Eight prominent economists have written a letter to the Financial Times arguing that the UK needs a ‘step increase’ in public investment in order to boost growth and to fix social and environmental problems. There is clearly something in this, but many risks too.
As the writers correctly note, there is an emerging consensus that a lack of investment has been a central cause of the UK’s poor economic performance. Indeed, there are three points that most economists could probably sign up to.
First, investment spending should be viewed differently from current spending on day-to-day bills. In particular, it makes more sense to borrow for capital projects that yield long-term benefits both for the economy and for future taxpayers.
Second, there has been a long-term shortfall of investment in both the private and the public sectors. Worse still, the Labour Government has inherited spending plans that imply substantial real-terms cuts in public investment over the current parliament too.
To put a few numbers on this, the OBR is projecting that public sector net investment will fall steadily year by year, from around £70 billion in 2023-24 to less than £50 billion in 2028-29 (all in 2023-24 prices). That would see public investment decline from 2.6 per cent of national income to just 1.7 per cent.
Third, the existing fiscal rules do not leave much room for additional public investment, without either offsetting cuts in current spending or substantial increases in tax. In particular, the main rule requires public sector net debt to be falling as a share of national income by the fifth year of the rolling forecast period. This is too short a horizon for the full benefits of investment to come through (including the efficiency savings in current spending).
Moreover, the supplementary target that requires public sector net borrowing not to exceed 3 per cent of GDP, also by the fifth year, makes no distinction between borrowing for investment and borrowing for current spending.
Nonetheless, there are some important caveats.
One is simply that the public finances are in a worse state now than during the ‘austerity’ years after the Global Financial Crisis of 2008. It is still reasonable to argue that deep cuts in spending would be counter productive. But with public debt now much higher, interest rates no longer close to zero, and private sector balance sheets in better shape, the risks of a further splurge in government spending are greater – including the risks of ‘crowding out’.
It is also debatable whether the public sector is competent enough at large-scale investment projects. There are some areas where the state has to lead, notably ‘public goods’ such as the criminal justice system and environmental protection. For example, the previous Government surely under-invested in prisons, courts and flood defences.
But you only have to look at the problems with HS2, or numerous other big programmes, to see the issues here. Outside some obvious gaps in investment in public services, there is not a long list of ‘good to go’ projects that the state could do best – and quickly.
Finally, we do not actually need a huge change to the fiscal rules in order to boost public investment to decent levels. The new Chancellor, Rachel Reeves, has proposed reverting to a ‘Golden Rule’ which would balance day-to-day spending with current revenues.
The existing target of 3 per cent of GDP for annual borrowing would then allow the government to borrow 3 per cent a year for additional investment (or more, if running a surplus on the current budget). We could even borrow 4 per cent of GDP a year for several years of ‘catch-up’ investment without increasing the debt-to-GDP ratio, assuming inflation and real economic growth both average 2 per cent.
There might also need to be some tweaks to the debt rule, either changing the definition of debt or extending the time horizon. But there should be room for a small and well-targeted increase in public investment – without bankrupting the country.
A shorter version of this piece was published by CityAM on 17 September 2024
Plain-speaking Economics 