(Bloomberg) -- An emerging plan to loosen the UK’s rigid fiscal rules could help Prime Minister Keir Starmer resurrect his ambitious climate investment plans and answer critics who say his government lacks a plan to generate growth.
More than seven months after effectively killing off the £28 billion ($37.6 billion)-a-year Green Prosperity Plan, Chancellor of the Exchequer Rachel Reeves signaled this week that she supported alternative approaches to measuring the national debt that would allow more infrastructure spending. The former Bank of England economist told supporters at the Labour Party’s annual conference on Monday in Liverpool that the UK should move from “just counting the costs of investment in our economy to recognizing the benefits, too.”
While the move would allow more borrowing across a range of projects, the green plan — which Reeves shrunk to just £4.7 billion to fend off accusations of fiscal irresponsibility from the then-ruling Conservative Party — would be the main beneficiary. Energy Secretary Ed Miliband, the chief advocate for the initiative, on Tuesday described Reeves’s comment as “one of the most significant things a chancellor has said in 29 years I’ve been coming to conference.”
Earlier this month, eight leading economists called for a new fiscal framework that allows greater investment to deliver Labour’s goal of achieving the fastest growth in the Group of Seven nations. Starmer has yet to set out a plausible plan to provide a positive counterpoint to his warning that the public finances are in such a mess “painful decisions” await in Reeves’s budget on Oct. 30.
Reeves’s comments suggest she is looking at ways to overrule Treasury orthodoxy and end a fiscal arrangement that penalizes investment in anything from windfarms to housing and hospitals. “We can’t always have ‘No’ for any answer when it comes to infrastructure investment,” she told business leaders at an event after her speech on Monday.
The option under closest consideration is removing public corporations, like the UK Investment Bank, the British Business Bank, the National Wealth Fund and GB Energy from the government’s debt measure, according to one government official, who asked not to be named. The Treasury looked looked at a similar moves in recent years, a second government official said, but rejected it over concerns that it would look like an accounting trick.
Reeves will have to move cautiously to avoid reawakening the fiscal fears that caused the pound to crash and mortgage rates to soar in wake of then-Prime Minister Liz Truss’s mini-budget in 2022. Labour has spent much of the run up to July’s election promising to be good stewards of the economy, and the decision to slash the Green Prosperity Plan was a key part of that effort.
Sam Hill, head of market insights at Lloyds, said that gilts could come under pressure if changes to the fiscal rules lead to greater bond issuance. “The implication of extra gilt issuance is a risk for the government and investors at the budget,” Hill said in a note on Wednesday.
The UK is an outlier within Europe on public-finance accounting. In the European Union, countries use a measure of general government debt that excludes public corporations like UKIB if its debt is raised from private markets and repaid from revenue generated by the investments. In the UK, the private debt goes on the government books.
Excluding such institutions from the national debt would draw the UK into line with EU practice and release at least £15 billion of additional borrowing over this parliament for investment, according to Andy King, a former Office for Budget Responsibility official who is now specialist partner at advisory firm Flint Global.
The new National Wealth Fund, which Labour created to carry out what’s left of the Green Prosperity Plan, pointed out the problem in July. It has £7.3 billion of state funding, against which it hopes to raise a further £22 billion from the private sector for green projects.
However, a footnote to the report said “further review of implications on fiscal rules (in particular Public Sector Net Debt) are required” and that the government may need to exclude “certain public development institutions from PSND.”
Thomas Aubrey, an affiliated researcher at Cambridge University’s Bennett Institute for Public Policy, described the arrangement as “bizarre” and one that “puts the UK at a competitive disadvantage.”
Analysis by King showed that European equivalents to UKIB and BBB, such as Germany’s KfW, invest several times as much, relative to economic output, because they are not hamstrung by accounting rules.
Organisation for Economic Cooperation and Development Chief Economist Alvaro Santos Pereira appeared to support the plans at a news briefing on Wednesday: “The UK needs more investment, so we need to create fiscal space to do so,” he said in response to a question on changing the framework, adding that extra borrowing headroom was needed for infrastructure, “including the green transition.”
Aubrey said an accounting overhaul could also help the government deliver its ambition to build 1.5 million homes over the parliament without resorting to discredited private finance initiatives. Labour’s manifesto set out plans to build “a new generation of new towns.” In a paper presented to the Treasury and published on Tuesday, Aubrey proposed setting up development corporations to build the new towns that integrate housing with transport and civic infrastructure.
Using a law passed in the last days of the Tory government that ensures land is purchased at “use value” rather than elevated “hope value,” the development corporations could raise debt for the new town projects privately. Investors would be repaid from the land value uplift on the sale of the homes and from service charges on train operators using new rail tracks. Although the proposal would “not negatively impact the public finances,” it would require a change in the debt rules, Aubrey said.
Excluding public corporations from the debt isn’t the only way of creating room for investment. The Treasury could move from PSND to “public sector net financial liabilities,” which nets assets off against the debt and thereby removes the public corporations, the government official said.
Public sector net worth is an even broader measure that captures not just financial assets that can be sold if the government needs to raise money, but physical ones like the road network that cannot. Reeves said in her Mais lecture in March that she would use net worth to show “how the health of the public balance sheet is bolstered by good investment.”
Others say raising taxes or cutting spending and redirecting the funds into capital investment would protect the public finances, with debt already at 100% of GDP.
Jonathan Portes, professor of economics at King’s College London and one of the eight economists calling for a new fiscal framework, welcomed plans to change the debt rule, but said other reforms would be needed to give markets confidence that there will be restraint on public borrowing.
“A good fiscal rule introduces some meaningful and economically justified constraints on deficit spending and encourages decisions that are fiscally sustainable in the long term, while minimizing incentives for game-playing and accounting tricks,” Portes said. “If you keep on changing them like this, you get all the downsides with few upsides.”
How UK’s Reeves Could Get Creative in First Budget: QuickTake
--With assistance from Katherine Griffiths, Joe Mayes and Andrew Atkinson.
(Adds warning about impact of possible extra gilt issuance in eighth paragraph.)
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