Christie Commission on the future delivery of public services

2. CHALLENGES FACING OUR PUBLIC SERVICES

Introduction

2.1 The aim of this chapter is to describe the economic and budgetary context in which the Commission is making its recommendations and, in particular, to outline the nature and scale of the major challenges that Scotland's public services will confront over the course of this Parliament and beyond.

2.2 It is important to recognise that the underlying financial challenges facing the future delivery of public services are not solely, or even principally, a consequence of the current budgetary situation. They also reflect long-standing needs in Scottish society as well as new demands, particularly from demographic change.

2.3 Obviously, the financial and economic crisis that began in 2007 is directly responsible for the sharp deterioration in the revenue available to the Scottish Parliament over the next few years and which, in turn, has placed considerable pressure on the current provision of public services.

2.4 The broad parameters within which public spending in Scotland will be determined over the short to medium term were clearly elaborated by the Independent Budget Review ( IBR) Panel in their Report of July 2010. ¹ That work remains a key authoritative account of the scale of the fiscal squeeze confronting the Scottish Government over this spending review period and we have drawn substantially on their evidence.

2.5 The recommendations we make will contribute principally towards the better sustainability of public services over the medium to long term. However, their prompt implementation would help to improve services and deliver cost savings in the short term, thereby alleviating some part of the current financial pressure on public services.

2.6 The following four sections focus attention on:

• the major public policy challenges that arise from deep-rooted inequalities in Scottish society;
• the links between public services and growth - in particular, the potential to engender a virtuous cycle of improved services and stronger economic development;
• the trends in devolved public spending and the outlook for Scotland's public finances; and
• the significant pressures on public services including rising costs and the demand implications of predicted demographic change.

PUBLIC SERVICES AND INEQUALITIES

2.7 The greatest challenge facing public services is to combat the negative outcomes for individuals and communities arising from deep-rooted inequalities.

2.8 This challenge is not new but public policy has failed consistently to resolve it, despite political initiatives and the strong growth in public spending in the first decade of devolution. Part of the problem has been a failure to prioritise preventative measures; a weakness which helps trap individuals and communities in a cycle of deprivation and low aspiration.

2.9 Research carried out by the Improvement Service demonstrates that the gap between the top and bottom of the distribution in key outcomes such as income, employment, health, learning and safety is significantly wider in Scotland than in other European countries. ² Worse still, most of these negatives are inter-related, mutually reinforcing and often clustered in small areas.

2.10 A number of important outcomes for the Scottish population have improved since the late 1990s but, on most key dimensions, inequalities have remained unchanged or become more pronounced.

2.11 Healthy life expectancy and household income have, in general, improved as have some learning outcomes, and the overall risk of being a victim of crime. However, the income inequality gap has widened since devolution due to an increase in the income of the 30 per cent of the population with the highest incomes, while the income of the 30 per cent of the population with the lowest incomes has remained static.

2.12 In education, the gap between the bottom 20 per cent and the average in learning outcomes has not changed at all since devolution. At the same time, the gap in healthy life expectancy between the 20 per cent most deprived and the 20 per cent least deprived areas has increased from 8 to 13.5 years and the percentage of life lived with poor health has increased from 12 to 15 per cent since devolution. The link between deprivation and the likelihood of being a victim of crime has also become stronger.

Costs of alleviating social problems

2.13 All this impacts negatively on individuals and communities (illustrated in Box 2.1 below), while the consequences of disadvantage impose significant financial burdens on public services and society in general.

2.14 High levels of public resources are devoted annually to alleviating social problems and tackling 'failure demand' - demand which could have been avoided by earlier preventative measures. But it is a reactive spending - targeting the consequences not the causes of inequalities.

…the Group has estimated that dealing with negative demand, i.e. negative outcomes retrospectively, absorbs 40%+ of local public service spending.

National Community Planning Group

2.15 Until now we have funded that 'failure demand' with annually increasing budgets. That is no longer an option. So tackling these fundamental inequalities has to be a key objective of public service reform.

Box 2.1 - Evidence from EHRC on the links between inequality and outcomes The Equality and Human Rights Commission ( EHRC) presented evidence to the Commission that was based on an analysis of reliable evidence and data on seven equality strands. 1,2 It concluded that the link between equality and outcomes is a consistent theme throughout the Scottish data. For example: Half of all young people in Scottish prisons have been in care. This rises to 80 per cent when looking only at those convicted of violent offences. This is despite just one per cent of all Scottish children having been in care. 32 per cent of adults in the most deprived areas in Scotland report a long-standing illness, disability or health problem compared to 14 per cent in the least deprived areas. It is estimated that only 20 per cent of gypsy and traveller children of secondary school age in Scotland regularly attend school; this figure may be even lower in remote areas. Even those who attend school experience unequal access to an appropriate curriculum, teacher expectations and cultural support. Across Britain, the employment rate for disabled adults is just over half the rate of non-disabled adults. In Scotland the employment rate for working age adults without disability is 82 per cent, while it is only 47 per cent for disabled working age adults. Employment rates are particularly low for those who are both generally and work-limiting disabled 3 - at only 29 per cent in Scotland. Disabled people are more likely to be on low incomes compared with the general population - with 15.7 per cent of disabled people in Scotland earning below 60 per cent median hourly earnings (the technical definition of poverty in Scotland). Scottish households headed by females with children are more likely to live in poor housing (12 per cent) than male headed households with children (3 per cent). Notes 1 How Fair is Britain? The first triennial review executive summary, EHRC (2010) http://www.equalityhumanrights.com/key-projects/triennial-review/full-report-and-evidence-downloads/ 2 This includes: age, disability, gender, race and ethnicity, religion or belief, sexual orientation and transgender. 3 This defines disability as having 'a physical or mental impairment which has a substantial and long term adverse effect on a person's ability to carry out normal day to day and work activities' (Disability Discrimination Act).

PUBLIC SERVICES AND ECONOMIC DEVELOPMENT

2.16 Public services play a crucial role in shaping the society and the economy of Scotland. They make a major contribution to the wellbeing of our communities, enable many people to participate fully in society and promote economic development.

2.17 Many public services are social investments. They may be targeted at individuals or communities but contribute to a better educated workforce, a healthier population, a more vibrant and resilient economy and a well-founded sense of social cohesion.

2.18 Public services make a significant direct and indirect contribution to Scotland's economy, being a major source of employment and a source of private sector demand.

2.19 The public sector alone produces over one-fifth of Scotland's total economic output - a substantial concentration of economic power which has the potential to generate further economic activity. ³ A large proportion of the output of other sectors of the economy - the private and third sectors - is linked to the annual public sector procurement budget of over £9 billion.

2.20 As importantly, public services have a significant influence on the quality of the business environment with a role in control of planning, infrastructure, enterprise support and investment in research and innovation. They have impact too through public transport, social housing, skills developed in schools, colleges and universities and through training and re-training programmes aimed at increasing job prospects for the unemployed. The collateral bonus is reducing unemployment and its associated demands on public services.

2.21 Public services are therefore a crucial element in enhancing opportunity to the advantage of individuals and society, improving social outcomes and lessening 'negative' demands on public services. In turn, economic growth provides the resources that fund our public services.

2.22 So, the Commission does not regard public services as a drag on economic progress. It takes a positive view of public services and stresses the importance of a virtuous cycle between improving the delivery and effectiveness of public services and fostering stronger and more balanced economic development. And it strongly believes in the importance of developing a fairer society in pursuit of that goal.

DEVOLVED PUBLIC SPENDING TRENDS AND OUTLOOK

2.23 The overwhelming share of spending on devolved public services in Scotland is financed by the block grant from Westminster. The annual change in the block grant is determined by the application of the Barnett Formula, under which an adjustment is made to the grant according to changes in funding to those UK Government departments whose counterpart functions in Scotland are devolved to the Scottish Government.

2.24 The ability of Scottish public services to raise revenues to supplement the block grant is relatively limited. At the national level, the Scottish Parliament is able to vary the basic rate of income tax in Scotland by up to three pence in the pound, which could be worth approximately £1.2 billion in 2011-12. Other taxation levers include the council tax and non-domestic rates.

Scottish budget since devolution

2.25 As a consequence of increases in UK-wide public spending, the Scottish block grant more than doubled in cash terms and increased by 60 per cent in real terms between 1999 and 2010. This corresponds to an average annual growth rate of over 5 per cent in real terms spending during the period.

2.26 Scotland's devolved budget, expressed in real terms, peaked in 2009-10 before falling for the first time since devolution in 2010-11 (see Figure 2.1 below). The downward trend accelerates in this financial year, 2011-12, which is the first year of the new spending review period.

2.27 The onset of the global financial crisis in 2007 and the subsequent economic recession led to the UK Government introducing significant cuts in public spending over the current spending review period. In addition to the direct impact of these cuts on the Scottish block grant and thus Scottish public services, there will be additional indirect consequences for Scotland's public services as spending on reserved policies (including pensions, job-seekers allowances and a range of welfare benefits) is also curtailed.

2.28 Public sector employment rose between 1999 and 2010, though the public sector's share of total jobs remained broadly stable, increasing marginally from 23.1 per cent in 1999 to 23.2 per cent in 2010. ⁴ This proportion is somewhat higher than in the rest of the UK but, as the Council of Economic Advisers pointed out in their Third Annual Report, ⁵ that dominance is not as great as some people might imagine:

There is a widespread perception that Scotland is particularly dependent on public sector employment but this claim has little basis in fact. Per capita public expenditure on health and education, and on some other services, is around 10 per cent higher in Scotland than in the UK as a whole. The proportion of workers employed in public sector activities, at 23 per cent against a UK figure of 20 per cent, reflects this difference.

Figure 2.1 - Scotland's Devolved Budget Since Devolution

Source: Scottish Government

Short-term outlook for public expenditure

2.29 As a consequence of decisions announced in the 2010 UK spending review, ⁶ the Scottish Government's total budget in cash terms fell this year by £1.3 billion and remains well below its 2010-11 level in each of the next three years to 2014-15 (see Table 2.1 below). Total Scottish departmental expenditure limit ( DEL) expenditure will fall in real terms by over 11 per cent between 2010-11 and 2014-15, comprising an 8 per cent real terms cut in resource DEL and a 36 per cent real terms cut in capital DEL.

Table 2.1 - Scottish Government's DEL Budget

	Cash terms - £s million						Real terms change (%)
	2009-10	2010-11	2011-12	2012-13	2013-14	2014-15	2010-11 to 2014-15
Resource DEL	25.2	25.9	25.4	25.8	26.0	26.2	-8.1
Capital DEL	3.9	3.3	2.5	2.5	2.2	2.3	-35.9
Total DEL	29.1	29.2	27.9	28.3	28.2	28.5	-11.3

Source: Scotland's Spending Plans and Draft Budget 2011-12, Scottish Government (2010)

Independent Budget Review

2.30 In July 2010, the Independent Budget Review ( IBR) set out a range of policy options the Scottish Government had at its disposal to ameliorate the impact on the delivery of public services of this real terms decline in the Scottish budget.

2.31 A number of these recommendations focussed on measures that would reduce total spending on public services over the immediate future including efficiency-enhancing reforms, wage restraint across the public sector, and re-visiting the question of the universal free provision of some public services.

2.32 Certainly measures aimed at reducing public spending quickly are essential or total Scottish public spending will exceed revenue. Nonetheless, we believe that any measures to ease immediate budget pressures should recognise the needs of the most vulnerable in society and contribute to a permanent reduction in demand. That demand has the greatest impact on the long-term costs of public service delivery.

Longer-term fiscal outlook

2.33 Considerable uncertainty surrounds the fiscal outlook beyond the current spending review. It is not easy to predict beyond 2014-15, and it is not easy to be optimistic.

2.34 Future resources available to the Scottish Government via the Barnett Formula will be affected by a host of influences. These include:

• the pace of recovery in the UK economy;
• the success of the UK Government's financial sector rescue package;
• the impact of policies designed to restrain UK spending ( e.g. welfare reforms as discussed in Box 2.2 below);
• the impact of global commodities prices ( e.g. oil prices);
• the effect on Scotland of UK policy changes such as higher tuition fees; and
• the effects of any fiscal changes enacted through the Scotland Bill. ⁷

Box 2.2 - Potential implications of UK welfare reforms In February, the UK Government introduced the Welfare Reform Bill (2011), 1 proposing the biggest change in the UK welfare system for over 60 years. The reforms aim to strengthen work incentives, simplify the tax and benefit system and tackle administrative complexity. The Bill proposes the introduction of a new 'Universal Credit' to replace a range of existing benefits and tax credits for people of working age (including income-based jobseekers allowance, income-based employment support allowance, working tax credit, child tax credit and housing benefit), starting in 2013. Other proposals in the Bill include: the introduction of Personal Independence Payments ( PIP) to replace the Disability Living Allowance ( DLA); restrictions to housing benefit entitlements around accommodation size; caps to the total amount of benefit that can be claimed; devolution of the discretionary elements of the Social Fund; and new measures designed to tackle fraud. The Scottish Government, in partnership with the Convention of Scottish Local Authorities ( COSLA), has co-convened two external reference groups, the Welfare Reform Scrutiny Group and the Housing Benefit Stakeholders Advisory Group, to bring together stakeholders to develop a robust understanding of the impacts and potential consequences of these reforms. In terms of general principles, the Scottish Government has made clear that it supports the simplification of the welfare system. However, as the Legislative Consent Memorandum lodged with the Scottish Parliament states, the Scottish Government's expectation is that: "the real value of these benefits will be driven down prior to roll-out, through a narrowing of entitlement for benefits such as PIP (replacing DLA) and housing support. This is likely to lead to additional costs being incurred for devolved services. Although, we are not currently in a position to estimate the extent of this cost increase, work is in hand to draw this out using case studies generated by the Welfare Reform Scrutiny Group." 1 Full details of the contents of the Bill are provided on the Parliament website: http://services.parliament.uk/bills/2010-11/welfarereform.html

2.35 The prospective long-term outlook for Scottish Government expenditure in light of the UK Government's fiscal consolidation plans was examined in analysis produced by the Chief Economic Adviser to the Scottish Government. ⁸ This work, produced after the June 2010 UK budget and based on a range of assumptions, suggests that it may take until 2025-26 for the Scottish budget to return to its 2009-10 levels in real terms - an adjustment period of 16 years (see Figure 2.2 below). At 2010-11 prices, the shortfall over that period is approximately £39 billion.

Figure 2.2 - Illustrative Outlook for Scottish DEL Expenditure

2.36 A straightforward review of the medium- to long-term fiscal outlook for Scotland suggests a significant decline in the resources available to finance the provision of public services. However, the decline in resources is only one element in the challenges ahead. At the same time as the resources available to provide public services are declining, we can expect a substantial increase in demands.

Pressures on Public Services

2.37 A combination of rising demand and cost pressures compounds the impact of Scotland's tightening budget. Some of these pressures are cyclical and arise as a consequence of the current economic downturn. Others are longer-term and structural in character, and will affect permanently the financial sustainability of public services as presently delivered.

Impacts of the economic downturn

2.38 It is inevitable that the demand for public services will rise during periods of economic downturn and this invariably puts a strain on public finances. As joblessness increases, more individuals and families become eligible for a range of locally and nationally provided public services, putting added pressure on already scarce financial resources.

2.39 Under normal conditions budget deficits are temporary and can be financed by higher central government borrowing. However, because the current economic downturn occurred when the UK public debt level was already deemed to be excessive, the UK Government will only sanction limited further borrowing.

2.40 The longer the economic downturn lasts, the more complex are the public service needs of those directly affected and the longer their likely reliance on public services - given that individuals experiencing long-term unemployment find it increasingly difficult to re-enter the labour market.

2.41 The speed at which the Scottish economy recovers from the current downturn will therefore have an important bearing on the short- and long-term demand for, and costs of, public services. While there have been some positive signs in recently published labour market statistics, many experts remain very concerned that the Scottish economy has not yet embarked on a sustained period of economic recovery. The longer the recovery is delayed, the more serious the implications for future public services demand.

2.42 The downturn has had differing effects on local economies and labour markets. Emerging evidence suggests that regional employment disparities across Scotland have worsened, compounding disadvantage in areas of persistent and multiple deprivation. So, while the impact of the economic downturn will be temporary in some instances, its severity will result in a long-term increase in demand for public services from both individuals and communities with high unemployment. These effects impact on the range and diversity of public services required.

Long-term trends in demand for public services

2.43 The most significant challenge to sustainable services is the likely and considerable escalation in demand in the longer term.

2.44 While the Scottish Government's projections can provide estimates up to 2025 for budget revenue, there is no comparable, authoritative data for the growth in demand or the costs of meeting it. This lack of comprehensive analysis of future demand is a gap which must be filled, not just to improve resource allocation and transparency, but to inform public debate about how to address these issues.

2.45 We return to this point in Chapter 7 in our recommendation on the requirement for improved long-term analysis.

Box 2.3 - Assessing the scale of the demand challenge Despite the lack of authoritative estimates, the scale of the future demand challenge for public services can be assessed in approximate orders of magnitude. For example, NESTA (National Endowment for Science, Technology and the Arts) has produced an estimate based on published sources of information that indicates that over the next 15 years: "Scotland's public services will need to cope with additional demands in health, social care and justice alone amounting to more than £27 billion, due in particular to an ageing society and the prevalence of certain ill-health conditions." 1 The Scottish Government has estimated that if current models of care continue, the care budget of approximately £4.5 billion will need to increase by £1.1 billion by 2016 and £3.5 billion by 2031. 2 For local government services alone, projections commissioned by the Strategic Funding Review Group ( SFRG) 3 show that if services remain as currently configured a gap of over £3 billion could arise between demand and available resources by 2016-17 (see Improvement Service submission). Over half of this projected gap would be driven by demand growth. Notes 1 Radical Scotland - Confronting the challenges facing Scotland's public services, NESTA (October 2010). 2 Reshaping Care for Older People, Scottish Government (2010). 3 SFRG is an officer group that comes together to undertake budget scenario planning. The group comprises representatives from SOLACE, Directors of Finance, Improvement Service, COSLA staff and Scottish Government officials.

2.46 Arguably almost all public services play some role in delivering social justice, addressing the consequences of socio-economic inequalities and disadvantage and supporting the vulnerable in society. The following factors have been identified as principal drivers of this:

Demographic trends

• Between 2008 and 2033, the number of people aged 60 and over is projected to increase by 50 per cent; numbers aged 75 and over will increase by 84 per cent. ⁹ These trends affect public expenditure demand, not least because many universal entitlements ( e.g. public sector pensions and concessionary travel) are triggered by age criteria alone, irrespective of income or health status.
• Older people also make a major positive contribution to the economy and society. As well as contributing financially - through taxes, spending power and donations - they make a significant social contribution as active citizens, including through volunteering, provision of social care and providing the 'social glue' of communities and families.

Failure demand

• As noted earlier, some estimates suggest more than 40 per cent of local public service spending is attributable to 'failure demand'. It is clear that substantial savings to public service costs are achievable by prioritising preventative services addressing generational inequalities.
• One aspect of 'failure demand' is reflected in Scotland's prison population, which has risen steadily since the early 2000s. The Scottish Government's projections suggest a further 20 per cent increase in prisoner numbers by the end of this decade. Such increases would put considerable additional pressure on budgets and potentially divert resources away from rehabilitation activities and tackling overcrowding.

Capital budgets

• The provision of public services involves substantial capital expenditure. The costs of increasing, maintaining and financing the capital stock for public services will place considerable strain on the public finances going forward.
• Forced cut-backs in capital expenditure that reduce essential repairs and maintenance over the next few years will represent spending deferred rather than avoided - deficits that arise will have to be made good at a later date.

Current budgets

• Most public services are currently delivered by the public sector, and labour accounts for a large percentage of public sector costs. Given rising demand and falling budgets, it is clearly important to minimise the direct costs associated with meeting demand, especially when external cost pressures will be ever more evident.

Climate change and the environment

• The Scottish Government is committed to meeting ambitious emissions reduction targets and has produced detailed analysis of the financial costs of associated policies and proposals. How much will be borne by public services is not known but clearly domestic and EU environmental legislation will place considerable additional pressures on public service budgets.

Devolved / reserved Issues

• Scotland is vulnerable to changes in UK policy - in reserved and devolved areas - that impact on needs and the availability of funding delivered through the Barnett Formula. In addition to the welfare reforms already mentioned, UK policy in areas such as defence, taxation and higher education funding will have consequences for Scotland and for the resources made available to the Scottish Parliament.

CONCLUSION

2.47 Taken together, the factors outlined in this chapter represent a very significant challenge to the long-term financial sustainability of Scotland's public services.

2.48 Our analysis suggests that responses to these challenges must include:

• taking demand out of the system through preventative actions and early intervention to tackle the root causes of inequality and negative outcomes;
• working more closely with individuals and communities to understand their needs and mobilise a wider range of Scotland's talents and assets in response to these needs, and to support self-reliance and community resilience;
• tackling fragmentation and complexity in the design and delivery of public services by improving coherence and collaboration between agencies and sectors; and
• improving transparency, challenge and accountability to bring a stronger focus on value for money and achieving positive outcomes for individuals and communities.

2.49 The next chapter considers the capability of public services to address these challenges.