This is Armchair Economics with Hamish McRae, a subscriber-only newsletter from The i Paper. If you’d like to get this direct to your inbox, every single week, you can sign up here.
Rachel Reeves has set out the Government’s long-term priorities, the first time a Labour government has had the opportunity to do so for 15 years, and that is welcome. It is welcome, too, that there were no major surprises.
However, all public spending reviews are as much about the aspirations of the government as what might actually happen. That’s because the world economic situation will inevitably change during the three or four years they project ahead.
Three years ago, for instance – before Russia’s full-scale invasion of Ukraine and Donald Trump’s strictures on Nato spending – no UK government would have been planning a massive increase in defence spending, or indeed the savage cut in overseas aid that will go some way towards funding it.
So there are two basic points. One is that the global context will play a huge role in determining whether these plans will turn out to be realistic, or whether this government, like so many of its predecessors, will be blown off course.
The other is that while the main thrust of the Chancellor’s project has been to increase growth, the higher borrowing and tax increases needed to fund her spending will tend to cut growth – and that too may derail the project.
We saw a small example of the importance of those international forces on Wednesday. Initially there was a calm reaction on the markets to her plans, and that was encouraging. But then, as she was speaking, both equities and gilts suddenly jumped in the right direction: the FTSE100 index went up, and gilt yields came down.
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But neither of these moves had anything to do with the situation here in the UK. The rise in share prices was driven by stories that the US-China trade talks were heading towards an agreement, and the drop in gilt yields was a reaction to a parallel decline in US yields, in turn because of good inflation numbers there.
If the world economy grows solidly over the next three years, big UK-based businesses will grow along with it. That will bring in additional tax revenues, create more jobs and so on. That in turn will help take the pressure off national finances, and make it easier for the Chancellor to fund her current spending promises.
And if long-term bond yields come down, that will make it easier both to cover the interest on the national debt and to fund the additional investments she outlined in her speech. But of course if global forces move the other way, then that makes the spending plans much harder to sustain.
Jobs numbers a worry
On growth, there is a problem. Rachel Reeves’s objectives are clear but the increases in taxation in the Budget last autumn have already led to a reduction in payroll employment. If HMRC’s numbers are to be believed, employers have cut 250,000 jobs since the Budget increased their national insurance contributions.
There are problems with the estimates of employment numbers, but reports from companies, particularly in the hospitality businesses, do suggest that they have had to shed a lot of labour as their costs have risen.
In addition, consumers seem to be keeping their spending down, and tax receipts for the first month of the financial year have been disappointing. The Government’s deficit is running higher this financial year than it was last year, not lower.
Not only do the tax rises announced last year seem to have slowed growth, but the markets now expect a further bout of increases in the next Budget in the autumn, and that will dampen growth still further.
Market analyst Pantheon Macroeconomics sums up this view in the City: “The spending review lays bare the tight fiscal picture facing the Government, which continues to cast doubt on its ability to meet the spending plans it has laid out for the coming years… The only question is how much, rather than whether, taxes will need to rise to meet rising spending pressures in the coming years.”
Taxes have to come, in large part, from people in work. So Rachel Reeves’s objectives are fine; whether she can achieve them without breaking her promises on taxation is quite another matter.
Need to know
Whether Britons will be better off after Rachel Reeves’s spending review will depend on one thing and one thing alone. Will it deliver faster economic growth?
The answer to that will rely on whether the tax increases already announced, plus the possible further ones needed to sustain rising public spending, more than offset the positive impact of the measures she has just announced in the spending review. And much of that depends on what happens in the rest of the world, rather than what the Government does here in the UK.
That said, thanks to the additional investment announced in the review, there will be a clear positive in three main areas: housing, infrastructure and defence. There were no surprises here. The rising population of the UK will need many more homes, and easing the planning restrictions on housebuilding must be beneficial.
There was a focus on affordable housing, which was welcome, but what matters most is the numbers. How fast can we add to the housing stock? Infrastructure, both in railways and electricity generation, has been neglected over the past decade, so there is a clear advance there too.
There will be some disappointment in the lack of investment in roads, which affects more people than improvements to the railways, and there will inevitably be concerns about the delivery of nuclear power plants, given the delays of the past. But the direction is welcome.
As for defence, an essential transformation has begun, though this will not show through in higher living standards – indeed rather the reverse, for money spent on the Armed Forces is money not available for spending elsewhere.
And overhanging everything is the question: how will this spending be paid for? The Chancellor’s commitment to her fiscal rules should enable her to fund the investment side of her plans at whatever the yield on the global bond markets turns out to be.
The UK currently pays the highest rate of interest in its debt of any G7 nation, and that is a concern. But there was nothing in the plans that would suggest it will have to pay more of a premium than it does now. There may, however, have to be higher taxes to fund the current spending element – and those taxes inevitably hit growth.
So a mixed bag. Good intentions, and sensible identification of the weaknesses of the previous government. But if the spending review does not deliver faster growth, then we will end up poorer, not richer, as a result.
This is Armchair Economics with Hamish McRae, a subscriber-only newsletter from The i Paper. If you’d like to get this direct to your inbox, every single week, you can sign up here.
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