Towards a (Minority) Shareholder State? The Labour Government's Fiscal Framework

Public debate on fiscal politics is commonly framed in terms of ‘black holes’, ‘maxed-out’ credit cards and household analogies. These terms hinder democratic deliberation about what the government does today, what it can do, what it should do, and why.

Spending, tax, borrowing, and debt numbers—taken in isolation from their economic, social, and environmental causes, effects, or purposes—often take on the role of key standards for policy appraisal and debate, to the detriment of the substantive goals of policy. The means of policy commonly become the very goals governments want to achieve.

This article examines the fiscal politics of the fiscal framework launched by the Labour government in October 2024 against this background. The government certainly faces a difficult situation. It must balance multiple missions around, for example, economic growth, the energy transition, and higher investment in public services, while dealing with a significantly different policy environment relative to the previous decade.

Public finance statistics and their dominant interpretations are critical determinants of whether a fiscal framework traps a government in austerity as an end in itself or allows for necessary investment and encourages a more enlightened debate.

From reasoning by analogy to superfluous theatrics?

Fiscal rules have multiple purposes and uses. Top among them should be to guide policy decisions, assessment, and debate in a way consistent with the government's goals and the country's economic situation.

The use of formal rules as key anchors of the UK's fiscal framework was inaugurated by New Labour in 1997. As a critical complement to granting operational independence to the Bank of England, Chancellor Gordon Brown introduced two rules in the code for fiscal stability: the ‘golden rule’ that government would only borrow for investment, and the ‘sustainable investment’ rule that government would keep public debt below 40 per cent of GDP.

The rules came out of reasoning by analogy: if mainstream economists agreed on the credibility benefits of a transparent rules-based framework for monetary policy, the same principles can and should be applied to fiscal policy.4 This settled the division of labour between fiscal and monetary policy until this day.

New Labour's rules remained operational until the global financial crisis of 2007–2009, when the ensuing recession shook the fiscal framework. The scale of the crisis led government to step in and collaborate with the Bank of England to prevent financial collapse.

While the deterioration in the fiscal position was largely because of the financial crisis, the debt and deficit increasingly became the most salient aspect of public economic argument. The 2010–2015 Conservative-Liberal Democrat coalition government mobilised the idea that the fiscal deficit was the UK's most serious problem to justify large immediate public spending cuts.11

Public economic policy debate turned into how to make the debt and deficit numbers smaller regardless of what that meant for the economy, public services, and public infrastructures. The means of fiscal policy officially became the very goal the government wanted to achieve. The medium-term consequences are in plain sight: crumbling public services, decaying public infrastructures, and a decades-long pattern of consistent public underinvestment.12

The attempt to reduce fiscal numbers in the short term worked against economic recovery and ultimately led to higher long-term debt. Austerity led the British economy into a lost decade and a half.

Conservative-dominated governments saw recurrent changes to the fiscal rules. Whatever, if any, credibility gains fiscal rules may have provided during the New Labour years likely vanished. More importantly, recurrent changes to the rules also harmed public policy and political debate – the current and prospective economic situation is not at the centre.

Reeves's fiscal framework

The budgetary conventions inherited by Keir Starmer's Labour government represented obstacles to tackling urgent social, economic and environmental challenges.

Chancellor Reeves's changes to the fiscal framework bring good news for the country. The ‘stability rule’ targets a balanced day-to-day budget, defined as a range between 0.5 per cent of GDP surplus and deficit in the current budget. This rule differentiates current and capital transactions, freeing the latter from policy measures to fulfil the target.

Public investment cuts will cease to be the easiest and least politically costly short-term solution in future public spending cuts to meet the fiscal mandate. Briefly put, the ‘stability rule’ could decentre government borrowing from public economic policy debate.

The ‘investment rule’ keeps the previous government's promise to lower government debt, but substitutes a public sector net financial liabilities (PSNFL) or financial debt measure of government debt for the former public sector net debt (PSND). PSNFL is broader than PSND in that it includes both liquid and illiquid financial assets and liabilities. At the very least, this allows some additional room for public investment. Public investment is now expected to be at around 2.5 per cent of GDP over this parliament when the previous government's spending plans had it steadily declining to 1.7 per cent. This is a significant improvement, if painfully modest relative to the challenges ahead.

But the new fiscal framework brings contradictory news as well. Firstly, the government's decision to bring fiscal rules' rolling target forward from five to three years is both relatively surprising and likely to be damaging. Three-year rolling targets are likely to present an obstacle for appropriate counter-cyclical fiscal policy in the event of a profound economic recession or another health crisis, for example.

Short-term fiscal rules are little more than rules for sunny days. The global financial recession, Covid-19, trade conflicts, and the consequences of geopolitical tensions should be sufficient reminders that we are not likely to be anywhere near good times anytime soon. Setting rules for sunny days in the mid-2020s seems painfully naïve.

Secondly, another contradictory piece of news is that the new fiscal framework may actually reinforce the UK bias against successful (non-financial) public corporations and investment. Framed in terms of PSNFL, the investment rule could trigger a wave of indiscriminate PFI-like projects.

Of course, there is nothing essentially wrong with public sector financial activities. The risk lies in the incentives this poses for government politicians who, given the shape of the fiscal rules, are likely to see strategies that encourage private investment as the preferred way of addressing the country's urgent investment needs by default, regardless of whether they are the best available choice in each specific case. The investment rule leaves little room for significantly higher non-financial public investment and constrains all non-financial public corporations including, for example, Great British Energy and the railway companies already nationalised and those due to return to the public sector in the following years.

Towards a decade of renewal?

There were other avenues for reform available. On the one hand, an alternative could have been adopting a public sector net worth (PSNW) measure. PSNW counts non-financial assets as well as financial ones and, therefore, provides a more integral measure of what public money and debt buy—for example, infrastructure, school buildings, housing, financial assets, and so on. A shift to PSNW rather than PSNFL would have represented a major break with fiscal conservative ways of thinking.

On the other hand, the government could have aligned UK budgetary reporting with other rich countries' practices. EU countries, for example, do not include market producer government-controlled entities in the fiscal targets. In the case of non-financial public corporations, entities are market producers if most of their output is sold at ‘economically significant prices’ or cover at least 50 per cent of their costs through sales over three years. Accordingly, the EU's excessive debt procedure does not cover market producer non-financial public corporations.

Whereas the UK government includes all public sector entities in the debt target regardless of whether they are market producers or not, EU countries classify market producer public corporations out of their fiscal targets. This means market producer non-financial public corporations and their investment activities are not discouraged and are less likely to become subject to irresistible pressures whenever EU governments want to reduce headline public spending, borrowing, and debt numbers.

Conclusion

The fiscal framework launched by the Labour government in October 2024 represents a contradictory enterprise. If we consider government narratives so far, the new fiscal framework is unlikely to be sufficient to shape a better understanding of the public finances and the government's economic role.

This work was supported by the Isaac Newton Trust, registered charity no. 1209261.