Lord Willetts is President of the Resolution Foundation. He is a former Minister for Universities and Science, and the author of The Pinch.
Over the past three months, ConservativeHome has been hosting an interesting and important argument about reducing the demand for government. It opens up the question of why government grows. Is it producers of Ggvernment services wanting to supply more, or all of us as citizens demanding more of it?
The explanation to which I attach a lot of weight – demographic pressures – does not neatly fit into either category. Imagine a long-term stable set of cross-party commitments on pension, health and education spend per person which are just linked to the underlying growth rate of the economy. There is no ideological plan to increase the size of the state as a proportion of GDP. There is, however, a balanced budget rule so that each year’s public spending has to be paid for out of tax.
Then add in a once-off surge in the number of babies born. That large cohort works its way through society like a pig being swallowed by a python. At first, it shows up as extra pressure on education spend and taxes go up to pay for that. Then there is a favourable period when this big cohort are all of working age, so economic output goes up. But the number of school students is falling back to the level before the baby boom. And there is no increase in the number of pensioners.
That society looks as if it has cracked the challenge of boosting economic performance. Economic growth surges, public spending falls and taxes can be cut. This is celebrated as the triumph of a political programme for shrinking the state. But then the mood changes, as that big cohort grows old and pushes up spending on pensions and health care. That drives up public spending, so taxes have to rise. There are denunciations of the failed political leaders who can’t match the performance of the heroic period of economic growth and tax cuts.
This is very simplified account of the impact of the post-war baby boom on the shape of the state and our wider politics. I set it out in The Pinch. There is a lot else happening as well – I am not a complete demographic determinist. But nevertheless it is the back-drop to the ConHome debate on the size of the state.
In this accountm the role of the state has not really changed at all. It has grown and shrunk and then grown again not because of any change in policy, but because of the demographic impact of that one big cohort working its way through the system. It is applying to the size of the state an argument very similar to the one that what really matters as the measure of economic performance is GDP per head, not the total size of the economy.
The purist position could instead be that the absolute size of the state needs to be held down. So, then, it wouldn’t be the level of tax that adjusts to these demographic pressures, but instead public spending per person.
That would mean that if there is surge in the number of pensioners then there should be a reduction in spending per pensioner. But the Triple Lock is the opposite of this approach. It is a very generous upward ratchet by increasing benefits for pensioners by either 2.5 per cent or inflation or earnings whatever is higher.
Since it was introduced in 2010 nominal GDP per head has gone up by about 45 per cent but the state pension has gone up by 60 per cent. It might have originally been a means of achieving a step change in the level of the pensions, but that cannot be afforded indefinitely. Put it on top of the increase in the number of pensioners and you get big upward pressure on public spending which has to be financed by higher taxes. (There never was a plan, incidentally, that the state pension should be funded out of a massive fund of accumulated contributions. The Government in a free market economy discharges its obligations by its power to tax, not by owning most of the shares in British business and using dividends to pay out benefits.)
This generosity to pensions may be related to the Conservative Party’s particular reliance on older voters. Indeed, there is an argument that age is the new divide in British electoral politics. It is not unusual for a political party to try to protect the interests of its voters. But it does present the Conservative Party with a real challenge in communicating its values. There is a traditional Tory message about the need for fiscal discipline and restraining public spending, so as to make it possible to hold down taxes. But that message is not going to be very credible if the Conservative Party’s own voters are to be exempt from these pressures.
Whatever the demographic pressures may be, there is still a constructive role for good policy. Many of the contributors to this series have focussed on strengthening the family and the civic institutions which can take on roles which otherwise end up falling to the state. That is an important strand of Conservative thinking.
But there is also some basic economics behind the growth of the state as well. Britain is unfortunately a country with a low level of household savings. That leaves many people looking to the state because they have no other means of support. We should be doing more to promote household saving. The shift to higher interest rates, however painful, does at least help with that.
One of the under-estimated cross-party policy successes of the past two years is the roll-out of auto-enrolment in private pensions savings. The good news is that many people of working age are now building up a personal pension pot. The bad news is that there is not much in it and there are strict limits to what can be done with it. I would add to the many policy ideas which have already emerged from this exercise, measures to get more money into those savings pots and a bit more freedom on how it can be spent. A nation that saves more and where property ownership is more widely spread can depend less on the state.