This feature first appeared in Public Finance
As UK public sector organisations prepare
their first budgets following October’s Comprehensive Spending Review,
those working in the public finance area know that we are facing an
unprecedented situation. Certainly, it is the first time that we can
remember hearing senior managers in public services say that they
seriously doubt whether what they will be asked to do will be consistent
with their beliefs and values, or indeed will be achievable. Not
surprisingly, many have been looking around to see if any other
countries have successfully made the substantial shift in resource base
that is currently being demanded in the UK.
Countries generating large budget deficits with increasing levels of
public debt need to implement policies to ensure a ‘fiscal
consolidation’ and there are good international examples of how to do
this. It’s useful to look at recent cases in advanced economies,
focusing on members of the European Union and Organisation for Economic
Co-operation & Development, to see what lessons they offer for the
There is much OECD evidence on the many fiscal consolidations that
have taken place and the factors that are likely to produce success (see
box opposite). It is worth noting though, that of 85 fiscal
consolidations across 24 OECD countries in recent decades, the average
consolidation was around 2% of gross domestic product over a two-year
The current consolidations of 8% or more of GDP and the longer
timescale are at the very top end of previous experience. In some cases,
such as Ireland, they go well beyond anything seen since the mid-1970s.
Four main lessons for the UK emerge from these examples.
The first is that the severity of the effect on the public sector
will depend on how the rest of the economy responds. If there is strong
growth in the private sector over the next four to five years, this will
be significantly eased. This happened in Canada and Sweden, and so the
impact on public finances of a rise in unemployment and a collapse in
taxation revenues was avoided.
If the private sector fails to grow sufficiently in the UK, there is a
real danger that public spending will not come down fast enough and
taxation revenues will not increase enough to avoid a further round of
cuts, above the target already announced for the next five years. In
this case, as has happened in Ireland, the impact on public attitudes
would be seriously detrimental, and political difficulties would lie
This should be the single biggest item on the government’s risk
register, and somewhere there should be a ‘Plan B’ for what will happen
if growth is not as strong as expected. Given the weakness in global
demand, the potential dangers of protectionist ‘beggar my neighbour’
responses, and the impact on consumption of public sector unemployment,
this places real pressures on the ability of manufacturing and services
to lead the export-led growth that will be needed.
The second lesson from countries that have made this fiscal
transition successfully is that no areas of the public sector should be
exempted from the cuts. By deciding to protect, even at a zero base, the
National Health Service and schools budgets, the coalition government
has placed significant pressure on all other elements of spending, and
on the welfare budget. The net consequence is that there will be
significantly greater cuts than expected and, as we have seen with the
student tuition fees, the net change to individual groups’ circumstances
will be considerable.
Ministers need seriously to question whether the least efficient area
of the NHS has greater value than some of the lesser prioritised
services, and whether the impact of the welfare cuts on poorer income
families with higher public sector dependencies, and on geographical
areas of the country with higher public sector dependency, is
acceptable. There will inevitably be intergenerational comparisons made
here between the protected pensioners’ perks and the increased debt
levels of young people.
The third factor in the success or failure of any deficit reduction
programme is how well regulated the banks are. Western governments
initially avoided the Japanese experiences of the 1980s by taking
immediate action to recapitalise their banks after the 2008 banking
crisis. However, as Ireland has shown, leaving an unreformed and
under-regulated finance sector does not provide any certainty that the
pattern of speculative boom and bust will not continue.
The danger is that a fresh financially-driven crisis
might develop before a full transition can be made in public sector
finances. In the UK, the financial sector has recovered significantly
and is earning profits that support public expenditure by taxation and
help the economy to grow. But this has put the government in a bit of a
bind over the issue of regulation. Threats to increase the level of
regulation are vigorously countered and the banking sector threatens to
move elsewhere. Nevertheless, if this area is left unchecked, there is a
danger that people will feel that individuals and not the banks are
bearing the burden. If this sense of unfairness becomes embedded, the
issues that have emerged in Iceland and Ireland might crop up here.
The final lesson that has emerged from other countries’
experiences is, unsurprisingly, that radical approaches will be needed.
As Albert Einstein said: ‘You do not solve the problem by using the
same thinking that created it.’ Given the significance of the change
required, traditional techniques for budget reductions are unlikely to
be successful. Canada’s comprehensive approach and genuine public
consultation (see case study above) seems the least that is called for.
In the UK, much of the public consultation is based on a relatively
limited set of questions and options. There is a real danger that if
people are not involved in the solution, they will not feel responsible
for it. The consequences in terms of negative campaigns, protests and
legal challenges will only prolong the transition.
There is also a strong argument for major reform in the
way that public service organisations and the economy are managed. Some
of the devolved thinking outlined in CIPFA/Solace publications and the
government’s ‘Big Society’ ideas need to be implemented radically to
enable truly innovative solutions.
However, while we concentrate on the practicalities of
putting the necessary changes into effect, there are three things that
it would be dangerous to ignore.
First, there is a clear need for better communication
with the general public. A recent survey found that 30% of people
believed that their local authority wouldn’t be making significant cuts,
and an amazing 13% of people believed there would be more money to
spend on services in the next financial year.
Secondly, there is the whole issue of fairness. At every
step we need to be asking ourselves not only whether the change is
practical and will provide the required outcome, but how it will appear
to the general public and to those affected.
Thirdly, we need to remember that there are also some
very substantial longstanding issues that we can’t allow to drift. The
impact of demographic change and the long-term consequences of climate
variation are just two of the bigger items. Ignore these and we might
solve the immediate crisis only to be confronted with a much bigger one.
1: Canada runs dry
In the late 1980s and early 1990s, Canada found itself with
an unsustainable public sector deficit of around 8% to 9% of gross
domestic product, largely as a result of the collapse of over-stimulated
speculative economic bubbles. But it managed to bring the situation
under control in a relatively short period of time. This involved tax
increases and large-scale spending cuts (20%), implemented by a
comprehensive zero-based budget review. Driven by a ‘Star Chamber’
arrangement from the top, every single service was asked to justify
itself against five key questions:
> Is the service core to the community?
> If it is core, does this public authority have to do it or could others do it?
If another organisation can do it, does it need external support in
order to do this? Could another organisation do it more cheaply than
> If we have to do it, can we do it better?
> Even if we can do it better, can we afford to do it at a level that affects the communities’ well-being?
This exercise was backed up by public consultation on
priorities. There was a general concern that the public finances should
be put back on an even keel, so the budget changes had widespread
support in principle. Given the significance of the change, it was
somewhat surprising that some of the more traditional approaches such as
‘salami-slicing’ did not gain public support. There were some
unexpected results – the public supported increases in some areas of
public spending but cuts of 50% or even 100% in others.
Although the fiscal consolidation was successful, the
consequences were not painless. Hospital waiting lists shot up, some
hospitals were closed, and thousands of medical staff lost their jobs.
Hospitals that remained became more overcrowded and infection rates
rose. In education, average class sizes rose from 25 to 35. Science and
transport budgets were halved, defence was cut by 15%, and many of the
significant cuts were made at provincial and local rather than national
2: Tiger at bay
While the examples of Sweden and Canada relate to the 1990s and
the situation is now stabilised, Ireland is still in the throes of a
crisis. As in Iceland, it involves dramatic rises in the banking sector
to the point where it dominated the relatively small economy and
presented a significant risk to the much smaller ‘real economy’ that had
been the traditional mainstay of its prosperity.
The immediate crisis was staved off when the Irish government
gave an unconditional guarantee to underwrite all deposits in Irish
banks. Though this short-term and expedient move saved the day, long
term it has had serious consequences. Because of the difficulty of
determining the liabilities of Irish banks since the government
effectively assumed responsibility for them, Ireland has gone through
three successive rounds of public sector cuts and reductions in welfare
Although it has tried valiantly to stave off the need for
international loan support, which formed the basis of the Iceland
solution, it has in the past few months had to recognise the need for
this in the face of an escalating sovereign debt crisis.
The Irish people showed an initial tolerance and acceptance of
the need for drastic action to handle the public finance problem, but
increasingly the impact of repeated reductions has damaged public morale
and confidence. As happened in Iceland, it seems likely that a
disenchanted public will exact a penalty on the current government at
the imminent election.
3: Smorgasbord of cuts
The essential problem in Sweden in the 1990s was the tendency of
the Swedish Parliament to soften the draconian changes suggested by the
Executive in a series of budget amendments. The net result was an
escalation in the level of public spending. This in turn prolonged the
accumulation of public sector debt, which reached 50% of gross domestic
product around 1994 and peaked at 80% around 1998, before the situation
was brought under control.
The action taken in Sweden was to make changes to budget
priorities a ‘zero-sum’ game. Within the overall resource envelope, any
change that involved increasing expenditure had to include a lower
priority item that would be cut to fund it.
As a result it became increasingly difficult to generate the
necessary coalitions to pass a successful budget amendment. The number
of such amendments dropped dramatically, and this helped to bring the
budget under control.
As in Canada, all areas of public spending were examined. Göran
Persson, Swedish finance minister at the time of the consolidation, told
the 2010 CIPFA annual conference that it was essential to make the
change early, make it once, and ensure there were no sacred cows. It was
also vital that long-term liabilities – such as pensions – were equally
looked at so that the new rules ensured that the deficit could not
creep up again in future. It was made clear at every opportunity that
‘nothing was off the table’ and nothing was exempted.
Roger Latham and Malcolm Prowle are respectively visiting fellow and
professor of business performance at Nottingham Business School and
joint authors of a forthcoming book on planning and managing public
services in a time of austerity. Some of these issues will be debated at
CIPFA’s first international conference, being held in London on March
This article first appeared in the February edition of Public Finance