There are not very many difficult questions in economics. Or at least, when something to do with the economy is described as “difficult”, this usually means not that the question is hard to understand, but that all the answers are unpleasant.
Rachel Reeves, then, can consider herself unlucky as she approaches her first Budget. As well as having a lot of unpleasant answers to consider, she is faced with one of the few genuinely difficult question of economics, to which the profession has embarrassingly little in the way of a convincing answer. That is – what drives investment?
It matters because, as an open letter from several prominent economists to the Financial Times pointed out on 15 September, there is a large backlog of public investment. Crumbling infrastructure, decaying buildings, delayed transport projects – after 14 years of a Conservative government that promised to “fix the roof while the sun was shining”, even the literal roofs of schools and hospitals are unsafe.
“It is time,” the Chancellor said in her conference speech on Monday, “that the Treasury moved on from just counting the costs of investments to recognising the benefits too.” But questions remain – as George Eaton points out – over whether Reeves will actually deliver higher public investment (which is currently due to fall from 2.4 per cent of GDP in 2024-25 to just 1.7 per cent in 2029-30).
The Chancellor has said she is not planning any great programme of spending to clear the backlog. Instead, departments have been asked to come up with significant cuts in order to accommodate the public-sector pay settlements. And cutting every-day expenditure is difficult for services that are already stretched to the limit. So the natural place to look for savings is in the capital budget. However necessary a project is or however false the economy, investment spending can always be postponed.
Why is she doing this? It is important to understand that this is not a question of “austerity”. Or at least, if that word has really come to mean nothing more than “cuts to public spending”, then we need another one to distinguish between a focus on fiscal prudence during a recession, and the same policy on government deficits when the economy is near full employment.
This is not 2010, when George Osborne came into power during a crisis of insufficient demand and immediately made it worse. The unemployment rate is only a little above 4 per cent; there is no meaningful slack in the economy. If we are to invest in public assets, then capital and labour have to be diverted from private consumption – because there are no idle resources that can be put to work.
Rhetorically, it is almost possible to square this circle by saying that the public sphere will be repaired in a couple of years’ time from the proceeds of economic growth. But how can we rely on this growth to arrive? If eminent economists are right, the big drag on the UK economy is the very dilapidation of public sector assets. You can’t have the returns first and the investment second.
The only way out for the Labour government is to hope that private-sector investment picks up sharply. And this is the big, unknown technical question for the Chancellor, a former Bank of England economist. After all these years, the shape of her first Budget is going to come down to an intellectual dispute about the legacy of John Maynard Keynes.
In the standard textbook model that Reeves would have learned at Oxford and the London School of Economics in the late 1990s, business investment is a reward for governments that behave nicely. Investors want low tax rates, flexible markets and, above all, stability. Any hint of an increase in borrowing and they will spook, worrying that government debt will spiral out of control. In this kind of model, even austerity can be expansionary, as it demonstrates to the business community that the fiscal authorities are really committed, even at the expense of electoral pain.
But that model has surely been destruction-tested by the experience of the past decade. The older model of Keynes’ General Theory of Employment, Interest and Money is significantly weirder and wilder. Public spending might crowd private investment in, rather than out, by assuring companies that the demand will be there for their output in the future. Conversely, an excess of fiscal rectitude could depress investment rather than stimulate it, by creating a self-fulfilling expectation that stagnation is inevitable and nobody can do anything about it.
Keynes even said that there might be no sense to it at all – that, truly, investment decisions are “taken as a result of animal spirits – of a spontaneous urge to action rather than inaction”. It is an uncomfortable thought for a technocratic government to consider that all its problems might be down to pure luck, and that the only thing it can do is sit tight, project positive vibes, and hope that the growth pixies, who have been woefully absent for so long, return to help us all out. But that might be the situation we are now in.
[See also: Keir Starmer targets Russia at UN Security Council]
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