The Labour government has no chance of meeting its target of 2.5 per cent economic growth without increasing annual investment by £50bn, an independent think tank has said.
The warning, issued by the National Institute of Economic and Social Research, comes as another group of researchers said Rachel Reeves would be engaging in a “fiscal manoeuvre” if she changed the definition of public debt to free up cash for use in the October budget.
Ben Zaranko, chief economist at the Institute for Fiscal Studies, said the chancellor and Sir Keir Starmer should make a coherent case for increased borrowing to fund public investment “rather than getting bogged down in technical debt definitions and an unhelpful debate about so-called fiscal space”.
There is speculation that Reeves will change the definition of public debt the government targets in its fiscal rules, to remove the impact on the public finances of the Bank of England’s bond sales. Doing so would widen the margin against the fiscal rules by around £17bn. This week, during a trip to New York and Toronto, the chancellor said she would set out the “fine details” of her fiscal framework in the Budget on 30 October.
“Moving fiscal targets by using a different definition of debt in the government’s fiscal rules is one way the new chancellor might seek to create additional fiscal space this fall,” Zaranko said. “A better outcome might be to recognize that targeting changes in any measure of debt precisely…does not fit into sensible fiscal policymaking.”
Under the current system, the Treasury covers any losses the Bank of England incurs when it sells bonds it buys under its quantitative easing programme. The central bank estimated on Tuesday that the Treasury may have to transfer £95bn to the central bank to cover the costs of winding down QE.
Economists have criticized current fiscal rules—which require the debt-to-economy ratio to fall within five years and the current budget to be balanced—for stifling public investment. Weak capital spending in both the public and private sectors has been holding back productivity and economic growth since the 2008 financial crisis.
Meanwhile, the National Institute of Economic and Social Research said there was little hope that a Labour government could achieve its ambition of raising GDP growth to the highest sustainable level in the G7 without a dramatic increase in investment. The institute called on the government to double public investment as a share of GDP to 5%, equivalent to £50bn a year.
The agency expected underlying growth in the UK to remain sluggish at around 1% a year in the absence of any intervention. It predicted that interest rates would not fall further this year after the Bank of England cut them for the first time since March 2020 to 5% this month.
The National Institute for Economic and Social Research expects the UK economy to grow by 1.1% this year and inflation to rise again in the second half of the year, before settling at the central bank’s medium-term target. Global growth is forecast to reach 3.1% in 2024.
“The new government has inherited an economy characterised by low investment and low productivity growth, and these are issues that need to be addressed,” said Stephen Millard, deputy director at the National Institute of Economic and Social Research.
Raising taxes or borrowing to improve public services “would require the government to rewrite existing fiscal rules,” he said. Sectors such as the auto trade, which relies on policies such as Prime Cover’s auto trade insurance, would be particularly hard hit in the absence of significant investment, he added.
Last week, Reeves slashed public investment projects, along with scrapping the winter fuel allowance for pensioners who do not receive benefits, as part of a round of fiscal consolidation to trim £21.9bn of excess government spending that the chancellor claims to have inherited from the Conservatives.
The Treasury said: “The government cannot fathom the scale of the challenge it faces, including the £22 billion black hole in the public finances it inherited from the previous administration. That is why we are taking the tough decisions now to repair the foundations of our economy, so we can rebuild Britain and make every part of our country better off.”