With just ۱۲ weeks to go until his first budget, new chancellor John Healey is seeking ways to ramp up public investment, without busting the Treasury’s fiscal rules – and some economists are urging him to be bold.
As he settles into No ۱۱ Downing Street, the former defence secretary’s most immediate challenges concern day-to-day government spending.
These include the need to pay for Andy Burnham’s VAT cut on energy bills and to fill the £۵bn funding gap in the defence investment plan left by his predecessor Rachel Reeves – which helped prompt Healey’s resignation earlier this year.
Healey could opt to meet these costs through tax changes – with a bank windfall levy back on the agenda, for example – or by ordering Whitehall departments to penny-pinch elsewhere.
It will help that Reeves bequeathed him significant “headroom” against the rules, £۲۴bn at the time of her spring forecast, which is unlikely to have been completely eroded by the impact of the Iran war.
But separately from these short-term pressures, Healey’s boss has made clear that he wants to see a step-change in long-term investment in infrastructure and housing, to meet his promise of growth in every postcode.
One way to fund some of that additional investment may be to exploit what Burnham called “any flexibility” in the existing fiscal rules. The chancellor told the Times there was “scope for more and more rapid investment”.
Reeves, now a humble backbencher, made a historic change to the way debt is defined under those rules. It means extra borrowing doesn’t count against the Treasury’s target if the government uses it to acquire a financial asset. That can mean a stake in a company, or a loan, for example.
Reeves used the new definition, known in Treasury parlance as public sector net financial liabilities (PSNFL – pronounced “persnuffle”), to promise a significant increase in public borrowing, but economists have argued for some time that the Treasury could go further.
A recent paper by the Resolution Foundation thinktank argued that the “PuFins” – public financial institutions, which include the National Wealth Fund, British Business Bank and National Housing Bank – could borrow up to an additional £۹bn a year, without breaching the fiscal rules.
The Starmer government had already expanded these bodies, giving them additional capital, but the thinktank urged Burnham to go further.
Lord Jim O’Neill, the former Goldman Sachs chief economist who has been mooted as a possible Burnham adviser, has also suggested there could be scope within the rules to borrow more for infrastructure projects – and suggested creating a new independent agency to assess which should be supported.
Helen Miller, director of the Institute for Fiscal Studies (IFS) cautions that the question of whether there is flexibility within the rules may not be the best one to ask.
“People are getting a little bit hung up on the fiscal rules. I think they should stick to them, for credibility reasons. But if the government increases borrowing, it is still borrowing: it will still put up borrowing costs and increase debt, creating more problems for the future.
“The real, meatier question is: ‘What is the substantive case for that investment? Is that a good thing to be investing in?’” she adds.
Some experts argue for a more creative approach, however. Thomas Aubrey, of the Bennett school of public policy at Cambridge University, says: “If you really want to move the needle, which seems to be what Andy Burnham is implying in speeches, then the PSNFL stuff is just not going to be enough.”
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Instead, he argues that public corporations, such as the development corporation for Greater Cambridge that Reeves announced earlier this year, should be allowed to borrow directly from markets. “You could do that with energy, water, large-scale public infrastructure projects, housing,. The UK is one of the only major economies that doesn’t have a deep market for public corporation debt.”
Interest rates would be higher than for direct government borrowing, he argues, where there is a Treasury guarantee – but the trade-off would be significantly more scope for long-term investment.
And he argues the buyers of such debt, including pension funds keen to match their liabilities, would be distinct from those that now buy government bonds, or gilts – so the Treasury would not be cannibalising existing demand.
“There is no shortage of capital for projects with detailed costings, credible revenue forecasts and hypothecated income streams,” he argued in a recent policy note for the Centre for Cities thinktank.
The UK’s borrowing costs are already higher than many other large economies, and Treasury officials would likely caution Healey against anything that might unsettle the gilt markets.
Aubrey suggests other Whitehall departments have previously shown interest in allowing public corporations to borrow – but it has always been blocked by the Treasury, which would have to agree to classify their debts as separate from government borrowing.
The approach urged by Aubrey chimes with proposals from Burnham-adjacent thinktank Mainstream. The PM’s right-hand woman Louise Haigh also pointed to proposals for public corporations to be allowed to borrow directly, in a piece she wrote for leftwing publication Renewal, earlier this year.
How to boost investment is just one of a slew of economic questions facing Healey and the prime minister in the next few critical months, but it is perhaps the one most central to Burnham’s projects of devolution and reindustrialisation – and an early test of how radical the new administration will be.
