INSIGHT COVER STORY
Rational choice
Professor Brian Ashcroft Professor of Economics, Fraser of Allander Institute
‘Salami slicing’ and ringfencing should be ruled out in favour of cutting marginal value activities first
Scotland is facing a major shock to its economy and its public affairs. The scale of the fiscal consolidation in prospect will, we estimate, slow Scotland’s economic growth appreciably - by 0.5 per cent in 2011. But negative growth – at least on an annual basis – should be avoided and hence the so-called ‘double dip’. The anticipated cut in the Scottish DEL will, given current spending links and behavioural relationships, lead to significant economy-wide job losses up to 126,000. If wages are reasonably flexible there may be some ‘crowding-in’ of private sector activity and mitigation of public job losses. But there will still be a significant overall job loss amounting to 64,000. The Scottish Government is gearing up to deal with the reduction in its assigned budget, which will be revealed after publication of the UK Comprehensive Spending Review on October 20.
How can the Government respond to this? The excellent Independent Budget Review (IBR) considers cost savings and revenue- raising options as a means of limiting cuts to frontline services. Some indication is also provided by IBR on where spending cuts might be made. But it is highly unlikely that the need for spending cuts will removed by the adoption of some of these other options. What is required is the adoption of a rational process that links fiscal consolidation to the objectives of the Scottish Government. Economic stabilisation, economic growth and social justice would appear to be key. And these objectives may be mutually exclusive, to some degree: a potential trade-off between equity versus efficiency and growth. For example, the CBI seems to think so and is asking the UK and Scottish Governments to prioritise spending on supporting growth, e.g. infrastructure at the expense of welfare payments. But how much one should trade-off equity for growth and efficiency is a value judgement and hence a
22 Holyrood 4 October 2010
political decision. That said, spending cuts should be applied according to the rules of a rational choice model. Cuts are applied first to those spending areas where the marginal value to government – and hence the electorate and wider community – is least. This would rule out ‘salami slicing’ and suggests that some functions/services with low marginal value should be removed altogether. But is the application of this ‘economic’
principle in conflict with the political pressures on government to offer ‘something for everyone’? Perhaps. But the Government needs to be brave and resist the inevitable lobbying by special interests. Conversely, does the application of this principle justify ringfencing the whole of the health budget? The answer to this question is no! Because it implies that every activity upon which money is spent in the health budget has a higher
marginal value than spending activity under all other budgets. This is difficult to justify. However, some health spending will have a very high marginal value, perhaps spending on treatment of cancer and heart disease. It is rational to protect such areas, subject to the scale of the overall reduction in the assigned budget. The Government will not want the fiscal adjustment to destabilise the economy or damage long-run economic growth, which it is seeking to raise. I would offer the following guidance to help protect these important objectives.
Stabilisation The aim should be to minimise the effect of fiscal consolidation on demand in the economy, so reducing secondary job losses. There is a limited role here for the Government of a small open economy. But where cuts have to be made, or charges and taxes introduced, the
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