Beyond the billions: Seven big picture thoughts on the Spending Review

By Matthew Elliott and Dr Clive Black

There is a scene in the new season of Netflix’s The Crown which imagines the conversation between the Queen and Michael Fagan, the intruder who broke into Buckingham Palace and entered Her Majesty’s bedroom in 1982. Fagan decries the £3 billion “wasted” on the Falklands War and says the money would have been better spent alleviating the record levels of unemployment. That scene came to mind when the Chancellor delivered his Spending Review yesterday. At what point did £3 billion stop seeming like a lot of money?

Getting through the coronavirus pandemic is set to cost the country £280 billion. The Government is allocating “an initial £18 billion” for testing, PPE and vaccines next year, and over £2 billion subsidising the rail networks. Inflation accounts for some of this increase (£3 billion in 1982 equals roughly £11 billion now), but it is still a sign of the times when only five of Rishi Sunak’s spending announcements were in the £millions, compared to 39 in the £billions.

And with public sector net borrowing set to hit a record £394 billion this year (almost four times higher than when it first broke the £100 billion barrier in 2008/09 (after the Great Financial Crisis), the argument about how, when and who brings the country’s finances under control is clearly going to define the rest of this parliament.

Readers can find the full details of the Spending Review elsewhere. In this note, we share seven bigger picture thoughts on the Chancellor’s statement, the key questions for the Budget (likely to be in March 2021), and the politicians determining our economic future.

1. The Chancellor’s big focus was on jobs

With the economy set to contract by 11.3 per cent this year – the largest fall in output for 300 years – it is sadly unsurprising that unemployment is expected to rise to a peak of 7.5 per cent (2.6 million people) in the second quarter of next year. From the end of March 2021, the Job Retention Scheme will no longer provide a cushion, so the Chancellor will be hoping that the spending on jobs he announced yesterday, combined with the arrival of a coronavirus vaccine and further easing of the lockdown, will minimise the number of people made unemployed.

It is very good news that UK unemployment is lower than in Italy, France, Spain, Canada and the United States – and Rishi Sunak’s decisive intervention earlier in the year undoubtedly contributed to that – but as the Chancellor said in his statement: “Our health emergency is not yet over. And our economic emergency has only just begun.”

2. The tough choices on spending have begun

As ever, Rishi Sunak’s delivery was pitch perfect, but as some commentators noted, it felt like the Treasury couldn’t decide whether the message was “tighten belts” or “we’re still spending”, so we were provided with a bit of each in turn. But this perfectly illustrates how the Spending Review is pivoting from the “whatever it takes” commitment in the initial stages of the pandemic, to the budget tightening that will inevitably come next year. We are already seeing those trade-offs.

Last week saw record increases in defence spending in the Integrated Review. This week saw the 0.7 per cent commitment for international aid shaved to 0.5 per cent, which will only go up again “when the fiscal situation allows”. It didn’t escape people’s attention that both sums are roughly equal. Spending was shifted from international aid to defence. The nation’s credit card is being restricted and the tough choices on spending have begun.

Janet Daley was correct when she stated in The Daily Telegraph: “The cut in the foreign aid budget will almost certainly be popular in parts of the country outside of metropolitan elite circles, where ordinary people are seriously terrified about their own futures. Politicians on both sides of the House who are protesting about this are tone deaf: most voters believe that if there was ever a time for charity to be directed to the homefront, this is it.”

3. Prepare for tax rises in the Budget

Spending Reviews by definition focus on public sector outlays, so no announcements on tax were expected, but already tax rises are being mooted for the Spring Budget. An increase in Capital Gains Tax has been talked about, as has a cut in pensions tax relief for higher-rate taxpayers. But capital, property and corporation taxes raise only about a quarter of the Exchequer’s revenue.

Two-thirds of tax take comes from income tax, VAT and National Insurance – the three taxes the Conservative Party promised not to raise in the 2019 general election manifesto. Just as they promised to “proudly maintain our commitment to spend 0.7 per cent of GNI on development”, it will be interesting to see if their commitment on those three taxes remains solid. For the sake of our economic recovery, we sincerely hope it does. 

4. Rishi Sunak is a Chancellor, not No10’s Finance Director

Rishi Sunak has probably had a better 2020 than almost anybody else in the country – he’s had a good crisis, to coin a phrase. When he took over from Sajid Javid in February, the word was that he would be ‘Finance Director’ to an economically powerful No10 – hence the creation of the Joint Economic Unit. Over the course of the year, he has grown into the shoes of his hero, Margaret Thatcher’s heavyweight Chancellor Nigel Lawson, albeit slimmer and wearing a hoodie.

Ever since his strong response at the start of the pandemic, delivering his first Budget less than a month into the job, his star has been in the ascendency. But the true political test began this week. Being Chancellor with a blank chequebook is easier than having to turn down spending requests and restore the nation’s finances. We have every expectation that he will rise to the challenge but, to paraphrase his own words, his political difficulties have only just begun.

5. Anneliese Dodds will not become Chancellor

Putting to one side the question of whether the Labour Party can win the next general election, we do not expect Anneliese Dodds to remain Shadow Chancellor for very much longer. Granted her performance responding to Rishi Sunak’s statement was stronger than she has managed previously – and responding instantaneously to any financial statement from the Chancellor is notoriously tricky – but it lacked weight, and she has failed to cut through as a public figure.

In fairness to her, Sunak removed much of her potential venom by limiting the one-year public sector pay freeze to those earning over £24,000, so demonstrably looking after the low paid, whilst also increasing the National Living Wage. Additionally, he very powerfully spelt out the suffering and sacrifice of those who have been furloughed and unemployed from the private sector set against public servants, many of them not front-line Covid heroes, that have had job and pension security.

Compared to recent performances from Lisa Nandy, Jonathan Ashworth or even Ed Miliband, it lacked punch. Keir Starmer – who has also had a good 2020 – would do well to replace her at the next reshuffle. The Labour Party has thankfully distanced itself from the worst elements of Jeremy Corbyn’s time as Leader, but it now needs to develop a coherent economic policy delivered by a credible spokesperson and, critically, make sure that an unelectable and idealistic far left does not re-emerge to be a party within a party again with its pen on the manifesto.

6. Brexit and the private sector – the dogs that didn’t bark

Finally, the Spending Review was notable for the two dogs that didn’t bark: Brexit and the supply side of the economy.

With there being just 36 days to go of the transition period, it was interesting that Brexit barely got a mention, despite the nature of our departure at the end of the year still being unclear. We believe some form of UK-EU trade deal is likely, although frankly Brexit is not at the forefront of the economic news today with the costs, disruptions and potential to reset post-coronavirus arguably changing the policy agenda somewhat.

As for the absence of any supply side measures, being a review of short-term government spending, this was understandable. But if the Chancellor is going to get the economy firing on all cylinders again, then we will need to see some further encouragement for entrepreneurs and job creators – the only people who can ensure that unemployment falls from its peak of 7.5 per cent next year, to the projected 4.4 per cent by the end of 2024.

Ultimately, it will be the private sector, not the public sector, that will enable the Chancellor to get the country’s finances back under control, so business leaders will be looking for some pro-growth, pro-enterprise stimulus measures when the Chancellor next delivers a financial statement. We believe that this must focus on skills, digitisation, planning reform, trade deals for the service sector, the green economy with greener movement, and seizing the enormous potential of Britain’s knowledge economy.

No pressure, Chancellor. The Spending Review was good, but the proof will come with the Budget.

7. A Disunited Kingdom – the next big challenge

One final thought on the future of the UK. A Brexit deal and the successful distribution of a coronavirus vaccine will not mark the end of the country’s difficulties. With the Scottish nationalists using the pandemic to rattle the cage of the UK, one major outcome of their often nasty narrative has been to increasingly politicise the English to not only avoid seeking to keep the present Union together, but to actually encourage Scotland’s departure. With increasing regularity, many people in England simply say, “if the Scots want to go, let them go”. Such a narrative is also noticed in the two parts of Ireland and will become more so if the transition ends with a no-trade deal Brexit. The big political event next year is likely to be the Scottish Parliament election on 6th May, a likely victory for the SNP, and pressure for a second independence referendum. We will return to this subject nearer the time, but Budget planning from 2024 will certainly be very different if it involves a radically different United Kingdom.