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A fix for the system

As the Tories seek to take the axe to the welfare state, Phil Murphy looks at why governments have spent 15 years trying, and failing, to cut public spending

When Labour prime minister James Callaghan and chancellor Denis Healey first turned the screws on state spending in the late 1970s, government expenditure measured about 45 per cent of British economic output. Since 1979 Conservative governments have sworn to free the market system from the shackles of the 'big state'. Yet today, government expenditure is back to the same proportion of national output as it was when the 'cut state spending' campaign started in the seventies.

With the government's budget deficit now running at around £50 billion a year, the Tories have made this year's public spending review the centrepiece of their bid to get back in the economic saddle. Michael Portillo, the minister in charge of the review, has made clear yet again that government spending must be cut. Why do they bang on about the need to reduce public expenditure? And why have they consistently failed to slash the government budget?

Slump economies

State spending began to be perceived as a problem in the 1970s as the economy drifted into serious trouble. This was the start of an era of capitalist crisis which has continued more or less ever since. The trends towards crisis were briefly submerged during the credit-fuelled boom of the late 1980s, but soon resurfaced with a vengeance as a full-blown economic slump.

The crisis is rooted in the very way that wealth is produced in a capitalist economy. It is fundamentally caused by the intrinsic tendency within the capitalist system for profit rates to fall. (For a full discussion of this phenomenon, see 'The slump is here to stay', Living Marxism, April 1993). However, the causes of economic stagnation are not widely understood in this way.

Capitalists do not see their problems in terms of falling profitability at the point of production. They experience the crisis at the level of the market place and competition. This obscures the true causes of the crisis. The secular decay of profit rates in the production process remains hidden, while attention focuses on superficial, surface aspects of the recession. In this way the symptoms of the crisis are mistakenly identified as its causes.

Tax, tax, tax

One favourite scapegoat has been high state expenditure. The claim that state spending causes problems for capitalists has an apparent logic to it. This is because public expenditure has to be paid for out of the surplus produced by the economy.

Capitalists expand by investing the profit they reap from past operations. If they are not making enough profit over a period of time, they cannot keep going (and the banks will not extend credit indefinitely to unprofitable enterprises). Capitalists may not understand the inherent tendency towards falling profitability. But they are only too aware of the problem of finding sufficient funds to finance their operations. State spending is seen as exacerbating these financing difficulties. Most state funds come from taxation. And one way or another, the employers have to pay the government's taxes out of their profits.

It is obvious that the employers pay a duty like corporation tax. What is less obvious is that, in most circumstances, the employers also indirectly pay for their employees' income tax, and for sales taxes on the goods their workers buy. This is because increased taxes on income or purchases are usually compensated for by higher wage levels, so allowing real living standards to be at least maintained. In these circumstances higher taxes will be reflected in higher wage bills, which cut into what's available as profits.

Government tax revenue today stands at over three times the level of the post-taxation trading profits of British industrial and commercial companies. This means that a five per cent cut in government spending and taxation would be the arithmetical equivalent of a 15 per cent rise in profits. So, although government spending and taxation do not themselves cause the tendency for profit rates to fall, there are good grounds for capitalists to feel that high state spending makes their own situation worse.

Debt trap

Borrowing money to fund state spending doesn't get around this problem either. Although an advanced economy like Britain can build up quite a large government debt without facing pressing demands for repayment, the loans do have to be serviced. Interest has to be paid to the creditors and there can be further costs involved in rescheduling borrowings when the time comes for notional repayment. These costs add to the state budget and themselves need to be financed - through taxation, or more borrowing.

More and more government borrowing on the world's capital markets also tends to push up interest rates. In turn, these higher interest rates will swell the cost of debt financing. In the longer term there are limits to how much foreign financiers will be prepared to lend a government. The timing of this borrowing drought cannot be predicted, as it depends on many economic and political factors in the country concerned and internationally. However, the fear of such a state financing crisis is another reason for governments to wish to cut spending levels.


From the standpoint of the individual capitalist and of the Treasury, there are good reasons to want to cut state spending in a time of economic crisis. The higher expenditure is, the more likely that employers will have to bear some of the cost, through higher taxes. Public spending doesn't cause the crisis, but it can appear to aggravate it as a deduction from the funds which could be made available for capitalist growth.

Against this perspective some old-fashioned Keynesians would argue that state spending can provide additional demand in the economy. But this in itself won't help to resolve the problems of unproductive British industry. If British goods are already less competitive than foreign goods, then most of the demand stimulated by government spending will simply boost imports, contributing to the huge trade deficit. The Keynesian argument falls apart with the exacerbation of balance of payments crises - a pattern well illustrated by Britain's postwar experience of the 'stop-go' cycle.

So why has the rhetorical drive to cut state expenditure had such little effect? The essential reason is that, despite all the limitations of state spending, the modern capitalist economy is too feeble to survive without it.

Blaming state spending for the slump is a classic case of mistaking the symptoms of the crisis for its cause. State intervention in the economy grew in the first place because the market system was incapable of sustaining a dynamic of growth on its own. Modern capitalism needs state assistance to survive.

State intervention has been on a rising trend for a century, during which the secular trend in capitalism has been towards stagnation. The state has become crucial to offsetting the effects of falling profitability. The dominant role of the state in the economy therefore reflects the less dynamic character of the modern economy. Capitalism cannot do without it.

There are two main aspects of state intervention which cost money but have been necessary to maintain the capitalist system. The first is direct assistance to industry, through state subsidies. In the past, particularly since the Second World War, this has involved both direct government grants to private companies and the nationalisation of important but unprofitable sectors.

In recent years, however, things have changed. The privatisation programme has helped to create the impression that the government has a more free market, hands-off attitude towards industry. In fact, the reverse is true. State subsidising of British industry has become even more pervasive, but is no longer always immediately identifiable in government accounts.

Today, for example, government regulations protect parts of industry from international competition and sanction price-fixing cartels (these forms of state support remain vital to some of the big privatised corporations). The state provides tax credits for investment. And perhaps most importantly, central and local government contracts provide crucial support for British business.

Without government contracts, for everything from building warplanes or constructing roads to providing cleaning and catering services in the NHS, the private sector would be in a far deeper crisis. The multifarious ways in which the state now aids the private sector will be investigated further in forthcoming issues of Living Marxism. For the moment, however, it is important to note that this has implications for attempts to cut the other major aspect of state expenditure - the welfare state.

First and foremost, the welfare state was created for the good of British capitalism. Welfare measures were implemented by the state from the turn of the century in order to ensure a fit and compliant working class, able both to fight foreign wars and to work effectively on the home front. The elements of a welfare state were established in the early years of this century: the School Meals Act, the Hospital Panel (the forerunner of the National Health Service) and the first National Insurance Act.

After the Second World War these welfare measures were much extended with the creation of the NHS and the expansion of the education and social security systems. This was partly to ensure a healthier, better educated workforce, and partly a key element in the construction of the postwar political consensus.

During the fifties and sixties, Britain experienced an economic boom. While profits were relatively high, the burden imposed on the business sector by state spending was tolerated easily enough. In the seventies, the impact of the economic crisis stimulated the drive to cut back on state spending. But it quickly became clear that this was much easier to propose than to execute.

A luxury wasted

Treasury figures attribute most state spending to welfare provision. Today, for example, spending on health, social services and social security amounts to 44 per cent of British government spending. Education represents another 12 per cent and housing five per cent. The assumption on the right has been that this spending was a luxury wasted on the working classes, and could therefore be axed with little detriment to the functioning of the capitalist economy. But that assumption has proved false.

It turns out that the 'welfare' budgets contain a lot of spending which supports the economy. For example, in 1991 about 15 per cent of total government expenditure was accounted for by the welfare budgets' spending on goods, services (excluding wages and salaries) and capital grants to the private sector. In other words, this £34 billion of 'welfare' spending in fact goes towards maintaining the health of the private sector. As such, it is hard for the state to cut it, especially at a time of economic crisis.

Tory ministers seeking to cut public spending have also faced the political constraints created by the fact that not just working class, but many middle class people now rely on the welfare state for employment; the wage bill for this sector came to around £38 billion in 1991. Even the social security budget has proved politically difficult to cut ruthlessly, since many of the transfer payments go into the pockets of the middle classes.

The intricate way in which even the 'softer' parts of the state budget work to prop up the capitalist economy and the status of the middle classes has created enormous barriers to successive government attempts to cut spending. This provides the backdrop to the current public spending review.

With the budget deficit soaring ever higher, the time is coming when the government has to try to make some hard decisions about forcing through tax rises and spending cuts. It has already gone some way towards preparing the ground politically.

Undeserving lords

By kite-flying the notion that nothing could be ruled out of the cuts discussion - pensions, child benefits, dental care, prescription charges - the Tories have sought to win acceptance of the idea that deep cuts are now necessary. They have done so by packaging their cost-cutting exercise as a moral campaign, dividing people into those who deserve welfare services and those who do not. So cuts minister Michael Portillo argues that universal benefits are absurd since Lady Thatcher and Lord Callaghan do not need a state pension, while some health authorities insist that patients who smoke do not warrant proper medical care. 'The whole point', says Portillo, 'is to make sure that our public spending goes to the people who need it most'.

From the Tories' perspective, however, the people who need it most are those running British business. Behind the high moral tone of government speeches, the main targets of the cuts are not members of the House of Lords, but working people. The late Norman Lamont's last budget started the deficit-cutting campaign by raising indirect taxes, like VAT, which disproportionately affect the worse-off sections of society. That is a pattern we can expect to see repeated as the government embarks on a round of swingeing cuts and tax rises. (And in today's workplace climate, where management has the whip hand, there is little chance of passing on tax increases to the employers through pay rises).

By winning their moral campaign around public spending, the Tories hope to achieve a decisive shift against the political constraints which have held back previous spending cuts. This renders them a greater chance of success than in the past. But the fact that much of state expenditure is more vital than ever to the operation of the capitalist economy still stands in their way.
Reproduced from Living Marxism issue 57, July 1993



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