Budget 2024: How fiscal rules are impeding long-term investments – and what Rachel Reeves can do about it

Published

1 year ago

October 6, 2024

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Before we get onto the budget and what Rachel Reeves might do to fiddle her fiscal rules and give herself a little more room to spend, I want you to ponder, for a moment, a recent report from the Office for Budget Responsibility (OBR).

This wasn’t one of those big OBR reports that get lots of attention – such as the documents and numbers it produces alongside each budget, full of the forecasts and analyses on the state of the economy and the public finances.

Instead, it was a chin-scratchy working paper that asked the question: if the government invests in something – say, a road or a railway, or a new school building – how long does it generally take for that investment to come good?

The answer, according to the report, was: actually quite a long time. Imagine the government spends a chunk of money – 1% of national income – on investment this year. In five years’ time that investment will only have created 0.4 per cent of GDP. In other words, in net terms, it’s costed us 0.6% of GDP.

But, and this is the important thing, look a little further off. A high-speed rail network is designed to last decades, and as those decades go on, it gradually improves people’s lives – think of the time saved by each commuter each day – small amounts each day, but they gradually mount up. So while the investment costs money in the short run, in the longer run, the benefits gradually mount.

The OBR’s calculation was that while a 1% of GDP public investment would only deliver 0.4% of GDP in five years, by the time 10 or 12 years had passed, the investment would be responsible for approaching 1% of GDP. In other words, it would have broken even. The money put in at the start would be fully earned back in benefits.

And by the time that investment was 50 years old, it would have delivered a whopping 2.5% of GDP in economic benefits. Future generations would benefit enormously – or so said the OBR’s sums.

Having laid that out, I want you now to ponder the fiscal rules Rachel Reeves is confronted with at this, her first budget. Most pressingly, ponder the so-called debt rule, which insists that the chancellor must have the national debt – well, technically it’s “public sector net debt excluding Bank of England interventions” – falling within five years.

There is, it’s worth underlining at this point, nothing fundamental about this rule. Reeves inherited it from the Conservative Party, who only dreamed it up a few years ago, after COVID. Back before then, there have been countless rules that were supposed to prevent the national debt falling and, frankly, rarely ever succeeded.

But since Reeves wanted everyone to know, ahead of the election, just how serious Labour was about managing the public finances, she decided she would keep those Tory rules. One can understand the politics of this; the economics, less so – then again, I confess I’ve always been a bit sceptical about all these rules.

The upshot is, to meet this rule, she needs the national debt to be falling between the fourth and fifth year of the OBR’s five-year forecast. And according to the last OBR forecasts, which date back to Jeremy Hunt‘s last budget, it is. But not by much: only by £8.9bn. If that number rings a bell, it is because this is the much-vaunted, but not much understood, “headroom” figure a lot of people in Westminster like to drone on about.

And – if you’re taking these rules very literally, which everyone in Westminster seems to be doing – then the takeaway is that the chancellor really doesn’t have much room left to spend in the coming budget. She only has £8.9bn extra leeway to borrow!

Every spending decision – whether on investment, on the NHS, on benefits or indeed on anything else, happens in the shadow of this terrifying £8.9bn headroom figure. And since the chancellor has already explained, in her “black hole” event earlier this year, that the Conservatives promised a lot of extra spending they hadn’t budgeted for – not, perhaps, the entire £22bn figure she likes to cite but still a fair chunk – then it stands to reason there’s really “no money left”.

Or is there? So far we’ve been taking the fiscal rules quite literally but at this stage it’s worth asking the question: why? First off, there’s nothing gospel about these rules. There’s no tablet of stone that says the national debt needs to be falling in five years’ time.

Second, remember what we learned from that OBR paper. Sometimes investments in things can actually generate more money than they cost. Yet fixating on a debt rule means the money you borrow to fund those investments is always counted as a negative – not a positive. And since the debt rule only looks five years into the future, you only ever see the cost and not the breakeven point.

Third, the debt rule used by this government actually focuses on a measure of the national debt which might not necessarily be the right one. That might sound odd until you realise there are actually quite a few different ways of expressing the scale of UK national debt.

The measure we currently use excludes the Bank of England, which seemed, a few years ago, to be a sensible thing to do. The Bank has been engaged in a policy called quantitative easing which involves buying and selling lots of government debt – which distorts the national debt. Perhaps it’s best to exclude it.

Except that recently those Bank of England interventions have actually been serving to drive up losses for the state. I won’t go into it in depth here for risk of causing a headache, but the upshot is most economists think focusing on a debt measure which is mostly being affected right now not by government decisions but by the central bank reversing a monetary policy exercise seems pretty perverse.

In other words, there’s a very strong argument that instead of focusing on the ex-BoE measure of net debt, the fiscal rules should instead be focusing on the overall measure of net debt. And here’s the thing: when you look at that measure of net debt, lo and behold it’s falling more between year four and five. In other words, there’s considerably more headroom: just under £25bn rather than just under £9bn based on that other Bank-excluding measure of debt.

Might Reeves declare, at the budget or in the run-up, that it makes far more sense to focus on overall PSND from now on? Quite plausibly. And while in one respect it’s a fiddle, in her defence it’s a fiddle from one silly rule to an ever so slightly less silly rule.

It would also mean she has more room to borrow to invest – if that’s what she chooses to do. But it doesn’t resolve the deeper issue: that both of these measures fixate on the short-term cost of debt without taking into account the long-term benefits of investment – back to that OBR paper.

If Reeves is determined to stick to the, some would say arbitrary, five-year deadline to get debt falling but wants to incorporate some measure of the benefits of investment, she could always choose one of two other measures for this rule.

She could focus on something called “public sector net financial liabilities” or “public sector net worth”. Both of these measures include some of the assets owned by the state as well as its debts – the upshot being that hopefully they reflect a little more of the benefits of investing more money.

The problem with these measures is they are subject to quite a lot of revision when, say, accountants change their opinion about the value of the national road or rail network. So some would argue these measures are prone to more volatility and fiddling than simple net debt.

Even so, these measures would dramatically transform the “headroom” picture. All of a sudden, Reeves would have over £60bn of headroom to play with. More than enough to splurge on loads of investments without breaking her fiscal rule.

There’s one other change to the rule that would probably make more sense than any of the above: changing that five-year deadline to a 10 or even 15-year deadline. At that kind of horizon, a pound spent on a decent investment would suddenly look net positive for the economy rather than a drain.

Whether Reeves wants to do any of the above depends, ultimately, on how she wants to begin her term in office. Does she want to establish herself as a tough, fiscally conservative Chancellor – with a view, perhaps, to relaxing in later years? Or does she feel it’s more important to begin investing early, so some of the potential benefits might be obvious within a decade or so?

Really, there’s nothing in the economics to stop her choosing either path. Certainly not a set of fiscal rules which are riddled with flaws.

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Trump’s upbeat opinion of his meeting with Xi brushes over thornier issues

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1 hour ago

October 30, 2025

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Trump's upbeat opinion of his meeting with Xi brushes over thornier issues

For all the brinkmanship, for all the high stakes and attempts to wield maximum leverage, in the end, there was clear recognition from both the US and China that a degree of stabilisation was necessary.

The fact that some progress has been made on a relatively wide range of issues speaks to that.

But there are real questions about how deep that progress runs and how easily, in the hands of two leaders who staked both their reputations on being strong and unyielding, it could all come crashing down.

Follow the latest: Trump teases ‘large-scale’ energy deal

From the very outset, the differences in style could not have been more stark.

As the two posed for the introductory handshake, Donald Trump moved quickly to dominate the space – leaning in, doing all the talking, even quipping to the gathered reporters that Xi Jinping is “a very strong negotiator, and that isn’t good”.

That didn’t raise as much as an eyebrow from the Chinese leader.

Xi doesn’t like or respond well to unscripted moments; Trump, on the other hand, lives for them.

It might seem like a relatively inconsequential detail, but it speaks to how difficult it has been for two such opposing systems to see eye to eye, and how many stumbling blocks remained.

But it seems today, at least some of that was overcome.

Indeed, there appears to have been an agreement on key issues such as the movement of rare earth minerals, the purchase of soybeans, the reduction of tariffs and the crackdown on the trade of fentanyl and the chemicals used to make it.

There was further consensus to keep talking about the sale of high-end US chips and to work together to try to end the war in Ukraine.

None of this is insignificant, but Trump’s assessment of it all as a “12 out of 10” likely brushes over many much thornier issues.

The reality is that there is still a great gulf between them; there are many more barriers to trade than there were at the start of the year, there are still a raft of deep political and structural issues that divide them and the levels of distrust the trade war has left will take more than just one meeting to fix.

Disagreements, such as the future status of Taiwan, for example, weren’t even mentioned today.

There also doesn’t appear to be any guarantees baked in, and thus, there is nothing to prevent either party from reneging on what has been agreed and ramping pressure back up as soon as another issue arises.

And, given the characters involved, that feels all too likely.

Indeed, both sides, for different reasons, have found political advantage in the “maximum pressure” style brinkmanship we’ve seen in recent months.

Xi in particular cannot now be seen to cave in to Trump’s pressure and, economically at least, China doesn’t need to.

There was an agreement today that the two would meet again in the early part of next year; Trump plans to visit China in April.

This at least offers more diplomatic opportunity, but it would perhaps be naive to assume it will all be plain sailing until then.

Business

Donald Trump says tariffs will be cut after ‘amazing’ meeting with Xi Jinping

Published

12 hours ago

October 30, 2025

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Donald Trump says tariffs will be cut after 'amazing' meeting with Xi Jinping

Donald Trump has described crucial trade talks with Chinese President Xi Jinping as “amazing” – and says he will visit Beijing in April.

The leaders of the world’s two biggest economies met in South Korea as they tried to defuse growing tensions – with both countries imposing aggressive tariffs on exports since the president’s second term began.

Catch up on Trump-Xi meeting

Aboard Air Force One, Mr Trump confirmed tariffs on Chinese goods exported to the US will be reduced, which could prove much-needed relief to consumers.

It was also agreed that Beijing will work “hard” to stop fentanyl flowing into the US.

Semiconductor chips were another issue raised during their 100-minute meeting, but the president admitted certain issues weren’t discussed.

“On a scale of one to 10, the meeting with Xi was 12,” he told reporters en route back to the US.

Xi a ‘tough negotiator’, says Trump

The talks conclude a whirlwind visit across Asia – with Mr Trump saying he was “too busy” to see Kim Jong Un.

However, the president said he would be willing to fly back to see the North Korean leader, with a view to discussing denuclearisation.

Mr Trump had predicted negotiations with his Chinese counterpart would last for three or four hours – but their meeting ended in less than two.

The pair shook hands before the summit, with the US president quipping: “He’s a tough negotiator – and that’s not good!”

It marks the first face-to-face meeting between both men since 2019 – back in Mr Trump’s first term.

There were signs that Beijing had extended an olive branch to Washington ahead of the talks, with confirmation China will start buying US soybeans again.

American farmers have been feeling the pinch since China stopped making purchases earlier this year – not least because the country was their biggest overseas market.

Chinese stocks reached a 10-year high early on Thursday as investors digested their meeting, with the yuan rallying to a one-year high against the US dollar.

Analysis: A fascinating power play

Sky News Asia correspondent Helen-Ann Smith – who is in Busan where the talks took place – said it was fascinating to see the power play between both world leaders.

She said: “Trump moved quickly to dominate the space – leaning in, doing all the talking, even responding very briefly to a few thrown questions.

“That didn’t draw so much as an eyebrow raise from his counterpart, who was totally inscrutable. Xi does not like or respond well to unscripted moments, Trump lives for them.”

On Truth Social, Mr Trump had described the summit as a gathering of the “G2” – a nod to America and China’s status as the world’s two biggest economies.

While en route to see President Xi, he also revealed that the US “Department of War” has now been ordered to start testing nuclear weapons for the first time since 1992.

Business

Microsoft, Alphabet and Meta results overshadowed by growing fears of AI bubble

Published

13 hours ago

October 30, 2025

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Microsoft, Alphabet and Meta results overshadowed by growing fears of AI bubble

Some of the world’s biggest tech giants reported quarterly earnings on Wednesday – with a mixed bag of results as fears grow that a bubble is forming in artificial intelligence.

Microsoft revealed that its spending on AI infrastructure hit almost $35bn (£26.5bn) in the three months to the end of September, a sharp rise compared with the year before.

Despite revenue jumping 18% and net income rising 12%, shares plunged by close to 4% in after-hours trading, with investors concerned about the mounting costs of sustaining the boom.

Microsoft’s vice president of investor relations Jonathan Neilson said: “We continue to see demand which exceeds the capacity we have available.

“Our capital expenditure strategy remains unchanged in that we build against the demand signal we’re seeing.”

Big Tech is facing increasing pressure to show returns on the massive AI investments they’re making, against a backdrop of soaring valuations and limited evidence of productivity gains.

Microsoft became the world’s second most valuable company this week thanks to its 27% stake in OpenAI, the creator of ChatGPT.

Its market capitalisation surged beyond $4trn (£3trn) at one point, but that psychologically significant threshold is now in doubt because of recent selloffs.

Alphabet makes history

Last night’s results weren’t all doom and gloom – with shares in Google’s parent company surging by 6% in after-hours trading.

Alphabet has also set out aggressive spending ambitions, but placated investors thanks to an impressive set of results that surpassed analysts’ expectations.

Total revenue for the quarter stood at a staggering $102.35bn (£77bn), with the search giant’s advertising unit remaining robust despite growing competition.

But concerns linger that Alphabet’s dominance in search could be undermined by AI startups, with OpenAI recently unveiling a browser designed to rival Google Chrome.

Hargreaves Lansdown’s senior equity analyst Matt Britzman shrugged off this threat – and believes the company is “gearing up for long-term AI leadership”.

He said: “Alphabet just delivered its first-ever $100bn quarter, silencing the doubters with standout performances in both Search and Cloud.

“AI Overviews and AI Mode are clearly resonating with users, helping to ease fears that Google’s core search business is under threat from generative AI.

“With ChatGPT’s recent browser demo falling short of a game-changer, Google looks well-placed to put up a strong defence as gatekeeper to the internet.”

Meta faces a mauling

Meta – the parent company of Facebook, Instagram, and WhatsApp – saw its shares tumble by as much as 10% in after-hours trading.

Mark Zuckerberg’s tech empire anticipates “notably larger” capital expenses next year as it ramps up investments in AI and goes on a hiring spree for top talent.

Net income in the third quarter stood at $2.7bn (£2bn) and suffered an eye-watering $16bn (£12bn) hit because of Donald Trump’s “Big Beautiful Bill”.

Meta was late to the party on AI but has now doubled down on this still-nascent technology – setting an ambition to achieve superintelligence, a milestone where machines could theoretically outthink humans.

The social networking giant continues to benefit from its massive user base, and expects fourth-quarter revenues of up to $59bn (£44bn).