The UK economy has been mired in low growth rates for years, a problem that has worsened since the 2008 global financial crisis. Despite some short-lived recoveries, average annual growth has remained persistently weak, leading to stagnant living standards.
A stark indicator of this trend is that real wages in the UK are barely higher than they were 16 years ago, representing the worst wave in at least a century. Against this backdrop, something has to change, and Rachel Reeves thinks she has the solution: investing.
In her next Budget, Reeves is set to make a bold move, signaling a shift from previous fiscal strategies. Its focus on investment is expected to be the most significant budget move since the 2010 emergency budget drawn up by David Cameron and George Osborne. This budget will be crucial in determining the Labor Party’s economic agenda after 14 years of Conservative-led governments, and it is no less important in halting the party’s decline in opinion polls.
The Chancellor’s plans include around £40bn of fiscal tightening, largely funded by tax rises, including increases in capital gains tax and employer National Insurance contributions. However, this will be balanced by a significant increase in public investment, with money likely going to infrastructure projects such as railways, bridges and green energy.
This budget is likely to be the largest in monetary terms in three decades. Reeves plans to fund a £20bn increase in public investment by amending fiscal rules, allowing the Office for Budget Responsibility (OBR) to take a wider range of government assets and liabilities into account in its fiscal forecasts.
By switching from using net public sector debt excluding Bank of England debt (PSND ex BoE) to a broader measure such as public sector net financial liabilities (PSNFL), the Chancellor could have room to borrow up to an additional £50 billion. The inclusion of assets such as the student loan book and government equity stakes lowers the debt-to-GDP ratio, creating a fiscal margin.
How Reeves decides to allocate this windfall and the quality of her investment choices will be crucial to maintaining confidence in bond markets. It must demonstrate to investors and the OMB that these measures will lead to growth.
For years, low investment has hampered the UK economy, which lags behind many of its peers. Since 2000, the UK has ranked near the bottom of the Organization for Economic Co-operation and Development (OECD) countries in terms of public investment. This decline can be attributed to successive conservative chancellors cutting capital spending to achieve fiscal targets, which resulted in limited growth.
If previous Conservative fiscal plans, including those put forward by Jeremy Hunt, continued, public investment was set to fall further, falling from around 2.5% of GDP to just 1.5% by 2029/30. Reeves aims to reverse this trend, by taking the lead in increasing public investment to kick-start growth.
James Smith, research director at the Decision Foundation, commented: “The government must take the lead by pulling the UK off the bottom of the OECD rankings when it comes to public investment. In this way, it could directly boost growth but also attract more From private sector investments.
Lord Jim O’Neill, a former Chancellor of the Exchequer, said: “Borrowing to invest is not just a good thing, it is essential for this Government with its growth ambitions. Given the UK’s long-standing problem of underinvestment, the Government, as the most patient investor, must… Show serious ambition.
Recent reports from the Office for Budget Responsibility also indicate that increased public investment can have a positive long-term impact. It indicates that a 1% increase in public investment relative to GDP could raise maximum economic output by 2.5% over fifty years.
The International Monetary Fund supports this view, noting that public investment can lead to increased output, attract private investment, and lower unemployment, without significantly affecting the debt ratio. However, the strategy is not without risks. Increased borrowing can lead to higher interest rates, which may discourage private investment, and mismanagement of funds can waste taxpayer money.
Given Labour’s large majority in parliament, Reeves’ biggest hurdle will be managing bond market sentiment. The experience of Liz Truss, who became the shortest-serving Prime Minister because of the market backlash against unfunded tax cuts, is a stark reminder of the power of bond traders.
Truss’ fiscal failure arose from the prevention of audit by the Office for Budget Responsibility and the disclosure of unfunded tax cuts during the global bond market sell-off. Unlike tax cuts, borrowing to invest can be viewed more favorably through the bond market, as highlighted by Tom Railton, director of campaign group Invest in Britain, who said: “Bond markets can differentiate between different types of borrowing.”
Deutsche Bank has raised concerns that the government may need to raise more than £300bn through bonds, with the Bank of England also selling £100bn worth of bonds a year. With governments around the world competing for investors’ money, the UK needs to communicate effectively to maintain trust.
“Markets recognize that productivity-enhancing investments support longer-term growth, improve creditworthiness, and enhance debt sustainability,” said Mohamed El-Erian, President of Queen’s College, University of Cambridge. “The government must clearly articulate how its budget measures align with its growth objectives.”
To enhance its credibility, the government established the Office of Value for Money, signaling its intention to be accountable to investors. Dominic Caddick, an economist at the New Economics Foundation, noted that government bond yields are often more sensitive to the Bank of England’s responses than fiscal policies themselves.
Rachel Reeves is also expected to update financial rules, a move that was widely expected. Previous governments have exploited existing rules, scheduling unrealistic spending cuts to meet debt reduction targets over the OBR forecast period. Amendments to the rules, especially the shift to PSNFL, would create additional borrowing capacity by expanding the government’s balance sheet to include more assets.
Ben Zaranko of the Institute for Fiscal Studies warned against focusing too narrowly on one measure, which could lead to policy manipulation. Instead, he called for rules that take into account a broader range of indicators to ensure the credibility of fiscal policy.
As Reeves prepares to deliver her Budget, many hope that a shift to investment-led growth will be the key to unlocking the UK’s economic potential. James Smith of the Decision Foundation puts it succinctly: “There is no path to faster, sustainable growth that does not include more investment. The country must stop living in its past and invest in its future.”
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