UK spending cuts would damage ‘foundations of the economy’, Reeves told

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Cutting public investment in the UK would damage the “foundations of the economy,” a group of leading economists has warned Rachel Reeves, advising the chancellor instead to overhaul Britain’s fiscal rules to help bolster spending.

In a letter to the Financial Times, the group of eight senior economists warns that the fiscal plans inherited by the Labour government to reduce investment spending as a share of GDP would repeat earlier mistakes and backfire and undermine growth.

Signatories include Lord Gus O’Donnell, a former cabinet secretary; Lord Jim O’Neill, a former Treasury minister under David Cameron; and Mariana Mazzucato, an economics professor at University College London.

The UK government’s current debt rules are responsible for an “inbuilt bias” against investment, they said.

“To follow through on these plans would be to repeat the mistakes of the past, where investment cuts made in the name of fiscal prudence have damaged the foundations of the economy and undermined the UK’s long-term fiscal sustainability,” the letter warned.

Their warning comes as Reeves prepares to set out details of her version of the UK fiscal rules at her Budget on October 30.

Part of the new regime will be a switch to a current budget rule, which targets day-to-day spending rather than government investment. This, she said in her Mais Lecture this year, would mark a break from a “short-termist approach that disregards the importance of public investment”.

While Labour pledged in its manifesto to spend an extra £4.7bn a year as it invests in energy and the green transition, this would still leave public sector net investment on a downward trajectory as a share of GDP.

By 2029-30 government investment will be about 1.7 per cent of GDP, down from an estimated 2.5 per cent in the most recent year, according to the Institute for Fiscal Studies.

This contributes to lagging levels of overall investment, including the private sector, compared with other major economies.

In most years since 1995 the UK has had the lowest level of total investment in the G7 as a percentage of GDP.

The history of under-investment in the UK has resulted in a “vicious circle of stagnation and decline, whereby low investment leads to both a weaker economy and greater social and environmental problems”, the letter, published on Monday, said.

Part of the problem is a fiscal framework that drives “short-term thinking”, the letter added. The Treasury needs to initiate a process to implement a pro-investment fiscal framework focused on long-term sustainability, the economists argued.

In the Budget, the government will also report on wider measures of public sector assets and liabilities, to show how good investment decisions can improve the health of the public finances.

Last month the Office for Budget Responsibility, the UK fiscal watchdog, found that a sustained increase in public investment of 1 per cent of GDP could boost the level of potential output by just under 0.5 per cent after five years, and by about 2.5 per cent in the long run.

However, by sticking with the previous government’s debt rule, which requires debt as a share of GDP to fall between the fourth and fifth year of the official forecast in 2028 and 2029, Reeves has heavily constrained her ability to borrow to boost investment by more.

“We do not see how the planned ‘decade of national renewal’ can take place if these cuts are delivered,” the economists warned in the letter, which was co-ordinated by the Invest in Britain campaign.

The letter was also signed by Mohamed El-Erian, president of Queen’s College Cambridge; Sir Anton Muscatelli, principal of Glasgow university; Simon Wren-Lewis, of Oxford university; Jonathan Portes of King’s College London; and Susan Newman of the Open University.

The Treasury said the chancellor “has vowed to lead the most pro-growth, pro-business Treasury in the country’s history”, adding she “has set out her commitment to the current fiscal rules and will set out precise details at the Budget”.