Policy Exchange, alongside Reform, are probably closer than any other think-tank to the Conservatives, who may well make up our next government.   What they think matters.  This is why their unrealistic call for an immediate freeze in public spending is so worrying.  For when Policy Exchange write, influential columnists follow - see this by Martin Wolf, for example. With the government utterly failing to set the terms of the debate (partly because their approach is based on obfuscation and wistful nostaligia for 1999), there is a risk that a knee-jerk Right reaction can set the the terms for the debate.

Their document, called "Controlling public spending: the scale of the challenge", goes on for 27 pages, and so this is only a rushed stab at describing their analysis:

"Public Spending has 'surged . . ."

The evidence here is a quite straightforward time-series graph of public spending as a proportion of GDP.  So it grew under Brown during his first phase, and now from 2008-12 it will grow again.  Ergo, splurge.

What is wrong with this?  Well, first, you don't have to be a wingnut from the furthest Right to think that public spending is not the answer to everything. We agree: the politics of the shopping list went on for far too long, and G Brown was a major reason that useful reform was put off. 

But to use this logic to claim it has 'surged' since 2008 is highly misleading.  You can download the figures from previous Budgets, and quickly find that spending plans are not massively altered since before the recession.  Spending for 2009-10 has risen from £646bn to £671bn, entirely because of increased social security/tax credits - an increase that is smaller than that of Mrs T in the early 1980s. 

So what has happened?  Nominal GDP has collapsed, that's what.   When the plans were first made, nominal GDP for 2009-10 was £1550bn.  Now it is to be £1412bn.  A difference in the divisor makes the ratio shoot up.  What Policy Exchange somehow omit to point out is that over the same period the revenues raised - you know, those taxes that we're all meant to be groaning under - have fallen to 35.1% of GDP, a figure lower than any I can find going back to 1970. 

That is why we have a monstrous budget deficit: tax revenues for 2009-10 have fallen from £608bn to £496bn.  But since the Right dominate that discussion, Brown's failure to assure less volatile revenues - a failure just as significant as his hubrisistic spending plans, IMHO - are never discussed. 

" . . and is nothing to do with the recession."

This second claim is either incredibly naive, cynical, or (in the light of a brief discussion of active fiscal policy that follows, and clearly recognises this motivation), a tad confused.  Because it is clear that the reason core spending has remained constant in cash terms (and therefore increasing in Per GDP terms) is precisely because it would be an act of sheer lunacy to launch a round of public spending cuts in 2008-9-10. And since most economic actors plan forward,  from the largest government contractor to the newest nurse, the effect of not sticking to plans would have been like a cut. 

The reason it would be an act of lunacy is what removing so much demand in one go from the economy would do.  Unless you somehow cut taxes by a similar amount (which I doubt any of the fiscal hawks hyperventilating about the debt are proposing), and the tax cuts were (implausibly) spent by a public rendered terrified by rising unemployment and negative equity, the result would be an immediate fall in demand in the economy.  The fall in demand would have a multiplier effect.  Not only would the pay-frozen doctors and sacked nurses/laid off public construction workers spend less, but businesses, building their plans on the basis of future demand in the economy, would also invest less. 

But, 1981??, I hear you ask.  An earlier post has looked at this question (and our paper will in more detail).  Yes, sometimes cutting the government can help an economy in a recession.  It may lower rates, and if high rates are the reason for low private demand/poor investment, then the private sector can flood in to take the government's place.  Then you just have a straightforward fight between those who favour private sector growth or public sector - I would be on the side of the former. However, only the most deluded freemarket idealist could possibly think those conditions pertain right now.  This is a matter of judgement, not dogma. The differences between then and now: the different marginal tax rates, levels of the exchange rate, public sector involvement in the economy, and above all financial market conditions (they had just liberalised in 1981, we have just seen a collapse in lending now) point towards different policies.

In the meantime, the facts about the rise in public spending are:

• When planned, it was scheduled to stay roughly constant as a proportion of GDP, on some albeit rosy assumptions (speaks Harry Hindsight) about GDP growth.  Yes, this meant increasing public spending, though at a lower pace to the admittedly uncontrolled splurge of 2002-7.  For most public spending departments it represented a more difficult time than before, though long overdue in my book. 
• Then the recession happened. In cash terms, all the increase in the plans is pure-recession driven.  
• The increase relative to GDP is all about GDP falling i.e. pure-recession driven.
• The decision not to have it stay steady as a proportion of GDP - i.e. cut it in cash terms the already agreed plans - was driven by a recognition that in such a deflationary recession, Keynesian prescriptions work.  The fact that every other major developed nation has launched a programme of new spending suggests that the Labour government is not out on a limb here.  The IMF recommends fiscal stimulus. So does Martin Wolf, Sam Brittan and other bastions of freemarket thinking

So the idea that the rise in public spending is nothing to do with the recession is plain wrong.  It is all about the recession.  And letting preexisting plans continue to their fruition rather than cutting them is much the same as launching new Keynesian programmes, but somewhat easier.

'Fiscal strategies in a recession'

This section, dealing with a question that attracts so much interesting academic debate (e.g. for one of about 100 articles I have collected on this, go here ) is quite maddening, and I recommend that if you want to understand the topic, read a chapter or two of Blanchard or some other macroeconomics book first.

They write: in a recession "maintaining spending as if the conomy were going to go back to the way it was is an exercise in denial."  That's it - because, long term, economic output will be lower, to put off cutting when demand is in a downward spiral is just denial. So do it now.   

The real discussion about 'active' fiscal policy follows- creating a quite arbitrary distinction between not cutting and actively spending more.  They concede that tax cuts can work, though where they get the idea that in a savings-panic recession like this one a tax-rebate (rather than the wrongly mocked VAT cut) is the best method I have no idea.  The Bush rebate didn't really do much, I believe. The next straw man to be knocked over is the 'public works programme'. Keynes made a rod for his defenders' backs by talking of burying bottles filled with cash in mines.  But the interesting theoretical arguments on this area are instead boiled down to:

"It has historically proved very hard for Governments to time major projects such that they countered the cycle." 

Yes, this is true.  Quite true, which is why I myself am sceptical about ideas like the "Green road to Recovery".  But this is where the false distinction between not cutting and actively planning public works really comes in.  Failing to cut a programme is not the same as actively planning a new one, with all the negotiation and bother that involves.  The Policy Exchange way - suddenly tearing up spending plans halfway through their operation, because NGDP has suddenly fallen, regardless of the knock on effects to confidence and demand - is the one that involves fiddling around with clumsy fiscal instruments.  It is 'active'. Cutting is just as difficult as planning something new. 

 "Why not just freeze public spending right now"

It is worth comparing with the behaviour of those famously crazed spenders, Thatcher and Major.  The left hand axis is the real increase in spending year on year. 

Anyone who thinks that cutting spending on a dime is easy has never really read into previous episodes like 1976, for example (read here).   To achieve the above involved a serious political effort, and an undeniable cost to public services.  Thatcher also had council houses to sell (which equalled negative public spending) and a much higher starting point for the DTI and Defence. 

Public spending can seldom be cut quickly. Contracts have to be maintained or paid off, redundancy payments produced, sometimes even unions need to be negotiated with.  Why, exactly, did the Thatcher government take so long?  Because she was so wet? 

But Thatcher and Major went ahead, because they had a damned good reason.  Which was that interest rates were very high. Not only did high government spending really crowd out the private economy (rather than crowding it in, as Martin Wolf correctly argues is the case now) but the real cost for future governments was really inhibiting. Real rates were 6% or more.  Now they are 2% or less. A finance director who ignored this would be failing in his job. 

I'm running out of space on the Internet. There are some mitigating elements of the paper, once I look through the red mist caused by the cavalier attitude to macroeconomic implications. For example, it is true that public spending being high damages total economy productivity, and useful to have some sources for that. But the OECD also expresses concerns about the permanent loss of output caused by recessions like these if they are allowed to be prolonged - through the deskilling effects of long term unemployment, and lower investment for a period. It is not straightforwardly true that pursuing the fiscal-straitjacket approach always leaves the economy leaner, meaner and better. 

But on the whole it is really worrying that such a paper has got into the public domain with so little criticism of its major conclusion, despite it being so far out of whack with every practical suggestion for short-term fiscal policy.  For the long-term, I quite agree: public spending must fall, as a proportion of GDP, to closer to 40.  Rising GDP will solve some of this.  Efficiency some of the rest.  Some damned hard choices for most of it.  Taxes must also rise, a bit, and be less dependent on a frothy financial sector in future.  Brown has much to answer.  But by using some questoinable arguments this paper may damage the cause.