Stagnation and decline if government doesn’t boost investment, warn leading economists

Rachel Reeves has been warned that she needs to “substantially increase” government investment to avoid “a vicious circle of stagnation and decline”.

Eight leading economists have written a letter to the Financial Times today, saying they don’t see how Labour’s much-heralded “decade of national renewal” can take place if planned cuts to investment go ahead.

The intervention comes just six weeks ahead of the new government’s first budget.

The prime minister has already told the country to expect “painful” decisions, with the government claiming there is a £22bn overspend already this financial year.

Planned investment cuts

When Jeremy Hunt set out his last budget as chancellor in March this year, his plans showed that government investment was going to fall every year over the next five years – from £67bn to £53bn.

The Institute for Fiscal Studies says that if the new government wants to top up these plans so that investment is no longer falling, it will need to spend an extra £18bn in 2028/29.

That would be enough to avoid any cuts even after allowing for inflation. But if the new government wanted to go further and maintain public investment as a share of national income, it would have to find a total of £24bn in five years’ time.

The economists in today’s letter argue “…under-investment is a central cause of the UK’s poor recent economic performance…”. It leads to a weaker economy and they say raising investment can’t depend just on the private sector – there has to be a “step change in levels of public
investment”.

Labour wouldn’t necessarily disagree with this view. In its own manifesto, the party argued that “investment in the UK is too low”. And it goes on to accept that “Public investment… is one important tool being used successfully across the world. It can create good jobs across the
country and would mean British taxpayers can reap the benefits of economic growth.”

And it has made some commitments to boosting investment, promising an extra £23.7bn over the next five years, which is £4.7bn a year, with a focus on promoting green industries and cutting carbon emissions. But that still leaves the government needing to find around £13bn to
stop investment falling.

Labour’s fiscal rules

Labour’s problem with making up the rest of the investment shortfall is to do with its commitment to the so-called fiscal rules: a commitment it’s called non-negotiable.

At the moment, the most challenging of these rules is Labour’s promise to get government debt falling as a share of national income in five years’ time.

The thinking behind this rule is that the national debt has gone up a lot in recent years, because of the impact of the Covid and cost of living crises, and that means the country is paying more interest to service those debts. So Labour, and the Conservatives, want to show that they
won’t let those debts just keep going up forever.

The current Conservative plans do show that – but by a tiny margin.

It may be hard to spot, but the graph shows that debt does fall in five years’ time – by just 0.4 percentage points. In money terms, that’s just £8.9bn. That is a very small sum in the context of the country’s total debt, which will be over £3 trillion by that point.

It also means that, unless something else changes, Labour can’t borrow another £13bn in that year to top up investment.

Today’s letter from the economists makes sharp criticisms of these rules. They argue that the current fiscal framework has produced “short-term thinking and created an inbuilt bias against investment”. They want changes which they say should reflect the “significant long-term
benefits of increased public investment…”

Market confidence

But the chancellor has argued that the country’s financial state is so severe that the confidence of financial markets in the country could be seriously undermined. They remind people of Liz Truss and what they call her “reckless ideological budget”. That’s a concern at least one of the
signatories to the letter isn’t convinced by.

Professor Jonathan Portes told Channel 4 News that the financial markets “…know that a relatively modest increase in public investment does not make any conceivable material change to the UK government’s chance of default (which is basically zero) or to the future path
of interest rates…”

His view is that the crisis around the Liz Truss budget was about “her simultaneous trashing of all the UK’s key economic institutions (the Treasury, the Bank of England and the Office for Budget Responsibility)”.

For Labour, the challenge remains that if it wants to boost investment as these economists want, it will need to find a way to modify its fiscal rules, raise taxes or cut other areas of spending. If those options don’t work, it will need the OBR to come up with a significantly more
optimistic forecast for economic growth.

Who are the signatories?

Former cabinet secretary, Lord Gus O’Donnell.

Former Treasury minister under David Cameron, Lord Jim O’Neill.

Former Chief Executive of PIMCO (a global fund manager that looks after $1.9 trillion of assets), Mohamed El-Erian.

And five academics:

Professor Mariana Mazzucato of University College London.

Sir Anton Muscatelli, chair of the Royal Economic Society.

Professor Susan Newman, The Open University.

Professor Jonathan Portes of King’s College London.

Professor Simon Wren-Lewis, University of Oxford