Good morning from New Economy Brief.
Well, that’s it. Labour are in power for the first time in 14 years and have wasted no time with a string of appointments and policy announcements aimed at showing they are serious about ushering in a ‘decade of national renewal’.
But given the vast challenges facing the country, and the relatively thin manifesto they were elected on, how can the new government show they can rise to the challenge? This week’s New Economy Brief looks at the economic inheritance the Conservatives have bequeathed Labour and suggests a few policy areas where there might be more scope for action now the election is behind us.
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The Conservatives’ economic legacy.
Communications over the first few months of the Labour government will focus on defining the Conservative’s economic legacy. As George Osborne demonstrated in 2010, effectively delivering this message can win support for otherwise unpopular decisions. One challenge Labour faces is deciding which aspect of that legacy to choose. We have covered their fiscal inheritance previously, and have also analysed the fallout from Liz Truss’ infamous mini-budget. But one question will be how much Labour ties two other political choices into its narrative: Brexit and Austerity.
The price of failure? Oxford Economist Simon Wren-Lewis thinks the UK economy is 5% smaller than it would have been, mainly because of how austerity, Brexit and the bungled Covid response have suppressed growth. This is a huge amount. As Wren-Lewis puts it: "A UK government that enacts policies that reduce GDP by around 2% during its time in office is pretty unusual. To reduce it by 5% is extraordinary, but then since WWII we haven’t had a government that has cut public spending in a recession when interest rates were stuck near zero, or one that deliberately raised trade barriers with our largest market." Even this is a conservative estimate; other academic studies have shown that Brexit alone cost between 5% and 10% of GDP.
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The (absolute) state of public services.
The Institute for Government’s ‘Performance Tracker’ examined nine separate public services in 2023 and concluded that all, apart from schools, are performing ‘much worse’ or ‘worse’ than in 2010. The maintenance backlog now exceeds £37bn across hospitals (£10.2bn), schools (£10.6bn), criminal courts (£1bn), prisons (£1.4bn) and the road network (£14bn). The Centre for Progressive Policy (CPP) found that £142 billion more spending per year is needed by 2030 just to keep public services at their current (struggling) levels.
Re-election requires fixing them, fast. To keep their majority, Labour need to show they can fix them. But this is an uphill task. The Institute for Public Policy Research found that even if the Labour government manages to improve public services faster than any government in recent decades, getting them back on track could take a decade or more.
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Funding the decade of national renewal?
This is why Rachel Reeves emphasised delivery in her first speech on Monday, where the Chancellor outlined Labour’s approach to unlocking private investment, along with reforms to the pension and planning system. The new Cabinet have been keen to demonstrate quick progress in contrast to the previous Government. Reeves’ speech also outlined new analysis from the Treasury showing the UK economy would be £143.3bn (6.3%) larger if it had grown at the OECD average since 2010 (this is more than £2k per person, or £5k per household) while tax receipts would be £58bn higher.
“New chancellor, new rules”? It still remains to be seen how the Chancellor will pay for fixing public services and growing the economy, given the fiscal situation she has inherited from the Conservatives. Reeves reiterated her commitment to “robust fiscal rules” – arguing it was important that she does not break the promises in the manifesto. (Meanwhile, the Institute for Government and former Bank of England chief economist Andy Haldane join the chorus of mainstream experts and institutions calling for reform of the UK’s fiscal rules.)
Off the table. She also reiterated that Labour won’t increase VAT, income tax or NICs to raise money. Neither will she fiddle with the way commercial bank reserves are remunerated at the Bank of England, nor slow down Quantitative Tightening to give herself more fiscal space to solve these vast problems. However, various other revenue-raising options still haven’t been ruled out, like taxing share buybacks, excess profit taxes, capital gains tax and more.
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Where could we see action?
The new government have already implemented a number of ‘quick wins’ to deliver on manifesto commitments, such as removing the ban on new onshore wind and restoring housebuilding targets. These were signalled well in advance. Labour’s silence on some potential tax rises is well known but there are other policy areas where they have said very little or where the details are still vague. With a spending review about to kick off and a Budget due in the Autumn, here are a few areas to keep an eye on.
Finance and investment. Reeves hinted at reforming the pension system to both deliver greater returns for pensioners and to accelerate investment in British industries, but the exact details of this reform are still unclear. Will pensions be redirected from dirty industries to grow the green economy and capitalise the UK’s publicly owned banks, like the UK Infrastructure Bank, British Business Bank, National Wealth Fund, and others? Will a higher savings rate be mandated through auto-enrollment to ensure decent post-retirement incomes and also free up cash for investment? Or will relying on private money at the expense of public investment risk companies extracting profit from vital public goods?
Green industrial strategy. Ed Miliband has already outlined his priorities for the Department for Energy Security and Net Zero, and Great British Energy is set to launch imminently. But will their wider green industrial strategy adopt a more varied mix of ownership models and actively seek equity stakes in British businesses, or will it simply derisk private finance? Similarly, will the Industrial Strategy Council draw its members from a wider subsection of civil society, such as trade unions, and ensure it operates in the public interest, or will it be guided by representatives of international finance like BlackRock, as economist Daniela Gabor has warned?
Social security. There’s a new team at the DWP, but will this mean thorough reform of the social security system? New ministers have previously supported reforming job centres, enabling Universal Credit claimants to undertake more comprehensive training and study to fill local labour shortages. Will Labour abandon the punitive sanctions system and rethink benefit conditionality? And will they bow to the increasing internal and external pressure to scrap the two child limit and benefit cap?
Institutional tweaks. Finally (and most wonkily), there are a couple of examples where the devil really is in the detail. Though the Chancellor has reaffirmed support for the independence of the Office for Budget Responsibility (OBR), there are a variety of other pro-investment institutional tweaks that could increase the government’s spending power without directly changing the OBR’s mandate. These include amending their methodology for calculating fiscal multipliers, separating out green investment from OBR forecasts given at fiscal events, or enabling borrowing by public finance institutions’ (like Great British Energy, the National Wealth Fund, British Business Bank and National Infrastructure Bank) to be calculated ‘off-balance sheet’, as is mainstream in international accounting standards.
The Purpose of Pensions. As the new Chancellor promises to “turn [the government’s] attention to the pensions system”, Finance Innovation Lab’s Jesse Griffiths outlines the improvements that are needed, including higher employer contributions, a more progressive system and pension fund investment in green transition.
Deepening the opportunity mission. A new Fairness Foundation report argues that tackling inequality is key to the success of Labour’s opportunity mission. The paper suggests nine steps that the new government could take, including having a Secretary of State focused on fairness, equality and opportunity and setting up an Equality Delivery Unit at the centre of government.
Rewiring the Treasury brain. The Institute for Public Policy Research’s Harry Quilter-Pinner suggested how the government’s new mission boards could work. He argues that they must bring together all the key players in each policy area and that all big spending plans should go through a ‘mission test’.
How will bond markets react to new fiscal rules? The Telegraph’s Jeremy Warner suggests "There’s no chance of the new Government reaching its 2.5pc per annum growth target without abandoning the self denying ordinance of the fiscal rules, and instead reintroducing something like the old Brownite contract of borrowing to invest. Whether the bond markets will weather it is another matter." However, many bond investors have recently suggested they would support changing fiscal rules to enable more borrowing to invest.
Growth and re-election. Paul Johnson of the Institute for Fiscal Studies suggests some avenues for growth, including rejoining the EU customs union and single market, “stop[ping] penalising income from employment relative to other forms of income”, better early years, vocational and further education, and investment in infrastructure. He warns that “Each individual decision may come with a political cost, but a failure to raise living standards over time will come with the ultimate political cost of electoral oblivion.”
Redlines for GB Energy’s mandate. Common Wealth’s latest briefing argues Great British Energy “[m]ust take the form of a fully publicly-owned energy company that directly invests in and owns energy assets” in order to reduce costs and make both the pipeline of new investments and the power system's inner workings more coherent and transparent. They explain that a weaker institution that confines itself to derisking private-led investment with minimal public ownership or coordination would pose a major threat in terms of both policy delivery and political risk.
