The economic impacts of declining public sector net investment in the UK
As the British Chancellor prepares for her first budget on 30 October, we set out how declining Public Sector Gross Investment (PSGI) will reduce the UK’s potential output relative to scenarios of increasing public investment.
Public Sector Gross Investment (PSGI) consists of gross fixed capital formation plus capital transfers to the private sector plus changes in inventories. Over the coming fiscal period, PSGI is forecast to decline from 4.8% in 2023/24 to 4.09% in 2028/29, driven largely by the assumption that capital spending by departments is frozen in cash terms from 2025/26.
Three scenarios
In this analysis, we use recent work on the impact of public investment on potential output undertaken by the Office for Budget Responsibility (OBR) to estimate the impact of this decline in investment relative to an increase in investment.
We present three scenarios. The baseline scenario assumes PSGI is held constant at 2023/24 levels (4.8% of GDP). Scenario 1 is the OBR’s current forecast of PSGI from its March 2024 Economic and Fiscal Outlook. We assume that public investment after 2028/29 (beyond the OBR’s forecast) is held constant at 2028/29 levels until the end of the 10-year period. Scenario 2 includes an additional 1% of GDP in PSGI above 2023/24 levels. Each scenario is assumed to be a permanent rate of PSGI.
In Figure 1 we present the impact on long-run potential output relative to the baseline at five years, 10 years and in the long run (50-year horizon). Over these periods, the impact of the additional investment on aggregate demand has declined to zero, so the total impact we present is only the long-run impact on aggregate supply.
Under Scenario 1, public investment is projected to fall in real terms, which we find to have a £23bn negative impact in 10 years, relative to assuming a flat rate of investment under the baseline scenario. In contrast, under Scenario 2, an additional 1% of GDP in PSGI would raise an additional £33bn relative to the baseline. Over the long term, Scenario 1 would result in a –1.57% change to output relative to the baseline, compared to a 2.4% boost under Scenario 2.
These figures are broad estimates and do not reflect the impacts of investments in different types of assets. For example, investments in economic infrastructure, e.g. low-carbon energy investments and transport infrastructure, will likely see a larger impact than alternative types of public investment. Similarly, whether investment is direct or indirect via the private sector may impact these results. More discussion on this can be found in OBR (2024).
The Government faces a choice in how to bridge the gap in how to fund this additional investment
These options include reforming the UK’s fiscal rules to permit additional borrowing, increasing taxation or reallocating existing spending. CETEx has previously discussed the options available for reforming the fiscal rules.