Putting The Brakes On Spending In Scotland And A Gentle Uptick In Inflation
1st September 2024
From the Fraser of Allender Institue.
In a week that saw the release of GERS - usually a big day in the calendar - it is perhaps surprising that neither of the two stories dominating the economic news in Scotland is related to it.
Instead, all eyes were on Cabinet Secretary for Finance and Local Government Shona Robison's letter to ministerial colleagues stopping any ‘non-essential' spending in the year 2024-25, and on the inflation release that saw the rate creeping back above the 2% target.
‘Non-essential' spending halted: what we know so far
No official statement has been issued on this matter so far - likely because we are in recess - but it was through a piece in The Times that news broke that the Cabinet Secretary for Finance had circulated a letter to Cabinet imposing ‘emergency controls' in order to be able to settle public sector pay deals. This came days after the Finance Secretary had put forward £77.5 million in funding from the Scottish Government to local authorities to try and break the negotiating deadlock over refuse workers' pay, while highlighting that this would have to come from other savings.
The Finance Secretary's letter and subsequent statements to the media highlighted that these controls would take the form of halting any spending that was not ‘truly essential or unavoidable', meaning cases in which the Scottish Government not spending funds would breach its legal obligations, fail to provide essential support to emergency situations or cause significant economic damage across Scotland.'
It's still unclear what that will mean in full practical terms - many areas of spending will fall in a somewhat grey area, and so we await further details. But one of the consequences appears to be a recruitment freeze for ‘non-essential' posts, which points to the likelihood that the Scottish Government will end up in a situation where it stops the spending that can be immediately stopped rather than having the time or bandwidth to carry out a true value-for-money assessment of what is essential.
Should this have been foreseen?
This is a rather dramatic course of action, and one the Finance Secretary won't have taken lightly. But the fact that Shona Robison has had to resort to these measures is nevertheless extraordinary, and therefore it is useful to understand to what extent these are pressures that have come about in the last few weeks or whether more could have been done to foresee them.
Under the Fiscal Framework Agreement, the Scottish Government has relatively large borrowing powers for capital spending, but for day-to-day spending these are mostly limited to covering income tax reconciliations - with small amounts allowed to be exchanged from one year to another. So broadly speaking, the Scottish Government must balance day-to-day spending with revenues, which includes the Block Grant and Barnett consequentials.
So it's really important for the Scottish Government to have control over its spending, as it has responsibility for making the sum add up on the spending side given the funding it has available. And the sums it did present in its Budget for 2024-25 did technically balance.
There are two main issues that have caused headwinds to this however. One is that - as we highlighted all the way back in December - much of the in-year balancing for 2023-24 had been done on the basis of delaying spending into future years. But with pressures already exceeding funding for all years from 2024-25 onwards on the basis of the Scottish Government's own plans, simply delaying spending without a decision on whether to cancel it or not would simply pile on problems for the future.
The second, and probably even more important, is what the underlying assumptions for public sector pay were. At the time of the Budget, the Government said they could not publish a public sector pay deal, as would have been normal, due to uncertainty about funding.
The Scottish Government's resource budget is around £46 billion for this year; in 2023-24, central government pay was £14 billion, with local government pay around £10 billion. The paybill is one of the largest components of government spending, and therefore the Scottish Government must have assumed something about it and about how it would change in the year 2024-25.
Not publishing a public sector pay policy at the time therefore implies a lack of transparency, and leaves one wondering whether it was because it would have been obviously too low to avoid industrial action.
When the publication of the pay policy did come, on 30 May 2024, it was for an overall 2.3% increase (2% from April, another 1% from January) for this and coming years, which the Finance Secretary was the maximum the government could afford. A 2.3% uplift, with no changes in workforce, would cost an additional £320 million relative to the central government paybill in 2023-24, and a bit over £500 million if local government were included. Part of the issue is that we don't actually know how much was budgeted for to begin with due to the lack of transparency from the Scottish Government.
2.3% was already below the forecasts used by the Office for Budget Responsibility and Scottish Fiscal Commission's projections for inflation for this year at the time of the Scottish Budget, and that seems likely to be the case. And so it's unsurprising that the figures currently talked about are now higher and therefore the Scottish Government seems likely to exceed the budget it set aside for pay.
The lack of laid out planning in advance and of a clear narrative will also contribute to the difficulties. For one, the lack of wriggle room left in the budget for pay vis-à-vis non-pay spending commitments meant that if strict pay controls were not adhered to, there would be a risk of breaching the control total. And given that the Scottish Government is not allowed to do so, there is a question about whether at the very least less of the funding total should have been allocated and therefore some more left in reserve to deal with this kind of situation. This is especially true for a devolved government which has fewer levers to borrow its way out of spending issues - it makes it more, not less important that contingency be built into budgets.
Otherwise the Scottish Government leaves its ability to meet its budget controls at the mercy of labour market conditions and decisions of other governments across the UK, including how those fund their own pay policy. And since that the legal responsibility for complying with the spending controls falls on the Scottish Government, that is an uncomfortable position to find oneself in.
The lack of a longer-term plan for where pay should be and how year-on-year increases line up with historical and future decisions is also part of the issue. As we highlighted in our Budget Report in December, the Scottish Government succeeded in losing fewer days to strike action by prioritising higher pay awards; but that also means that the baseline for discussions is not necessarily the same as in England, where higher settlements have come after years of industrial disputes. With a stretched budget constraint, it’s perhaps surprising that this point is not being highlighted by the Scottish Government.
Instead, the announced recruitment freeze is likely to exacerbate the effect that we have previously highlighted in our Budget Report for the NHS in Scotland, and that seems likely to take place more widely: higher pay within an unchanged envelope means employing fewer people than would otherwise be the case. If this is indeed the policy of the Scottish Government - and that is a decision that can be reasonably argued for - ideally it would be by design rather than by accident.
Inflation inches above target, but no reason to panic
The latest inflation data for July was published on 14th August. This showed that CPI inflation has ticked up slightly to 2.2%, from 2.0% in June. The increase is partly due to changes in energy prices, because the inflation data is measuring changes in price compared to a year ago.
The June inflation data was comparing to June 2023, which had a cap of £2,500 (due to the Energy Price Guarantee). The cap in June 2024 was £1,643, a fall of 34%. The July inflation data is comparing to July 2023, which saw a big fall in the cap to £1,928. Comparing this to the July 2024 cap of £1,568, this gives a fall of 19%. So despite the fall of energy prices into July 2024, the comparison to the same period a year ago means the fall in energy prices is making less of a contribution to a lower inflation rate - essentially, they fell less than they did in the same period last year.
This change in headline inflation is not likely to concern the Bank of England (given it is broadly what they expected). Of more interest will be what is happening to core inflation (that is, domestically generated inflation excluding items like food, fuel etc which can be volatile).
Here the news is encouraging: while still significantly higher than the headline rate, core inflation has fallen in July to 4.1%, the lowest rate since January 2022. It is still likely that the Bank will be cautious about further rate cuts until they see the impact of the August cut (to 5.0%) coming through in all economic data including inflation measures.
From Fraser of Allender 16 August 2024
https://fraserofallander.org/weekly-update-putting-the-brakes-on-spending-and-a-gentle-uptick-in-inflation/
Notes
What is the Scottish capital budget for 2024-25?29 May 2024
The 2024-25 Scottish Budget included capital funding of £6.2 billion (compared with £44.3 billion of resource funding). In cash terms, this is £170 million less than budgeted for in 2023-24. In real terms, this represents a 3.9 per cent annual decrease.
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