The chancellor’s Budget officially fired the starting gun on the 2019 Spending Review, but questions remain about how the Treasury will run the negotiations while also grappling with Brexit. Beckie Smith and Richard Johnstone preview what lies ahead
Next steps: Philip Hammond's Budget set out the direction of the next government Spending Review Photos: PA
Theresa May’s pledge at the Conservative Party conference in October that “austerity is over” signalled that the government was shifting its policy on public spending, and in his Budget at the end of last month, Philip Hammond began to sketch out the details of what this will mean for departments.
In his annual major fiscal statement the chancellor set out a series of funding boosts to public services, both in-year and longer term allocations.
In addition, Hammond set out the path for public spending to 2023-24 in a move signalling the start of a Spending Review that will culminate next year.
The “indicative five-year path” Hammond unveiled in the Budget will see overall departmental spending, including an NHS boost, rise by 1.2% annually in real terms from 2019-20. This will mark the first increase in day-to-day departmental spending since 2010, according to the Red Book.
But when the NHS settlement – where spending is set to increase by 3.4% annually up to an extra £20bn by 2023 – is removed, average real-terms growth in overall departmental spending drops to zero. Hammond said this will rise if the UK strikes a Brexit deal with the EU and scoops a “deal dividend”.
As spending continues to rise in areas with protected budgets – such as defence and overseas aid – other departments will most likely still need to find savings. In light of this, the next Spending Review period “might still feel like austerity to those departments”, according to Ben Zaranko, an economist at the Institute for Fiscal Studies.
The IFS has said a “minimal definition” of ending austerity would require an additional £19bn in spending in 2022-23. However, this would mean a dramatic increase in borrowing or taxes.
Emily Andrews, associate director at the Institute for Government, told CSW the chancellor had “boxed himself in further with how he’s going to manage spending over the next five years” by saying an end to austerity “does not involve increasing people’s tax bills”.
The decisions outlined in the Budget (see box) would bring “financial pressures for some if not all services where demand is rising” such as social care, justice, education and police services, she said, which would mean departments may have to cut services or find further efficiencies. “Those are clearly the trade-offs and none of those mean the end of austerity,” Andrews said.
“The money doesn’t seem particularly calculated to solve any of the big problems,” she added. A £400m ‘in-year bonus’ for schools, for example, will not address a crisis in teacher recruitment and retention and “if schools spending stays flat in real terms and demand rises over the coming years, then that’s going to create a hard circle to square.”
Capital spending plans
The biggest capital spending announcements in the Budget were not related to any new schemes but to a funding model, as the chancellor ended the use of the Private Finance Initiative – and its successor PF2 – for new projects.
Hammond said that the use of private finance needed to “deliver value for the taxpayer and genuinely transfer risk to the private sector”, but there was “compelling evidence that the Private Finance Initiative does neither”.
The end of PFI does not alter existing contracts – although Hammond also announced a new centre of excellence in the Department of Health and Social Care to manage existing deals – but it does create something of a dilemma for how government will fund infrastructure in future.
“There are three big options for government now it has ruled PFI out,” said Graham Atkins, an infrastructure researcher at the IfG. “You could try to increase public procurement with bigger capital budgets, you could try to get users to pay for more infrastructure such as toll roads, or you could expand the UK Guarantee Scheme [where government underwrites some of the larger risks] for big projects.”
Early indications show that the Spending Review will use all of these methods. The Red Book indicated that from 2018-19 to 2023-24, capital spending will grow at an average of 3.4% a year in real terms – and, unlike revenue spending, this increase will likely be more evenly spread across departments.
Hammond was keen to point out that half of the UK’s £600bn infrastructure pipeline will be built and financed by the private sector, and in a post-Budget briefing the Treasury highlighted that it would continue to use methods such as Contracts for Difference, where the government promises energy providers a future price for their power, with any difference in the market price made up by consumers, and the UK Guarantee Scheme.
The document also revealed that the government would conduct what it called “a zero-based review of capital spending” at the Spending Review.
Running the Spending Review
Although the Budget set out a rough indication of what departmental spending might look like in the next Spending Review, it gave few details about what the review itself will contain.
Uncertainty over Brexit means the government is yet to confirm whether the review will cover the usual four-year cycle or just one. And this is just one known unknown. “Simply put,” said Martin Wheatley, senior fellow at the IfG, “we don’t know what the spending envelope is going to be, we don’t know when the Spending Review is going to start or finish, we don’t know how many years it’s going to cover and we don’t know when we will know.”
Nick Pearce, director of the Institute for Policy Research and professor of public policy at the University of Bath, agrees.
“In process terms, the Budget and the NHS settlement give a lot of context, although the Treasury has still got a lot of work to do,” he said. “The absolute envelope has not been set, nor has the split between annual managed expenditure [the parts of government spending that are demand-led, such as welfare and tax credits] and departmental expenditure limit [day-to-day spending for departments].”
There is also a wider strategic question. “Typically, you’d expect the Treasury to be setting out what its objectives for the Spending Review will be,” said Pearce. “This would identify its priorities in addition to the normal departmental allocations and highlight what needed to be conducted through cross-departmental review processes – like defence and security for example, or health and social care.”
Sir Oliver Letwin, who as Cabinet Office minister was involved in both the 2010 and 2015 reviews, called on the Treasury to go further and merge health and social care budgets.
“My own view is that it is extremely difficult to get different budget holders to cooperate in trying to use their mutual budgets efficiently,” he told CSW. “I think actually there is much more mileage in trying to bring budgets together under a single budget holder where the efficient use of money depends on flexible use between two or more objects that at the moment are held by different budget holders.”
Although the name plate now reads ‘Department of Health and Social Care’, Letwin notes this has not yet been matched by merging funding for what he characterises as one of the most significant issues for the country.
“Everybody across the health and social care system knows this is fundamental to healthcare economics in Britain today, because such a huge proportion of the total health and social care spending is on the frail elderly. I don’t think there is a solution to that problem other than to bring these two budgets together.”
One paragraph buried deep in the Red Book indicates how such cross-departmental plans could be developed. It is a pledge that the government would “build on experience and lessons” learnt from previous spending rounds and would “aim to ensure that policy issues are considered across departmental boundaries, and that performance and outcomes achieved for the money invested in public services are tracked systematically.”
Improving the way investments in public services are tracked was one of the key recommendations of a review on improving value in public spending by Sir Michael Barber. Barber, who led the Prime Minister’s Delivery Unit under Tony Blair, conducted the review for the government last year and in it proposed a Public Value Framework to measure the likelihood that public spending would drive improved outcomes in people’s lives. The framework should “set the agenda for dialogue” between the Treasury and departments, he said.
The Treasury has since set up a Public Value Unit to trial Barber’s methodology and is considering how this can support the review.
Whether and how the findings of the pilot will inform the Spending Review remains an “unanswered question”, said the IfG’s Martin Wheatley.
An IfG report, published in September and led by Wheatley, said there were “strategic issues stretching across the whole of government which the Spending Review needs to address”. Areas such as Brexit and local government should not simply be funded along departmental lines, it said.
Wheatley said the wording in the Red Book was “encouraging” but added that “we don’t know a lot about how thoroughly it’s going to be underpinned in the actual Spending Review processes”.
“These things are a lot easier said than done and particularly in the political environment we are in at the moment, they may be at least as difficult as they have proved to be in the past,” he said.
Indeed, Pearce, who was a Labour special adviser – and head of the No. 10 Policy Unit when Gordon Brown was prime minister – noted that the Treasury always says it will break down silos in a Spending Review.
He added: “The challenge for the Treasury is: can it break out of traditional departmental allocations on things like social care and others where spending really does need to be done in a much more cross-departmental way.”
Pearce – who was involved in the 2000, 2004 and 2007 reviews – said departments will be preparing for the Spending Review now, but the extent of their engagement with the Treasury will vary.
“Different departments will be weighing up how much they have an interest in putting their big issues into the Spending Review and how much they have an interest in trying to protect their policy discretion and just fight out the end game when ministers are doing the final negotiations in the weeks before the Spending Review is announced,” he said.
Although some secretaries of state will say “nothing will go to the Treasury unless I see it”, Pearce said early engagement between the Treasury and departments was vital to develop a shared understanding of what will squeeze spending over the period.
“Simply put, we don’t know what the spending envelope is going to be, we don’t know when the Spending Review is going to start or finish, we don’t know how many years it’s going to cover and we don’t know when we will know” Martin Wheatley, IfG
“You need to have an agreed understanding on for example, pay pressures in your services, demographic change – the things that you know are going to be faced by a department in an area of spending. In the early stages of a Spending Review, these are subject to quite a lot of technical discussion, and officials from the analysis function and others have to engage alongside those with responsibility for a particular service.”
This understanding needs to extend to capital spending as well as revenue, although Pearce notes there is a question over how serious the zero-based review of capital funding is. “The idea that you’re just going to completely take a zero-based approach to the Department for Transport’s budget is ridiculous,” he said.
But “most of the action” is on revenue spending, he said, including later in the review process, when the relationship between No. 10 and No. 11 – whose occupants have not been through a Spending Review together in their current roles – will be crucial.
“If the level of trust is low then the Treasury won’t share as much, whereas if levels of trust are high and there are areas where the Treasury thinks No. 10 can help it in the process, then the Treasury will want to bring No. 10 into discussion,” Pearce said.
Letwin noted that both PM Theresa May and chancellor Philip Hammond had experience of being departmental secretaries of state – a situation not seen in government since John Major and Ken Clarke more than 20 years ago.
“It is different [in the centre from in departments] but what you need to know when you’re sitting in the centre is how things work in departments, and [May and Hammond] do have a pretty comprehensive knowledge of how things work in very large departments,” Letwin said.
“Both the prime minister and the chancellor are very experienced departmental ministers who have participated in endless discussions of public spend over many years now. I think that is a very useful advantage.”
One of the key markers of how government policy has changed since the last Spending Review in 2015 will be how the next round deals with devolution. The then chancellor George Osborne set out plans for “a devolution revolution”, with the government backing the creation of elected city-region mayors with powers to raise taxes for infrastructure.
Although many of these mayors are in place, covering regions including Greater Manchester, the West Midlands and Merseyside, the flow of powers out of London has slowed to a trickle, say local government watchers.
“The loudest silence in the Budget came in the section on devolution,” said Charlotte Morgan of the New Local Government Network. “Despite the chancellor triumphantly asserting that the government is set to ‘go further’ on the devolution agenda, the closest he came to a devolution announcement for the English regions in this Budget was the confirmation that a ‘special economic area’ would be developed in South Tees.”
Since Theresa May became prime minister, the government’s Industrial Strategy has been viewed as its major vehicle for devolution.
But Morgan notes that – so far – the strategy has led to new funds for local areas to bid for, rather than decentralisation.
“Creating funds for councils to bid into is not devolution,” she said. “Devolution is about local leaders having the power and resources to make decisions affecting their local area with no strings attached, and this Budget only confirmed the growing fear in the local government sector that the government has finally ditched the Osbornite zeal for decentralisation.”
The Spending Review could confirm the end of that drive once and for all.