The UK’s three devolved governments, in Scotland, Wales and Northern Ireland, are responsible for designing and implementing large parts of the public health and economic response to the COVID-19 pandemic in their respective territories.
But how effective have the devolved governments’ funding frameworks been in enabling them to respond effectively to the COVID-19 pandemic as it enfolded? Do the devolved funding settlements adequately protect the devolved governments from funding risks, or impede their policy responses? And are there changes to funding frameworks that could be made to improve the robustness of the devolved budgets to future shocks, and support recovery from the COVID-19 pandemic?
The Fraser of Allander Institute, the Institute for Fiscal Studies, and the University of Stirling have just embarked on a year-long project to examine these questions. The project is funded by the Economic and Social Research Council as part of UK Research and Innovation’s rapid response to COVID-19.
Today we launch our first report from the project. It highlights the funding issues that have arisen as a result of the COVID-19 pandemic, and considers how they have been addressed. This article provides a summary of the first report’s findings. The full report can be accessed here.
Funding the devolved governments during the COVID-19 pandemic
The devolved governments’ fiscal frameworks protect their budgets against shocks that affect government spending needs in a similar way across the whole of the UK. The Barnett formula automatically provides them with a population-share of additional funding in England. Falls in devolved tax revenues are largely offset by equivalent-sized increases in block grant funding from the UK government.
The frameworks provide much less protection against shocks that have significantly different impacts across the UK. And strict limits on how much and for what purpose devolved governments can borrow mean devolved governments have limited budget flexibility.
In the early stages of the COVID-19 pandemic, the UK government applied the Barnett formula to its spending announcements in the normal way. But in the early stages of the crisis, two potential problems with the Barnett Formula emerged.
- The first was time-lags between English policy announcements and the confirmation of subsequent Barnett consequentials for the devolved governments.
- The second was the risk that the impact of the crisis and hence the spending needs of the devolved governments evolved differently from those of England.
In response to these limitations, the Treasury moved to a system of guaranteed funding for the three devolved governments in July 2020. These were minimum guaranteed increases in the devolved governments’ block grants for the 2020/21 financial year.
By February the total COVID-19 funding allocations for the 2020/21 year were £9.7bn, £5.85bn and £3.3bn for Scotland, Wales and Northern Ireland, respectively.
The scale of the funding allocations means that the potential for one of the devolved governments to suffer a funding crisis has not materialised. Nonetheless, the allocations might be seen as inequitable if the spending needs of one or other of the devolved territories evolved differently from other parts of the UK during the pandemic. And funding guarantees are a stop-gap measure rather than a long-term solution to issues with the current fiscal frameworks, and may be considered unfair to England.
The impact of the COVID-19 pandemic across the UK’s territories
At the outset of the pandemic, it was very possible to imagine that the health impacts of COVID-19 might have disproportionately affected some parts of the UK over others, perhaps reflecting underlying demographic or population health factors. It was also possible that the economic impacts of restrictions – even if applied uniformly across the UK – might have had geographically uneven impacts, given variation in the structures of the economy.
Indeed, the health incidence of the pandemic has not been identical across the four nations. However, fine tuning of grant allocations to the devolved authorities on the basis of differences in the demands placed upon health and social care services may have been impractical, given the rapid changes in infections and therefore the unpredictability of the course of the pandemic.
The economic impact of the COVID-19 crisis has been broadly similar across the UK nations. This reflects broad similarities in the extent of social restrictions, the degree of exposure of the economies to sectors most affected by restrictions, and the policies designed to mitigate the economic impact of restrictions.
Did the funding settlements constrain the devolved governments’ policy responses?
The devolved governments are responsible for designing and implementing large parts of the public health response to the COVID-19 crisis in their respective territories. But key elements of economic support – notably the furlough scheme and equivalent support for the self-employed – are determined by the UK Government.
In autumn 2020, uncertainties around whether the furlough scheme would be available within a devolved nation if a devolved government felt the need to apply tighter restrictions than prevailed in England created significant inter-governmental tensions, and may have marginally influenced the timing of particular restrictions being applied in Scotland and Wales.
But major crisis around this issue was averted by the UK government’s subsequent decision on November 5th to extend the original furlough scheme across the UK until March 2021 (since further extended to June 2021).
New streams of economic development funding: a different approach
New funding streams including the Levelling Up Fund, the Community Renewal Fund and the UK Shared Prosperity Fund (the initial, part-replacement for EU regional development funds), mark a significant change in fiscal relationships between the UK government and the devolved governments. In both cases the funds will ostensibly be allocated on the basis of ‘needs’, but the assessment of what constitutes ‘need’ has been developed by the UK government without consultation with the devolved governments.
This approach has been made possible by the Internal Market Act which provides a new means for the UK government to allocate spending in the devolved territories to areas which had previously been thought to be the purview of the devolved governments.
The effect is to circumvent not only the Barnett Formula but the devolved governments themselves. While it is unclear how the main Shared Prosperity Fund itself will be allocated, the Community Renewal Fund and Levelling-up Fund further extends the role of competitive bidding processes controlled by the UK government in the devolved nations. and replace it with a transactional, deal-making approach to regional assistance in which local authorities across the whole of Great Britain compete for funding. In the absence of co-operation agreements, the devolved nations may be anxious that this will undermine their activities and authority in economic development and associated policy areas, and potentially lead to overlaps or mismatches between schemes.
The forthcoming review of the Scottish fiscal framework
The Scottish fiscal framework is due to be reviewed by the Scottish and UK governments in 2022, following the preparation of an independent report in the second half of 2021.
To date, the two governments have been unable to agree the scope of the review. The UK government would prefer it to be relatively narrow, focussing on the detail of mechanisms for adjusting the block grant, and potentially the scope of forecast error borrowing tools. The Scottish government would prefer the review was wider in scope, potentially also considering the scope of fiscal powers devolved, and issues around intergovernmental coordination.
At the moment it remains unclear how these differences will be resolved.
The devolved governments’ fiscal frameworks and settlements were clearly not designed with a shock like the COVID-19 pandemic in mind.
At the outset of the pandemic there were reasons to be concerned about the ability of the devolution funding frameworks to cope. As it happens, the devolved governments’ funding arrangements have largely coped with the COVID-19 pandemic. This is the result of a combination of luck, the huge sums of money provided by the UK government to address the crisis in England, and ad-hoc bypassing of the normal rules of the frameworks.
The ‘luck’ part of the equation reflects the fact that both the devolved nations have not been disproportionately negatively impacted by the virus in either health or economic terms.
But the shift away from the usual process of allocating funding by Barnett consequentials to the concept of funding ‘guarantees’ has also been important in providing the devolved governments the resources and flexibility they need to meet the evolving demands of the pandemic.
However, the COVID-19 pandemic has exposed some limitations and risks of the devolved funding settlements, and poses a number of questions for their future. For example, do the block grant adjustment mechanisms provide sufficient insurance against the risk of asymmetric shocks? Do the devolved governments have enough budgetary flexibility to respond to short-term fluctuations in need, or to vary policy in response to such events? To what extent is there a need for new arrangements for collaborative decision-making or improved communication on policy areas which are ‘reserved’ to the UK government? Can economic development policy operate effectively as an area of joint competency or does more direct UK government involvement in this realm pose a major problem for the devolution settlement and effective policymaking?
The aim of our report – launched today – has not been to answer these questions, but to lay out the issues that we will consider throughout the remainder of our one-year project. Addressing these issues will raise challenging questions around where the responsibility for managing various fiscal risks should lie, and the extent to which the answer to this question depends on the nature of the fiscal powers devolved, and the nature of constitutional arrangements more broadly.
David Bell is Professor of Economics at the University of Stirling and a Fellow of the Centre on Constitutional Change.
David Phillips is Associate Director at the Institute for Fiscal Studies.