Cutting public spending would 'damage foundations of the economy', Reeves warned

Former cabinet secretary Lord O'Donnell among economists who have urged the chancellor to update fiscal rules instead
Rachel Reeves is gearing up for her first Budget next month. Photo: Tayfun Salci/ZUMA Press Wire

A former cabinet secretary is among a group of leading economists who have warned Rachel Reeves that cutting public investment in the upcoming Budget would damage the “foundations of the economy”.

In a letter to the Financial Times, the group – which includes ex-cab sec Gus O’Donnell and Mariana Mazzucato, an economics professor at University College London – urged the chancellor to instead overhaul fiscal rules to enable more public spending.

The signatories, who also include Jim O’Neill, who was commercial secretary to the Treasury under David Cameron, said the fiscal plans inherited by the current government to reduce investment spending as a share of GDP are responsible for an “inbuilt bias” against investment.

“To follow through on these plans would be to repeat the mistakes of the past, where investment cuts made in the name of fiscal prudence have damaged the foundations of the economy and undermined the UK’s long-term fiscal sustainability,” they said.

The history of under-investment in the UK has created a “vicious circle of stagnation and decline, whereby low investment leads to both a weaker economy and greater social and environmental problems”, they added.

“We do not see how the planned ‘decade of national renewal’ can take place if these cuts are delivered,” the economists said.

They said changing the fiscal rules and the Office for Budget Responsibility’s mandate would be a “more responsible approach, which better reflects the significant long-term benefits of increased public investment”.

The letter was also signed by Mohamed El-Erian, president of Queen’s College Cambridge; Sir Anton Muscatelli, principal of Glasgow university; Simon Wren-Lewis, professor of economic policy at the Blavatnik School of Government; Jonathan Portes, professor of economics and public policy at King’s College London; and Susan Newman, head of economics at the Open University.

A Treasury spokesperson said Reeves “has vowed to lead the most pro-growth, pro-business Treasury in the country’s history” and that she “has set out her commitment to the current fiscal rules and will set out precise details at the Budget”.

OECD: Fiscal rules may lead to a 'deterioration of public finances'

The letter followed a separate warning from the Organisation for Economic Co-operation and Development that Reeves will need to take “significant action” to stabilise the public finances.

The OECD's latest economic survey of the UK says the government faces “mounting spending pressures related to population ageing, through higher health, long-term care and pension costs, aggravated by needed investments in the green transition, infrastructure, skills and innovation”.

These “come on top of the current difficult position of high debt, high interest payments and low growth, which raises borrowing cost over time”, it adds.

The OECD similarly called for greater public investment, which its researchers said would likely require a change to the fiscal rules.

“Since investment is treated in the same way as current spending, resources allocated to public investment often end up as the adjustment variable to meet fiscal rules, resulting in inefficiently low levels of productivity-enhancing public investment,” they said.

The current fiscal rules "may lead to short-termism and to a trend deterioration of public finances", the report warns.

It says that since public investment is already low compared to the remaining 37 rich economies represented by the OECD, "this will have important repercussions on the ability to maintain public infrastructure and to create the necessary signal to raise complementary private investment".

The OBR has estimated that new public investment of around 0.4% of GDP is needed each year by the end of the decade to meet the investment needs for the green transition alone, and that more will be needed to renew or replace existing infrastructure, according to the report.

As well as making changes to the fiscal rules, the report urges the chancellor to scrap stamp duty, which it says discourages people from downsizing or moving for better job prospects “hampering the reallocation of housing in a tight market”.

And it says the “expensive” pensions triple lock, which it says is expected to add about 8% of GDP to public debt by 2072-73, should be replaced with the indexation of pensions to an average of the CPI measure of inflation and wage inflation, and providing direct transfers to poor pensioners to “mitigate poverty risks”.

The report also says Reeves should unfreeze fuel duty, simplify the income-tax system, cut the amount of interest expenditure that companies can deduct from their tax bills and property values, which determine how much council tax a household pays.

The Treasury said: “Following the spending audit, the chancellor has been clear that difficult decisions lie ahead on spending, welfare and tax to fix the foundations of our economy and address the £22 bn hole the government has inherited. Decisions on how to do that will be taken at the budget.”

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