The text of Mr Major’s speech to the Adam Smith Institute on 27th June 1989, entitled “Adam Smith and the Public Sector”.
CHIEF SECRETARY TO THE TREASURY:
If I am allowed to start a memorial lecture for Adam Smith by mentioning Keynes, I think we should recall his famous remark that, in reality, all practical men are the slaves of some long dead economist. When Keynes said that, he cannot have imagined that the long dead economist whose ides would dominate the practical and successful policies of the 1980s would be Adam Smith. But Adam Smith is the man of the 80s. The renewed acceptance of the benefits of competition, of private enterprise, and the recognition of the dangers of monopoly, owe an enormous amount to the influence of Smith’s works, promoted to assiduously and successfully by your Institute.
In recent weeks I too, have re-discovered a lot about Adam Smith. He was certainly no entrepreneur – indeed it has been said of him that “he never engaged in any sort of trade and would probably never have made sixpence if he had”.
And quite apart from the never engaging in private enterprise, the apostle of the free market had a dark secret. He worked for the Government. Worse, he was no political adviser urging radical ideas. He was an official in Customs and Excise! Incidentally, that is a distinction he shares with a number of other great men including Robert Burns, Geoffrey Chaucer, Daniel Defoe, Horace Walpole and Sir George Downing. And whilst he was there he did not, as far as I am aware, address his formidable intellect to the thorny problem of managing Customs collection although he did utilise his forensic skills to express highly radical views on public services. He was insistent that some form of primary education should be provided free, by the State – a proposal which probably reflected his Scottish background and took a century to be implemented.
And Smith also thought that road transport should not be in the hands of the private sector – a point where, to some extent at least, we are now moving away from his prescription and encouraging private capital into road transport development. This is happening on an increasing scale – the Channel Tunnel project being the most dramatic example. To encourage more such projects we have now retired the Ryrie rules – not before time in my view – and confirmed that the acid test is whether private sector involvement means better value for money. Where it does, we have also given the assurance that private road schemes will generally be additional to the existing planned public road programme.
Although much of his wisdom is timeless, Adam Smith lived in a different age when the public sector barely existed and when its 20th Century growth could not have been imagined. Government simply was not responsible for the vast range of activities it provides today. Taxes existed to pay for the armed forces and a minimal government machine and that was that. But Smith’s philosophy raises an interesting question. What would he have thought and said about the kind of public sector we have today? How would he have applied his principles to the management of public service? And what public spending policies would he have advocated to promote those principles?
Unlike Adam Smith I am not a moral philosopher. Nor an economist. Nor an intellectual. I am a practical politician and for me the allocation and management of public expenditure is a practical business, not a matter of ideology. But I do believe that his ideas have both a very great appeal and practical relevance for governments today. We should start from the presumption against intervening to hamper or replace free markets. Indeed we should look for ways of extending the market sector, and this we are seeking to do. First by reducing the relative size of the public sector, and second by using market mechanisms within the public sector as far as we possibly can.
The fact that Eastern bloc countries are beginning to introduce free market policies is the clearest indication that the planned economies of socialism are in retreat. It is not necessary for political philosophers to prove that free enterprise economies are superior to planned economies. History has done that and the political judgement of eastern Europe, is starting to endorse it. Their people too, have observed that political freedom and economic freedom are indivisible.
The appeal of Adam Smith persists because he put the interests of individual citizens at the forefront. Consumer power is an economic expression of individual freedom. A key characteristic of centrally planned economies is that they are driven by producers for producers, whereas the characteristic of a free market economy is that the consumer has primacy. So the first objective is to increase as far as possible the area in which the market economy operates.
It follows from this that, while we do not have a rigid doctrinal view of the ultimate size of the public sector, controlling and reducing its expenditure as a share of the national income is vital to our economic policy. We have now eliminated the structural budget deficit which we inherited from the 1970s and we have the prospect of our budget continuing in balance for the future. But we now need to maintain our policy of restraint in public expenditure in order to produce a sustained reduction in the burden that taxes impose on wealth creating activities. As Adam Smith said, “that burden may obstruct the industry of the people, and discourage them from applying to …. business which might give employment to great multitudes”.
We have achieved considerable success in checking the upward trend in public expenditure which was such a pronounced feature of the post war period right up to the early 80s. Indeed, in proportion to national income public spending is now at its lowest level since the 1960s.
I was glad to see that in his recent book Madsen Pirie recognised the progress we have made:
“What had seemed until 1979 as perhaps an inevitable and remorseless growth of the public sector has been sent into sharp reverse. The speed with which this was achieved in Britain has been astonishing”
And he goes on:
“and so has the speed with which the rest of the world has taken up the example”.
Madsen is right. But we cannot relax. The pressures for extra spending are always strong and sometimes individually may seem compelling. Unless we are vigilant in sticking to a policy of prudent fiscal management, there is the risk that the public sector will again start to pre-empt resources needed in the market sector of the economy. Thus the progress we have made so far is constantly under threat. This problem was addressed explicitly in your Institute’s Omega report on Expenditure and Taxation Policy.
This report posed some tough questions. How to achieve the objective of increasing the entrepreneurial sector in the face of the strong pressures for growth in public expenditure, and against any change? How to identify waste “in a system that separates costs from benefits?”. How to cut waste in the face of public sector producer interests? How to motivate public sector administrators to improve efficiency?
Our approach has consisted of four elements:
– Above all, top down pressure on cash spending. This means setting expenditure totals for each year which reflect a realistic view of the prospects for the economy; if we have a wish list of desirable policies that we fund irrespective of affordability then we will simply ignite inflation.
– Within the totals there must always be a rigorous assessment of priorities.
– Efficiency and value for money must remain an absolute obligation for the public sector.
– And we must wherever possible open public services to competitive pressures through market oriented policies.
These points now sound very familiar – almost truisms. But that is a measure of how far we have come over the past ten years. You only have to take a moment to think back to the mid-1970s to appreciate how much of a change there has been.
If we are to apply Adam Smith’s principles in setting priorities within the public sector we must face the problem that we do not have the invisible hand, that interplay of individuals pursuing their own interests, through free exchange, which promotes both the increase of wealth in society and its wider distribution. The great attraction of this force is that it is both benign and uncontrolled. It works through people having freely and spontaneously. And, as a result, Adam Smith gives us a prescription for a society which maximises both freedom and prosperity.
That inter-play is missing in the public sector above all because there is generally no real price mechanism. And the surrogates for it are at best imperfect. Decisions on resource allocation have to be taken centrally. Economists are always looking for theoretical answers to the question : how do you allocate public sector resources rationally? Politicians must address the same question. The answer of course is that there is no objective system for weighing the demands of different public services. There is no escaping political responsibility. In an open, democratic society, decisions made by the political process will always be fought over. Planning and controlling public expenditure is intrinsically a contentious business. In short, instead of the invisible hand, we have a very visible hand – that of the Government. And, to the extent that anyone in Government has the responsibility of operating that visible hand at any one time, it is the holder of my present job.
When you look at the past 10 years it is clear that the political commitment to market oriented policies of the sort advocated in the Omega report has in fact influenced the distribution of public spending quite dramatically. Subsidies to industry and housing have fallen, spending on health and law and order have increased substantially. We have pressed for, and obtained, reform of the Common Agricultural Policy and made substantial reforms to the SERPS scheme. In recent years we have seen a dramatic fall in spending on unemployment benefits, and correspondingly remarkable increases in benefits for the elderly and disabled.
This switch in resources reflects a combination of economic growth, privatisation and political choice in response to public concern. There is no doubt that pressure for higher spending on priority areas will continue and intensify. To meet them means not only avoiding wasteful and ineffective programmes but also means spreading out the timing of some desirable spending so that more resources can be provided for priority services at a pace which the economy is capable of sustaining. Hard choices are unavoidable and we must be prepared to make them.
It also means improving the performance of the public services. To achieve this I believe it is both logical and desirable that this approach that is making the private sector work better should also be applied to the public sector. The public sector must be part of the general improvement in the supply performance of the economy. We insist on excellence in the private sector, so we must achieve the best possible value for money in the public sector too. We owe that responsibility to the taxpayer. And that depends on applying the market principles of choice, competition and high quality service, more widely throughout the public sector, wherever we sensibly can.
The simplest and most effective way to subject public enterprises to the invisible hand is of course through privatisation. We are introducing the stimulus and discipline of the market place, not only by privatising nationalised industries, but also, for example, by transferring the main responsibility for housing from the public to the private sector. On top of the gain in efficiency, and responsiveness to consumer choice, these measures are having an enormously beneficial impact in widening ownership across the board. Home ownership would not have grown from 55% in 1979 to 65% now without the policies we have followed.
Where complete privatisation is not possible, or desirable, and it often may not be, the discipline of the market place may be introduced in other ways. Services previously performed directly by central or local government can be opened to competitive tender, in which the existing organisation may still compete with commercially provided services. Competitive tendering has already released for better uses some 170 million pounds a year across the public sector. In this way the invisible hand can still have its influence on the efficiency with which services are delivered.
There is of course room for endless debate about the scope for privatisation and the ideal size of the state sector. Beyond those inescapable duties such as defence and law and order, there seems no theoretically tidy state/private distinction. Taking a practical rather than a philosophical view there is no doubt that a substantial number of activities will remain in the public sector and financed from taxes.
The scope for positive policy choice in allocating resources is increased very substantially by better efficiency and value for money. This is a continuing crusade. Not a gimmick. It may be unglamorous and undramatic but it is essential and the rewards are considerable. By eliminating waste and providing services at lower cost we are releasing substantial resources for allocation to improve services or meet priority needs.
The scale of savings is substantial. In the Civil Service, for example efficiency scrutinies and other management improvements have already saved 1.25 billion pounds a year, including last year a quarter of a billion pounds from better purchasing alone. In local government, authorities are estimated to have implemented already more than 300 million pounds of 900 million pounds annual value for money improvements identified by the Audit Commission. And in the NHS the cost improvement programmes are expected to yield cumulative savings this year approaching 900 million pounds – the cost of 20 District General Hospitals or 70,000 nurses’ salaries.
How is this being achieved? First, by comparing costs and benefits seriously, putting effort into stating clearly the objectives of programmes, setting targets for their effects, and measuring their success. We now have literally hundreds of value for money targets covering each and every spending programme.
Second, and just as importantly, by decentralising decision making and by motivating public services managers to improve efficiency. After two years as Chief Secretary is has become increasingly clear to me that anyone who seriously wants to improve the service to the consumer must give priority to pushing decisions down to the individuals who can best take them. For the quality of service depends ultimately on individuals working in the health service, in local authorities and in the local offices of central government departments and agencies.
They are the people who are close to the problems and who should know what the needs are and how to use resources most effectively to meet them. Ministers still need to set objectives and decide on the allocation of resources to meet them. But with that essential constraint, managers should have the greatest possible incentive to maximise performance. I do not believe that incentive means financial reward alone. The incentive, and ability, to provide a better service is a vital motivating force. If it operates effectively individuals enjoy greater job satisfaction and perform better. In this way the requirements of efficiency and better service come together.
At the same time, service managers need to be set sharper targets for their performance, and will be more accountable for the efficiency with which they deliver the services. To do this, they will need better management systems, and more timely information about what they are achieving and how their targets are being met. They will be helped in this by the rapid advances now being made in developing and applying information technology.
Managers and those who provide services will also need to respond to the challenge of greater choice and competition which we are introducing across the public services. The public are right not to accept shoddy services and we are giving them the opportunity to press directly for higher standards and better value for the money they provide as taxpayers. In the health service, it will be much easier for patients to choose the GP who provides the best service. And the GPs who attract more patients because they provide a better service, will be rewarded for doing so. In education parents will be able to exercise greater choice upon which school their children will attend. The establishment of TECs means that the needs of employers will have a greater impact on training and enterprise grants. The funding of universities and polytechnics will reflect students’ choice of course. And so on. We are constantly seeking opportunities to extend choice and make the public services more responsive to consumers’ needs. These are development very much along the lines of the Omega report.
I want to stress tonight that all this is not an easy or comfortable process. The need to restrain overall government expenditure, to set priorities and improve value for money is always acute as the understandable aspirations of society – for better health, for better education, for better environmental standards – rise and the pressures for more spending intensify. Such pressures are particularly acute this year. To some extent this is a response to the demands and expectations of a more successful economy. But it also reflects the belief that expenditure levels do not matter so much if there is a large budget surplus to fund them. Such thinking is seductive but it is unacceptable for any Government that regards control of inflation as paramount.
The fact is that a budget surplus is right for the present circumstances. We are running a surplus because, in his Budget, only three months ago, the Chancellor judged it prudent to do so. Nothing that has happened since then casts doubt on that judgement, on the contrary, events have shown just how right he was. It is true that we have been more successful in containing public spending than we have in reducing the burden of taxation. But that does not create a presumption in favour of higher spending, rather one of lower taxes, when it is safe to do so. But so long as inflationary pressures remain strong, we must be cautious. Of course better infrastructure and better services are important but they are something we must tackle sensible, not rush into with our cheque books flapping.
Our existing public spending plans already incorporate substantial increases for priority programmes. Over the last 5 years the Government has increased its own spending on roads by over 10% in real terms, and on rail by over 75%. And our plans provide for further dramatic increases over the next 3 years – 25% for roads and nearly 50% for rail. Also, in terms of spending on welfare services, benefits for the sick and disabled have risen by nearly 40% in real terms and are expected to rise by more than 25% over the next three years. Spending on the NHS has risen by 15% in real terms in the last 5 years and is planned to rise by 5.5% in the next three years.
In weighing up demands for extra capital spending in particular, we must look not only at the increases already built into the plans, but also the capacity of the supplying industries. There is no point in public spending plans that are over ambitious and unrealistic, either individually or in total. There is no sense in planning increases on a scale that will not only bid up prices and earnings and add to inflationary pressures, but also fail to provide extra roads or extra hospitals on time. That only wastes money, and risks squeezing out private investment which is rising strongly reflecting business confidence in the Government’s performance and policies. We certainly cannot do everything at once. Rome was not built in one financial year. Nor in one survey!
Ultimately the scope for increasing public spending depends on growth in the economy and can only depend on that. It is possible to grow your way into spending by you cannot spend your way to growth. We have discarded the discredited assumptions of the 60s and 70s when well meaning Governments intervened here there and everywhere, inexorably spending more than they were prepared to raise in taxes. This pushed up inflation with all its socially divisive effects, and severely damaged the supply side of the economy. Steady growth led by a strong supply performance is the precondition of public spending. To achieve that growth we must continue to hold down taxes and borrowing. Non inflationary growth encourages social possibilities.
I have said a great deal about the financing and management of public spending in a sustainable way. Here I have clearly taken to heart the words of Adam Smith:
“The uniform, constant and uninterrupted effort of every man to better his condition… is frequently powerful enough to maintain the natural progress of things towards improvement, in spite both of the extravagance of government, and of the greatest errors of administration.”
I can promise tonight that we will continue to resist the extravagance of government – but you will not expect me to promise to eliminate all errors of administration!