The UK public spending review is no as radical as it seems and leaves many questions open for later

Tony Blair likes to say that the new UK spending review marks the distinction between the two main political parties: Labour is in favour of higher spending on public services while the Tories prefer tax cuts.

But with respect, prime minister, this is not what the spending review shows at all, if examined with the barest minimum of historical perspective. Instead, it shows the semi-Biblical story of three lean years for public spending followed by four fat years. Or to put it more crudely: what goes down may sometimes come up.

Forget the debating arguments about whether departmental expenditure limits (so-called "frontline services") are to rise by £43bn compared with 2000-01 or by £68bn compared with 1999-00. These are meaningless figures which can be made to look as high or as low as one wants depending on the number of years added together.

A much better idea of the changing role of public spending can be obtained from the table on page 154 of the spending review, which shows total managed expenditure as a proportion of gross domestic product. The chart shows that this total fell sharply from 41.2 per cent of GDP in the last Conservative year of office, 1996-97, to 37.7 per cent in 1999-2000.

Even in the terminal year of the new spending review, 2003-04, it is expected to reach only 40.5 per cent. It will not only be lower than in the last Conservative year but will be even further below the total reached in the early years of John Major’s government, when it peaked at 44.1 per cent.

Thus the present projections, assuming that they are fully observed, are consistent with at least two possibilities. One is that the public spending ratio is recovering from a temporary dip to something like what was reached during the Conservative years. The alternative possibility is that we are at the beginning of a new upward trend of which the new spending review is but the first stage. The choice between the two hypotheses will depend on spending later this decade, after 2003-04.

To diagnose a fundamental difference between the two main political parties, one would have to make projections beyond 2004, which is a pretty fruitless task. The movement of public spending later in the decade will depend much more on the perceived success of the spending increases now in train, and the movement of fashion and opinion, than on any macroeconomic crystal-gazing now possible.

Do the government spending plans require an increase in the tax burden? One senior official, who is above the fray, puts the matter as follows. The public sector emerged from the 1992 recession with a chronic imbalance. This was put right partly by the spending restraints imposed by the Conservative government in its last few years, and Gordon Brown in his first few years; and also by three sets of tax increases imposed respectively by Norman Lamont and Kenneth Clarke, the last two Conservative chancellors, and by Gordon Brown in the "stealth taxes" of his first few years. These adjustments are behind us.

Indeed, the Budget Red Book has a table (C10 on page 204) showing taxes and social security contributions remaining in the early years of this century at or slightly below the 37 per cent of GDP estimated for 1999-2000.

We are still left with a question. Taking current and capital investment together, the government is budgeting for an annual average increase in managed expenditure in real terms of 3¼ per cent per annum in the three years. Yet its estimates for economic growth at trend rate is only 2½ per cent per annum; and there is an alternative cautious projection in which the economy is presumed to be 1 per cent above trend at present, which is similar to the old idea that, for fiscal purposes, trend growth should be prudently projected at 2¼ per cent.

What accounts for the difference between the projected growth of the economy and that of public spending?

Some of this can be explained by the projected fall in the current budget surplus by one percentage point of GDP from the high level reached in the last financial year. This loosening of fiscal policy was much discussed at the time of the Budget. Another part of the answer may lie in non-tax items in government receipts, such as income received from various public investments.

These projections have, in any case, been made much safer by the larger than expected proceeds from the auction of mobile telephone licences and from similar such auctions planned in the future. The scale of these was quite unknown at the time of the Budget.

As long as the fiscal projections are realised they remain consistent, even in the cautious case, with a falling ratio of public sector debt to GDP and with the Maastricht criteria. They may not be absolutely consistent with the European Union growth and stability pact, which calls for a balance or surplus in a normal year, including capital as well as current spending. But they are more ambitious than anything the euro-zone is likely to achieve.

The broader sceptical question is: how likely are the government projections to be derailed by events? As far as I can see they have been prepared by non-political civil servants in the normal way, just as they were for Norman Lamont, who was afterwards accused of leaving behind a borrowing requirement approaching £50bn. If anything goes wrong it will be not because of any technical deficiencies in the projections, but because of Harold Macmillan’s famous "events, dear boy".

These are no more nor less likely than with any government at any time. A really big shock such as a Wall Street collapse that spread to other countries, or an international political crisis, could derail the projections by far more than shown by any alternative variant that a normally cautious official would care to project.

Many in the financial communuity are much less interested in these long-term questions than in what the spending review means for base rates in the next few months. Goldman Sachs believes it increases the likelihood and size of further increases this year. This is not because of imprudence, but because the swing from an underspend in the last financial year to a substantial growth this year will exhaust the normal trend increase in output, leaving little room for private spending.

This is not inevitable. It may be that past interest rate increases and worries about information technology shares are already damping spending. Or it may be, too, that sterling will not fall further, and that the monetary policy committee will have the wisdom to go by actual signs of inflation in the pipeline rather than by hypothetical calculations about the output gap. Here, however, we reach the outer reaches of crystal-gazing.