LONDON, ENGLAND – OCTOBER 30: Chancellor Rachel Reeves poses with the red box outside number 11 … [+] Downing Street on October 30, 2024 in London, England. This is the first Budget presented by the new Labour government and Chancellor of the Exchequer, Rachel Reeves. (Photo by Dan Kitwood/Getty Images)
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By Linda Yueh, Adjunct Professor of Economics
The new British government’s first Budget is geared at boosting economic growth, which can raise standards of living as well as increase tax revenues with which to fund public services. As the Chancellor put it during her speech, they will ‘invest, invest, invest,’ but also balance the books when it comes to day-to-day public spending.
The Chancellor announced two new fiscal rules to enable borrowing to fund their growth strategy. The new ‘investment rule’ commits the government to borrow only to invest, while the ‘stability rule’ states that the day-to-day spending on public services will be funded by taxation. The former is at the heart of the government’s growth strategy, which is to promote investment, while the latter can also provide a ‘guardrail,’ so creditors of the UK do not become spooked by the additional borrowing. The rules are intended to reassure bond investors that the borrowing will generate growth in the future, so there should be greater returns with which to repay that borrowing. And to stress that it’s not borrowing to pay for the running of public services on a day-to-day basis.
The reaction of bond markets will be important. If they are not convinced, then they could sell off gilts which would increase the cost of borrowing for the UK. As repayment of interest on debt would come out of day-to-day spending, this could require the government to raise taxes further, which would be tough during a weak growth period. Alternatively, they would need to reduce public spending, which would also be unwelcome since the Chancellor does not want a return to austerity.
A key factor as to whether the government’s fiscal plans will be viewed as credible is if it generates GDP growth.
The OBR’s assessment will help financial markets assess whether or not the additional borrowing to invest will generate economic growth. But, it won’t be sufficient. To boost economic growth requires the broad enablers of growth, such as regulatory transparency, planning reform, energy, investing in a skilled workforce, among others.
The Budget and the pre-Budget briefings set out a number of ways to provide the context for economic growth, including pre-clearance for foreign direct investment so multinational companies can gain some assurance before committing significant funds invested over a period of years, as well as their intention to reform planning and the energy mix. The latter factors add considerably to the cost of investment, so private investors will be carefully watching for developments in both areas. Also, although investments in people will take time, but businesses will expect the UK to address its shrinking workforce as it is the only major economy not to have its labour force return to pre-pandemic levels.
Balancing the books so that day-to-day spending is paid for by taxes requires essential services not to be unduly constrained since that’s public support for people’s welfare and skills, which are essential for society and as a growth driver of the economy. Indeed, for growth to occur within this Parliament, all of these factors are important as well having projects that are ready soon from a planning and regulatory perspective to be invested in by the public and the private sectors.
But, by focusing on separating capital from current spending, this Budget has increased transparency, which is what bond markets in particular will be looking out for. But, as with all policies, the proof of the pudding will be in the implementation.
In short, these two fiscal rules have laid the foundations for an investment-driven growth strategy for the UK. Now comes the hard part of delivering it.
Worryingly but perhaps not surprisingly, the independent Office for Budget Responsibility (OBR) has downgraded GDP growth from 2 percent to 1.8 percent in 2026, and to 1.5 percent in 2027 and 2028. This is due to the sizeable £40 billion of tax rises that’s needed to fund day-to-day public spending. The OBR estimates that it will have a dampening effect on economic activity as households and firms have to pay higher taxes. This will be concerning for the government if investors question whether the Budget and growth strategy will generate faster economic growth, which could affect their willingness to lend to the UK or invest in the government’s plans for infrastructure and green investment, led by the new National Wealth Fund and GB Energy, respectively. Both need to attract private investors to invest alongside the state, so confidence is important.
However, the OBR had previously assessed that a sustained public investment of 1 percent of GDP will generate around half a percent increase in national output in about five years, and 2.5 percent over the long term, in about 50 years. So, the dampening impact of tax increases has impacted those estimates, but investment in growth should still pay off over the longer term. Indeed, not investing would worsen the growth forecast if there was no public investment to help offset £40 billion of tax increases.
Linda Yueh is Adjunct Professor of Economics at the London Business School; Fellow in Economics at St Edmund Hall, Oxford University; and the author of The Great Crashes and The Great Economists.