(Bloomberg) -- The UK’s fiscal watchdog laid out the case for new Chancellor Rachel Reeves to embark on a public investment splurge, amid concern that she risks hurting growth with an overly cautious budget.
The Office for Budget Responsibility said that most benefits from higher investment arrive long after the five-year period that’s captured by its forecasts and by the government’s self-imposed fiscal rules. Within that timeframe, an investment boost equal to 1% of gross domestic product could raise the economy’s potential output by just under 0.5%, the watchdog’s economists wrote in a discussion paper. But gains would snowball over the longer term, adding some 2.5% to GDP after 50 years, they said.
The findings feed into a growing debate over how prudent Reeves needs to be with public spending, after the new government warned that it’s set to deliver a “painful” budget on Oct. 30.
Prime Minister Keir Starmer has vowed to make the UK the fastest-expanding economy in the Group of Seven with a 2.5% growth rate, and too much belt-tightening could stifle that ambition.
But Reeves must also reassure markets that she’ll be a trustworthy manager of the public finances. Debt is at a six-decade high, and memories of the bond rout under Liz Truss’s government remain fresh in investor minds.
The OBR study is the latest to warn about the risks of austerity.
“This is a really significant report from the OBR which demonstrates the importance of long-term thinking when it comes to public investment, and the damage that the UK’s dire public investment record has done to our economy,” said Tom Railton, director of the Invest in Britain campaign.
The National Institute of Economic and Social Research said earlier this month that Reeves sent a “worrying signal” by cutting some road and rail capital projects shortly after she came to office. Starmer has told voters to expect a “painful” budget in October, blaming “14 years of rot” under the previous Conservative governments.
‘Short-Termist Approach’
UK chancellors seeking to win investor confidence have faced a tougher job ever since the collapse in gilt markets two years ago, triggered by the Truss government announcing tax cuts without saying how they’d be financed. Government bonds have edged higher since Starmer’s landslide election win last month.
The last time a Labour government came to power with a big majority, in 1997, then-Chancellor Gordon Brown laid out a fiscal framework that was specifically aimed at protecting capital spending. Brown’s so-called “Golden Rule” essentially said that the budget for current outlays — like benefits or public-sector wages — should be in balance over the medium term, but that it was OK for the government to borrow in order to invest.
Before entering the Treasury, Reeves had warned that Britain must abandon a “short-termist approach that disregards the importance of public investment.” Since taking office she’s emphasized fiscal probity, vowing to “risk short-term political pain to fix Britain’s foundations.”
The OBR said that overall public and private investment has averaged 17% of GDP since the 2008 financial crisis — the lowest in the G7, where the average was 21%.
Some analysts have called for an overhaul of Britain’s fiscal rules to encourage more investment. Under the current framework, the government aims to bring debt down as a share of GDP by the fifth year of the forecast, a constraint that means that the full effect of investment is not seen in the projections.
“Short-term cuts to capital spending might help satisfy self-imposed fiscal rules, but they damage future growth prospects,” said Nick O’Donovan, senior lecturer in political economy at Keele University. “The OBR’s new paper is a welcome reminder that the benefits of public investment – and the costs of failing to invest – only become fully apparent over the long term.”
--With assistance from Alex Wickham.
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