How Chancellor is using 'reverse Truss’ strategy to return to New Labour boom years (and why it might not work)

Sticking close to Britain’s financial institutions is intended to induce falling interest rates, a rising pound and a surge in company investment, taking the country back to annual growth rates of 2.5 per cent

Change awaits! Let’s hope so because without it things look pretty grim. The key change, in order to fund struggling public services and raise stagnant living standards, is a higher economic growth rate. But such hopes are not particularly well-founded.

The best figure to use for this is gross domestic product per capita, as it removes any impact from higher economic growth simply due to a higher population. In other words, it is a better measure of how living standards are changing for the average citizen.

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Before the financial crisis, GDP per capita growth averaged around 2.5 per cent a year, of which more than half came from productivity gains. From 2010 to 2019 (ie, the start of the Covid pandemic) the growth trend halved, with productivity’s contribution falling to 0.5 per cent. After the Covid bounce-back – since 2022 – growth has been negative and productivity gains have disappeared entirely.

Labour Chancellor Rachel Reeves is taking a very different approach to Liz Truss, pictured on her first day as Conservative leader, (Picture: Carl Court/Getty Images)Labour Chancellor Rachel Reeves is taking a very different approach to Liz Truss, pictured on her first day as Conservative leader, (Picture: Carl Court/Getty Images)
Labour Chancellor Rachel Reeves is taking a very different approach to Liz Truss, pictured on her first day as Conservative leader, (Picture: Carl Court/Getty Images)
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Disaster for public finances

The Office for Budget Responsibility (OBR), in which Chancellor Rachel Reeves places so much faith, currently forecasts both growth and productivity to be positive and recovering faster than most other forecasters, including the Bank of England. What if it doesn’t? Even worse, what if the post-Covid trend continues?

This would be disastrous for public finances. The Institute for Fiscal Studies predicts that a ‘lower growth’ path – but in line with the latest Bank of England forecast – would result in a £30 billion reduction in government’s spending ‘headroom’ by 2028, and this is by no means a worst-case scenario.

Reeves’ optimism stems from the effects of political stability and maturity in her relationship with the ‘economic establishment’. She might also be able to edge back closer to the EU and so improve trade – but only edging this way as a big realignment would consume too much political energy and goodwill. She might also get the private sector to support public sector investment plans. But these are ultimately steadying measures, designed to create a more positive economic environment prior to lift-off.

Inflation isn’t licked yet

Her 'reverse Truss’ strategy – hugging the Bank of England (where she used to work), the Treasury (where her husband used to work) and the OBR – is intended to induce falling interest rates, a rising pound and a surge in company investment, taking us ‘back to the future’ and a return to 2.5 per cent annual growth rates. This, in turn, would allow the government to repeat the New Labour years of rising public investment.

That’s the plan, except that even if all those positives arise it might just take us back to the post-financial crisis ‘normal’ of weak growth. Reeves refuses to discuss the possibility that her plans wont work. We’ll see what the OBR makes of the impact of ‘stability' on the growth rate. Not much I suspect.

On the downside, and there’s always a downside, above-target inflation isn’t licked yet and may well be reignited by long-sought-after, above-inflation, public-sector pay settlements. Productivity shifts, especially post-Covid, remain difficult to interpret. The number of people who are economically inactive because of poor health remains high. Raised migration numbers continue to cause social concerns. And Russia, China and the Middle East aren’t exactly helping matters in global trading terms.

There’s also a Catch-22 in some of this. We need more money in the NHS and mental health services to get more people back to work – but we don’t have the money to fund such boosts on the scale needed. We need more money to improve public-sector infrastructure – like transport, green power, housing – but, again, there’s little money in the kitty. Public-sector investment, based on the last Tory plans, was falling when adjusted for inflation, and nothing Labour has said so far will change that. This begs the question: how will higher growth be stimulated if so many areas of public spending which have been underfunded for so long, remain so?

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Labour needs a Plan B

It may be that Labour finds itself running an efficient and stable government, making the right decisions, but at the same time unable to fundamentally alter the underlying position of struggling public services alongside high taxes. An improvement on what we have seen of late but not a reversal of the hard times we have been through. Such a scenario would require a substantially different Plan B in order for Labour to make its desired mark on society.

Another thing that Labour needs to be wary of is the distribution of any income gains that emerge. Contrary to what some espouse, poorer households have done relatively well over the past 14 years, and even over the past five, compared to richer ones. This is because the wealthiest have been hit by higher taxes, while the poorest have, despite some benefit cut-backs, gained from big jumps in the minimum wage and increased employment levels. Labour will aim for a similar outcome – although hopefully based on rising, rather than flat, household incomes – but will do well to repeat such a pattern.

As for Scotland, the finances will struggle, like the rest of the UK, and the economic debate will, I confidently predict, remain abject. While the relevant powers may largely reside at Westminster, that is no excuse for the Scottish Parliament to turn its back on economic matters, as the source of many of the productivity gains needed can be found in devolved areas.

But that’s enough from me, these are the last words I shall ever pen (cheers), unless I change my mind again (boos). Goodnight and thank you.

John McLaren is a political economist who has worked in the Treasury, the Scottish Office and for a variety of economic think tanks

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