UK’s Reeves Told to Change Fiscal Rules to Allow More Investment

(Bloomberg) -- A group of leading economists has told UK Chancellor Rachel Reeves to rip up her fiscal rules at the October budget in order to borrow more to invest in the country’s ailing public infrastructure.

In a letter to the Financial Times, eight top economists including former civil service head Gus O’Donnell and former Goldman Sachs chief economist Jim O’Neill wrote that Labour’s “decade of national renewal” will fail unless the state increases spending on Britain’s “crumbling public services.”

“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 economists said. “This challenge cannot be met by the private sector alone, it requires a step change in levels of public investment.” 

To release the funds, Reeves will need to change both her fiscal rules and the broader “mandate for the Office for Budget Responsibility,” the government’s spending watchdog, they added.

Reeves’ fiscal rules are that the government can only borrow to invest in capital projects and that the debt must be falling as a share of the economy in five years’ time. The debt rule in particular is restrictive, but the UK national debt is already nearly 100% of GDP and on track to hit 270% of GDP in 50 years time, according to a report from the OBR last week.

The intervention from the group of senior economists, who also include former Pimco chief executive Mohamed El-Erian and Mariana Mazzucato, professor at University College London, comes shortly ahead of Labour’s first budget since winning power in July.

Budget Pain

Reeves claimed to have found a £22 billion hole in the public finances in July and has since warned that the budget will be “painful” because her fiscal inheritance from the Conservatives is the worst of any government since World War II.

Tax rises and cuts to welfare are expected that could jeopardize the party’s growth agenda. The Resolution Foundation think tank said £19 billion of extra spending needs to be found for public services simply to restore normal trends. Any investment in hospital, prisons, schools and transport would need to be on top of that.

The economists said: “In the upcoming budget it is essential that the government recognises the important role that public investment must play in the decade of national renewal. Further cuts to public investment must be avoided.”

“The current fiscal framework has helped to drive this short-term thinking and created an in-built bias against investment. A more responsible approach, which better reflects the significant long-term benefits of increased public investment, will require changes to our fiscal rules and to the mandate for the OBR.”

The OBR currently operates with a five-year timeframe and a paper it recently released showed that the gains from infrastructure investment over that time horizon are reasonably small. Over a long time horizon, the investment starts to look much more attractive.

The other economists were Anton Muscatelli, chair of the Royal Economic Society; Simon Wren-Lewis, emeritus professor of economics, University of Oxford; Jonathan Portes, professor of economics and public policy, King’s College London; and Susan Newman, head of economics, The Open University.

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