Thank you for this opportunity to talk with you today, as Chief Secretary to Her Majesty’s Treasury. This conference is very timely, and deliberately so. It was my responsibility in 2010 to lead the UK’s Spending Review, and exactly two years ago we published our plan for its implementation.
And I’m delighted to have the opportunity to be in Rome, one of the most beautiful and historically rich cities in the world, to speak about our experience.
The relationship between our Government and Mr Monti’s administration has been very close. We share much common ground, especially on the EU jobs and growth agenda and the strengthening of the Single Market. I hope today we can share our own experience of implementing our relative Spending Reviews, the challenges we faced, the lessons that we have learned from one another and progress that we have made.
The coalition inheritance
On election in 2010, the UK Government faced significant challenges to say the least.
High levels of private debt, which had fuelled the housing boom that contributed to the financial crisis;
High levels of public debt, which had grown rapidly and significantly as a result of the downturn in 2008 and the high pre-crisis government deficit being run by our predecessors.
And a rapid decline in financial services, which had formed such a significant part of our economy - leaving a major gap.
Many of those issues were global, and many of our problems were shared by our friends in Europe - and indeed Italy.
In fact our location - geographically, politically and economically - in Europe, which continues to suffer from a deep crisis, provided a further challenge to the economy.
Almost half of UK exports go to the rest of Europe, and so the uncertainty and decline in Europe’s fortunes created a further drag on the demand side of our economy. And the panic resulting from a sovereign debt crisis that started in Greece, and threatened to creep across Europe - as it still does - created a new imperative to reduce the deficit and address the structural problems with our own economy.
This narrative the Italian people will know very well. To an extent there are many similarities to the pressures we have all faced. Pressures which have resulted in both our countries growing slowing in 2011 and contracting in the first quarter of 2012.
But in some respect our country’s differences with Italy made the situation worse. Our economies are of a similar size but ours is less diverse. Financial services constituted ten per cent of the UK economy, and over twelve per cent of our tax revenues. The balance sheets of UK banks were worth more than five times our GDP. And the UK’s private sector debt was much higher.
The property boom and unsustainable profits and remuneration in the financial sector during the pre-crisis years had driven rapid growth in tax receipts. As tax receipts fell away during the crisis, the public sector was revealed to be living beyond its means.
When we came into office, the UK was forecast to have the highest deficit in the G20. It was more than double that of Italy’s. And the economy was forecast to be about 9 per cent smaller by 2015 than was expected before the crisis.
In this context, it was clear that strong and decisive action was necessary. Two parties in the UK - the Conservatives and the Liberal Democrats - came together to form the first British coalition government since the Second World War to address these historic challenges.
The size of the problem demanded large scale reform of the UK’s economy and finances:
- monetary activism, to support the recovery and increase the availability of credit
- financial sector reform to increase resilience and reduce risks
- structural supply-side reforms, to promote sustainable growth across a wider range of sectors and regions and so rebalance our economy
- tax reform to improve our competitiveness, reduce distortions, and promote private sector enterprise and growth
- and fiscal consolidation, to restore the public finances to a sustainable path.
And it’s today, two years on from our Spending Review in October 2010, that I’d like to talk to you about the last, but most certainly not the least, of these challenges.
But first I’d like to pay tribute to our Italian colleagues. Following me today is Piero Giarda whom I’d like to congratulate on the successful passage of his 2012 Spending Review in August. This was an impressive Spending Review by all accounts, and came at a crucial time for the Italian economy. Combined with previous rounds of spending cuts by the current and previous governments, this will result in Italy having eliminated its structural budget deficit by 2013. Moreover, Italy is projected to have the highest primary budget balance - a surplus of around 4 per cent - in the euro area by 2013.
I commend him and the Italian Government for the significant achievements since they came into office, and I look forward to hearing first hand from him today on the Italian experience of enacting your own Spending Review.
The coalition’s challenge
Our coalition agreement made it clear that the number one priority of this parliament was, and remains, returning the UK to sustainable balanced growth, reducing the deficit, and rebuilding the economy.
Carrying on as the previous Government had done would have meant higher debt, higher interest payments, and even higher cuts in the long run.
Instead we made the decision to cut our cloth to reflect our means, and prove that we could be trusted to restore health to the public finances.
Building that trust had two elements: firstly establishing numbers that people believed. And secondly coming up with a credible plan that we could deliver on.
We took on the first challenge through the establishment of a new, independent Office for Budget Responsibility to provide the official economic and fiscal forecasts.
Historically, and I’m sure the UK is not alone in this, politicians have been tempted to adjust their economic forecasts to suit their policies.
But with the establishment of the independent OBR, Government’s in the UK can no longer sweep uncomfortable realities under the carpet. The Government must base policy on OBR forecasts whether they like it or not.
This is a major institutional shift that will shape our Government for decades to come. Never again will politicians be able to fiddle their forecasts in the face of awkward truths. And never again will Government’s be able to spend the financial mirages that these forecasts then create.
I believe this is an example of the UK leading the way.
The European Commission has already proposed that Euro area Member States put in place independent fiscal councils to monitor the implementation of national fiscal rules. And I’d be interested in hearing from Mr Giarda on his Government’s plans to establish an independent fiscal authority.
And what about our second task? Delivering a credible plan for fiscal consolidation.
We signalled our intent immediately upon coming to power. Our Emergency Budget in June 2010 set the Government’s fiscal mandate: commitment to a cyclically adjusted balanced budget by the end of the rolling five year forecast period.
The Emergency Budget also;
- announced immediate efficiency savings of £6bn in 2010-11;
- announced £32bn of net tax increases;
- set out further savings from welfare, freezing public sector pay and benefits from lower debt interest payments; and
- launched the Spending Review process.
The Spending Review completed in October 2010 set out our budget reductions department by department.
I’m not going to pretend that this was a smooth or straightforward process. When you are faced with a large number of elected Ministers, from quite different political backgrounds, it was going to be a tough job to reach a consensus.
That is why I met regularly for bilaterals with departmental Ministers. And we established the Quad of the Prime Minister, Deputy Prime Minister, The Chancellor and myself.
This combination of intensive bilateral negotiations, with a small, central decision making body, ensured that decisions made through the Spending Review were consistent with the coalition agreement and had the authority of the leaders of both parties within the Government. Where necessary, it could also focus on sensitive areas of public spending.
We were in agreement, the Chancellor and I had the authority with which to secure agreement at bilaterals and at Cabinet.
And we set an incentive for departments to reach budget agreements with the Treasury. Those departments who settled early were given a seat on the Public Expenditure Cabinet Committee. It operated a bit like Henry VIII’s Star Chamber. Just as Henry Tudor’s inner circle judged the plight of overmighty ministers. So the Public Expenditure Committee would decide the budgets of those departments who could not come to a settlement.
The deterrent effect of the Committee was so effective, that no department ever needed to come before it.
The engagement was not just across the Government. We had to make sure that the Spending Review got the big decisions right for the country.
As part of this, the Government invited public sector workers and members of the public to submit ideas on how to achieve more for less. All ideas were reviewed, and many were taken forward by the relevant Departments as part of the Spending Review process.
In total over 100,000 suggestions were submitted including over 63,000 from public sector workers.
And HMT ran a number of parallel engagement activities including expert roundtable discussions and regional events.
And we established an Independent Challenge Group of Civil Service leaders and external experts which scrutinised and challenged Departmental plans and cross-cutting themes including localism and workforce, pay and pensions.
The Spending Review also drew upon independent reviews into key areas of contention such as public services pensions and university tuition fees.
And a separate Strategic Defence and Security Review was conducted and published, setting out how the Government would deliver the defence and foreign policy priorities identified in the National Security Strategy in an affordable and sustainable way.
Of course these negotiations were worse than a zero sum game. There was a smaller pot for departments to bid for and we had to prioritise the most important areas of spend.
The health budget was ringfenced to grow slightly in real terms.
The Basic state pension was to be uprated by a triple guarantee of earnings, prices, or 2.5%.
We committed to 0.7% GNI spending on Overseas Development Assistance.
We protected the schools budget in real terms.
And we committed £2.5bn of pupil premium to support disadvantaged children and the extension of free child care to disadvantaged two year olds.
Where the money came from
Of course, to maintain these crucial commitments, whilst getting a grip on the finances, we had to make cuts elsewhere.
We made a total of £18bn of welfare savings. Where we could, we targeted families of the most well off - for instance we withdrew child benefit from families who earned the most.
We saved on central government administration costs. £6bn a year by 2014/15.
And we established processes at the centre of government with which to drive efficiency - creating an Efficiency and Reform Group in the Cabinet Office to drive down operating costs and protect spending on frontline services. Our approach rests on standardisation and aggregation to achieve best value - for example, centralising commodities procurement; reducing wasteful spend on consultants and marketing; and building centres of expertise in areas such as property, construction and delivering major projects. This has led to efficiency savings across central Government of £5.5bn in 2011-12.
We increased the cap on university tuition fees without burdening the least well off.
And we made reforms to the criminal justice system, introduced measures to ensure public sector pay restraint, and significantly cut our defence budget.
In all, Departmental budgets other than health, schools and overseas aid were cut by 19 per cent.
The decisions we made two years ago were tough ones. But they were the right ones.
And they were not ideological.
Confronting unsustainable public finances is core to good government. It’s a vital precondition to growth. And it’s absolutely necessary in delivering fairness.
It is the poorest and most disadvantaged, not the wealthy, who are hit hardest when a country loses control of its public finances.
It is fair that we tackle our debts today so that we don’t burden our children tomorrow.
Ensuring that we can continue to provide high quality public services and support to those who need it the most.
Even as we have taken the tough decisions to tackle our debt, we are making sure that everybody in British society makes a contribution, but those who have the most contribute the most.
To support this, we published more detailed distributional analysis of the welfare and public spending than any government ever has before.
The UK has come a long way in just two years.
We’ve made significant progress in restoring credibility to the public finances.
Last year Government departments achieved budget reductions, of almost £7bn more than planned at the start of the year.
By the end of 2012/13 we will have achieved almost 50 per cent of the spending reductions planned by 2014/15 - the end of the period covered by the 2010 Spending Review.
The deficit has been cut by a quarter as a share of GDP since we came into Government.
And the cyclically adjusted primary deficit has been halved from its peak in the last two years. It is forecast to approach zero by 2014-15.
In 2010/11, the year we came into power, total public spending was almost 50% of UK GDP. By the end of 2012/13, we will have spent 43% of GDP. And by the end of the Spending Review 2010 period, we will be spending 42% of GDP.
Fiscal discipline is a vital precondition to growth.
Our commitment to fiscal discipline and economic stability has helped secure record low market interest rates.
Rates that support households paying mortgages, and businesses securing loans, right across the UK.
And credibility that is essential for private sector investment, growth and job creation:
Fiscal credibility has given monetary policy the space to act. The policy rate is 0.5% and the Bank of England has committed to £375 billion of QE. The IMF have welcomed the recent unconventional measures by the Bank of England to encourage bank lending and access to credit.
It also allows the Government to pass on the benefits of a credible balance sheet to the wider economy. We recently announced up to $50bn of guarantees for major infrastructure projects and new homes.
Inflation continued its downward trajectory in September falling to 2.2% from a peak of 5.2%. In its August Inflation Report the Bank of England forecast that inflation would fall back towards the 2% target in the medium term.
The UK moved up to 8th the World Economic Forum’s global competitiveness rankings.
And we have seen well over 1 million new private sector jobs since the start of 2010, more than twice the number of jobs lost in the public sector.
Private sector growth built on a foundation of economic stability.
The Spending Review was a big task. Some things we did well. Others we did less well. I drew a number of lessons from it.
External engagement exercises proved to be a very useful tool for inviting challenge, and developing the Spending Review narrative over the summer period. Independent challenge structures were also more effective in time-limited exercises, where the parameters of engagement are clear and there is room, and appetite, for real impact.
There were a number of key aspects to the process that worked very well. Firstly, setting firm planning assumptions plenty of time ahead of negotiations. This was critical in managing expectations, and avoids departments coming back with higher spending demands.
Secondly setting the date at the outset. This was invaluable in sequencing negotiations and decision-making and also demonstrated the Government’s confidence in delivering the review comprehensively and on time.
And thirdly a zero based approach to capital expenditure. This provided a good basis for prioritisation.
Overall - it is key for a Government undergoing a substantial piece of work such as our Spending Review in 2010 to be absolutely committed to making the process as open, transparent and collaborative as possible. Certainly in our experience this helped to build public understanding of the difficult choices that needed to be taken, and also provided external input and scrutiny to Government decision-making.
We haven’t waited to implement lessons learned. To meet our fiscal objectives, it is imperative that we further strengthen our commitment to controlling Government expenditure over this Spending Review period. The ‘Improving Spending Control’ document that we announced in April 2012, aimed to enable a change in culture across Government whilst encouraging more self-reliance in Departmental spending. It also provided stronger incentives for Departments to improve their wider financial management capability.
The UK economy has faced some serious headwinds. The ship is very much still afloat, but the latest assessments show the scale of damage down by the financial crisis is greater than we first thought.
According to the OBR’s March forecast, the part of our deficit that is structural is greater than previously thought.
In 2016, our economy is forecast to be 11% smaller than it would have been had the crisis not taken place.
We still have one of the highest deficits in the EU, second only to that of Ireland’s, and three times that of Italy’s
When you have set out detailed spending plans as we have done, credibility comes from implementing those plans, not tearing them up. The credibility which we have thus far secured means that we have not been forced by the markets to tear up our plans because of rising interest rates and economic instability.
In the face of economic headwinds, we have set out our plans for further spending reductions into the next parliament, to ensure sustainable public finances. In the short term, we have made decisions to build a stronger and more balanced economy, support social mobility and help young people find work.
A longer period of spending reductions means that we too will be embarking on the next stage of fiscal consolidation in due course. And we will look back to the 2010 Spending Review for lessons.
Long term challenges
But even as we galvanise our efforts to tackle the deficit, we are also concentrating our minds on the much longer term challenges to ensure fiscal sustainability. For all countries, it is these longer term challenges, which unless faced up to now, will consume an ever increasing share of public spending in the years and decades to come.
In the UK the average 60 year old today is living ten years longer now than they did in the 1970s. This is of course a welcome feat, but it brings challenges. Challenges in financing pensions, health care and social care.
The Government has already made some progress. Bringing forward the rise in the state pension age to 66 from 2026 to 2020 will save around £30bn. And around £60bn will be saved by bringing forward the rise to 67 in 2028.
Part of the remit of the independent Office for Budget Responsibility is to assess the long-term sustainability of the public finances through an annual Fiscal Sustainability Report. This publication examines long-term projections for different categories of spending and revenue - for example, the impact of an ageing population on spending on health care and pensions. This analysis encourages the Government to consider the long-term consequences of our policy decisions, and to recognise that we face fiscal challenges that extend beyond the immediate period of consolidation.
The Government is also taking forward significant changes to public service pension schemes to get a grip on increasing costs. The changes include increasing the amount members contribute to these high quality schemes, the indexation measure used for public service pensions, and increasing the retirement age. The Treasury estimates that the overall package will deliver more than £430 billion of savings, in current GDP terms, over the next 50 years, nearly halving the cost of public service pension provision.
Before I finish I’d like to reflect on how the touch choices we are making in the UK, also relate to tough choices being taken by Government’s across Europe.
The arguments in favour of fiscal discipline are clearly being heeded by member states across the EU.
France last month set out its budget plans for the coming years. Plans which will cut the French deficit by 1.5% of GDP in a single year. President Hollande described this as ‘the toughest budget in 30 years’. And yet even this effort has been matched and surpassed by plans in other Member states.
And as I mentioned earlier the Italian Government have recently set out, in its Spending Review, measures to make an additional €26bn in savings - above those already announced earlier in 2012 and in 2011 - by 2014; a remarkable effort.
Yet this is an effort which is being put at risk by proposals for excessive spending at the EU level.
The experience of the citizens of Europe must also be shared by the institutions of Europe. That is what solidarity in an EU context must be, and the UK has been absolutely clear - the maximum we are willing to accept in the next multiannual financial framework is a real terms freeze in payments.
As one of the most pro-European politicians in the United Kingdom, I find it impossible to understand why it could be thought acceptable to propose substantive increases in the EU budget in a time of austerity.
In June last year, President Barroso argued that ‘many member states need to show more ambition when it comes to fiscal consolidation’. But at the same time he is proposing a budget increase for the next seven years of well over €100bn. These two messages are inconsistent. And we need to tell the Commission this.
As Member states we are showing the ambition that President Barroso asked for. It is time that President Barroso and the Commission follow Member States’ lead by matching their words with actions, to reduce EU spending not increase it.
The Commission’s proposal is the wrong proposal at the wrong time. It is completely divorced from economic reality facing ordinary people across Europe.
A real freeze is the most we can accept.
The choices we all faced at our last Spending Reviews were inescapable. And the choices we face at our next Spending Reviews are also inescapable.
There’s no going back on the reforms and credible fiscal consolidation that our respective Government’s have embarked upon. We have both made progress, but what has been achieved must be bedded down and reinforced over the next several years.
Quite simply the world is a different place to than it was two, ten or twenty years ago. If we want to continue to act fairly, improve social mobility, provide good public services, provide capital investment that continues to grow, and educate a workforce that is able to drive our economies forward, then we will need to work out where and how we save to make all these things possible.
We will all need to solve the dilemma of delivering high quality public services and promoting growth, with scarcer resources.
Both our countries have endured Governments who have mistakenly thought they could duck the longer term challenges, for short term political gain. We know our countries cannot afford this.
But it will not be easy.
All the work that we are doing to restore competitiveness and consolidate our finances is putting the UK in the strongest possible position. But that is not the whole picture. Britain cannot return to growth on its own. Globalisation means our economies are inextricably linked. It will take a collective effort from all of us in this room and across Europe to take on the challenge that confronts us.