Beyond Growth

“At the election we promised there would be no return to austerity,” Chancellor of the Exchequer Rachel Reeves explained to the British Parliament on October 30. “Today we deliver on that promise.” The remark came halfway through the newly elected Labour Party’s budget message, a statement shaped around the government’s “mandate to restore stability to our economy.”  Prior to the budget, Reeves had been sending mixed messages about how this was to be done. In one keynote speech, she called for a new regime of investment-driven growth, quoting Joan Robinson and Karl Polanyi. Elsewhere, she stuck to platitudes that suggested anything but radicalism. “Just as we cannot tax and spend our way to prosperity,” she said in the message itself, “nor can we simply spend our way to better public services.”

The headline measures announced by Reeves are encouraging: the Labour Party’s autumn budget is the biggest tax- and deficit-increasing budget outside of major crises for thirty years, comprising over £70 billion of new annual spending financed by £40 billion of tax increases and £35 billion (equivalent to around 1 percent of GDP) of new borrowing. Despite pre-election rhetoric about “black holes” in the public finances, Reeves made space for much-needed public investment by loosening rules limiting the issuance of public debt. The scale of the budget suggests that Reeves recognizes the magnitude of the UK’s problems and has the ambition to confront them—yet it remains unclear whether Labour is capable of reversing the decline of the last fifteen years. Aside from blaming the previous government, Labour have yet to articulate a clear diagnosis for the country’s predicament, let alone a set of solutions. There is little in the detail of the budget that sheds light on how Labour intends to restore the nation’s fortunes.

Indeed, beneath the headline figures, problems quickly emerge. The bulk of revenue increases come from employers’ national insurance, which is essentially a payroll tax. This means higher costs and job losses for small businesses—not least the private contractors that provide general medical practice and social care to the public sector—unless exemptions are introduced or funding for public-sector providers increased. The bulk of spending hikes are concentrated in the first two years. Few think a return to cuts in the second half of the parliament is plausible, but avoiding these will require further increases in taxes or borrowing, both of which are politically difficult.

These implementation problems point to deeper unresolved issues. Labour has limited room for maneuver either politically or economically. The electorate is disillusioned and distrusting; Labour’s commanding parliamentary majority masks the fragility of a historically low vote share and the threat of the far right as an emerging electoral force. Labour takes stewardship of an economy battered by fourteen years of Conservative mismanagement. The outgoing administration leaves an unenviable legacy of stagnant wages and productivity, crumbling infrastructure, and a badly underfunded health system. Indicators such as poverty, food insecurity, and even measures of life expectancy and stunting in children, are moving in the wrong direction. ​​The country’s non-fiction best-seller lists tell the story of decline: “How They Broke Britain,” “Failed State: Why Nothing Works and How We Fix It,” and “Great Britain? How We Get Our Future Back.” What are the Chancellor’s prospects of turning the tide?

Demand deficiency

Although the economic decline of recent years was driven by austerity, Brexit, and the pandemic, the last decade and a half represents an intensification of previous trends as much as a distinct period with its own set of problems: British economic history is defined by structural continuities dating back at least to the shift in policy that was initiated by Thatcher’s election as prime minister. Since the 1980s, capital investment has declined and, despite upticks, has never returned to post-war levels; income inequality has risen. Despite repeated attempts at deficit reduction since Thatcher, growth in public sector borrowing has persisted. Politicians and the media have repeatedly seized on the deficit as a political battleground, often as a proxy for wider ideological conflicts over the size and purpose of the state.

In part, deficits are a symptom of demand deficiency: inadequate investment, high inequality, and labor weakness impose limits on private spending, leaving an underfunded and often unwilling public sector as the only buffer against recession and unemployment. Perhaps more so than a deficiency of demand, deficits represent repeated failed attempts to shrink the state via tax cuts: a continuity that, with the exception of the 1997–2010 New Labour era, runs through much of the post-1980 period.

The ascendance of technocratic macroeconomic policy can also be traced to Thatcher’s era. Her Chancellor of the Exchequer (Treasury), Nigel Lawson, upended the post-war consensus by arguing that the primary objective of macroeconomic policy should be inflation control, while supply-side policies such as deregulation and privatization would ensure growth and employment. In practice, Lawson hitched monetary policy to Germany’s Bundesbank by first “shadowing” the German mark and then joining the European Exchange Rate Mechanism (ERM). Following the UK’s ignominious exit from the ERM in 1992, inflation targeting was introduced; since then, the Bank of England has been expected to respond to inflation by reducing demand and raising unemployment. One of New Labour’s earliest acts upon entering government in 1997 was to formalize this role: the Bank of England was given an explicit inflation-targeting remit and made independent of the Treasury. Gordon Brown, then Labour’s Chancellor, also introduced the UK’s first fiscal rules. Alongside a cap on total public-sector debt at 40 percent of GDP, Brown introduced a classic “golden rule” for fiscal policy—a stipulation that current spending should be matched by taxation over the business cycle.

Poverty indicators moved in the right direction under New Labour. But the bargaining position of workers continued to deteriorate. Benefits erosion, means-testing, and conditionality—an approach known as “workfare” in the United States—replaced direct confrontation with organized labor. As deindustrialization took hold, weak demand and the absence of an industrial strategy left “flexible” labor markets to fill the gap, supplemented by a public sector whose revenues depended on the precarious growth of the financial sector.

After fourteen years of Tory rule

While New Labour repeatedly failed to meet their own public-debt targets, the practice of adjustment by shifting the goalposts on the state of the business cycle appeared sustainable until the cataclysm of 2008. The financial crisis forced the government to nationalize banks and extend broad fiscal support; the deficit quadrupled from 2.5 to over 10 percent of GDP. The national debt rapidly blew through Brown’s 40 percent ceiling, by 2010 reaching around 70 percent of GDP. Conservative politicians and media commentators invoked the example of Greece—then in the early stages of what would become a full-blown sovereign-debt crisis—as an example of what could befall the UK. By the time Brown’s term ended, both major political parties had adopted the position that large cuts in government spending were inevitable.

The Conservative-Liberal Democrat coalition, with George Osborne as Chancellor, took power amid this torrent of deficit scaremongering. Instead of adhering to what had been conventional macroeconomic policy and allowing the deficit to take the strain until the economic recovery was established, Osborne introduced immediate cuts to government spending. Austerity snuffed out the recovery and the UK entered a long period of historically unprecedented stagnation. Median real wages were no higher in 2024 than they were in 2007. Between 2010 and 2019, productivity growth averaged close to zero. Osborne structured spending cuts so that the least well off (and the least likely to vote Conservative) bore the brunt. The Tories repeated a single message to justify their actions: the only economic indicator that matters is the public debt.

Osborne also updated Brown’s fiscal rules. The debt-stock limit of 40 percent of GDP was replaced; instead of any particular limit to the government’s debt, there was now a requirement that debt-to-GDP fall within a fixed period of time. Parliament established an Office of Budget Responsibility (OBR) to forecast public borrowing and evaluate the government’s performance against this fiscal rule. Despite repeated Conservative failures to meet their own targets, their message about the importance of limiting the growth of public debt has remained one of few constants throughout the turmoil of recent British political history.

The resignation of David Cameron following the Brexit referendum of 2016 began a tumultuous sequence which saw another four Conservative prime ministers in eight years: May, Johnson, Truss, and Sunak. Though Johnson moved to raise public investment and ease austerity in late 2019, these changes were overwhelmed in mere months by the onset of the pandemic and the massive fiscal support that it triggered. Debt surged again, now exceeding 90 percent of GDP. In the first budget of Truss’s premiership, with the post-pandemic public-sector deficit still in excess of 5 percent, and with inflation running at 10 percent, Chancellor Kwasi Kwarteng announced tax cuts worth around £45 billion alongside promises of more to come. As government debt markets briefly panicked, Labour took a leaf out of Osborne’s book and turned the tables on the Conservatives: Starmer’s team led with the inaccurate but effective claim that Truss had “crashed the economy.”

How serious is renewal?

Starmer’s Labour Party took power committed to an impossible policy offer. Pre-election pledges ruled out increased taxes on “working people”—widely interpreted to mean not only income tax, but also national insurance and VAT—as well as increases in corporation tax. This placed around 75 percent of the tax base out of reach. Labour retained fiscal rules inherited from the previous administration, including a commitment to ensure falling debt-to-GDP on a rolling five-year basis. Despite apparently ruling out increases in either taxes or borrowing, Labour were somehow adamant that there would be no return to austerity in the form of spending cuts.

Reeves squared the circle with a flexible approach to definitions. Firstly, she argued that employers’ national insurance is a tax on corporations not on workers. This is technically true, but it does not obviate the problems that will be caused by leaning so heavily on this tax. A better option would have been to break an election pledge and reverse the £20 billion cut to employee national insurance implemented in the final Conservative budget. Secondly, Reeves adjusted the definition of public debt by netting off some financial assets, allowing her to spend tens of billions more on investment without breaching the letter of the fiscal rule. Public investment will now remain constant at around 2.5 percent of GDP, rather than declining steadily over the parliament as was the case in the plans Reeves inherited.

Arresting the decline in public investment is essential to any economic renewal: a return to sustained growth in wages and productivity will be impossible without rebuilding public infrastructure. In isolation, however, public investment will not be sufficient. In that sense, the emerging consensus that higher public investment is the key to growth comes with the risk that this commitment will become an end in itself—as the destination rather than the starting point for public policy.

One constituency of progressive thought sees persistent demand weakness as the root cause of the UK’s malaise. In this view, higher public investment and expansionary fiscal policy will return the UK to growth via demand-side stimulus. The experience of the US in the wake of Biden’s fiscal largesse provides some support: alongside measures of demand strength such as employment figures, the US has also seen a recovery in productivity. Another justification for public investment, emphasized by more mainstream economists, is that it will unlock growth via longer-run supply-side effects. While both mechanisms—short-run demand stimulus and longer-run supply response—provide important justifications for higher public investment, there are risks associated with each: demand stimulus risks inflationary pressure while the delayed gratification of a supply response may come too late for a weary electorate.

In the case of demand stimulus, it is difficult to gauge how much supply-side slack remains. Headline unemployment is around 4 percent, a rate not seen since the early 1980s. Inactivity due to poor health has risen since the pandemic. How much can the government increase spending without inflationary pressure emerging? The unknowns are significant. The systematic dismantling of organized labor and the “flexible” UK labor market have ostensibly left workers with diminished bargaining power. Yet during the upheaval of the post-pandemic period, substantial pay rises were awarded in some sectors. If renewed inflation, driven by geopolitical events or climate-driven disruption, interacts with tight labor markets to induce wage and price pressure, Labour’s plans will be derailed.

Trump’s victory increases this risk. A consensus is forming, perhaps prematurely, that inflation was the decisive factor in handing Trump a second term. Fear that inflation (and its potential electoral consequences) could be triggered by Biden-style investment projects could lead to the scaling back of public investment plans. This would be foolhardy. Nonetheless, Labour faces a difficult balancing act, not on account of the largely illusory threat of bond vigilantes—the much trailed post-election bond market rout failed to materialize—but because of the difficulties in calibrating macroeconomic policy in the presence of low unemployment and ongoing inflation risks.

This problem will be exacerbated by Trump’s policies: tariffs, deficits from top-end tax cuts, and deportations will lower global growth and raise inflation and interest rates. Prior to Trump’s re-election, the OBR predicted the autumn budget would do little to raise growth, forecasting average real GDP growth rates of little over 1.5 percent annually. Even if, as some critics allege, the OBR has underestimated the effects of higher investment, this is well below the 2.5 percent target that Starmer unwisely selected as a headline policy. These forecasts are now more likely to be revised downwards than upwards. Trump’s election also raises the pressure for increased European defense spending. Lower growth alongside higher defense spending means that even loosened fiscal rules are likely to be breached.

Safeguarding against inflation

What should be done if inflationary pressure does emerge? The conventional answer is that the central bank should raise interest rates. The case for the superiority of monetary policy for managing demand was never compelling, but in a world in which inflation is increasingly driven by supply shocks it looks ever less so. High interest rates will constrain investment spending, particularly climate investment characterized by high upfront costs and a long payback period, as well as squeezing working families with mortgages.

A range of fiscal demand-constraint policies are available, including the use of taxation and household saving incentives. How should these be structured? The progressive answer is that additional revenue should be generated by increasing the contributions of the most well off. However, the structure of tax in the UK is already highly progressive: the top 10 percent by income already provide over half of tax revenues. Thus, while the share of tax in national income is at a historically high level of around 36 percent of GDP, the effective personal tax rate for the average earner is at its lowest since 1975. Further tax increases on average earners will be increasingly hard to avoid if the intention is to raise growth and avoid inflation while sustaining tight labor markets.

Another possibility, perennially popular among progressives, is that wealth could be taxed. But wealth taxes will do little to constrain demand: their effect is to adjust the relative balance sheet positions of the public and private sectors, as well as the distribution of wealth within the private sector. While wealth taxation could assist in countering the trend towards plutocracy and in fending off the bond vigilantes, its effectiveness as an inflation fighting tool is limited.

This brings us to the issue of distribution. The UK’s stagnation is not simply the result of weak demand and low investment but also reflects deeper structural problems. The UK is one of the most geographically unequal countries in Europe. High income inequality, rising rentier incomes, and growing wealth concentration act as a drag on dynamism and growth. Debates about the details of Labour’s approach to economic policy—whether we get ten or twenty billion pounds of new investment, whether income tax bands adjust with inflation—currently ignore these underlying problems.

Questions about the economy’s structure and the broader social contract that underpins it will be central to any serious program to accelerate and sustain British economic growth, or to any program enlightened enough to look beyond growth as a policy target. From this perspective, ambitious design of Britain’s economic policy should go beyond the technicalities of managing the public finances or maintaining stable inflation. Instead, it becomes a question of which groups face challenges to their wealth, power, and influence. Whose income and consumption will be restrained in order to free up resources for higher investment? Is Labour genuinely committed to rethinking the economic model that has held sway for the last forty years, or will it be more of the same but with somewhat higher taxes and spending?

Perhaps the biggest problem for Labour lies in the fact there are no easy short-run solutions. National renewal takes time: the legacy of the last fourteen years will not be overcome in a single parliamentary term. With a restive electorate and a hostile media, it is not clear whether Labour will be allowed the time it deserves. If it is to win a second term, Labour needs a narrative about how it is improving peoples’ lives. Beyond a misguided freeze in fuel duty, there is little in Labour’s budget that can be sold as offering immediate relief from the cost of living crisis. Indeed it is hard to think what could be done, at least without more radical redistribution policies. Yet without such a narrative, Reeves’ efforts are likely to be in vain.