When Rachel Reeves stood up in the Commons on Wednesday as the first Labour Chancellor in 14 years and the first ever female Chancellor, she faced a myriad of challenges. Chronic levels of underinvestment – both public and private – had been holding back economic growth since the financial crisis more than 15 years ago; public services were starting to crumble, particularly in the health sector, when getting a GP appointment had started to seem like an almost Herculean task. Yet at the same time, she had inherited both a tax burden and debt levels that were already at historically high levels. And all this in the context of the previous reckless Truss budget, still reverberating around the financial markets, making every move just that bit more risky.
Key to squaring the circle was unlocking the country’s economic growth and starting to rebuild the nation’s infrastructure. According to World Bank data, total UK investment as a proportion of GDP has been lower than every other G7 economy in almost every year over the past 30 years. Faring particularly poorly was public sector investment – and it was due to get worse. Plans set by the previous Conservative Government at the Spring Budget 2024 were for public investment to fall from 2.6% of national output in 2023-24 to 1.7% in 2028-29.
So perhaps it wasn’t that surprising that alongside her tax-raising measures, Reeves proposed changes to the Government’s self-imposed fiscal rules to allow for public investment to rise. On the one hand the rules governing borrowing for public investment were loosened (but the time-scale for resuming a downward profile shortened), while on the other, the rules governing current spending were tightened, giving some comfort to financial markets that the brakes on spending hadn’t been totally removed. The seemingly technical change to the definition of public sector debt to include financial assets and liabilities, such as the student loan book, saw the Government giving itself licence to lift capital spending by up to £25 billion a year.
So will the greater capital investment help turbo-charge growth? At first sight, the figures produced by the Government-sponsored Office for Budget Responsibility look disappointing. The growth of the UK economy over the next few years are strikingly similar to that forecast just six months ago under the previous Conservative government. While there is a slight boost from fiscal loosening in the first couple of years offset by slightly slower growth later in the Parliament, growth rates look nothing like the 3% seen in the 1990s and early 2000s, before the financial crisis.
Why? Largely because, the OBR says, the positive effects of higher investment are more or less offset by dampening impact of higher employers’ national insurance contributions, which will feed through into wages. In addition, there is a real chance that higher borrowing could push up interest rates and lead to less private sector investment than there otherwise would have been.
Arguably, however, that short-term analysis misses the point. This budget can only be seen as step one among several designed to boost growth over the longer term.
The only way of telling a sensible economic story is to view the rise in capital spending as a downpayment on a longer-term vision for the UK economy, one in which over time the productive potential of the economy rises. Indeed, the OBR itself acknowledges that over 10 years higher public investment should encourage more private investment and increase the underlying rate of growth of the economy.
But whatever the theory says, the fact is that poorly targeted investment will have a much less positive impact on the economy than investment targeted at those areas which underpin economic growth – skills, R&D, innovation and transport infrastructure linking people to jobs, for example. In other words, money needs to be spent well.
Hence the importance of plans for an Office for Value for Money, alongside the ten-year capital plan and the industrial strategy due to be published next year. Another important plank in the strategy will be five year Departmental capital plans that are extended at every Spending Review every two years, allowing sensible decisions to be made over priorities, gaps to be identified and addressed. Departments will also be told to publish business cases for major projects and programmes in a bid to increase transparency.
And any increase in public sector investment can only be one part of the broader package of economic reforms.
Phase Two of the economic plan therefore must therefore have two prongs. First, there needs to be an acceleration of reforms to the planning system, a greater emphasis on promoting competition, and reforms to the regulation of utilities to promote greater private sector investment and economic growth (full disclosure: I am Chair of Water UK which has been arguing for more investment). Some of this has already been touted.
Second, and just as importantly, there needs to be a recognition that the demands on the state are currently on a one-way upward trend, leading to an every-increasing pressure on public spending and a rise in the tax burden. For that to stabilise and start to reverse, one part of the national renewal narrative needs to be the rebuilding our social as well as our economic infrastructure. Of course, there is a chance that the injection of cash into the NHS will help do just that. There needs to be a concerted effort to tackle worklessness and encourage more people into the workforce. That in itself would increase economic growth.
But the challenge goes even further than that. The demands on front-line care have become so intolerable, that only a focus on prevention will reduce demand and stabilise the sector overall. Such as strategy could involve more care for elderly or sick relatives enabled in the home or, for example, a greater use of community groups in battling loneliness or encouraging physical activity. It would see a revival of the Sure Start programme and help for young mothers to support each other and their families. It could see housing policy adapted to facilitate people with caring responsibilities to leave nearer to each other. Rebuilding needs to come from the bottom up as well as the top down.
Rt Hon. Ruth Kelly is a Senior Fellow at Policy Exchange. She has served as Labour Secretary of State for Transport, Secretary of State for Communities and Local Government, Secretary of State for Education and Skills and Minister for Women and Equalities, as well as holding ministerial roles in HM Treasury.