#
My Lords, one word hovers like a spectre over this debate on the fiscal outlook: debt. Two years ago to this very day, your Lordships’ Economic Affairs Committee, which I then chaired, published a report on our national debt, It’s Time for Tough Decisions. It concluded that the UK’s national debt risks becoming unsustainable unless tough decisions are taken in this Parliament to address the major challenges that the UK faces and put debt on a gradual downward path. We found that sustainability depended not just on the level of debt but on having sufficient fiscal buffers to absorb future shocks and on avoiding a trajectory of rising debt service costs.
Two years on, our debt stands at nearly £3 trillion, over 94% of GDP, almost £96 billion higher than a year ago and, relative to the size of our economy, at levels last seen in the early 1960s. My argument today is that our debt remains on an unsustainable path. Our fiscal buffer is dangerously small. The risks facing our public finances have grown and are growing still. All this is thanks in very large part to the actions that this Government have taken.
Some may point to the fact that the debt accumulated during the last Administration, which is correct. I have argued that the last Government made mistakes, but however critical one is of that Government, one must accept that they faced Covid and the energy shock. Others may argue that Britain has carried far higher debts before—notably after the Second World War. That too is correct. However, after 1945, the baby boom, the peace dividend and the opening of world trade all boosted growth, which helped to lower our debts.
Today, Governments here and worldwide face the challenges of the Ds: higher defence spending, the demographic challenge of ageing populations, dependency—large welfare states—and decarbonisation, with the green transition. All these Ds increase demands for higher government spending at a time when Governments are already drowning in debt.
Across the advanced economies, government debt rose from around 70% of GDP on the eve of the financial crisis to around 110% today. That debt explosion took place during an era of low inflation, ultra-low interest rates and unprecedented quantitative easing, and in a world that is largely at peace. That world has gone, but government debt remains at record levels and is growing. The OECD expects Governments to borrow around $18 trillion this year. Almost four-fifths of that is simply to refinance debt coming due. Advanced economies spent more than $2 trillion on debt servicing alone last year. Dozens of nations, including the USA, now spend more on debt servicing than defence. In this rising tide of red ink, the price that each Government pays on their debt—ours included—is ultimately determined by investors, by their judgment on the health of a nation’s economy. To coin the Prime Minister’s phrase, it is that thing of being in hock to the bond market.
That brings us to the question that bond traders and all of us here today are asking: just how resilient are the UK’s finances? On Monday, the Chancellor told us that Britain is turning a corner. If so, surely debt should be on a steady downward path—but no, it is not. Debt will be higher at the end of this Parliament than at the start, before falling only slightly to around 95% of GDP by 2030-31. Even that fall is questionable. As the OBR notes:
“Plans to reduce borrowing and stabilise debt have been a common feature of forecasts since the pandemic, but have not yet materialised in outturn”,
or, as St Augustine might have put it, “Lord, make me fiscally responsible, just not yet”.
Indeed, the OBR concluded in July that Britain’s public finances were
“in a challenging position relative to history and to other similar countries, with … debt having increased by one of the largest shares of GDP of any advanced economy over the past two decades”.
It is the structure of our debt that makes us unusually vulnerable. QE shortens its effective maturity, while Britain has a particularly large stock of index-linked debt, so when borrowing costs rise, we feel the effects very quickly. Even before the economic impact of the Gulf war, the OBR was forecasting that debt servicing would cost us £110 billion in 2025-26. That is 3.5% of our national income, which is more than we have spent on education and approaching twice what we spend on defence. By 2030-31, that figure is expected to hit £137 billion.
The bond market is beginning to reflect investors’ anxiety about all this. Britain may not be an outlier in the amount it owes, but it is becoming an outlier in what it costs us to borrow. Our 10-year borrowing costs are now the highest in the G7 and the fourth highest in the advanced world. On Tuesday, Britain paid the highest borrowing cost on a sale of 30-year debt in almost three decades, and that rising interest bill is eating into the Government’s fiscal buffer. At the spring forecast, that buffer was around £24 billion. Against £3 trillion of national debt and £1 trillion of annual spending, that is not a buffer; that is a wafer, and some estimates suggest it has already shrunk to just £5 billion.
The Chancellor’s optimism cannot camouflage the facts: debt is high and still rising, its structure leaves us unusually exposed to shocks, our fiscal buffer is wafer thin and shrinking, and investors are demanding an increasingly high price to lend to us. In that sense, though, the Chancellor may be correct: we are turning a corner. Ken Rogoff, the former chief economist of the IMF, now puts the chances of a major UK debt crisis by 2030 at more than 50:50.
This brings us to a central question: what would convince investors that Britain has a credible plan to stabilise its debt? The answer, I would argue, lies not so much in economic theory as in political choices. A central conclusion of the Economic Affairs Committee two years ago was:
“If we wish to maintain the level and quality of public services and benefits that we have come to expect, we face a choice: taxes will need to rise or the state will need to do less. Addressing this will demand clarity as to the responsibilities and the role of the individual versus that of the state. Muddling through is not an option. If this choice is ducked in this Parliament, the UK risks being on a path to unsustainable debt”.
Two years on, my argument is not that the Government have failed to take tough decisions: it has, but it has taken the wrong tough decisions. Labour decisions have weakened growth, dug us deeper into the debt hole and increased our fiscal vulnerability. What is needed is a plan to control spending and strengthen the underlying budget so we live within our means, bear down on inflation and the cost of our debt, and, above all, get the economy growing faster. But the Government’s actions have produced the reverse of all that.
Let us look at spending. I was intrigued to hear the Chancellor say on Monday:
“Staying true to our values means being honest about the need to control government spending”.
For a moment, I thought I was listening to fake news. By the end of this Parliament, the Government will be spending around £260 billion more a year than at the start. Public spending will absorb more than 44% of national income. That is a level we have not seen on a sustained basis, outside shocks and their aftermath, since the 1970s. Let us look where that increase is going. Welfare spending is set to rise by some £75 billion a year over this Parliament, to £390 billion. Within that, spending on health and disability benefits is forecast to hit £104 billion, an increase of more than a third.
Instead of taking the tough decisions needed to control spending, the Government have chosen higher spending, financed by higher taxes. Working hard, investing, setting up a business, employing more people—the very activities that drive growth and generate the revenue needed to stabilise our debt—are being taxed more heavily. To give one example, the rise in employers’ national insurance alone means an employer now pays around £900 more a year for every worker on median earnings, and the tax burden is set to rise still further, to the highest level on record.
Then there is inflation. I fully concede that the war in the Gulf has made the fight against inflation more difficult, but that is all the more reason for the Government to double down on measures to cut costs on business. I welcome the Government’s promise to take an axe to the bureaucracy holding back private investment, but why are they stopping there? If regulation is holding back investment and growth, the Government should take an axe to the burdens they have themselves imposed on business and employers, such as their energy policies and the Employment Rights Act—an Act that will impose direct costs on business of around £1 billion a year.
These policies have undermined growth, which is the all-important ingredient to bring down our debt. The Government will rightly point out that there was stronger growth in the first half of this year, but two good quarters do not solve the structural problem. The OBR still puts our potential growth rate at only 1.5% and forecasts GDP per head to grow by just 1.1% a year over the rest of the decade. That is roughly half its pre-financial crisis rate. For debt sustainability, it is that underlying rate of growth—year on year, not a couple of strong quarters—that matters.
Let us put this together. What lies around the corner? A higher-spending Government, extracting ever more tax from a weak, debt-laden economy. There is clearly a debate to be had about the role that the fiscal rules play in all this. My view is that today’s fiscal rules, like their predecessors, can be too easily gamed, and we can debate how to address that, but let us not lose sight of the main point. What matters is whether the underlying fiscal trajectory is credible, and that trajectory is shaped by political choices and political belief. Do you believe the state should be the driving force of growth, or do you trust people and the markets? Should the state encourage people to take greater control of and more responsibility for their lives, or should the state assume ever more responsibility for itself? The answers to these questions will shape our fiscal trajectory and the decisions in next month’s Budget.
The Minister obviously cannot prejudge that Budget, but, that said, there are some simple questions he should be able to answer. First, does he think British business can afford to pay still higher taxes without damaging growth—yes or no? Secondly, the Prime Minister has said he will use “flexibility” within the existing fiscal rules. Can the Minister define what “flexibility” means? Thirdly, what did the Prime Minister mean exactly when he said:
“We’ve got to get beyond this thing of being in hock to the bond markets”?
Finally, what does the Minister think about the current trajectory of our national debt? Is it sustainable—yes or no?
My answer to that question is a firm no. We may not face a debt crisis today, but the horizon is darkening, with weak growth, a record tax burden, sticky inflation, rising welfare dependency and more of our national income consumed by servicing the debts of the past. I do not see this as turning a corner. I see it as proof that, after two years of Labour, with its massive majority, we are on the wrong path and going in a very dangerous direction. We need to change course now, before that thing called the bond market forces us to change, and in a way that will be more painful and more costly.
Let me end by taking us back 50 years to September 1976. Britain had just turned to the IMF for a loan. A few days later, standing at that Dispatch Box, Lord Carrington said something which echoes down the generations. He said that
“you cannot go on spending vast sums of money which you have not got. You cannot go on improving your own standard of life on other people’s money because, sooner or later, they will not lend you any more. … Whether we like it or not—and we do not—and the sooner the better, we are going to have to cut our public expenditure. Of course, it is not going to be nice. Of course, we are all going to be hurt by it, and of course, we shall all have to cut the things we would much rather not cut. Of course, we will dislike it very much. But what other alternatives are there?”—[Official Report, 4/10/1976; col. 953.]
#
My Lords, it is a privilege to follow the noble Lord, Lord Bridges of Headley, and I congratulate him on securing the debate. The challenges facing this country and many others globally because of the current fiscal outlook have been a consistent focus for him, both during his distinguished stint as Chair of the Economic Affairs Committee and since. I welcome my noble friend Lord Pitt-Watson to the Front Bench, as this is the first time I have spoken in a debate to which he will be responding. I should declare interests, as in the register, as a trustee of LAMDA, an adviser to the family office WFO and a director of Digbeth Loc. Studios.
The survey of the fiscal outlook by the noble Lord, Lord Bridges, could be described, perhaps by Sir Humphrey Appleby, as very grounded, verging on the bleak. There is no denying that globally the challenges are formidable, with economies in a more vulnerable position to future new shocks, by some measures, than before the global financial crisis of 2008. As the noble Lord described, the UK is, unfortunately, not a positive outlier relative to the global picture and in too many respects is at the wrong end of the spectrum.
Before I make my observations on these challenges and some of the responses to them, I begin on a positive note by welcoming the encouraging trend in productivity growth that has emerged in recent weeks. Output per job increased by 1.4% in the 12 months to 30 June and has been consistently above average since late 2024. It is premature to call victory or attribute the improvement to the effects of AI, but productivity is so central to the turnaround of the economy and the balancing of the fiscal books that there seem to be grounds for cautious, tentative optimism. It perhaps supports the argument that my noble friend Lord Eatwell made after the Government’s first Budget: that the increase in employers’ national insurance would drive productivity growth more than hit employment.
But for all that, there are powerful headwinds to contend with. The Financial Times this week described the issue of national debt service globally as “a $2tn monster”. The US, France and the UK are all having to pay more debt interest than they spend on defence. This not only poses real challenges in setting steady state spending plans but, as I have already noted, gives less leeway to respond to future financial crises. The OBR, in its long-term forecasting, assumes a financial crisis every nine years. In this week’s announcement by the Dutch central bank that it was moving the physical custody of 14% of its gold from New York and Ottawa to London—an eloquent demonstration, perhaps, of the damage that the Trump Administration are doing to international confidence—it made a strikingly blunt assertion:
“This ensures that DNB is … prepared for severe crises”.
As my right honourable friend the Chancellor prepares his Budget, he is undoubtedly constrained by the commitment in the Labour manifesto not to increase the three most significant personal tax rates. Taxation policy has always been part of the political debate, but perhaps most acutely since the Conservative Party’s campaign—fake news—“Labour’s Tax Bombshell”, which can credibly be seen as having swung the 1992 general election result. It is understandable why the party, scarred by that, has sought to avoid a repeat. But, to be frank, it is not conducive to the best management of the economy in inevitably changing circumstances.
Those changing circumstances include, most importantly, the effects of the war in Iran. The NIESR has estimated that every 10% increase in the oil price reduces GDP by 0.12%. So the rise of 40% or more since the US’s misconceived attack on Iran is likely to have reduced GDP by 0.5%, with the IMF having concluded that prior to this the UK economy was on a positive, improving trend.
I will end on one or two more positive notes. The fiscal devolution started by the last Chancellor and turbocharged by the new Prime Minister has the potential to have disproportionately beneficial effects on growth, employment and housing, as I am already seeing in the work I am doing in the West Midlands. My right honourable friend Gordon Brown made a compelling analysis in the Financial Times of the role of innovation in driving growth and the UK’s world-leading strength in science and technology. I hope my noble friend the Minister can reassure the House of the Government’s understanding of the need to address the fragile state of the higher education sector.
The scale and severity of the challenges that we face are formidable. These are global challenges, faced by multiple countries and exacerbated overwhelmingly by the policies of the US Administration. The noble Lord, Lord Bridges, is wrong to attribute the causes of that challenge to this Government. In fact, in contrast, I am totally confident that the Labour Government—governing, unlike its predecessors, in the national interest—are best placed to find a successful path through these challenging times.
#
My Lords, the noble Lord, Lord Bridges, has outlined the challenges facing fiscal policy very well. I was a member of the Economic Affairs Committee that he chaired so ably, and he has summarised the conclusions of the report of that committee two years ago. Since then, the OBR too has set out the significant risk that UK debt could become unsustainable unless offsetting action is taken. While the previous Chancellor was successful in stabilising the debt ratio, we now need to make significant progress in reducing it, not just in the forecast but in practice. The need for early action is not removed because the debt ratio of other countries is similar or even worse than that of the UK. Having a shared problem might make it feel less urgent, but the UK debt ratio can be brought on to a sustainable downward path only by our own actions.
The noble Lord also set out the initial source of the problem very clearly. Since 2007 we have engaged in three rounds of exceptional expenditure in response to events. There were good reasons in each case why that was undertaken, even if in some cases it was overdone. In one case, the financial crisis, we were trying to protect savings and maintain a functioning financial system; the Covid crisis required support for people who were suffering in lockdown; and there was a sharp rise in energy prices after the invasion of Ukraine. So some of that was right in principle, but I cannot recall any Government giving much warning that these rounds of fiscal support would eventually have to be paid for, even if not immediately. Nor did Governments warn that the longer the delay, the greater the cost in terms of higher debt interest. Taxes were cut when the opportunities arose, and expenditure control proved to be too difficult politically.
While there is general support for changing the fiscal rules to accommodate public sector investment, less has been said about the debt service costs involved in that, at a time of rising and very high global interest rates. Taking out a mortgage means starting your monthly payments immediately. The same applies to government borrowing and we are, of course, experiencing that.
Both the Economic Affairs Committee and the OBR have set out the significant headwinds we are facing, and they are very tough. They include an ageing society, increased defence spending and rebuilding our energy grid to make the best use of renewable energy.
Dealing with these matters will not be easy. In my view, it means a combination of increased taxes, restraint on increases to benefits and improved public sector productivity. As far as possible, this should involve reducing the array of exemptions and tax credits that are characteristic of our tax and benefits systems, and we need closer scrutiny of claims for benefits. The goal should be a wider tax base and a narrower welfare base, and we should be doing our best to avoid the high marginal tax rates or damaging cliff-edge withdrawal rates that are also very evident now.
Faster growth could improve the situation, but we need to be cautious. The OBR has pointed out that if faster growth is simply translated into proportionate growth in the provision of public services, growth on its own will not be sufficient to solve the problem.
Here lies a fundamental challenge. Demand for the major public services tends to increase more than proportionately in a growing economy. We see this with health, social care, education and some aspects of welfare. So, it is not surprising that costs rise more rapidly than the growth rate itself. Indeed, in the case of the triple lock the arrangements mean that pensions will grow faster than earnings. It was designed to produce that effect. This explains why growth alone will not solve this problem.
In an earlier phase of my career, I had close experience of three difficult periods for fiscal policy: 1976, 1981 and 1993. I was an academic and commentator during the first, and a Treasury official during the second and third. In each case, decisive action was taken, even though it involved difficult and often unpopular decisions, as the noble Lord, Lord Lamont, will remember in the case of the 1993 event. But eventually, we saw an improvement in the balance of the economy and improved market confidence.
If coping with excessive debt becomes the priority for a Government, it tends to crowd out discussion of longer-term structural policy and issues such as tax reform, which are so necessary. Once debt is clearly on a downward trajectory, life becomes much calmer, leaving more time for dealing with the longer-term issues that really deserve scrutiny. Above all, if we could get on to a path of a falling debt ratio, we might spend less time discussing the fiscal rules and whether they are a sufficient buffer for the next Budget—and I suspect we would all welcome that.
#
My Lords, it is a great pleasure to speak after the noble Lord, Lord Burns, who brings so much experience and authority to his comments. They were extremely balanced and will be well received by all sides of the House.
My noble friend Lord Bridges set out his case with his customary clarity. The figures he gave speak for themselves. The rest of the world is now catching up with the warnings two years ago of our own Economic Affairs Committee. Not a day goes past at the moment without more evidence of the stresses and strains, not just in the bond markets but in the wider world of geopolitics, that are adding to the pressures and bringing closer some kind of reckoning.
Although I agree with my noble friend that the decisions the Government have chosen to take over the last two years—ducking cuts to the welfare budget and increasing taxes on business and employment—have made the problem worse, we on this side have to acknowledge that this is a problem that has been a long time in the making. Whereas in 1997, the Conservatives left office with a surplus—I repeat, a surplus—in 2024, the fiscal signs were already flashing red.
That brings me to the main point I would like to make today. It may seem slightly to one side, but I want to bring it to the discussion. Our fiscal and economic problems are a consequence of structural political problems, and we will not be able to address them unless we also address the whole way in which our political system operates and our political classes have come to behave.
When I started working in government back in the 1980s, the basic operating model for politicians was something like this: the leadership worked out their overall vision and values, and then developed policies that were coherent with that vision. The job of politicians was to make an argument in favour of that vision and seek to persuade as many people as possible of the wisdom of a particular course of action. I am not arguing that this was universally applied, nor that there were not sometimes contradictions, but I do argue that the Government and Parliament were fundamentally transmission mechanisms and that their core job was to make an argument that was as coherent as possible.
We did not obsess over opinion polls. We did not carry out endless focus groups and taxpayer-funded market research. We did not, at bottom, think our job was to split the difference between competing interest groups. Contrast that with what we see today: incoherent and contradictory policy positions to please different lobby groups. For example, there is a drive on deregulation, on which I believe the Government are to be congratulated, but it sits alongside higher taxes on business, employment taxes on non-doms and laws to make it less attractive to hire workers. One set of measures is pro-investment but another is anti-investment. The result is incoherence.
In essence, we have moved the Government and Parliament from a transmission mechanism into one that is always on receive and sits on top of a giant lobbying system, where the plaudits go to the politician who can negotiate the next 24 hours most skilfully or take most plausibly some ludicrous line—ideally, while wearing a high-vis jacket or hard hat. So is it a surprise that our fiscal problems have compounded as our political system has become ever more performative? I remember my noble friend Lord Lamont once saying, “To govern is to choose”. More recently, we have had a Prime Minister who said, “I’m pro-cake and pro-eating it”.
Fortunately, we face a test that will show whether we have a political system that is indeed capable of being serious once again. What are we going to do about the pension triple lock? It is already clear that, in the circumstances we face, it is indefensible economically. But if, as a society, we believe in some kind of intergenerational fairness, it is clearly also indefensible morally. A policy that locks in the transmission of money from a declining number of young people to a growing number of relatively well-off older people—or, if you like, from our children to us—is not the path to a strong, balanced society.
I hope we can rise to this challenge, which applies to my Benches as much as it does to the Benches opposite. As my noble friend Lord Bridges said, we can either take steps ourselves to start sorting out the mess or wait to have change forced on us. I know which I prefer and which I believe is better for our democracy, but honesty about our fiscal situation requires honesty in our politics. To restore seriousness to our fiscal position, we first need to restore seriousness to our politics.