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UK chancellor Rachel Reeves is seeking ways to bolster investment in infrastructure and other public assets as she seeks to re-energise economic growth with her upcoming Budget on October 30.
In a speech to the Labour party conference on Monday, Reeves said the government’s plans would herald “an end to the low investment that feeds decline”.
However, Reeves faces a battle to create space for extra government spending as she bumps up against fiscal rules that leave her tightly constrained. Her words indicate she is open to a rethink of the government’s fiscal framework if it allows her to plough more money into infrastructure such as hospitals and roads.
What are the current plans?
Labour inherited plans from the Conservatives that would entail steep cuts in government investment. While the party pledged in its election manifesto to invest an extra £4.8bn a year, that would still lead to a large drop in real-terms spending.
To hold public sector net investment flat in real terms the government would need an extra £13bn a year on top of the manifesto pledge, according to the Institute for Fiscal Studies think-tank. To keep public sector net investment level as a share of GDP by 2028-29 would require an extra £19bn in addition to the manifesto commitment.
Labour’s fiscal rules heavily constrain the government’s ability to borrow money to top up its investment plans. The regime focuses only on day-to-day spending instead of the wider deficit, allowing for a boost to longer-term investment.
But it remains hemmed in by a parallel rule that requires overall public debt, including investment, to fall between the fourth and fifth year of the official forecast.
What might change?
The Treasury is in the early stages of examining how to handle this tension between Labour’s investment ambitions and the operation of its fiscal rules.
One potential change is to adjust the definition of debt to exclude some Bank of England losses as the central bank unwinds its quantitative easing programme, according to people familiar with the discussions. But Reeves’s speech at the conference in Liverpool indicated she wants to go further.
“It is time the Treasury moved on from just counting the costs of investment in our economy to recognising the benefits too,” she said.
Ben Nabarro, UK economist at Citigroup, said the chancellor was alluding to an “asymmetry” in the fiscal rules where debt associated with the creation of new assets through government investment is counted towards public sector net debt, but the financial value of those assets is not.
“It suggests they want there to be greater consideration of this in a long-term sense: evaluating the longer-term economic benefits of investment and putting more emphasis on alternative measures of the government balance sheet,” he said.
What are those alternative measures?
One key measure is public sector net worth (PSNW). This is the difference between the value of government assets and liabilities, thus taking account of the benefits of public investment. By contrast, net debt focuses on the liability side, crediting only a small category of liquid assets that can easily be turned into cash.
The Treasury already examines metrics beyond public sector net debt, including PSNW and another called public sector net financial liabilities, but they do not play a central role in its fiscal rules. In her Mais Lecture before the election, Reeves said she wanted to report on “wider measures” of public sector assets and liabilities to show how the health of the public balance sheet was “bolstered by good investment decisions”.
IMF economists have praised PSNW as a way of assessing the health of the public finances. In a working paper this summer, the fund said “compared to debt-based anchors, a PSNW anchor is more conducive to public investment and economic growth, while providing for sensible policy reactions to changes in long-term interest rates”.
Other countries, including New Zealand, also use public sector net worth as a way to gauge the fiscal outlook.
What are the risks?
Many of the assets included in these alternative measures of debt are difficult to value and may be impossible to sell, meaning an increase in their worth should not be taken as a green light for borrowing.
Ben Zaranko, an economist at the Institute for Fiscal Studies, said he would not advocate using PSNW alone, but it could be a useful part of a wider, more “holistic” fiscal framework, as opposed to the current “pass-fail” debt target.
It would be, he said, “coherent to justify an increase in debt by pointing to the additional assets you are creating”.
Alternative approaches could entail the greater use of off-balance sheet vehicles, where neither assets nor liabilities would impact core government debt metrics, said Nabarro. One idea could be placing GB Energy, a new state-owned company being set up to invest in green energy, off balance sheet.
But he warned that any change that created scope for extra borrowing for investment needed to be approached with caution.
“Any suggestion of a marked increase in fiscal stimulus in the near term [is] likely to prompt an adverse market reaction,” he said.
A spokesman for Reeves said on Monday that the fiscal rules were “a matter for the Budget”.