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Philip Hammond: Hard Times - Strategic Challenges for Government and the Public Finances

After the last three Prime Minister's Questions, the need for proper and informed debate is clear.

Let me start with the good news.  Gordon Brown was wrong when he said he'd abolished boom and bust - so we will come out of this recession.  I can't tell you exactly when it will be, but the recession will come to an end.

But there's some bad news as well. 

The bad news is that the end of the recession does not mean business as usual.  Britain's fiscal imbalance is not going to correct itself.  Dependence on a housing boom and the financial services sector for tax revenues over the last few years and half a decade of living beyond our means, running large deficits during the years of strong economic growth, have left us with a major structural problem with our public finances. 

Just yesterday, the Governor of the Bank of England, Mervyn King, described the scale of our deficit as "truly extraordinary" and told the Government we need a clear and credible plan to bring it down.

And the OECD have confirmed Britain will have the largest fiscal deficit of any developed country next year.

Our Government is borrowing almost £500m a day. Next year the Government plans to raise only £3 in tax for every £4 it spends.

We have, as a nation, been warned by Standard & Poors, the world's largest credit rating agency, that our coveted AAA credit rating is on probation.  The loss of that rating would means a surge in borrowing costs for businesses, families and Government - raising the prospect of a debt trap for our public finances with ever larger proportions of public spending gobbled up in interest payments on our £1.4bn National Debt.

So Britain needs change. 

Tax rates in the UK are already among the highest in Europe. And while no Chancellor, and certainly no aspiring Chancellor, can rule out the possibility of tax increases, it's clear that we cannot risk further damage to the UK's international competitiveness by constantly trying to solve our problems through ratchetting up taxes.

The brunt of the burden of fiscal adjustment is going to have to be borne by spending.

And the Government - at least in its Budget Red Book - acknowledges this simple fact - even if no-one seems to have explained it to the Prime Minister.

Departmental spending under Labour's plans - that is, spending after taking off debt service cost, EU Budget contributions and entitlement benefits - will fall by about 7% overall over the next three years. 

That is a scale of contraction that has not been seen since the 1970s. And the Government, for reasons best known to itself, has decided that that process should only start after the next General Election, in 2011-12.

Labour is in denial.  They don't have a model or a message for hard times.  Time and again the Prime Minister repeats his mantra of increasing spending, real current rises and capital growth - in flat contradiction of his own Budget Red book.  And he accuses us of having a secret agenda for 10% cuts in public service budgets. 

In fact there is no secret agenda and there's no mystery either.

The truth is that anyone with a calculator and a copy of the April 2009 Budget can work out the implications of this fiscal crisis for themselves.

And for the Government to continue claiming otherwise is simply to delay the moment when the real debate can begin.  The real debate about how we protect frontline public services, and how we re-engineer service delivery in response to this fiscal crisis. 

The Government's problem is that for a decade or more it has defined its agenda by reference to inputs rather than the outcomes of public services. 

It's created a political rhetoric where, quite bizarrely, more costly public services are better than lower cost public services delivering the same outcome.

And we have paid the price for this indulgence in falling public service productivity.

As recent estimates from the ONS have shown, productivity in public services actually fell by over 3 per cent between 1997 and 2007.

In the NHS, the fall was even larger - at 4%.

Put another way, the amount we spent on public services rose considerably faster than the quality and quantity of those services.

It is clear we now have to move beyond political rhetoric and face up to the huge challenges ahead for the public services.

The challenge of sustaining and improving public services, whilst cutting the cost of delivery.

Moving beyond the bogus assumption that less cost means a poorer outcome.

Labour's approach is a top down one, an interventionist approach. 

Bring in consultants to look at the problem, identify savings that can be made, set "efficiency" targets. 

But ultimately that can only deliver a one-off saving. And it will not deliver long-term value for money.

I believe we need a different approach.  An approach based on the concept of "innovation".

A bottom-up approach embedding a change of culture that encourages innovation.

Innovation at every level. At Ministerial level, at central Civil Service level, in local Government and in front-line public service delivery organisations. 

Let's take Ministers first.

My colleagues in the Shadow Cabinet all understand that they will be expected to deliver better value for taxpayers' money when the bills of rising unemployment and the huge interest costs of a soaring national debt mean that many government departments will face budget cuts.

Anybody can cut a budget.  The challenge for them is to take out costs while fostering the innovative approaches that will protect frontline public services.

Of course all major Government programmes will have to be reviewed to ensure that they represent value-for-money for taxpayers.

Some that provide no social or economic benefit to the public - like the ID cards project and the Contactpoint database and the Regional Assembles will be scrapped under a Conservative Government. 

Other programmes will need to be reconfigured to deliver the value-for-money that the taxpayer demands and that service users need.

The Civil Service too has to re-focus.

We need a new culture of financial discipline in Whitehall. 

So a Conservative Government will take steps to embed performance management culture in the Senior Civil Service.

We will re-define the role of Finance Director as the second most important in a department and create a dual reporting line to both the head of department and to new Office of Financial Management.

It will be led by a full-time Head of Government Finance and report to the Chief Secretary to the Treasury.

We will expect Finance Directors to be involved in all aspects of Departmental activity - including policy and planning - bringing a financial perspective to the work of the Department.

We will also restore the Treasury to its traditional role as a guardian of taxpayer value and a driver of financial discipline. 

Under Gordon Brown, the Treasury has become one of the principal sources of government policy rather than an auditor of its effectiveness.

And it has accrued huge spending responsibilities, with a budget bigger than that of the Home Office.   We will move those responsibilities - Tax Credits, Child Benefit, Child Trust Funds, Health in Pregnancy Grant - to the DWP.

We will create an independent Office of Budget Responsibility which will prepare the fiscal projections that underpin the Budget so that there is a credible framework for evaluating the Chancellor's Budget proposals to restore the public finances to health.

But spending rounds under a Conservative Government won't simply be a matter of Treasury diktat.

David Cameron has made clear that he Cabinet as a whole will be responsible for spending decisions. Collectively deciding spending priorities in a constrained environment.

We will also introduce a new transparency into the system. 

In the spirit of the "Google your tax dollars", approach, we've made a commitment that all items of public spending over £25,000 will be published on the Internet for public scrutiny. 

That means everyone will be able to see exactly how Government spends their money.   And the media, the public, the Opposition, will become part of the process of accountability.

And we hope, and expect, that Local Government, which in many ways is already ahead of a Central Government in this area, will enthusiastically embrace the spirit of this agenda.

But the greatest changes will be needed in frontline public service delivery.

Gordon Brown has long since abandoned meaningful public services reform.

Instead, he has opted for a centralised, micro management system that constrains, rather than empowers, those delivering public services.

Now we need to undo the damage done by years of budget increases without the quid pro quo of a requirement to reform.

We need to reverse years of declining productivity, and to drive productivity growth in achieving the required outcomes that will allow service improvements even at a time of budgetary constraint. 

And that productivity growth will be delivered through process innovation. 

Innovation needs first to be permitted, and then to be fostered. 

We must liberate public service professionals from the myriad process controls and targets that constrain innovation of process.  Granting autonomy to explore different ways of delivering the outcomes we mandate.

And we need to put in place an alignment of incentives so that the pursuit of value for money is a shared goal at the heart of public service delivery.

There will clearly be opportunities for the private and voluntary sector to work alongside the public sector as we reshape the delivery of publicly funded services. 

Opportunities to deliver to individuals holding personal budgets; opportunities to contract to public organisations. 

But Conservative approach to public/private partnership will be pragmatic, not dogmatic. Because what matters is what works.

The public expects competitive taxes and high quality public services.  Our success in office will depend on our ability to deliver on this agenda of public service reform.  On our ability to maintain public service outcomes in the face of this unprecedented fiscal squeeze.

And if the private sector can help us to achieve that, we will certainly embrace them.

But there are three preconditions to ensuring that private sector engagement is effective.

First is transparency.

Transparency in the baseline comparator of public sector delivery cost so that we can properly evaluate any private or voluntary sector alternative.
 
We also need transparency around the balance sheet so that we can permanently end the deep-rooted suspicion that PFI and PPP has been driven by a desire to conceal capital spending off balance sheet.  We need neutrality between treatment of different types of capital spending so that decisions on project structure depend entirely on what delivers the best value for the taxpayer. 

Secondly, we need a strengthening of capability. 

In many areas, the public sector's capability to procure and commission effectively from the private and voluntary sector is inadequate. We need to build that capacity if we are going to have a vibrant interface between public and private sector. 

And the third is genuine risk transfer. 

Under a Conservative Government there will be opportunities for the private sector in delivery of public services. But we will expect the private sector to shoulder more of the risk than has been the case in some of the projects under the present Government. 

We will be expect new Public-Private projects to be paid for on the basis of delivery of outcomes, with liquidated damages provisions where contractors do not deliver minimum agreed outcomes, and a mechanism for sharing the over-performance where they out-perform the requirements of the contract. 

My vision is a future in which innovation is driven by different providers in the public, private and voluntary sectors exploring different approaches so that consumers and commissioners of public services have real choice, and a genuine evolution of best service delivery models occurs through a competition to innovate.

For example, by breaking up the state monopoly in education and allowing publically funded schools to be set up by a wide range of expert organisations, each with its own ethos and its own methods.

Or, in welfare, using payment by results contracts to engage the capability and the flexibility of third sector welfare to work providers.

Or, in prisons and probation, empowering local managers to commission a rehabilitation revolution, with success - and payments - based on levels of recidivism.  Measuring the outcome that really matters.

So the consumer will make his choice not based on who delivers a public service, but on the quality of the outcome being offered.

One final point

The success of this approach will depend, crucially on us explaining to public sector workers how this transformation can be empowering for them.  Giving people new freedoms to do their jobs.

Because if we don't bring the workforce with us, then we won't succeed.  This change; the embedding of an innovation culture and a value for money ethos has to happen at all levels, and in all areas.

<h2>Conclusion</h2>

These are great challenges, but also great opportunities. In a global marketplace the option of ever higher taxes to support public services delivering negative productivity growth simply does not exist any longer. 

We are ready to deliver change:

Eliminating expensive and pointless projects like ID cards.

Improving financial management throughout the public services, and publishing the data so everyone can see how we are doing.

Empowering public service professionals.

Reforming our public services through choice and competition.

Breaking the bogus link between cost and quality.  And showing that our great public services, and the professionals who work in them, properly empowered, properly motivated, really can deliver more with less.

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