Evercore Pan Asset

The UK has talked a lot about a public sector squeeze, but has been living through a tough private sector squeeze. Whilst most media attention was focused last year on cuts to public spending, inflation mounted. Along with tax increases it hit real incomes, reducing discretionary spending power. Current public spending rose by more than 5%, whilst real incomes fell by more than 2%. Higher VAT, National Insurance, and Income Tax for the higher paid all added to the private sector misery. This week the inflation figures showed the squeeze continues, with large gas price rises hitting the headlines. 
 
The public sector will still enjoy a 3.8% cash increase in current spending this year if all goes to plan. It is the later years of the 5 year strategy where the numbers get tighter and the going could get tougher. The idea was to put in place the reforms of the public services that would make it easier to live within more constrained cash increases in later years.
 
The Health reforms will now be amended. The main issue has been how much competition to allow. The original idea was to charge the regulator, Monitor, with the duty of promoting competition, putting the NHS under the full EU competition regime. That is to be altered, with Monitor being asked to promote collaborative working and integration as well. Whether they can avoid EU competition rules applying anyway is an interesting issue. The intention is not to allow competition on price, and to limit competition on quality. Whilst the Coalition government has said there will be  small real increases every year for the Health  budget, the NHS is used to substantial cash and real increases on a regular basis. They say they need £20 billion of efficiency gains over the next four years to live within budgets. This has just got a lot more difficult without stronger competitive pressures to provide care within the framework of a national service free at the point of use. 
 
The welfare reforms remain on track. A wide range of private companies have accepted the challenge to find jobs for the unemployed and to earn remuneration for success in guiding people into jobs which last. These reforms are central to controlling public spending. They are made more difficult by slowing growth, as they need a lively pace of job creation in the private sector. The government has also found it more difficult to control inward migration, meaning more competition for the jobs that are created.
 
The government is finding it difficult to cut the overhead by 30% and to rein in local spending by Councils in ways that avoid cuts to services that people value. The price of localism is the acceptance that some Councils will choose to cut the popular and the visible to make a political point. The deficit reduction plan rests heavily on large increases in tax revenue from general economic growth, which is vulnerable to disappointing global growth and to the sluggishness of bank credit and money following the Crunch.
 
It looks as if the public sector unions will now threaten industrial action against some of the changes. The UK has been relatively strike free since the new settlement of the 1980s. Investors will need to watch to see if the government can manage change and budget control within the large and wide ranging public sector. If it finds current conditions choppy when spending is still rising overall, it will get more difficult when the cash increases in planned spending shrink in 2013-15. When you see the double figure borrowing rates that now apply to Greece, Portugal and Ireland for ten year money the government has little choice but to try to cut the deficit according to plan. 
 
We remain cautious about the world outlook. The emerging market economies are still taking action to slow inflation, whilst the west lives under the long shadow of the banking crisis.