THE Bank for International Settlements’ (BIS) Annual Report into the world economy should be taken seriously. Unlike many mainstream economists, those at BIS have the credibility of having warned of the dangers of underlying imbalances being caused in asset markets by loose money through the early 2000s.
Unless we in Britain take immediate heed of the advice buried within their report – that fiscal sustainability hinges on reforming age-related spending – we face financial catastrophe. Tomorrow’s Comprehensive Spending Review must bear this in mind.
Our fiscal position still compares incredibly unfavourably with other advanced economies. BIS projects, for example, a 7.1 per cent of GDP overall budget deficit for 2013 – higher than any other advanced nation except Japan or Ireland. The underling primary balance (the structural part of the deficit adjusted to exclude debt interest payments) is the second highest at 4.3 per cent of GDP, behind only Japan again. And since 2007, UK government gross debt has increased by around 60 percentage points of GDP (smaller only than Ireland and Portugal).
This shows there is a lot of work to be done to stabilise the public finances – after all, by definition, the structural component of the deficit is the bit which won’t be eliminated even if the economy returns to trend growth. More cuts or tax rises will be necessary in the next five years to get debt on a downward path. But the longer-term challenge comes in the form of demographic factors, and the subsequent structural drivers of higher spending on health and pensions expected with an ageing population.
Between 2013 and 2040, BIS predicts that age-related health and pension spending in the UK will increase by around 6 percentage points of GDP. If nothing is done to stem this, cuts to the non-age-related portion of budgets would therefore be required in the order of 13 per cent of GDP by 2040 to get debt-to-GDP to the relatively “safe” level of 60 per cent. This, quite simply, will not happen. The choice is thus either an ever-increasing tax burden on the working population, or reforms to old-age entitlements.
This all serves to highlight some of the problems with the coalition’s actions so far. The Conservatives and Lib Dems have largely insulated the pensioner population by introducing the generous triple-lock state pension provision, committing to implement some form of the Andrew Dilnot cap (£75,000) for old age care, ring-fencing the NHS budget, and protecting non means-tested pensioner benefits (partially offsetting the long-term consequences of these by bringing forward increases in the retirement age). Yet these are the very budgets that will lead to an upward rising debt path if left unreformed.
Of course, the government is right that adjusting entitlements for current pensioners would be wrong. They have based their decisions leading up to retirement on assumptions of what they will receive, and cannot easily adjust their behaviour. But that is no excuse to duck undertaking reforms for future pensioners today.
Ryan Bourne is head of research at the Centre for Policy Studies.
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