Autumn and Spring Budget Letters: fiscal rules and resisting austerity

Mar 27, 2025

Yesterday the UK’s Chancellor of the Exchequer, Rachel Reeves, delivered her Spring Statement to Parliament, signaling a government that is currently stuck between a rock and a hard place. This is partly of the Government’s own making. With such tight fiscal rules, and a refusal to increase taxes, there is an ongoing debate about the degree to which cuts are needed for the government to stick to those rules. In the Autumn, alongside other economists, I argued that for the government to be able to adopt an investment-led strategy, it needed to change those rules. And in another letter to the FT last week, we argued that cuts were not the way to foster growth. These issues are two sides of the same coin. Especially in a country whose real problem is not over-spending but under-investing.

It is key for governments to not be stuck reactively responding to fiscal pressures, but rather begin with a clear vision of what is required to foster a prosperous future. As I argued in my recent post “Beyond Purpose-Washing: making public-private partnerships work,” governments need to move beyond crisis management to actively shape markets around collective goals, while creating and protecting public value through well-designed partnerships. Without such direction, the state becomes a lifeless vehicle for managed decline, with spending cuts becoming an end in themselves rather than part of a fiscal policy agenda that is building a more innovative, sustainable economy. Whilst some cuts are necessary, blanket cuts with no clear purpose other than reducing spending in line with self-imposed fiscal rules, will not get the country back on its feet. Both cuts and spending need to be outcomes-oriented and aligned with government priorities, rather than short-term responses to exogenous economic and political factors.

The announcement of a £3.25bn 'Transformation Fund' alongside 15% cuts to the UK civil service over the next 10 years reflects a concerning trans-Atlantic tendency that has dominated economic thinking for more than 50 years – where rethinking the state inevitably means shrinking the size of the state. While investing in digital technology and AI for public services could improve efficiency, without sufficient attention to maintaining core state capabilities, these investments risk becoming hollow. In the US, we see the mentality of the newly formed Department of Government Efficiency (DOGE)–an approach mimicking Argentinian President Javier Milei's chainsaw-tactics. While in the UK, successive governments have pursued civil service reductions under the banned of bureaucratic 'efficiency'.

As I’ve explored in the “The Big Con: how the consulting industry weakens our businesses, infantilizes our governments and warps our economies,” this approach has led to the hollowing out of state capacity and an over-reliance on external consultants, undermining the government’s ability to implement complex policies, deliver public services, and manage long-term investments effectively. State capacity is not a luxury but a vital pre-requisite for an effective government capable of delivering on its priorities. The planned civil service cuts will further erode this capacity precisely when it is most needed to address the UK’s significant challenges.

Rather than cutting state capacity, welfare and public service administration, the UK should be redesigning its fiscal framework to accommodate strategic investment in infrastructure, climate resilience, and public services that build long-term economic stability. This requires shifting from a mindset which asks, “what can we afford to spend?” to “what does Britain need to thrive in the 21^st century, and what are the structures, financing and tools that we need to achieve that vision?”

While I was happy that the new government developed their own 5 missions, borrowing from the mission-oriented framework for government that I developed over last 7 years (beginning with the report for the European Commission, “Mission-oriented research & innovation in the European Union,” which has informed their Horizon Europe programme) and wrote about in my book “Mission Economy: a moonshot guide to changing capitalism,” its success depends critically on how these missions are designed and implemented. As I argued in an article in the New Statesman before the election, missions, done well, should transform broad challenges into concrete goals that require cross-sectoral collaboration and investment. However, treating "growth" itself as a mission rather than an outcome of that investment, represents a fundamental misunderstanding of the approach. Growth should be seen as the result of well-executed missions that catalyze investment and innovation across the economy - especially in a low investment economy like that of the UK. If fiscal rules unnecessarily constrain public investment, it becomes much harder to crowd in private capital toward shared goals. The challenge is not simply to be "business-friendly" but to forge purposeful partnerships oriented around shared risk and shared reward, with clear conditionalities attached to public funding to ensure equitable outcomes. Without sufficient state capacity and cross-governmental coordination, even the best-designed missions will struggle to achieve their potential.

The UK faces a big challenge in terms of underinvestment. The public and private sectors have historically underinvested in the UK. UK public investment has averaged 2.6% of GDP over the last 25 years vs. the G7 average of 3.5% and OECD average of 3.7%. Had the UK invested the same as the OECD average over the past two decades the government would have invested £500 billion more in the UK economy. Business investment is lower in the UK than any other country in the G7. This underinvestment has dire consequences for growth and productivity. Beyond low investment, the UK also is an overly financialised economy, meaning that capital doesn’t flow effectively in the real economy. Share buybacks have become the norm for big business in the UK, furnishing the pockets of shareholders without expanding the productive capacity of the UK. In 2023, FTSE 100 firms returned £137.2 billion to shareholders through ordinary dividends, special dividends and share buybacks – a tiny fraction below 2022’s all-time high of £137.6 billion.

While the Labour government announced its Autumn Budget with plans to “invest, invest, invest,” increasing public investment to 2.6% of GDP, this still falls well below international peers - and only just matches the average levels of public investment over the last 25 years. Chancellor Reeves’ changes to the UK’s fiscal rules last year were a welcome first step to addressing these issues, however it did not go far enough. Switching from public sector net debt (PSND) to public sector net financial liabilities (PSNFL) — represents a small step in the right direction, but these metrics still create a short-term bias, with investments valued on 5-year horizon.

While the Labour government announced its Autumn Budget with plans to "invest, invest, invest," increasing public investment to 2.6% of GDP, this still falls well below international peers - and only just matches the average levels of public investment over the last 25 years. The Spring Statement looks to have confirmed this investment level while the OBR has halved its growth forecast for 2025 from 2% to 1%, highlighting how insufficient investment continues to constrain economic potential.

Chancellor Reeves' changes to the fiscal rules last year were a welcome first step to addressing these issues, however it did not go far enough. Switching from public sector net debt (PSND) to public sector net financial liabilities (PSNFL) — represents a small step in the right direction, but these metrics still create a short-term bias, with investments valued on 5-year horizon.Public sector net wealth (PSNW) would be a more robust metric than PSNFL, factoring in long-run returns on public investment.

Across the continent, Germany’s approach to the current moment offers a stark contrast, having recently announced plans for a €500 billion infrastructure fund and overhauled borrowing rules to significantly increase defense spending. The UK could have followed Germany's example by redesigning its fiscal rules to accommodate strategic investment in infrastructure, energy transition, and public services that build long-term economic resilience. And with the worsening geo-political environment, the key question is how to make sure investment happens not only in military areas but in areas that can drive a new direction for growth: inclusive, sustainable and innovation-driven. Indeed, this was the core message we put forwards in the Group of Experts to the Task Force for the Global Mobilization Against Climate Change for the Brazilian G20, which I co-chaired alongside Vera Songwe last year. As part of that group, our final report, “A Green and Just Planet,” putting forth key ideas on how to drive green growth—a topic I am working on again this year with the South African G20 process (the subject of my next Substack).

To tackle the economic challenges faced by the UK, we need to rethink the purpose of a government's budget and the role of the state. The state's role is not merely to correct market failures, but to actively shape markets around grand challenges, like navigating the green transition, and improving people's everyday lives. The Spring Statement revealed a significant allocation of resources toward defense as a centerpiece of industrial strategy, with £2.2bn in additional funding and a commitment to make the UK a "defense-industrial superpower." This narrow focus raises important questions about why similar resources aren't being directed toward equally pressing social and ecological challenges that could generate broader, more sustainable growth opportunities. We're seeing a concerning prioritization of ‘warfare’ over ‘welfare’, despite evidence that investments in other areas particularly green infrastructure offer substantial economic returns while addressing critical societal needs.

Rather than cutting without direction or purpose, the government should be asking: what do we want to accomplish, and what capacities do we need to achieve those goals? The Spring Statement's emphasis on defense as a centerpiece of industrial strategy raises important questions about priorities—why similar ambition and resources aren't being directed toward equally pressing social and ecological challenges that could generate broader, more sustainable growth opportunities. A truly mission-oriented approach would apply the same level of strategic thinking and investment seen in defense to areas like clean energy infrastructure, sustainable housing, and public health systems that offer substantial economic returns while addressing critical societal needs. This requires developing the right ecosystem of tools and institutions–such as the National Wealth Fund, flexible fiscal rules, strategic procurement, and a dynamic capable civil service–to ensure that the state is equipped to meet these challenges on both the demand and supply sides.

The evidence is clear: we cannot cut our way to growth. There's a clear economic case for investment. The OBR estimates that increasing public investment by 1% of GDP annually would raise economic output by 2.5% over a 50-year period, generating returns of 1.7% for government and 8.7% for the wider economy over a decade—far exceeding the costs of borrowing to invest. Achieving growth will require rebuilding public services, investing in skills, R&D and the strategic, climate-safe industries of the future; and boosting demand by strengthening the social safety net.

The challenge of national renewal requires both rebuilding deteriorating public services while also investing in the clean energy infrastructure needed to meet our climate targets and create a more resilient economy. The commitment of £13bn in additional infrastructure investment and £2bn for social housing, alongside planning reforms intended to enable building 1.3 million new homes during this parliament, represents positive steps. However, without a clear connection to decarbonization goals, these investments risk locking in carbon-intensive development patterns. As I argued in my Substack, "Making the Just Transition Just," this transformation cannot be achieved by the private sector alone–it demands a step change in the levels of public investment – as well as a new social contract with labor at its center.

The Spring Statement could have been another opportunity for this new Government to signal it's intent for Britain's economic future. Notably absent was any substantial commitment to green growth or the industrial strategy needed to direct growth toward solving our climate challenges. This omission is particularly concerning given the UK's climate commitments and the economic opportunities that a genuine green transition would create. This is not simply a matter of rejecting the government's fiscal rules, but rather recognizing that while the current framework represents an improvement over the previous short-termist approach, it still places unnecessary constraints on the government's ability to expand productive capacity of the UK and address it's core challenge of underinvestment.

What Britain needs now is economic leadership with a clear strategic vision. The challenge now is to start with a clear vision of what society needs – robust public services, green infrastructure, a healthy population – and then develop the fiscal frameworks, tools, and institutional capacities, to deliver on that vision. This means employing the full range of policy tools available, from strategic procurement to mission-aligned industrial strategy, while investing in rebuilding state capacity rather than dismantling it. Only through this more ambitious, forward-looking approach can Britain achieve the economic renewal it so desperately needs.

Autumn and Spring Budget Letters: fiscal rules and resisting austerity

Further reading:

Discussion about this post