Monday, January 15, 2007

The coming crisis in the British Public Sector

Once upon a time there was an Island country that had an independent civil service. This civil service attracted many good brains and so was a finely honed tool of administration. Senior leaders of the civil service were not extravagantly paid- indeed they usually earned less than their equivalent in the private sector, but there were regular perks: Knighthoods for the big bosses and good gongs for the rest that help to recompense the lack. In addition there was a pension that was non contributory and index linked, so overall the civil service was not that badly off. There was a certain "flexibility" too- since decision making was private mistakes could occasionally be overlooked and therefore not blight the careers of those involved: Ministers were responsible for their departments, and if the mistakes that were made were serious enough, then the Minister would have to carry the can and resign. As The Economist points out, this week, much has changed

Over time the public sector became less fashionable and struggled to attract the cream of the graduates that it had once enjoyed. Salaries began to rise substantially. Over the five years to 2006 the number of senior civil servants earning over £100,000 tripled. Even areas that were nominally autonomous, although funded by the state, like the Health Service, saw pay scales soar. The average GP was soon earning over £100,000 too. The British National Health Service, which had not delivered adequate service for some time, despite the earnest ideals of the 1946 National Health Service Act, but had at least been relatively cheap, now became both inadequate and expensive.

Further blows followed. Public sector pensions also increased vastly in cost- no longer could the unfunded pensions be ignored, when the cost the average British family over £900 a year. The attractiveness of public sector pensions led to vast- but entirely legal-fiddles, where huge pensions could be purchased for minimal outlay, provided that the employee stayed in the state sector, and final salary schemes continued unchecked- opening up a gigantic deficit in the public pensions systems.

Perhaps unsurprisingly the Army began to become involved in the pillaging of the public purse. The value of projected PFI projects contracted for equipment and training exceeded the entire military budget for 2006- an estimated cost of over £35 billion.

While nominal inflation remained low in the economy as a whole, the cost inflation rate for the public sector became a massive multiple of costs elsewhere. The projected increases in the role of public sector proposed by Gordon Brown did not take into account the even larger increases in unfunded pension liabilities which multiplied the overall costs dramatically.

Sterling interest rates- already at a considerable premium to Euro rates- began to increase more rapidly than the UKs competitors....

What happens next?

Brown has not delivered prudence, he has delivered accounting adjustments (and statistical fiddles). The cost of the public sector, nominally sustainable, is in fact out of control.

The consequences, together with the pressures on the British Housing Market point to a serious downturn. The bond market- trading on an inverted yield curve-already predicts this.

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