The British economy has suffered from low growth for years, a problem that has worsened since the 2008 global financial crisis. Despite some short-term recoveries, average annual growth has been consistently weak, leading to stagnant living standards.
A striking indicator of this trend is that real wages in Britain are barely higher than they were 16 years ago, marking the worst performance in at least a century. Against this backdrop, something needs to change, and Rachel Reeves believes she has the solution: investing.
In her upcoming budget, Reeves will take a bold step, signaling a shift from previous budget strategies. Her focus on investment is expected to be the most significant budget move since the 2010 emergency budget by David Cameron and George Osborne. This budget will be crucial in setting Labour’s economic agenda after fourteen years of Conservative-led governments, and is equally important in halting the party’s decline in the polls.
The Chancellor’s plans include a budget tightening of around £40 billion, largely funded by tax increases, including increases in capital gains tax and employers’ national insurance contributions. However, this will be offset by a significant increase in public investment, with resources likely to be allocated to infrastructure projects such as railways, bridges and green energy.
This budget could potentially be the largest in cash terms in the last thirty years. Reeves plans to finance a £20 billion boost in public investment by tweaking budget rules, allowing the Office for Budget Responsibility (OBR) to include a wider range of government assets and liabilities in its financial forecasts.
Switching from using public sector net debt excluding Bank of England debt (PSND ex BoE) to a broader measure such as public sector net financial liabilities (PSNFL) could free up the Chancellor to borrow up to an additional £50 billion. Including assets such as the government’s student loans and equity stakes lowers the debt ratio, creating fiscal space.
How Reeves decides to spend this windfall and the quality of her investment choices will be critical to maintaining confidence in the bond markets. It must demonstrate to investors and the OBR that these measures will lead to growth.
For years, low investment has held back the UK economy, which has lagged behind many of its peers. Since 2000, Britain has been near the bottom of the list of 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 expenditure to meet budget targets, resulting in limited growth.
Had previous Conservative budget plans, including Jeremy Hunt’s, gone ahead, public investment would fall further, from around 2.5% of GDP to just 1.5% in 2029/30. Reeves wants to reverse this trend and take the lead in increasing public investment to boost growth.
James Smith, research director at the Resolution Foundation, commented: “The government should lead the way in moving Britain from bottom in the OECD league when it comes to public investment. This way it can directly stimulate growth, but also bring in more investment from the private sector.”
Lord Jim O’Neill, a former Treasury adviser, said: “Borrowing to invest is not only good, it is essential for this government’s growth ambitions. Given Britain’s long-standing problem with weak investment, the government, as the most patient investor, must show serious ambition.”
Recent reports from the OBR have also indicated that increasing public investment could have a positive impact in the long term. It suggests that a 1% increase in public investment relative to GDP could increase the maximum output of the economy by 2.5% over fifty years.
The International Monetary Fund (IMF) supports this view, noting that public investment can increase output, attract private investment and lower unemployment, without significantly affecting the debt ratio. However, the strategy is not without risks. More borrowing can lead to higher interest rates, potentially discouraging private investment, and mismanagement of funds can waste taxpayer money.
Given Labour’s substantial majority in Parliament, Reeves’ biggest hurdle will be managing sentiment in the bond market. The experience of Liz Truss, who became the shortest-serving Prime Minister as a result of market backlash against unfunded tax cuts, is a stark reminder of the power of bond traders.
Truss’ budget failure stemmed from obstructing OBR oversight and unveiling unfunded tax cuts during a sell-off in the global bond market. Unlike tax cuts, investment loans may be viewed more favorably by the bond market, as highlighted by Tom Railton, director of campaign group Invest in Britain, who said: “Bond markets can distinguish between different types of loans.”
Deutsche Bank has raised concerns that the government may need to raise more than £300 billion through government bonds, while the Bank of England also needs to sell £100 billion of bonds every year. As governments around the world compete for investor funds, Britain must communicate effectively to maintain trust.
Mohamed El-Erian, President of Queens’ College, University of Cambridge, said: “Markets understand that productivity-enhancing investments support longer-term growth, improve creditworthiness and strengthen debt sustainability. The government must communicate clearly how its fiscal measures align with its growth objectives.”
To strengthen credibility, the government has introduced the Office for Value for Money, signaling its commitment to accountability to investors. Dominic Caddick, economist at the New Economics Foundation, noted that government bond yields are often more sensitive to the Bank of England’s responses than fiscal policy itself.
Rachel Reeves is also expected to update budget rules, a move that has been widely anticipated. The current rules have been exploited by previous governments, which planned unrealistic spending cuts to achieve debt reduction targets over the OBR’s forecast period. Adjustments to the rules, especially a shift to PSNFL, would create additional borrowing capacity by expanding the government’s balance sheet with more assets.
Ben Zaranko of the Institute for Fiscal Studies warned against focusing too narrowly on a single 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 are hopeful that a shift to investment-led growth could be the key to unlocking Britain’s economic potential. James Smith of the Resolution Foundation put it succinctly: “There is no route to faster sustainable growth without investing more. The country must stop living on its past and invest in its future.”