It’s time to rethink public spending

Focus on near-term budget constraints may miss looming long-term issues

A key political battleground for the Conservative and Labour parties ahead of the UK general election is how they will balance the books. The near-term focus on fiscal sustainability is necessary in the UK and much of the world. But the current discourse overlooks the looming cost of longer-term fiscal issues, such as tackling climate change and ageing populations. Having better metrics to bring such long-term problems into the present may help to prompt more decisive action now.

There is a clear need for governments across the world to get their houses in order. The International Monetary Fund projects that public debt as a share of gross domestic product will continue to escalate in advanced and emerging economies in the coming years, raising questions about the sustainability of public finances. The discourse among many politicians in the UK and across Europe is how to improve fiscal positions in the near term.

However, the focus on budget balancing now risks missing the bigger picture. Demands on public spending will grow in the coming decades on areas such as climate resilience, greening infrastructure and providing healthcare and pensions to ageing populations. The risk is that kicking these issues into the long grass may lead to more disruptive fiscal and social consequences further down the line.

A working paper by Adrien Bilal and Diego Känzig finds that ‘a 1°C rise in global temperature causes global GDP to persistently decline, with a peak loss at 12%’ – suggesting that inadequate public spending on climate mitigation or preparedness will have stark long-run costs.

A reset is needed

Against this backdrop, Mark MacDonald, global public finance management lead at EY, told OMFIF ‘I believe that we’re facing a situation where there is a requirement for a much more fundamental reset in our thinking’ on public spending. This view runs throughout this year’s collaboration between OMFIF and EY on the ‘Future of public money’.

The research project aims to outline how public money could be better allocated through more effective institutions, data and technology. It is being informed by discussions with a panel of public sector experts with experience across government, international organisations, academia and the private sector, and will be supplemented by analytical research and case studies. This will culminate in a report due to be released in October.

One of the key points that has emerged from the expert panel discussions is the intertemporal challenge of fiscal policy: how to address long-term spending commitments in the short term. Political cycles were one reason cited for overlooking long-term issues. Moreover, there is a lack of measurement, reporting and standards to bring issues such as climate change and demographics to the forefront of policy-makers’ minds today.

This was mentioned by Carolyn Bordeaux, senior visiting scholar at the University of Georgia and former member of the US House of Representatives, in a podcast conversation with OMFIF. She emphasised the need to ‘develop present value metrics… about these long-term costs and risks that we face’.

Bourdeaux provided a clear example where reporting and data have helped to shape decision making. ‘The Governmental Accounting Standards Board changed its accounting standards to require state and local governments to build in deferred maintenance into their… financial statements… That deficit started to show up in much more dramatic ways to people, it became present for them.’

A similar process could be used to bake in future sustainability or demographic-related costs into fiscal positions now. Analysis on this front would not be straightforward though there are existing examples. The UK’s Office for Budget Responsibility outlined in its 2021 fiscal risks report that ‘The fiscal impact of achieving net zero in the early action scenario adds 21 per cent of GDP to public sector net debt in 2050-51’. Worse still, delayed action would increase net debt by 44% over this time.

The European Commission’s 2024 ageing report assesses the cost of ageing populations on spending for pensions, healthcare, long-term care and education. It highlights that ‘For the EU as a whole, the cost of ageing is expected to increase by 1.2 [percentage points], from 24.4% of GDP in 2022 to 25.6% in 2070’. This baseline assessment is based on relatively upbeat economic assumptions and there is significant divergence between countries. A more unfavourable scenario shows a 2.7pp of GDP increase in spending.

While such analysis may be imperfect, it offers a window into the type of long-term costs that could be standardised, reported and scrutinised within government balance sheets today. Incorporating the present value of future climate-related or demographic costs would worsen existing fiscal positions and add to concerns over the state of public finances globally. Crucially, though, it would help to provide a more holistic assessment of current and future economic and social conditions.

This would be a first step to informing the improved allocation of public funds – not only to improve outcomes tomorrow but for the years, or perhaps decades, to come.

Nikhil Sanghani is Managing Director of OMFIF’s Economic and Monetary Policy Institute.

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