The Labor government has no chance of achieving its target of lifting economic growth to 2.5 percent without increasing annual investment by £50 billion, an independent think tank has said.
The warning, issued by the National Institute of Economic and Social Research (NIESR), comes as another group of researchers said Rachel Reeves would be engaging in “fiscal jiggery-pokery” if she changed the definition of the national debt to to free up cash for use in the October budget.
Ben Zaranko, a senior research economist at the Institute for Fiscal Studies, said the Chancellor and Sir Keir Starmer should set out a coherent case for increasing borrowing to finance public investment “rather than getting bogged down in technical debt definitions and a pointless discussion about so-called budget space”.
There is speculation that Reeves will change the definition of government debt, which the government uses in its budget rules, to remove the impact on public finances of the Bank of England’s bond sales. This could increase the margin against budget rules by around £17 billion. This week, during a trip to New York and Toronto, the chancellor said she would map out the “precise details” of her fiscal framework at the October 30 budget.
Zaranko said: “Shifting budget targets by using a different definition of debt in the government’s budget rules is one way the new chancellor could try to create additional fiscal space this autumn. A better outcome might be to recognize that focusing precisely on the change in any debt measure … does not lend itself to sensible fiscal policymaking.”
As it stands, the Treasury covers any losses incurred by the Bank of England on the sale of bonds purchased under the quantitative easing program. The Bank estimated on Tuesday that the Treasury may have to transfer £95 billion to the central bank to cover the costs of phasing out the QE programme.
Economists have criticized existing fiscal rules – which see debt as a share of the economy falling within five years and the current budget remaining in balance – as hampering public investment. Poor capital spending in the public and private sectors has limited productivity and economic growth since the 2008 financial crisis.
NIESR, meanwhile, said there is little hope that the Labor government will achieve its ambition to lift GDP growth to the highest sustainable level in the G7 without radically increasing investment. The think tank called on the government to double public investment as a share of GDP to 5 percent, which amounts to £50 billion a year.
The body estimated that without intervention, Britain’s underlying growth potential would remain sluggish at around 1 percent per year. Interest rates are unlikely to fall further this year, the Bank of England has predicted, after cutting them for the first time since March 2020 to 5 percent this month.
NIESR forecasts that the UK economy will grow by 1.1 percent this year and that inflation will pick up again in the second half of the year, before reaching the Bank’s medium-term target. Global growth will reach 3.1 percent in 2024.
Stephen Millard, deputy director at NIESR, said: “The new government has inherited an economy with low investment and low productivity growth, and it is these issues that need to be addressed.”
He said taxes or borrowing would have to rise to bring public services “up to standard”, which would require the government to reform existing budget rules. He added that sectors such as the motor trade, which rely on policies such as Prime Cover car insurance, will be particularly affected without significant investment.
Last week, Reeves cut public investment projects, in addition to abolishing the winter fuel surcharge for pensioners not receiving benefits, as part of a round of budget consolidation to cut the £21.9 billion in public spending that the chancellor says has been left behind by the Conservatives.
The Treasury said: “The government is under no illusions about the scale of the challenge it faces, including a £22 billion black hole in the public finances inherited from the previous government. That’s why we’re taking the tough decisions now to rebuild the foundations of our economy, so we can rebuild Britain and make every part of our country better off.”