Rachel Reeves’ as the UK chancellor highlighted the financial constraints the new Labour government faces. With taxes already at a in relation to national income, she repeated the pledge of no increases in national insurance, income tax or VAT.
Author
Alan Shipman
Senior Lecturer in Economics, The Open University
A parallel pledge to stand by present , requiring public debt to be falling within five years, leaves Reeves looking for ways to .
The government also aims to expand its non-tax revenues by rebuilding a stock of state-owned assets, including a and a new green electricity provider, .
Labour’s approach is to treat public spending as a catalyst for private enterprise – providing the infrastructure, skills and technological development that can spur the private sector to produce and invest more. Its industrial strategy is founded on the idea that £1 of public investment, wisely targeted, can attract .
This is in line with economic research suggesting that chronically low public investment explains much of the UK’s relatively , and that public investment in green technology would be especially at reviving these.
For the past 50 years, governments of all parties have tended to take the opposite approach – associating public investment with economic stagnation, and anticipating stronger private-sector performance once state-owned assets were privatised.
Labour’s change of course concedes that the UK’s financial markets, even when deregulated and encouraged to expand, have failed to mobilise the necessary investment – leaving wide for smaller innovation-based firms, especially in disadvantaged regions.
Labour has good reasons to be firmer with financial institutions. Its loss of office in 2010 followed a global financial crisis triggered by , whose at the public expense undermined the government’s previously successful and public debt repayment.
The need to absorb these losses from the City of London, then let it keep the subsequent return to profit, forced the Treasury into a decade of that left it financially overstretched when COVID struck.
Yet Labour’s pre-election hailed the UK financial sector as an “engine of growth”, describing it as “one of Britain’s greatest success stories” and promising to assist its growth and innovation. It’s a far cry from the half a century ago, when it flirted with a state takeover of banks and pension funds as the solution to a previous decade of stagnation.
Finance’s peculiar pedestal
Governments’ fear of imposing more tax or regulation on the City of London, even after its costly 2007-8 implosion, is rooted in the financial sector’s extraordinary contribution to the UK economy.
Finance and related professional services contribute more than 8% of gross domestic product (GDP) and 10% of tax revenue, and support 2.2 million jobs (7% of the total), according to of official data by its main lobby group.
Its contrasts with, and helps to offset, the on manufactured goods trade. And the financial surplus it generates, by attracting inflows of money from across the globe, is vital for financing the on the UK’s current account, caused by paying out more than it receives for current transactions with the rest of the world.
But this may not be the whole story of finance’s contribution to the national income and government finances. In the wake of the financial crisis, experts including the Bank of England’s and suggested the financial sector’s appetite for risky lending and short-term profit could hinder productive enterprise as much as it helps.
They also recognised that conventional measurements, especially treating the gap between lenders’ and borrowers’ interest rates as , might greatly overstate the sector’s contribution to the economy.
In doing so, they joined a long line of researchers arguing that the City diverts funds from productive investment into speculation that promotes asset bubbles and house-price inflation.
The financial sector’s post-crisis rebound owes much to the lowering of from 2008-22 and . This additional source of ultra-cheap funds let banks preserve their “bonus culture”, and widened inequality as the holders of financial assets like stocks and bonds saw their prices rise.
UK financial companies also profit from an elaborate network of , denting the tax-raising powers of the UK and many other governments.
The Conservatives had already taken steps to make invest more in innovative small firms, and set up a state-owned to provide funding where commercial banks would not. Past governments have also used windfall taxes to recoup public money from the banks, and polling suggests there is now for imposing another on banks’ excess profits.
But Labour’s scope to steer resources back to the “real” economy, away from the financial sector, is limited by lingering doubts about the sector’s underlying health. Banks have strengthened their balance sheets since 2008 and now pass much stricter stress tests. But this partly reflects a shift of lending towards less-regulated “shadow banks”, which are not banks at all but other bodies that have the ability to offer credit.
Now, new threats to global financial stability are looming, including among companies and .
The fear of another systemic slide – on the scale that left Labour’s previous prime minister, Gordon Brown, with and more recently sank – means the government is unlikely to give financial institutions the tougher treatment some would recommend.
Alan Shipman does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.
