The pandemic has led to a severe recession. This briefing examines different aspects of the economic impact of the crisis to date and outlines the key issues for the economic outlook.
On Wednesday (25 November 2020), the Chancellor delivered the 2020 Spending Review, setting out plans for Government spending for 2021/22.
On the same day, the Office for Budget Responsibility (OBR) produced its most recent set of forecasts both for the economy in general and the Government’s spending and borrowing.
This Insight summarises some of what the Chancellor and OBR said, and what this might mean for the economy and public finances over the next few years.
Overall spending will start to head back to its previous trend
Spending on measures to cope with the Covid-19 pandemic will result in total public spending exceeding £1 trillion this year.
Although some of this extra spending will continue into next year, the predicted trend is for total spending to get back to its previously forecast increases within the next few years. By 2022-23 it will be lower than forecast back in March.
However, as the Chancellor announced, the economy has taken a significant hit this year (the OBR forecasts the largest annual fall in GDP since 1709), and the effects of this damage will remain apparent for some time.
Spending as a proportion of the economy (sometimes called the ‘size of the state’) will therefore stay above its previously forecast level, having hit a post-war record of 56% this year.
Infrastructure and investment spending
Infrastructure was a major theme of the Spending Review. Investing in infrastructure is seen by the Government as a way to “level up” economic growth and prosperity across the country.
In the Spring Budget 2020 the Chancellor set out relatively large increases in future public sector net investment. The Spending Review gave more details on how this will be spent:
- The National Infrastructure Strategy was published, which is based on three themes: economic recovery; levelling up and strengthening the Union; and meeting the UK’s net zero emissions target by 2050.
- An infrastructure bank will be set up to support private investment in infrastructure.
- Programmes including High Speed Rail, the Road Investment Strategy and the Affordable Homes Programme received multi-year capital settlements.
- A “Levelling up fund” will invest in local infrastructure.
- Following a review, the Treasury has changed how it will assess major investment programmes to make sure that “government investment spreads opportunity across the UK.” The Treasury’s approach is set out in the Green Book.
Investment increased sharply during 2020-21, due to Covid-19 measures. It’s set to come down from this recent high but not back to its previous levels.
The Government still expects investment spending to be around 3% of GDP in the coming years – a level last regularly reached in the late 1970s, when there were more publicly owned industries than now.
However, as the chart below shows, in cash terms future investment spending is now set to be lower than forecast in March 2020. This is largely because the OBR now expects lower capital spending by local authorities and public corporations. Central government capital spending plans are mostly unchanged.
Winners and losers among the departments
The Chancellor’s speech included the Government’s funding priorities, with a focus on “lives and livelihoods.” This prioritisation means the money being made available will not be evenly distributed between Government departments, as the chart below shows.
This chart shows changes just in departments’ core budgets – that is, planned spending on things other than Covid-19 measures. Relative to 2019-20, most departments are set to see reasonably large real-terms funding increases.
The Department for Environment, Food and Rural Affairs (DEFRA) in particular will have its budget increased by nearly 45%, with most other departments having increases of around 5% or more. DEFRA’s increase is largely driven by it taking responsibility for payments to farmers that previously came from the EU, as well as increasing spending on flood defences.
However, some departments will see much less generous increases, or even decreases. The Foreign, Commonwealth and Development Office will have its funding fall over 15% in real terms. This is probably driven largely by the cut in the aid budget from 0.7% to 0.5% of gross national income.
Significant borrowing, some cuts to spending
The Government borrows to make up the difference between what it spends and what it receives from taxes.
According to the OBR’s forecast, government borrowing will finance nearly £1 in every £3 of public spending in 2020/21. By 2025/26, borrowing will finance nearly £1 in every £11 spent.
The OBR forecasts the Government will borrow nearly £400 billion in 2020/21. This is equivalent to 19% of GDP, the highest level since 1944/45. £280 billion of the surge in 2020/21 is attributable to the steps taken by the Government to tackle the pandemic and its economic impact. The OBR also forecasts government borrowing of at least £100 billion annually from 2021/22 to 2025/6.
The Chancellor’s steps to reduce spending included:
- Public sector pay rises will “pause” in 2021/22. Not all public workers will be affected. NHS workers will continue to receive pay rises and the lowest paid public sector workers will receive a minimum £250 increase.
- The UK’s spending on overseas aid will fall to 0.5% of national income in 2021. The Government’s legislated target is currently 0.7%, which it intends to return to “when the fiscal situation allows.”
Background to the 2020 Spending Review, House of Commons Library.
Public spending: a brief introduction, House of Commons Library.
The budget deficit: a short guide, House of Commons Library.
About the authors: Philip Brien, Matt Keep and Daniel Harari are researchers at the House of Commons Library, specialising in economic policy and statistics.
Photo: ‘Chancellor of the Exchequer on Spending Review 2020’ under CC BY 3.0 , ©UK Parliament/Jessica Taylor (Cropped)
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