The recent British election was, by most accounts, a “service-delivery” vote. Appalled at the state of their public services, Britons opted for new management. And while they need no reminding of how bad things have become, the facts are still startling, with a recent report from the Institute of Government assessing that public services are in a worse state today than in 2010. Nor is the decline finished: all but general practice, hospitals and schools are currently on track for further decay between now and the end of the decade.
Reversing this trend will require money. Unfortunately, that situation may also be worse than we thought. We already know the Treasury is empty but what is only now becoming clear is the number of unfunded spending commitments which, while having been kept off the books by the previous government, will soon come due. In her speech today, Rachel Reeves is expected to hit this point home, announcing that the previous Conservative government left a black hole in the public finances. She estimates that the bills for compensation to tainted-blood and post office victims, promises to boost defence spending, public-sector pay awards, and other such invoices inherited by Labour amount to around £20 billion — though they could run as high as £50 billion.
However, the new Labour Party came into office having promised not to raise taxes nor alter the outgoing government’s borrowing limits. Instead, it hopes to generate the revenue needed to revive public services by raising the growth rate of the economy. Hope is the key word here. The cyclical recovery of the British economy, along with the positive mood music associated with the incoming government, will probably lift economic activity somewhat this year, affording the government a bit more breathing room. Reflecting this optimism, the IMF recently upgraded its forecast for the British economy this year, with private forecasters similarly more upbeat.
Still, it’s not much to get excited about. The IMF upgrade is in the order of a mere 0.2% of GDP, which works out to a few billion pounds of added output, some of which will make it into the state’s coffers in the form of tax. That won’t do much to improve the government’s fiscal position. If it’s to give a substantial lift to the country’s economic growth rate, the Government will need to find a way to raise the economy’s level of investment, which is the lowest in the G7 (a group whose investment performance has itself been declining for decades). Foreign direct investment in the UK is currently sitting at a 12-year low.
There are some measures the Government can take to stimulate investment without much spending, much of which it’s already committed to: tax reform, encouraging private-pension consolidation to make it easier for funds to invest in a wider range of assets, changes to the planning system, and improving its trade relations with Europe. The return of policy predictability and political stability after the chaos of the last eight years should also go a long way towards encouraging businesses to start looking to the long term again.
Nevertheless, for private investment to take off, there will almost certainly need to be more public investment in the infrastructure which facilitates economic activity — everything from roads and railways to research and development. Because if the state’s current account looks bad, its capital stock is even worse.
Politicians love to say that the government should run the country the way a household manages its finances. It’s a silly analogy since households bear no resemblance to countries — they can’t issue currencies or contract eternal loans, among other things. However, even if we took the idea at face value, governments haven’t been up-front with how they’ve been managing the kitty. What they’ve done would be similar to your partner saying the accounts were all in balance while neglecting to add he’d cashed in the kids’ college fund to settle some gambling debts. The fact is, the country’s public endowment, once rich, is now threadbare.
If we look at what amounts to the public savings account, the figures are eye-watering. The government’s net worth — the value of public assets minus debts — now stands more than £700 billion in the red, making it one of the very worst in the developed world. Governments have been raiding Britain’s jewellery cabinet, privatising state assets or putting off maintenance work on deteriorating infrastructure, then distributing the revenues or savings in the form of tax cuts. Although this has been going on for decades, the fall into negative territory happened under George Osborne. The former chancellor used to justify his austerity programme by saying he was repairing the roof while the sun shone. In truth, he was actually dismantling the roof and selling the tiles.
Now the rain has come, and we all know the result. Trains that are slow or run late, if at all; backlogs at ports; leaky school buildings and ill-equipped hospitals; building permits which are delayed by a lack of planning officials or inspectors; workers whose productivity is hurt by long-term illnesses, due to their inability to get timely treatment in an overcrowded health care system; employers who can’t find workers with requisite skills due to under-investment in the school system.
All this is unpleasant enough on its own, but it also discourages private investment, by raising costs and lowering returns. So Britons don’t just suffer as consumers from the collapse of the public sector. They also suffer as producers, hindered as they are from realising their economic potential. But even if the Labour government were to eschew the ambition of leading an investment revival, merely rebuilding the roof on the public sector will require more money than it is likely to have at its disposal. So unless the Chancellor is willing to deepen the austerity against which the electorate rebelled at the election, she’ll have to either raise borrowing or taxes, or both.
If Reeves is willing to be bold, and if she’s prepared to absorb the battering she’ll get over having misled the electorate, there is scope for her to do both. On debt, the Chancellor has pledged to abide by the fiscal rule the previous government imposed on itself, namely that the ratio of the national debt to GDP should fall within five years, while the ratio of the fiscal deficit to GDP, which currently stands at more than 4%, should come down to 3% within that same time-period.
While such targets have the virtue of communicating stability and predictability to investors, ensuring against the panic of “Liz Truss moments” — a term which has forevermore entered the economics lexicon — they can also lead to perverse outcomes. Germany’s rigid adherence to its debt brake has, amid recessions of the sort it’s currently experiencing, forced the government into pro-cyclical measures that deepen recession: with the economy contracting, the government must cut spending, and with the government cutting spending, overall demand drops and the recession gets worse.
Contrast that with the US, where the Biden administration’s experiment with industrial policy has shown how effectively government investment can crowd in private investment. The Infrastructure Act, CHIPS Act and Inflation Reduction Act have together ushered in a period in which private investment has risen by nearly a trillion dollars a year, helping to power an economy that is out-performing all its G7 partners by some distance.
Labour would thus do well to consider various ways it could tailor the fiscal rule without raising alarm in markets. There are book-keeping measures it could use to, for instance, transfer Bank of England losses off the government’s ledger so as to give it some respite. Equally, it could begin to incorporate the government’s net worth into its budget statements, giving a truer picture of the nation’s finances and thereby enabling investment that raises the value of public assets to offset the debt incurred to expand them (much as a mortgage loan is offset by the value of the property). Bond investors would be unlikely to look unkindly on such measures, because they’d rest on the foundations of asset-values, and not the ethereal promise Truss offered that her tax cuts would somehow pay for themselves through future growth.
Similarly, when it comes to taxes, the British public have for years been telling pollsters they’d be willing to pay more to restore public services to their former glory. Just how much more is another matter, but what is undeniable is that, despite all the furore about Britain’s tax burden reaching levels not seen in decades, the country has a relatively light burden compared to most other developed economies. Were the Chancellor to break her pledge not to raise taxes, she would undoubtedly get some blow-back. But if she did it early in her tenure, and were the condition of Britain’s neighbourhoods and public services to improve noticeably as a result, it seems doubtful her compatriots would punish her and demand for sewage to be put back in water. By the same token, were taxes rising and economic growth accelerating thanks in part to public investment, people might not feel a rising proportionate tax take to be burdensome.
When Labour left office in 2010, the chief secretary to the Treasury scribbled a note to his Tory successors: “I’m afraid there is no money.” It sullied the party’s reputation for fiscal responsibility for years afterwards. Rachel Reeves, wisely, wants to rebuild public trust. But to do this she must be honest about Britain’s economic situation. The Chancellor should take this moment to capitalise on the public’s good will, make unpopular but needed decisions — and rebuild Britain’s roof.
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Source: UnHerd Read the original article here: https://unherd.com/