Speaking yesterday at the IMF in Washington, Rachel Reeves finally confirmed the rumour that has been circulating in recent weeks: she will adjust her fiscal rules in order to unlock more public investment at the Budget. The choice of venue was symbolic and significant.
The IMF is one of a number of both mainstream economic institutions and respected economists to recently advocate increased public investment as a key solution to the economic malaise facing advanced economies.
In the UK this consensus is perhaps best seen in the open letter to the FT from distinguished economists that launched the Invest in Britain campaign, including a former Conservative Treasury Minister, an ex-head of the civil service, one of the most prominent bond investors in the UK, and the economist who developed the concept of Missions now adopted by the Labour government.
Reeves reflects a new consensus
By aligning with this new consensus Reeves writes that she is choosing investment over decline. She is right to do so. Under the spending plans Labour inherited from the previous government, public sector investment would have fallen sharply over the parliament, relegating the UK back to the bottom of the G7 league table for investment – where we have languished for much of the last decade.
A new paper from the LSE’s Centre for Economic Transition Expertise (CETEx) spells out what that would mean for the economy: billions of pounds of lost growth. The Chancellor confirming that she wants to avoid these cuts is very welcome. This should be a prelude to a significant increase in the rate of public investment across the parliament, to put the UK back on a similar footing to other advanced economies, and help us catch up after more than a decade of decline. Changing the fiscal rules is a necessary first step in this journey.
Tory fiscal rules incentivised cuts to investment
The old rule, inherited from the Conservatives, created incentives for the cuts to public investment which have left Britain worse off. They also left the new government with almost no room to do productive investment.
READ MORE: Labour’s Budget 2024: What policies could Rachel Reeves announce?
The government’s new rule, which Reeves now calls the ‘investment rule’, will instead take a more holistic view of the public finances by targeting a measure called Public Sector Net Financial Liabilities (PSNFL). This way of measuring government debt takes into account a much broader set of factors, including valuing financial assets the government owns, and is a more holistic and sensible way of thinking about the government’s fiscal position than just focusing on the headline debt figure.
New rules may incentivise indirect investment rather than public infrastructure
No fiscal rules are perfect, and this new investment rule is no exception. PSNFL only takes into account financial assets the government owns, not physical assets, so may create incentives for the government to undertake investment indirectly rather than directly building public infrastructure itself.
READ MORE: Budget 2024 fiscal rules: What is Reeves changing – and why does it matter?
It also seems likely that the government will retain the short-termist five year time horizon that fails to take into account the long term positive impacts of public investment on economic growth. But overall this is a big step towards a more sensible; pro-investment fiscal framework.
This talk of fiscal rules may be technical, but this isn’t an abstract debate. On the line is whether the UK is able to thrive and prosper in the coming years. It is about ensuring we are able to rebuild our crumbling public services, fix our creaking transport infrastructure, and develop and build the green energy infrastructure that will clean up our planet and bring down our bills. It is about whether Britain succeeds in building the economy of the future.
There are still questions for the government
There will still be challenges to come in the Budget, and questions for the government to answer. How will the public services recover in the short-term if there isn’t more cash for day-to-day spending, as well as long-term investment? How will we properly value the impact of investment in social infrastructure and human capital, like childcare, skills, and education, as well as investments in physical infrastructure?
But by “choosing to invest in Britain”, as the chancellor puts it, she has taken the first step to putting Britain back on the road to prosperity.
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