This article was originally published as an edition of the Green Transition, New Statesman Spotlight’s weekly newsletter on the economics of net zero. To see more editions and subscribe, click here.
The Chancellor sounded furious as she told the House of Commons what Treasury officials had found in an audit of public spending. Running through commitments the previous government made, she said over and over, “If we cannot afford it, we cannot do it.”
The challenge for Rachel Reeves is that we cannot afford not to increase investment in the UK economy, particularly in the green industries of the future. The UK is in last place compared with its economic peers on levels of public and private investment in 2024, and the last time it met the G7 average was in 1990. The result is an economy held back by poor transport links and crumbling infrastructure.
Nearly a decade ago, the then head of the UK Government Economic Service Nicholas Stern described spending on curbing climate change as a highly productive investment. Since then, we have found specific evidence of why green investment is a good idea. The Climate Change Committee points to the UK’s peculiar dependence on imported oil and gas, which lets value leak out of the economy. By contrast, expanding renewable energy sparks innovation, and as the cost of electricity drops, the economy benefits.
But the key argument in favour of green investment is that in some parts of the UK economy, there is too much capital and labour that isn’t used productively. Reeves herself has lamented the previous government’s failure to invest in the UK economy when “historically low interest rates and slack in the economy” offered a “unique opportunity” to do so after the 2008-09 financial crisis.
Public investment in green industries can be particularly productive for three reasons. First, the private sector might not invest there at all without public-sector support: so public money is more likely to persuade new private capital, not divert investment from elsewhere in the economy. With a zero-emissions vehicle mandate in place, for example, private investors have a stronger case for investing in the EV supply chain, from batteries to charging points.
Second, these industries could grow on a sufficient scale to provide employment and boost investor confidence. Low-carbon infrastructure needs workers, and generates low-risk returns as people pay to use it in the decades after it’s built. Third, there is the potential for sustained market growth. Smart technologies not only help people to do energy-intensive things when cheap, renewable power is available. They support a global market in the underlying technologies expected to be worth $130bn in 2028.
Yet Reeves has committed to a set of hard fiscal rules, including a “sustainable debt” rule that puts a ceiling on how much extra investment the government can generate. This signals a responsible approach to financial institutions and markets; and it provides the political contrast with the previous government that Reeves underlined repeatedly as she presented her spending audit.
Yet some market actors think Reeves could cut herself some slack. An investor at Abrdn told the Financial Times, “fiscal rules change all the time”, which is particularly true in the UK. Mohamed El-Erian, the former head of the world’s sixth-largest asset management firm, is more explicit: without a review of the fiscal rules in line with Labour’s growth plan, they risk “getting in the way of economic wellbeing”.
The Chancellor can, however, already invest more without breaking her fiscal rules. As I previously argued in the Green Transition, she plans to nudge the UK’s fiscal policy institutions to treat the impact on growth of investment spending more positively. There could also be a shift away from the traditional focus on public-sector liabilities – that is, borrowing and debt – towards maintaining and improving the value of its assets. In particular, she wants the OBR to “report on the long-term impact of capital spending decisions”.
We now have a greater sense of how the OBR plans to think differently about investment, thanks to a new discussion paper, just published. Its analysis suggests that a 1 per cent increase in public investment can increase output by half a percentage over five years, but the long run (50 years) effect is five times greater at 2.5 per cent. The long lag between the initial investment and its full effect may further give pause for thought over the rather short time horizons (typically a maximum of five years) over which the economic benefits of extra investment are typically assessed.
Chancellors are traditionally incentivised to focus on the national debt and the budget deficit – these are what generate embarrassing headlines and opposition zingers on Budget day. But Reeves wants to tell the country how she’s grown the public-sector balance sheet through good investments. And because the OBR will presumably take a more positive view of the output multipliers of investment, investment in the productive capacity of the economy will be scored against a more positive assessment of how it’ll contribute to future growth.
The Chancellor’s first major appearance in office, when she excoriated her predecessors for reckless spending and unfunded commitments, borrowed heavily from George Osborne. But she’s also shown that she thinks quite differently to David Cameron’s austerity architect about how to make the economy grow, and signalled that she wants to bring the UK’s institutions around to her point of view. Chancellors often come up with surprises on Budget day – but Rachel Reeves is starting early.
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