The government’s economic policies are under close scrutiny as the economy falters and bond market vultures gather. Clearly, things are not quite going to plan. The apparent stability offered by Labour that many investors and businesses clamoured for after years of drama under the Conservatives has not materialised.
But strip away the noise, and allowing for some unfortunate early missteps, the fact remains that the government has a plan to grow and decarbonise the economy and it will be a tragedy if it allows itself to be blown off course.
The plan is based on a simple, but widely held, diagnosis that we don’t invest enough and that this needs to change if we are to have a successful, modern and green economy. The real question is to do with how much conviction the government is following through on this analysis, and whether it will deliver results in time for it to be re-elected and avoid the fate of US president Joe Biden, whose programme of green spending is set to produce jobs and green growth just in time to benefit the climate sceptic Donald Trump.
More public investment in the past would have given us growth
Labour blames chronically low investment for the UK’s dismal productivity performance over the last two decades. Had we managed even OECD average levels of public investment over the past 20 years (around 3.7 per cent of GDP a year, 50 per cent higher than the UK), we would have invested around £500 billion more (in 2022 prices). Investing more to tackle our crumbling infrastructure, decarbonise power generation and modernise the transport system requires spending more upfront. But the payoff will be stronger and greener longer term growth.
The government has sometimes been hesitant about reversing this investment drought. In the months before last year’s election it gutted its Green Prosperity Plan for £28 billion of annual investment, as it judged this to be incompatible with its fiscal rules. Chancellor Rachel Reeves also announced public sector pay increases alongside initial cuts to capital investment.
Although the October 2024 budget reversed course with a large cash increase in spending on infrastructure, this still barely maintains the level of capital spending as a share of GDP. A post-budget spike in gilt yields reflected market nervousness over whether this will lift trend GDP. Recent bad news on growth and inflation has seen these jitters re-emerge.
Investment advocates hope changes made last year to how the Office for Budget Responsibility (OBR) appraises the growth impact of extra investment could allow for more to be spent within the fiscal rules.
The government needs a stronger line on green investment
Labour needs to decide what it thinks about green investment. Is it purely to deliver net zero, or growth as well? Advocates of ‘investing your way to growth’ face entrenched scepticism within economics, including the Treasury.
Some historical studies suggest that only an eighth of the increase in US GDP per worker in the first half of the 20th century was due to increased capital investment. On this basis, given the enormous size of the UK’s capital stock – estimated by the ONS at £3.5 trillion – it would take a lot of capital spending to achieve even a minor increase in growth. Investment also diverts money from consumption, which can run up against the preferences of individuals and firms and may have a negative short term impact on growth.
But this may be overplaying the problem and ignoring the context. First, the effect of investment on growth is compounded over time, so it pays to start early, and any large impact takes time to occur. But it does occur.
If, for example, the UK had achieved that £500 billion investment, our analysis suggests we could have built over 150GW of offshore wind, along with the interconnectors necessary for electricity export to the EU. By 2030, accounting for the expected electrification of heat and transport, this would be enough to return the UK to being a net energy exporter, supplying a sixth of the EU’s total electricity demand. Put another way, the UK would, by then, be exporting more power than either France or Germany consumes, making electricity a large export earner for the UK.
Second, investment sceptics take an overly static view of the economy that ignores key spillovers and underplays the dynamism of the technological and environmental transformations underway. Many green industries are new and embody a lot of emerging technologies. Investing in these provides learning opportunities that are greater than from the established technologies they replace.
Renewable energy investment is wasted without supportive reforms
The growth effect does not, therefore, come only from the investment itself but also from improving productivity. This is reflected in the sharply falling costs of renewables and plunging estimates of the annualised resource costs of getting to net zero.
Still, the government needs to be selective about where it invests if it wants growth as well as decarbonisation. More renewable energy generating capacity will be wasted in the absence of improvements to the grid. Other reforms are needed as well, particularly on planning.
It would help to foster more urgency around the green investment case if the Treasury, OBR and Climate Change Committee could co-ordinate more about what investment is needed, whether it can be accommodated by the fiscal rules and its wider economic impact.
Raising growth is hard. More green capital spending will be difficult and is no panacea. But the government is right to try.
A version of this piece was first published in Renewal: The Labour Party’s climate strategy in government.
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