The growth of the state

The growth of the state

The last 125 years have seen a significant expansion in the size and role of government. Growth has not been linear, with wars, crises and politics, creating swings in the size of the state. The post-war Labour government created the welfare state, permanently expanding the role of government. Under Margaret Thatcher privatisation and the winding down of cold war defence spending shrank the state.

• The unmistakable trend in the last 25 years has been bigger government. The UK has gone from a relatively small state in the late 1990s to a large one today. The ratio of government spending to GDP has risen from under 35% in 1999–2000 to 45%.

• Current plans envisage spending running around 45% of GDP through to the end of this decade. That would represent a period of sustained, high spending unparalleled since 1945. UK government spending is now closer to European than to US levels. 

• Events and political choices got us here. 

• The first big boost came in the early 2000s when the Blair government raised spending on health, education and public investment. This was a political choice and reflected growing disenchantment with the austerity of the Thatcher and Major years. Against a backdrop of good economic growth and relatively strong public finances higher spending looked eminently affordable.

• The next leg up to public spending was driven by events, not politics. The financial crisis triggered a deep recession and propelled public spending to a 30-year high. The coalition and then Conservative government that governed from 2010 spent ten years squeezing spending back down to the levels that prevailed on the eve of the financial crisis in 2007.

• But Conservative chancellors did not seek to reverse the large, Blair-era rise in spending that preceded the financial crisis. And, by 2019, after a long period of austerity, the feeling in the government and the country was that austerity had run its course.

• Sajid Javid, who replaced Phillip Hammond as chancellor in July 2019, eased his predecessor’s rules for controlling debt and pencilled in increases in public expenditure. In opposition Labour was proposing even more ambitious plans to boost spending, and both parties went into the 2019 general election with plans to expand the state. The political mood was, as it had been in the early 2000s, for higher public spending.

• Then came the pandemic, which rendered all spending plans obsolete, and took public spending to 53% of GDP, a level only previously seen during the second world war. As pandemic support wound down and the economy recovered the state shrank – but not back to pre-COVID levels. The current projections assume that expenditure will stick at around 45% of GDP.

• Looking back over the last 25 years, the pandemic, and before then, a shift to higher health and other spending under Tony Blair and Gordon Brown explains much of the increase in the size of the state since 2000.

• A bigger state is financing much higher levels of spending on health and social security. Demographics and factors beyond the control of government, such as wage inflation, are significant drivers of spending. The government can, of course, make changes – subject to, as last week’s government reversal on cuts to sickness and disability benefits shows, being able to retain the support of its own MPs. 

• Higher health spending is by some way the biggest single driver of the post-2000 expansion of the state, accounting for well over of a third of the increase in spending. Social security, through higher spending on pensions, disability benefits and working age benefits, accounts for 16% of the uplift. Rising debt financing costs, due to higher levels of bond yields, account for a similar share. The rest of the uplift to public spending is thinly spread across a number of areas.

• High levels of public spending don’t seem to be delivering better services. The British Social Attitudes Survey shows satisfaction with the NHS, which has been a priority for successive governments, fell to a record low last year. The survey also shows that public support for raising taxes and public spending has fallen well below the averages of the last 40 years, while support for cutting taxes and spending, although in low double digits, has never been higher.

• It is too early to say that public opinion is tilting in favour of a smaller state. But with levels of debt, taxation and public spending at elevated levels, the scope for a further increase in the size of the state looks increasingly limited. Faster growth would help, but after years of disappointment, no one is banking on a step change in Britain’s growth rates. On top of the inexorable rise of health and welfare spending, more money has to be found for interest payments and increased defence spending.

• All of this means that the headroom in the public finances for dealing with adverse shocks, such as recession, is limited. As chancellor George Osborne compared his drive to reduce debt to repairing the roof when the sun was shining. In recent years we haven’t had much sun – in terms of growth – and attempts at repair are, well, incomplete.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 0.3% at 8,799 while the US S&P 500 equity index reached a record high on Friday as it continued its recovery from the tariff-induced sell-off. The US dollar hit a three-year low last week over reports that US president Donald Trump could nominate the next Federal Reserve chair early. The oil price briefly rose to $79 a barrel last week following the escalation of hostilities between Israel and Iran but has since fell back to around $67.

Economics

• US consumer confidence fell unexpectedly in June, according to the Conference Board, partially erasing the gains made in May. Trade tariffs remained the top concern for US consumers
• Mr Trump called for the US energy department to “DRILL, BABY, DRILL” to keep oil prices down following the recent rise in oil prices
• Investors are exiting the US bond market at the fastest rate since the COVID pandemic, according to FT analysis, amid fears over US public debt sustainability
• The US Treasury department requested that Congress remove a provision in Mr Trump’s tax bill that would have allowed the US to raise taxes on foreign investments. Treasury secretary Scott Bessent said the measure was no longer required following the recent agreements made on the wider global tax regime
• The UK government released its industrial strategy last week, which included plans to lower energy prices for businesses and £500m for quantum computing projects over the parliament
• UK prime minister Keir Starmer agreed to dilute his welfare reform plans following discussions with Labour Party MPs who disagreed with the proposal. The concessions are expected to cost £4.25bn
• The UK government’s employment rights bill will not receive royal assent to become law until at least the autumn due to delays in the legislative process
• UK graduate job openings fell to their lowest level since 2018, according to the job search website Indeed, with advertised roles currently 33% lower than the same time last year
• UK real incomes in 2030 are projected to remain unchanged compared with 2020, according to analysis by the Resolution Foundation, the worst decade of performance since the 1970s
• Annual UK car production fell in May to its lowest level since 1949, excluding the COVID pandemic, due to disruption from US tariff announcements and model changeovers
• German business sentiment continued to improve in June, according to the ifo Business Climate Survey, with a notable rise in future expectations. The ifo Institute commented “the German economy is slowly building confidence”

Business

• Heathrow Airport reported that they are seeing “early signs of softness” in demand for transatlantic flights following heightened economic uncertainty in the US
• Chinese battery maker CATL said it plans to introduce battery-swapping technology to the European electric vehicle market. The technology is reported to increase sustainability of the industry and the lower upfront costs of buying an EV
• Energy company Centrica is expected to take a 15% stake in the Sizewell C nuclear project, the FT reports
• Software company Visma, valued at approximately €19bn, announced plans for an initial public offering in London next year, contrasting with the trend of large technology companies leaving London for US equity markets
• The UK government rejected a £24bn plan for transporting renewable electricity from Morocco to the UK via subsea cables, citing viability and security concerns
• The UK government said it would buy at least 12 US-made fighter jets capable of carrying nuclear weapons in response to “a growing nuclear threat”
• Chinese phone maker Xiaomi said it received over 200,000 pre-orders in just three minutes for its new electric vehicle, as it continues to expand into the competitive electric vehicle market

Global and political developments

• Mr Trump said he is with NATO allies “all the way” following earlier comments that commitment to NATO’s mutual defence pact “depends on your definition”
• NATO members agreed to increase their target for defence spending to 5% of GDP by 2035, comprising 3.5% of GDP on core defence spending and 1.5% on security-related infrastructure. However, Spain said it has secured a deal to opt out of the NATO requirement 
• German defence minister Boris Pistorius said Germany would return to conscription to increase its military personnel if a planned voluntary scheme fails to attract sufficient recruits
• Five European nations, including Italy and Spain, criticised a UK-French “one in, one out” migrant proposal, citing concerns over the wider implications for other EU member states
• President Trump said that the New York mayoral candidate Zohran Mamdani is a “100% communist lunatic”, as the Democrat candidate unexpectedly took pole position ahead of the upcoming mayoral election

And finally… the famous annual Glastonbury music festival took place this weekend in the UK, with up to 210,000 music-lovers attending to watch nearly 4,000 performers. This year, more than 1.2m pints of beer will be stocked at the music festival – Glaston-brewery