Labour promised ‘borrow to invest’ before – and it didn’t end well

Rachel Reeves and Keir Starmer
Rachel Reeves and Keir Starmer

If you want to understand this Government, judge its actions and identify the beneficiaries. Straight after the election came pay deals for the trade unions that help fund the Labour Party. Then came the Employment Rights Bill, which repeals the laws that govern when a union may call a strike.

The Budget this week will also put the public sector first. Breaking Labour’s manifesto promise, the Chancellor, Rachel Reeves, is expected to announce tax rises of £35 to £40 billion. Employers’ national insurance contributions, capital gains tax, and inheritance tax reliefs for agricultural land and family businesses are in her sights. And she will change the fiscal rules, allowing her to borrow up to £50 billion more.

None of this reflects the mandate Labour sought in the general election. Last year Reeves promised fiscal restraint, saying, “I’m not going to try to fiddle the figures” to allow higher borrowing, adding, “we will use the same models the Government uses.” Now she plans to change accounting rules to target public sector net financial liabilities, not net debt. This would treat items of uncertain value such as student loans and government stakes in companies as balance sheet assets and reduce debt in the statistics.

Reeves also denied she would claim, once the election was done, that the fiscal position was worse than expected and tax rises were therefore necessary. She explained that data published by the Office for Budget Responsibility meant “you don’t need to win an election to find out” about the public finances. And she was categorical about tax, promising Labour’s programme for government was “fully funded and fully costed – no ifs, no ands, no buts … no additional tax rises.”

Since the election Reeves and the Prime Minister have argued that they need to spend more, and therefore increase taxes, variously to address inherited in-year spending pressures, end strikes in the public sector and on the railways with above-inflation pay deals, save the NHS, and reverse economic decline. The changing justification is cause for suspicion, but it also reveals the true problem with what Reeves intends to do.

In fact, one of the claims she makes is true. Our economy needs investment to grow. We need better transport connectivity, improved digital infrastructure, more housing, reliable and competitively priced power generation, reservoirs and more. We need more research and development, and to do more to link academic research to commercial innovation and enterprise. We need more private and public investment.

Borrowing to invest – if what we mean is investing in projects that lead to economic growth and bring a guaranteed return – is sensible. But there are good reasons to worry this is not the Chancellor will do. And the fiscal context is precarious.

Our stock of debt now stands at around 100 per cent of GDP, and government borrowing is less straightforward than it once was. British pension funds now own only about a quarter of outstanding gilts, and demand is falling as defined benefit schemes have closed and existing schemes mature. The value of gilts that still need to be sold each year is significant: around £140 billion, or 5 per cent of GDP.

Any sign that the fiscal responsibility of the Government is slipping will mean that the cost of borrowing increases. And here Reeves is playing a dangerous game. Ten-year gilt yields have already increased from 3.8 per cent in September to around 4.2 per cent now, and the markets are watching closely. Overseas investors set the price.

Already, we can see that Reeves’s priority is not investment spending to stimulate growth, but the public sector. It is possible to argue, of course, that capital spending on schools and hospitals will improve productivity in the public sector and relieve demand for more current spending in future. But this is far less direct than investment in the physical and digital infrastructure the economy needs most. And if public sector productivity really is the goal, why hose money at the unions without linking pay to reform, while making it easier to strike?

Equally, for the infrastructure investment that does come, there is no supply-side plan to reduce the cost of building. If we want to make sure every penny of investment spending goes as far as it can, we need to address the fact that everything from light rail systems to nuclear power stations is more expensive in Britain than in comparable countries. But there is little sign Reeves is prepared to strip back the layers of regulation that increase those costs, many of which relate to environmental and administrative law – fields dominated by Labour-supporting vested interests.

Other “investment” is likely to be wasted. Reeves plans to spend billions on Great British Energy and a National Wealth Fund, using borrowed money to guarantee returns to investors for technologies the market does not back. The changed accounting rules mean the cost of failed investments can be hidden by presenting them as assets with fictional value, just as items of public sector spending can be presented as loans.

And we know that while the tax rises Reeves announces will be bad for growth, the proceeds are likely to be lost on day-to-day spending. As the Budget nears we have seen billions of pounds of shares sold off, an exodus of higher-rate taxpayers, and 1,600 businesses closed just this month. The National Insurance changes alone will increase the cost of hiring a new employee on average wages by £600. But NHS bosses have said billions in extra health spending cannot deliver government waiting list promises – in part because of the pay settlements with the unions.

If this all seems familiar, it is because it is. The Blair/Brown governments promised only to borrow to invest, and left us with a structural deficit and PFI debts worth more than £300 billion. One of Labour’s weaknesses today is that its party mythology denies these failures, and remains blind to the lessons they should have learned. It may be a good idea to borrow to increase the investment we need – but funding vested interests by gambling with gilts and taxing wealth creators can only end badly.