Long before Rachel Reeves entered the Treasury the challenge facing her as chancellor was clear. Britain’s economy had been underperforming for years, not only as the result of successive global crises, but also self-inflicted shocks including austerity and Brexit.
The latest figures show some progress to get back on track was being made before Labour’s general election landslide: Britain recorded the strongest growth in the G7 in the first half of 2024 – a detail seized on by Jeremy Hunt to argue that the Conservative legacy was not all that bad.
However, underneath the headlines were details that could worry the new chancellor: business investment fell, while progress to raise the productivity of the economy went into reverse.
To fix both, Reeves has turned to a theory in the ascendancy on both sides of the Atlantic: modern supply-side economics. Championed by the US Treasury secretary, Janet Yellen, the concept involves using the tools of the state to manufacture an investment boom, while also tackling inequality. The aim is to expand and upskill the workforce, while encouraging employers to use the latest technologies to boost productivity.
Back in the 1990s Labour had another big idea behind Gordon Brown’s plans – “post-neoclassical endogenous growth theory” – pilloried by Michael Heseltine, who after hearing that Ed Balls wrote the impenetrable phrase into a speech, famously declared: “It’s not Brown’s. It’s Balls’.”
That idea – that stronger economic growth is created by investing, rather than waiting for outside developments to do the work – has similarities. State activism through tax and spending is a tried and tested tactic of successive Labour governments. This time, however, there are also comparisons with ideas typically linked to the political right.
Talk of “supply-side reform” has been most closely associated with successive conservative British and US politicians since the 1980s ascendancy of free-market economics under Margaret Thatcher and Ronald Reagan. The idea focuses on boosting the supply of goods and services, as opposed to stimulating demand.
Typically such policies focus on cutting taxes and regulation to tempt business investment, rolling back the state to avoid “crowding out” the private sector. On the flipside, policies targeting demand involve governments spending to influence household consumption and business investment.
Ironically, it is Labour that has taken up the mantle with a focus on supply-side reform. Plans announced by the government so far include rolling back planning regulation to incentivise a housing boom, spearheaded by private sector builders – to the chagrin of Tories frustrated as their party splinters between liberal free-marketeers and populist conservative nationalists.
However, there are differences. Earlier this year, Reeves used her Mais lecture in London to point out that “the state simply getting out of the way, to leave markets to their own devices” was “no longer enough”. Using state spending and regulation, through stronger public services, was vital to the bedrock of a dynamic market economy, she said.
Instead, Reeves intends to use the levers of the state to “crowd in” the private sector, including through targeted spending, alongside the government’s regulatory changes, to get businesses spending again.
However, the chancellor warned late last month that “tough decisions” would be needed to limit spending after unearthing a £22bn “hole” in the public finances she says was left by the Conservatives, leading her to axe the funding for several infrastructure projects.
“It seems perverse that the government is cancelling construction projects while stating that they are serious about growing the economy,” said David Crosthwaite, the chief economist at the consultancy BCIS.
“I appreciate that it’s early days of the newly elected Labour government, but we have to ask, where is the much talked about growth going to come from?”
Mark Gregory, a professor at Staffordshire University, who has advised Labour politicians and was previously chief economist at the accountancy firm EY, said the US approach involving billions of taxpayer dollars would help to “pump prime” private sector activity. “But can you in the UK, within fiscal targets? To borrow to pump prime? That’s the conundrum,” he said.
“If you just concentrate on the supply side, you’re only addressing half of what’s important to business. Demand really matters to businesses. Public investment can stimulate private, and you grow the economy by convincing people there are opportunities out there.”
Labour is sticking to some promises to “crowd in” private investment. Despite Reeves warning of restraint, the new government has announced a £7.3bn national wealth fund, aiming to leverage £3 of private funds for every £1 of taxpayer cash. Great British Energy, backed by £8.3bn of public money, has a similar role. Both are policies straight from the modern supply-side economics playbook.
However, the party’s manifesto plans also indicate a reduction in public sector investment as a share of GDP over the next five years. Scrapping funding for road, rail and hospital rebuilding projects within the first month also sends a conflicting message.
Some economists do not necessarily see this as a problem, including Neil Shearing, the chief economist at Capital Economics. “Much ink has been spilled in the UK about how a lack of ‘fiscal space’ will constrain [Labour],” he wrote last month, saying that driving up economic growth would rely more on the party’s reforms to raise the supply of workers and private sector investment.
“It is not obvious that the cause of weaker growth is a lack of demand that needs to be addressed through fiscal expansion.”
However, others say the scale of the challenge is vast, after decades of the UK languishing behind other G7 nations for business investment – a position economists say was made worse by austerity, Brexit, and political instability under the Tories.
“It’s a big ask,” says Gregory. “Leadership and better policy is part of the story. But it’s a long game.”
