This op-ed was first published in The Times – 01st October 2024
Rachel Reeves, the chancellor, wants to address the UK’s low rate of investment. Ideally, this should include incentivising the private sector and requires the City to pull its weight in closing funding gaps.
It also requires higher public investment. This is expected to be the focus in the budget and funded by borrowing. Also, taxes look set to rise to fund current expenditure.
The fiscal rules could be replaced, as they lack credibility. Instead, the definition of debt looks set to change to allow increased public investment, by including assets through a balance sheet approach. The various definitional options of debt available have pros and cons, as the Institute for Fiscal Studies outlined last week.
While welcome, a balance sheet approach doesn’t get away from the fact that debt is high and the deficit still has to be funded, with investors and financial markets kept on side.
It may create extra fiscal space of £50 billion but the chancellor should not use it all immediately, given the cost. Next year, as inflation subsides and global growth disappoints, interest rates and bond yields should fall. In 2012-13, and soon after the pandemic, the opportunity to lock into ultra-low, longer-term borrowing to invest was not taken. While yields may not return to such lows, the government might be able to lock into borrowing, longer-term, at attractive yields in 12 to 18 months.
It’s not just timing. What should the government invest in? Picking winners through future industrial policies is not easy. The IMF is rightly critical of a global shift to such policies. They can be unsuccessful, expensive and protectionist. Even spending on UK infrastructure has proved expensive compared with elsewhere. Planning reform is essential, whether you want to pick winners or encourage private investment.
Borrowing makes sense if the investment generates future profits that offset the cost of borrowing, thus paying for itself, with benefits to the private sector too. But the UK’s track record is poor.
In the 1980s the Ryrie Rules were adopted to ensure that investments were scored properly and to prevent public spending constraints being circumvented by private finance that was insulated from risk. These rules were then deemed a hindrance, and supplanted by Gordon Brown’s costly and unsuccessful private finance initiatives.
It’s not just the cost. The distinction between public investment and consumption is nuanced. In a mature economy like the UK, the highest returns may be in smaller projects, which are often cut, as we saw in the first weeks of this government. Or, in maintaining the existing capital stock, which counts as current spending. Also, investment in a public asset such as a hospital or a school is useless without higher associated current spending on doctors and teachers.
The chancellor is pursuing a sovereign wealth fund which — without being funded by a natural resource — requires tax, borrowing or pushing pension and insurance funds to invest in it.
In its recent 50-year projection, the Office for Budget Responsibility saw the ratio of debt to GDP reach 274 per cent, but their high growth scenario saw net debt at 65 per cent. Solid, sustainable growth is key to address the debt problem. It will be a spend, borrow and tax budget on October 30 but it needs to boost growth.
As it takes time for higher public investment to boost growth, financial markets need to be convinced: by the chancellor’s narrative; that the investment will succeed; is cost-effective; and that it will not just see spending rise but reduce future debt to GDP.