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Are Sajid Javid's spending reviews too ambitious?

Have you ever decided to spend money on something without quite being sure that you can afford to pay for it?

Later on Wednesday, Chancellor Sajid Javid will do something similar in his spending review.

Javid is set to announce significant increases in the budgets for many government departments without being confident that he will get the economic growth he needs to finance them.

What's a spending review?

In a spending review, the Chancellor allocates funding to Whitehall departments.

Spending reviews traditionally cover multi-year periods - this one will only apply to the year 2020/21, due to the ongoing political upheaval and the economic uncertainty thrown up by the Brexit process.

The sums that Javid announces will cover department “resource” budgets (day to day spending) rather than capital budgets (the money that is spent on investment).

A spending review is not “a budget”, which means we won’t hear anything more about the sizeable tax cuts Boris Johnson promised during his leadership campaign, and the Office for Budget Responsibility (OBR) won’t be offering their independent analysis of the economic outlook for the UK.

This is a scaled down spending review for sensible reasons, but a significant one none-the-less because it will signal this government’s determination to spend more on public services - some of which are showing the strain after almost a decade of sustained funding cuts.

But isn't austerity already over?

Not really.

In his spring statement in March, Philip Hammond signalled the beginning of the end of austerity when he published his provisional spending plans.

Under Hammond’s plans, day-to-day spending is set to increase by £4.5 billion between this year and next, although the lion’s share is going to the NHS.

However, spending on other government departments remains broadly flat and both capital and day-to-day spending budgets across Whitehall remain below 2009/10 levels by the end of the forecast period in 2023/24.

The Chancellor is set to end austerity decisively by shifting public spending up another gear, which is timely because opinion polls suggest that public opinion is supportive.

Former Chancellor Philip Hammond. Credit: PA

Who wins?

Everyone.

Well, it will seem that way if you listen to the Chancellor’s speech.

Extra spending for schools, further education, police, prisons and hospitals have already been announced and are likely to be added to.

The question is will there be anything for the departments that have been at the sharp end of austerity?

The Institute for Fiscal Studies (IFS) calculates that the Ministry of Justice’s day-today budget has been cut by 28% since 2010 and that local government spending on services is down 21%.

Can the Chancellor afford to be generous?

In one sense, yes.

The explosion in government borrowing that followed the financial crisis has been brought down to more obviously sustainable levels by nine years of austerity.

The deficit (a measure of the degree to which government spending exceeds its income) is now at a 17-year low so the Chancellor is in a position to borrow more.

In March, the OBR estimated that in 2020/21 the government was on target to meet its “fiscal mandate” - its pledge to keep borrowing at 2% of national income - with £27 billion to spare.

The IFS estimates that, after properly accounting for the ongoing costs of the student loan book, Javid probably has around £15 billion of borrowing “headroom” left - enough to fund all the spending pledges made to date and probably more.

You will recall that the previous Chancellor Hammond indicated that he was inclined to use this extra “headroom” to improve public services but would only do so if Britain left the EU in an orderly way.

Boris Johnson’s government has taken a far less cautious approach, making all sorts of tax and spending commitments while simultaneously threatening to leave the EU without a deal on October 31.

Can they take on an ambitious budget and Brexit at the same time? Credit: PA

Why does Brexit matter?

The manner in which departs the EU is extremely important because it will determine our future economic growth, and therefore the number of people in work, what they earn and the tax they pay to government.

Put another way, the chancellor’s ability to deliver on his promises to invest in public services depends on the performance of the economy.

Least we forget, most expert and business opinion believes that an abrupt departure from the European Union, of the sort Boris Johnson countenances, would be very bad for the economy.

The Office for Budget Responsibility (OBR) estimates that even a relatively benign “no-deal” outcome - where delays at the border are avoided but tariffs and non-tariff barriers impact trade with the EU - is likely to nudge our economy into a recession and whack a large hole in tax revenues, necessitating extra borrowing of around £30 billion a year.

Such an outcome would almost certainly force the government to abandon its spending plans and may well necessitate another round of austerity.

Okay, but what if Brexit goes smoothly?

If common ground can be found and a deal struck with the EU then the consensus is there may well be an economic bounce, although it is likely to be modest given that most forecasts (rather heroically) assume Brexit will be smooth.

But the new Chancellor is unlucky in the sense that at the very time he is preparing to deliver what Boris Johnson calls “the most ambitious spending round for more than a decade”, the economic outlook has worsened noticeably, here and abroad.

The £15 billion of borrowing “headroom” that Javid is busy spending is calculated on the basis of growth forecasts that the OBR produced in March for this year and next.

Since then economic growth around the world has weakened. Credit: PA

Since then economic growth around the world has weakened.

The Bank of England has downgraded its growth forecasts, so too has the NIESR, and last month we learned that the UK economy contracted between April and June.

The OBR will not be updating its forecasts today, which will allow the Chancellor to claim that he can afford to increase spending and meet the fiscal targets he inherited from Hammond - but the Resolution Foundation, NIESR and the IFS are highly sceptical.

They calculate that the worsening outlook for the UK economy means Sajid Javid’s borrowing “headroom” is in reality much diminished and that his spending plans probably already breach his fiscal mandate, even before the costs of the promised tax cuts are considered.

Does it matter if Javid breaks his fiscal rules?

The average person on the street probably isn’t preoccupied with the cyclically-adjusted structural deficit - and with good reason.

There is no hard and fast consensus on what the correct level of debt to GDP should be.

But there is a value to having a government which sets out how it intends to run the public finances.

Fiscal rules tie a government’s hands in a way that creates reputational damage if it suddenly does something different and helps us to form a view on whether it is competent and in control of matters.

The Conservative Party has traditionally sought to define itself as being prudent, a party you could rely on to make tough but necessary decisions with the nation’s finances.

The party has spent the best part of ten years getting deficit down and fought the last two elections on a pledge to eliminate it altogether.

The promise to balance the books was politically important - a point of difference that the Conservatives used to argue that they could be trusted with the public finances while characterising Labour as a party of magic money trees and unfunded spending commitments.

The Tories have traditionally sold themselves as frugal and fiscally responsible. Credit: PA

Times have changed.

In June last year, Theresa May’s government served up an huge, imprompt five-year unfunded spending settlement for the NHS.

Now Boris Johnson’s government is making spending commitments it knows it can’t be certain it will be able to deliver.

The idea that the Conservative party will fight the next election - whenever that is - on a promise to balance the books looks for the birds.

If you listen carefully you can hear the sound of the spending taps opening.

A point of difference with Labour has gone.