British chancellor Rachel Reeves needs a credible growth plan

It is hard not to feel sorry for Keir Starmer and Rachel Reeves. Unlike Tony Blair and Gordon Brown in 1997, the prime minister and chancellor of the exchequer inherit a dire position: stressed public services; chronic public and private underinvestment; an ageing population; high interest rates; heavy reliance on foreign lenders; a need to spend more on defence; a worsening climate; the legacy of Brexit; and, above all, slow economic growth. They were also elected with a mere 34 per cent of the votes of a jaundiced population. If they fail to make people feel happier, what might follow?
These painful realities are spelt out in the Office for Budget Responsibility’s report on “fiscal risks and sustainability” and the House of Lords economic affairs committee’s “National debt: it’s time for tough decisions” (full disclosure: my wife is one of the 14 members of this committee). Both are depressing.
The ratio of public sector net debt to GDP has jumped over the past 20 years – as a result of the global financial crisis, Covid, the post-Covid supply shocks and Ukraine war – from less than 40 per cent to close to 100 per cent. UK debt levels are not exceptional among G7 members, however. Much the same has happened elsewhere, though the UK level was initially relatively low. By long-term historical standards, this is not even a high debt ratio for the UK. At the end of the second World War, debt was 250 per cent of GDP. Subsequently, the combination of rapid growth with high inflation lowered the ratio to just above 20 per cent in the 1990s.
Alas, we have gone a long way in the opposite direction since then: together, recent crises have been almost as expensive as a world war. We may hope that such big shocks do not recur. But, unfortunately, avoiding further shocks will not be nearly enough to stabilise debt. According to the OBR, with the policy settings of 2024, public spending is projected (note, not forecasted) to rise from 45 per cent of GDP to over 60 per cent over the next 50 years in their baseline scenario. As a result, net public debt would reach 274 per cent of GDP. That would be the highest ever ratio. Moreover, this would not be the product of some huge national crisis, but rather one of decades of rising fiscal deficits, substantially driven by soaring spending and interest costs.
This is not a forecast, because it will not happen. Yet what might change this trajectory? According to the OBR, keeping the global rise in temperature to less than 2 degrees could lower the rise in indebtedness by 10 percentage points. Improving the health of the population could lower the rise in indebtedness by 40 percentage points. But improving the rate of productivity growth by 0.1 percentage points could lower the debt-to-GDP ratio by 25 percentage points. A percentage point increase, which would deliver pre-financial crisis rates of growth, could “keep debt below 100 per cent of GDP throughout the next 50 years”. Growth, then, is the Holy Grail.
It follows that the most important thing the chancellor has to do is explain how her plan for faster growth is going to work. It will have to have many elements, including higher spending on investment, especially in essential infrastructure, liberalising planning, encouraging innovation and creating a greater supply of risk capital, especially in support of innovative businesses at all stages of their development; and opening the economy to innovators from abroad. Moreover, all this has to happen despite the self-inflicted wound of Brexit.
Unfortunately, the effectiveness of such policies is uncertain. Economists do not know which key to turn to deliver growth. Moreover, some of it will cost money. Where is this going to come from, given the dire fiscal outlook?
The House of Lords committee argues that the UK needs credible fiscal rules if it is to preserve confidence. It argues, too, that promising to lower the debt ratio only in the fifth year of the forecast, as now, is absurd. It argues, instead, for a plan that shows steadily lower indebtedness over five years. It rightly calls this “difficult”. As a matter of “fiscal prudence” this makes sense. But what would the years of austerity do to the country, particularly given the dire state of so many public services?
The government needs to combine reform with more spending. Where there are plans for high-priority investment, it should take the risk of time-limited borrowing. It should also look again at taxation. As Charles Goodhart has argued, the place to start, given that so much has foolishly been ruled out, is with taxation of property in general, and of land in particular. This should also promote development.
Necessity is the mother of invention. Reeves should now make it the mother of common sense on tax. – Copyright The Financial Times Limited 2024