Fixing the foundations: how the UK’s Chancellor should prioritise clean investment in response to a tight fiscal situation

Rachel Reeves has announced significant spending cuts in her first major speech as Chancellor. Daisy Jameson and Esin Serin set out what this means for the UK’s clean transition and the necessary considerations for driving much-needed progress in this challenging fiscal environment.

On 29 July 2024, the Chancellor announced the cancellation of several spending commitments made by the previous Government, in response to a review by the Treasury indicating a £22 billion blackhole in the UK’s public finances. She stated that the fiscal position Labour has discovered since coming into government is more challenging than previously expected. Many found the cuts unsurprising, with the Institute for Fiscal Studies’ director saying: “the extent of the in-year funding pressures does genuinely appear to be greater than could be discerned from the outside, which only adds to the scale of the problem”. The Office for Budget Responsibility has referred to the Treasury’s findings as “one of the largest year-ahead overspends against DEL [Departmental Expenditure Limits] forecasts outside of the pandemic years”.

While the spending cuts do not touch the core of the Government’s commitments towards a cleaner economy, they do reflect an ongoing pattern of successive chancellors abandoning critical investment when the UK’s fiscal position becomes challenging, despite the long-term benefits of these investments.

It is precisely because of the pressures on the public finances that the UK needs bold leadership from Labour.

The UK needs to invest more for a clean, resilient and competitive future

Economic policy is inseparable from environmental policy (we discuss why at length in this earlier blog). Labour acknowledges this, having launched GB Energy (with £8.3 billion funding over five years) and the National Wealth Fund (with £7.3 billion of funding) within its first month in government. Both of these institutions will help the UK to deliver its clean energy transition as quickly as possible and provide economic benefits along the way. The Government has also injected an additional £500 million into its upcoming renewable energy auction, making this a record budget of any year.

However, this scale of investment remains far short of the required increase in annual public investment, identified by LSE earlier this year to amount to at least 1% of GDP (or £26 billion at current prices). It also follows Labour’s earlier watering down of its £28 billion a year investment programme ahead of the election, which it had previously described as being intended to drive ‘green prosperity’ in the UK.

Public investment could crowd in at least twice as much in private investment. This would help make up for decades of underinvestment in the country’s physical, natural, human, knowledge and social capital, to deliver on the need to tackle climate change, biodiversity loss and environmental degradation, and to be economically productive and competitive in the future.

The Chancellor has also cancelled some specific programmes that could have had a positive impact on net zero investment, such as the Investment Opportunity Fund, which may have seen investment in projects in green industries (among others). Furthermore, the review of the transport infrastructure portfolio and cancellation of the Restoring Your Railways programme could reduce investment in the public transport infrastructure required to rebalance demand between private and public transport and reduce overall energy demand.

How to scale up public investment

The Chancellor must scale up public investment in line with what is needed to transition the UK into a clean and resilient economy for the long term, even given the short-term spending challenges. This requires designing and setting up several enabling processes – as we set out below.

Enabler 1: make the clean transition a priority in upcoming Spending Reviews

The Chancellor launched a multi-year Spending Review that will set spending plans for a minimum of three years of the five-year forecast period. The Review will conclude in spring 2025. A one-year Review will be set alongside the October Budget. The Government has committed to making this a “mission-led” approach to improving public services.

To achieve Labour’s missions to i) kickstart economic growth and ii) make Britain a clean energy superpower, we argue that the clean transition must be a priority in these Spending Reviews. In practice, this should mean:

1. The Spending Review should align with the UK’s pathway to net zero. The Government should present a separate analysis of the policy announcements in the upcoming Spending Review that assesses the impact of all policies, not just those with a positive climate impact, on the UK’s net zero pathway.
2. Similarly, the Spending Review should consider how investments, particularly those in large-scale infrastructure projects, will be resilient to climate change. The impacts of climate change present a threat to these missions. All relevant policies, particularly infrastructure and housing projects, should be assessed for their contribution to the country’s resilience to climate change and avoid locking in any long-term decisions that could increase its vulnerability to these impacts.
3. The Spending Review must reflect a vision for a long-term industrial strategy. Investments in low-carbon energy generation should be made while recognising potential supply chain opportunities and additional measures that may be needed to capture them. Domestic capabilities in technologies in which the UK appears likely to serve global markets competitively should be supported, both through direct funding and improvements in the broader investment environment (e.g. planning reform and skills programmes).
4. The Spending Review must tackle some of the difficult choices the Government must make in the transition to a clean economy. The Government has already developed plans for the decarbonisation of the power system. As the Climate Change Committee recommended in its 2024 Progress Report to Parliament, it now needs to focus on removing the barriers to decarbonising buildings and industrial heating, and on scaling up tree planting and peatland restoration.

Enabler 2: exclude policy banks from fiscal rules to enable greater investment

As set out in a recent policy paper, we assert that reforms should include changing the treatment of the UK’s policy banks (the National Wealth Fund, UK Infrastructure Bank and British Business Bank) by removing them from the fiscal rules. This would recognise that these banks make investments either by financing private sector assets through loans and equity stakes, taking on a financial asset, or issuing guarantees to businesses and investors, taking on contingent liability in return for a fee. This results in these banks owning a financial asset and is in contrast to other central government investment that sees the provision of grants or the state ownership of real, non-financial assets.

Making this change would work alongside the sensible decision to partner GB Energy with the Crown Estate and giving the Estate powers to borrow money. The Crown Estate could bear some of the project development costs by borrowing against its assets, in turn assisting GB Energy in drawing as much private investment as possible into the UK’s vast sources of clean offshore energy. Exploring similar ways of increasing investment through the UK’s policy banks would help protect vital public investment in the transition to a clean economy.

Including policy banks’ activities in the UK’s fiscal rules means that their liabilities score against the rules, but the value of their corresponding assets do not – and constrains their activities. Strengthening the spending framework should therefore follow international precedent (e.g. France and Germany’s respective treatment of BPIFrance and KfW) in removing the UK’s policy banks from the fiscal rules. This would enable the banks to expand their activities and increase investment in net zero.

Enabler 3: change the fiscal rules to better accommodate investments with long-term benefits

As we have recommended previously, we suggest increasing borrowing for investment in productive assets to address the chronic underinvestment the UK has experienced in recent decades. Temporary and targeted borrowing could ultimately create additional fiscal space to promote investment that generates future returns. This investment should focus on the transition to net zero.

Increased investment is critical for reaching net zero, but the benefits of the investment (and risks from lack of investment) will not be realised immediately. The Government should therefore consider extending the medium-term forecast that underpins their fiscal decision-making from five to at least 10 years to recognise the immediate net zero investment requirements and longer time period required for the advantages of these investments to be realised. This would benefit all those investments that are required to kickstart the UK’s economic growth, not only those for net zero.