Finally, for many theoretical concepts of welfare (e.g. Atkinson’s expected utility for the society, or Sen’s real national income) it is possible to find an inequality index described above such that the welfare concept can be represented as GDP multiplied by one minus the inequality index. Since we can compute these inequality indices, we can show that because world inequality fell, welfare measured for the world as a whole grew even faster than world GDP did, and more than doubled over the period 1970-2006.

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Lights out, Britons told – we’re running out of power

I wrote earlier about a possible gas shortage, but the evidence of a general energy shortage is mounting too. The Register reports:

Exclusive Carbon quango The Energy Saving Trust has come up with a new reason for Britons to save energy in the home. Our power stations will soon close, and you’ll need to do your bit.

That’s what one Reg reader discovered, after enquiring about the Trust’s calculations on the effectiveness of new low-energy bulbs.

“A reduction in electricity consumption will be essential over the coming decade as a large number of power stations are being withdrawn from service, and as a result there is a gap looming between supply and demand,” Graham Crocker was told. “More efficient lighting (which accounts for nearly 20 per cent of domestic electricity consumption) will go some way to alleviating these demand pressures.” The answer came from Alex Stuart, assistant manager of services of development at the quango.

“This is the first time anybody has acknowledged that new power capacity will not be delivered on time to replace existing capacity,” Peter Lilley MP told us.

There’s no doubt that Britain faces a looming energy crisis. CapGemini estimates that a quarter of the UK’s energy plant capacity will close by 2015. The nation will also see declining oil and gas output from the North Sea. But new, replacement power generation will not arrive in time.

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Is Britain facing a gas shortage?

EU Referendum writes:

The source of this information is Centrica, owner of British Gas, which says that, on present trends, its main reserve will be totally depleted in a little over three weeks. And though extra gas can be imported from Norway and the Netherlands to make up any shortfall, serious breakdowns have hit pipelines from both countries in the past week.

Thus we are told that the crisis reveals an extraordinary failure to plan for the future as supplies of gas from the North Sea have run down, turning Britain into an importer of the fuel. Though now dependent on overseas supplies, it keeps only about a quarter as much gas in reserves as France, Germany and Italy, making it uniquely vulnerable to shortages and price hikes.

As we have observed, though, this is only half the story. The underlying problem is the excessive reliance on gas for electricity generation, a problem that is set to get considerably worse as generators build new gas-generation capacity to fill the gap caused by the lack of a coherent energy policy and the insane emphasis on renewables.

The scale of the current problem though is quite daunting. Three-quarters of the country’s reserves are stored by Centrica in an old North Sea gas field, called Rough, some 9,000ft below the seabed off the East Yorkshire coast.

This year – thanks largely to global warming the cold weather – its gas has been pumped at record rates. It is now 24 percent lower than at this time last year, and 49 percent less than the year before. Everything depends on the weather and the Met Office expects the cold back by the beginning of March. On past form, that means we should be alright, but you never know. The Met Office could break the habit of a lifetime and get it right.

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The credit bubble and the market

Matthew Parris makes an interesting point:

So amid all the doom-mongering and recanting, I have an assertion to make. The market has not failed. The present collapse is evidence that the market is working. Confidence bubbles are an inherent feature of a free market system. Panics — confidence vacuums — are an inherent feature too. The test of the theory of market capitalism is whether the system provides from within itself the means to prick both.

It does. The first — a confidence bubble — has been pricked. We are now sucking ourselves the other way: into a confidence vacuum. In time this too will be pricked. The market will steady.

The bubble that has just burst was based, worldwide, on financial services. Financial services are a product. It is true they are a product critical to the efficient functioning of the market (so is electricity, so is oil) but that just makes them an unusually important product. From time to time products fail in any market. They may fail through force majeure — droughts, floods, pestilence. They may fail due to inherent flaws — airships, Thalidomide, blue asbestos. Or they may fail through ignorance, trickery or the credulity of human beings — Madoff, the property bubble, the repackaging of sub-prime debt.

The present financial crash has been precipitated by product failure of the third kind. Trade in financial instruments too opaque for even those who traded in them to assess them properly, and bonus incentive schemes that acted against the interests of the companies offering them, fuelled a banking bubble that has now burst.

But ask: what pricked it? Did politicians rumble the trade? Did governments, or international forums or symposiums, provide the sharp instrument? Did academic research and expertise expose the dodgy product? Did statutory regulators apply the pin? No, the free market wised up and pricked this bubble. Politicians and finance ministers (if they had had the power) would have tried to keep it inflated. The market puffed itself up, and then, without intervention — despite intervention — the market let itself down. The speed with which this has happened has been awful, but however inconvenient for many or catastrophic for a few, correction is not a failure of the market, but a success.

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On the impact of increasing mandatory redundancy payments

The Independent reports:

The minimum amount of money that employers must pay staff they make redundant is set to be increased by the Government, The Independent has learnt. In another attempt to ease the pain of those worst affected by the recession, ministers have launched a review of the minimum payments to which people are entitled by law when they lose their job. With around 1,500 posts being axed each week, unemployment will soon pass the two million mark and could eventually rise to more than three million.

The plan emerged on the day that the Bank of England reduced interest rates to 1 per cent, the lowest in its315-year history, and warned of a “severe and synchronised downturn” in the global economy.

At present, statutory redundancy pay is based on a week’s pay for each full year’s service between the ages of 22 and 41, and one-and-a-half week’s pay for older workers. Total payouts are capped at £7,000 and £10,500 respectively because wages above £350 a week and service of more than 20 years are ignored. Some 46 per cent of the workforce earns more than £350 a week. But Lord Mandelson, the Business Secretary, plans to propose a more generous scheme in his submission to the Chancellor Alistair Darling ahead of the Budget this spring.

Although no decision has been made, a big one-off rise in the £350-a-week limit is under consideration.

Other options include lowering the qualifying period for redundancy payments from two years’ service to one year, and raising the tax-free limit for more generous pay-offs. Since 1988 the first £30,000 has not been subject to tax, but the TUC wants it raised to £50,000. However, ministers may decide to focus any help on lower-paid workers by boosting minimum payments.

MPs and unions have launched a campaign for higher payoffs because the maximum pay figure used in the formula has declined from 203 per cent of average weekly earnings when the scheme was launched in 1965 to 56 per cent today. They want the limit linked to earnings rather than inflation in future. But employers are warning that at a time when many firms are desperate to keep costs down, bigger payouts could result in more job cuts.

Certainly, for those made redundant, an increased redundancy payment will help them get through their period of unemployment. However, as Guy Herbert points out, this is not the only impact such a measure has.

There are several negative effects from such a move:

  • If a firm is considering making redundancies in order to cut costs, then an increased redundancy payout will encourage them to lay people off earlier than they otherwise would – if they were to employ the person for a longer they have to pay them their wages plus the redundancy payout. In marginal cases, this can make the difference between an employer holding onto a worker during the recession and letting him go. E.g. employers who try to hold onto someone until business picks up will find it more risky to do so – the cost of holding on to someone only to let them go if things don’t go as well as expected will have gone up.
  • The measure effectively increases the cost of labour by increasing the overheads associated with employing someone. It will thus make employers more averse to hiring people in the first place.
  • By increasing the costs businesses incur, they also increase the risk of the business failing completely and being unable to make redundancy payments.

This measure thus seems counterproductive to me, in that it is liable to increase the amount of unemployment and prolong the recession.

The only people to benefit from this are those who would have been made redundant anyway, and even there, by making employers more averse to hiring, this benefit may be offset by prolonging the period of unemployment.

A further point: By announcing that minimum redundancy payment increases are being considered, the government is encouraging any company considering making people redundant to do so before any such changes are made.

I wonder if the government consider such issues before pronouncing on something.

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The Credit Crunch: What the lenders were doing

From “The Crunch”, by Alex Brummer, pages 42-43:

To get an idea of how all this worked in practice, and to understand why it was built on such shaky foundations, take the fictional example of Mr and Mrs Jerome Smith of downtown Cleveland. They are persuaded by Fast Talking Mortgage Brokers Inc. (FTMB) to buy their shabby clapboard property with a $100,000 mortgage. The interest rate of 10 per cent is being waived for the first two years. In fact, interest has not been forgiven but is being rolled up with the original mortgage, increasing the debt to $120,000. FTMB, having taken an arrangement free from the Smiths, then sells on the mortgage to Grasping Investment Bank (GIB) of New York, which pays the broker a commission for the mortgage. GIB wraps up the Smiths’ loan with dozens of other loans to other Smiths from poor neighbourhoods around the country and renames it Smith Mortgage Obligation (SMO), and then pays its favourite credit rating company, Stamped & Correct, to certify the SMO as good quality debt. The attraction of this SMO is its 10 per cent return at a time when government bonds are getting between 2 and 3 per cent.

But rather than selling SMO directly to clients, GIB takes another route. It creates a new company — a special purpose vehicle called GIB Capital — and this borrows from other banks cheaply and uses the money to buy Smith Mortgage Obligation. GIB then offers shares in GIB Capital, now the proud owner of SMO, to clients, who lap up the shares because of the high return.

Grasping Investment Bank benefits from the process in several ways. It has collected profits and commission on the sale of the SMO and also benefits from leverage (borrowing) because it is using someone else’s money. GIB has also cleverly placed the SMO off its balance sheet in the special purpose vehicle, which it does not have to disclose on its accounts as a liability. It can stretch its capital further and will not have the regulator on its back.

Thus not only are mortgages given to people who are likely to find it difficult to pay them, but they are rated on a dubious basis, responsibility for them is diffused amongst several players, proper accounting of the debt is obscured by creating the special purpose vehicle and extra borrowing from banks is used to facilitate the whole process. It seems to me this process was bound to hide the riskiness of the mortgages from the investors.

Note that SMO in this scenario is an example of a collateralized debt obligation.

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