View from City Road: Hard decisions on social security

The Mais lecture yesterday by Peter Lilley, the Social Security Secretary, should provoke some hard thinking in the gilts market. Weak governments with small majorities are not likely to come up with big spending cuts (or tax increases). But Mr Lilley showed enough of his hand to suggest that there may be real changes in the pounds 80bn social security programme - 31 per cent of all public spending and 12 per cent of national income.

Falling unemployment will not save the Government from hard decisions. The underlying growth in social security, excluding unemployment, is projected at 3.3 per cent a year for the rest of the decade. If unemployment fell by a quarter, total growth would still be 2.6 per cent a year. If unemployment were halved to 1.5 million, spending would still grow by an average 1.7 per cent a year.

There are several sources of this extraordinary rise. Spending on the elderly is up by 38 per cent since 1979, mainly for demographic reasons. Spending on pensioners in residential and nursing care homes is up from pounds 10m in 1979 to pounds 2.5bn last year.

The pounds 15bn spent on long-term sick and disabled people has trebled since 1979 in real terms, while the number of invalidity benefit claimants has doubled. Add in the growth of lone parent families, council house rents (and therefore housing benefit) and the unemployed, and you have an explosion of social dependency.

The gilts markets may not mind which of these client groups is hit: it is the bottom line that matters. But the quality of whatever 'structural reforms' Mr Lilley comes up with does matter. First, there is the impact on incentives. Any attempt to introduce steeper withdrawal rates of benefits for those at work will have an effect on the attractiveness of low- paid jobs and on growth. Secondly, if reforms are to stick, they will have to be fair. That means that the real targets have to be the better-off rather than the poor.

Mr Lilley needs to question the basics of the welfare system, which means looking both at the contributory principle and at universal benefits. It is a nonsense to pay as much child benefit to a duchess as to an unemployed single parent, and it is increasingly indefensible to pay wealthy old people the basic state pension. But these are hot political potatoes. Mr Lilley's proposals will be interesting.