Alistair Darling is staring into the abyss. Unless he makes severe cuts to government spending there is a real risk he will plunge the UK into another economic crisis.
Without a credible commitment to bring public expenditure down to sustainable levels, the bond investors funding Britain’s near £200 billion annual borrowing may demand a risk premium in the form of higher interest rates. A big rise in rates would in turn increase the cost of the government’s debt repayments, threatening a debt spiral which could jeopardise economic recovery.
Growth is already threatened by the well-known crowding out effect of public borrowing, which diverts resources from the productive parts of the economy. This may mean official growth forecasts are too optimistic, making cuts in spending even more necessary.
In the context of these grim economic realities, Darling cannot make savings of sufficient scale without tackling the major areas of government spending – health, education and, most importantly, welfare. Including state pensions, welfare benefits cost about £170 billion per year, around one in four pounds the government spends. This emphasises the magnitude of the problem. Even a highly contentious 10% across-the-board cut would save just £15 billion – worthwhile, but a fraction of what is needed.
Yet many welfare benefits are more about favouring particular groups of voters than providing a safety net to cover basic needs. For example, a whole host of payments have been introduced that favour the over-60s, including pension credits, winter fuel payments and free travel. These special benefits add up to at least £12 billion per year and often go to relatively well off households. They also reduce incentives to work and save.
A combination of phasing out special payments for the over-60s and reducing benefit rates by a relatively small percentage across the board would help ensure welfare played a proportionate role in rescuing the public finances. A failure to address Britain’s huge welfare bill in today’s PBR will augur very badly for the country’s economic future.