The incoming government will face a difficult economic situation. Public spending is rising well ahead of Budgetary targets, taxation is well below expectations and yesterday new figures showed that the rate of inflation remained at 4.9 per cent last month, twice the EU average. Even if economic growth picks up towards the end of the year whichever administration takes power will face tough decisions in its early months.
The latest indicator was yesterday's inflation figures, which showed that prices rose by 0.9 per cent last month, keeping the annual rate at 4.9 per cent. Part of the reason was higher oil prices feeding through to energy and transport costs. However there was also a widespread rise in inflation in the services sector, including sectors such as hotels, restaurants, education and health. The rate of inflation may start to ease over the balance of the year, particularly if oil prices fall back. However some trends in the figures are worrying. In particular, it appears that higher inflation has become entrenched in parts of the services sector; this may be due in part to higher wages for employees being passed on to the consumer.
If there is a cycle of higher wages chasing higher prices then this has obvious implications for the competitiveness of the economy. Encouraging competition needs to be one of the key policy responses; in the clothing and footwear sector, where retailers fight for business, prices actually fell last year. Stubbornly high inflation also has implications for the public finances. Rising prices mean less value is obtained for higher spending levels. For example, inflation in the construction sector has lessened the impact of state investment in areas such as roads and hospitals. Also, rising prices will add to pressure on public sector wages, a key issue with the benchmarking body due to report shortly.
If the public finances are to be brought back to a sustainable path, then the next government will have to reduce the growth rate of current spending from an annual rate of 22 per cent in the first four months of the year to close to single figures by the end of the year. Squaring this with a response which the trade unions will find acceptable to the benchmarking process looks well nigh impossible. With income tax receipts running well below target, the new government will have little enough room for manoeuvre if the economy recovery - and none at all if it doesn't.
So what will be the key policy issues? The first will be the need to make choices. The outgoing coalition coasted along on record economic growth, cutting taxes significantly and allowing spending to run out of control. Even if the economy recovers to grow at 5 per cent per annum, the next government will have to choose its priorities. The second - and related - issue is the crucial need to ensure better value for money from public spending. This is an area which has received little attention during the campaign, but with the public finances entering a tighter period, greater value must be obtained if we are to improve public services and achieve the major improvements needed in building our infrastructure.