The British welfare state has a grand tradition. Many argue it has no future. It includes highly popular mass services, such as the NHS, the education system and state pensions, and also welfare for the poor and low-waged, including unemployment and housing benefits, tax credits and family support. Services in the first area are highly popular, but cost a lot to run (currently nearly a quarter of GDP, some 55 per cent of all state spending). Those in the second are cheaper (6 per cent of GDP, nearly a sixth of state spending) and at the heart of debates about work incentives and spending cuts. Healthcare, education and pensions (the lion’s share of the welfare state) are seen as unsustainable because costs will escalate as the population ages and staff costs rise. This assumption is misleading.
The claim that healthcare, education and pensions are unsustainable is often based on long-term spending projections, such as those of the Office of Budgetary Responsibility, below:
Spending on the main state services, 2011-2062 (% GDP)
Spending initially falls, as austerity and capital spending cuts bite home. Healthcare and pension expenditure then rise as the number of older people increases, while education stays roughly constant. Independent projections by the European Commission show a similar pattern. The projections assume a return to sustained economic growth in the near future. If growth does not return, all bets are off—and we will live in a very different world.
The projections cover a very long time period, during most of which the economy will also grow. If GDP grows at 2.5 per cent annually (the average over the past half century, including boom years and recessions) it will be 2.35 times larger in real terms by 2062. Spending about 2 per cent extra from this larger GDP on pensions and another 2 per cent on sustaining the NHS does not seem too heavy a burden when spread over 40 years during which resources expand. Living standards would have to grow at a slightly lower rate than the economy as a whole to make room for the extra spending on public services.
Spending across the three areas grew by roughly 4 per cent of GDP under Labour and Conservative governments during the two decades before the economic collapse of 2007. If we simply follow the pattern established in the past, spending growth will exceed what is needed. Even the coalition, committed to rapid deficit reduction, prioritises NHS and education spending and increases pensions above inflation. There is also real effective demand for more spending in these areas. The social policy expert John Hills has shows that at the same time as state spending was expanding, people chose to put more resources into these areas out of their own pockets. Private spending on health, education and pensions increased by 1 per cent of GDP in the two decades before the economic collapse of 2007. The pattern of both state and private spending indicates that the mass services of the welfare state are highly popular with voters.
A major factor in rising costs in the NHS and education is higher wage-bills as the pay of skilled professionals rises. This poses a real problem. If staff costs rise faster than output, the cost of providing the service will escalate and impose a growing strain on budgets. Many initiatives have been pursued to hold down costs, including internal markets, pay freezes, efficiency savings and target-centred management. Recent studies by ONS following the methods developed by Tony Atkinson show that these methods can contain rising costs. The output for each health care or education worker has in fact kept pace with rising wage costs, neutralising the impact of higher wage bills. A recent study by the European Commission’s Economic and Finance Council confirms Office for Budget Responsibility analysis to show that the UK is a good position compared with most other European countries. Cost pressures here are rather lower than the EU average because our services tend to be less generous.
The argument that the big three services (NHS, education and pensions) are unsustainable is misleading, provided growth returns. All we have to do is follow the pattern established before the crisis, when we increased expenditure gradually over time and managed pressures equivalent to those we will face in the future. If growth does not return as in the past, our problems will stretch far beyond the welfare state.
These arguments are developed in more detail in Peter Taylor-Gooby’s new book, The Double Crisis of the Welfare State and What We Can Do About It (Palgrave)
