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FT editor Roula Khalaf selects her favorite stories in this weekly newsletter.
The writer is president of Frontier Economics and former Cabinet Secretary.
Contrary to what many have said about the Treasury, I know that it welcomes ideas. And as a former permanent secretary, I feel compelled to suggest some answers to the key question facing this government. When it comes to a much-needed increase in public investment, how could the chancellor, Rachel Reeves, do it without opening the floodgates to increased public spending and unsustainable borrowing?
There is a growing consensus that more investment is needed to stimulate growth. But the reality is that current fiscal plans and rules leave very little room for this: according to projections by the Office for Budget Responsibility, only between 1.5 and 2 percent of GDP. How can we enable investments that truly stimulate growth while reassuring markets that the UK’s public finances are on a sustainable path?
One possibility is to promise to balance the current budget in three years instead of five and not rely solely on borrowing for additional investments. If we really want to prioritize investment, that means making difficult decisions: higher taxes or less spending. The House of Lords economic affairs committee has just warned that It’s time to make tough decisions about the national debt.: You are absolutely right.
But assuming the investments are worth it, borrowing should also be part of the answer. One problem with the current definition of debt is that it does not recognize assets that could be purchased or created through investments. If the new National Wealth Fund taps its balance sheet to buy a stake in a new green energy company, the current rule counts the debt but not the value of the financial asset. The current debt rule also does not reflect the value of any new transportation infrastructure produced by government investment.
Labour’s manifesto says there should be a debt target, but leaves some room for what it should be. As the Chancellor’s speech at the conference put it: “It is time for the Treasury to move from simply counting the costs of investments to also recognizing the benefits.” The ONS already uses public sector net worth (PSNW) and public sector net financial liabilities (PSNFL), two government balance sheet measures with a long history that relate to the IMF definition, a definition that many global investors they understand. Both would do a better job of capturing financial benefits from future investments. PSNW would also capture the value of physical assets, such as roads or buildings, built by the government.
Neither is perfect, but it would make sense to include one or both definitions in assessments of overall debt sustainability. We should get rid of the last government’s absurd debt rule, which requires debt to fall between years four and five but says nothing about the other years. Market credibility would be enhanced if the OBR were asked to provide an independent assessment of debt sustainability using a measure such as the PSNFL alongside more traditional ones, and bringing it to the fore.
The second change required is to have a capital plan that extends over a reasonable period of time. I would emulate the private sector and plan much longer than traditional spending review periods: 10 years would make sense, allowing for mid-course corrections in case of major shocks.
The third change would be to ensure that public investments actually stimulate growth. The Treasury will need to scrutinize spending offers for optimistic biases, including big investment projects put forward for the spring 2025 spending review.
Another approach is to involve the private sector to add much-needed rigor to the assessment of future benefits. It remains to be seen how successful Great British Energy and the National Wealth Fund will be in attracting private investment. Again, this will be aided by using different definitions of debt. But an even more direct way is to create a stable, attractive and predictable climate. A good example is the recent offshore wind auction: successful bids should deliver real results without needing government money up front.
It is worth emphasizing that all public investment decisions should be based on financial and non-financial returns, as set out in the Treasury guidance contained in the Green Paper. The argument for giving greater weight to investments that generate financial returns is that public finances are currently in a dangerous state. The debt-to-GDP ratio is around 100 percent and debt interest is the second largest spending program. This weighting could be removed when public finances are sustainable, verified by the OBR.
Finally, Mario Draghi’s scathing report on EU competitiveness shows that we are not alone and that there is a way out. Why not show the EU what it lacks by first adopting its excellent recommendations?
These changes would allow room for larger and more valuable investments, while maintaining market credibility. Some can be done on the budget, others will take longer. But it would be a huge contribution to growth, the government’s number one priority.