Post Segments
The Budget is Even Worse than Predicted
Even though the Budget was by far the most trailed in history Rachel Reeves still managed to deliver something even worse than expected. We knew that there would be a major increase in taxes, taking the tax to GDP ratio to a post-war high. We knew, as in her 2024 Budget, she would choose a dog’s breakfast of tax rises that will disincentivise saving, investment, hard work and entrepreneurship, rather than the cleanest and least harmful option of raising the income tax rate. However, it turns out that there was a lot we didn’t know. We didn’t know that the £26bn tax rise was primarily there to finance a £16bn increase in the already unsustainably large welfare budget. In Kemi Badenoch’s memorable phrase “The rider is becoming heavier than the horse”. This in an attempt to placate the left wing of the Labour Party and save the PM’s job, and in complete contradiction to the manifesto of raising economic growth and restoring fiscal credibility.
We also didn’t know that the Chancellor deliberately misled the public and markets, because at no stage did the OBR tell her that there was a large “black hole” in the public finances which needed to be filled. Indeed, their final estimate, delivered on Oct 31st, was that there was £4.2bn of “headroom” and thus no need to raise taxes at all (this was four days before Ms Reeves signalled that the income tax rate would go up, before later backtracking). Finally, we did not know that the additional “headroom” which the Chancellor had said she would build into the public finances would be a mirage. This is because the higher spending is “front loaded”, while most of the new taxes (and some spending cuts) are “back loaded” into the 2028-29 pre-election period. This has not escaped the attention of key domestic and foreign investors.
However, with the Starmer government breaking all records for unpopularity after only 17months in office could it be that there is an election much sooner than 2029? I raised this possibility in an article as long ago as January (“The Starmer Government Could Fall Well Before 2029”), but even I have been astonished at the speed of collapse in its authority, accelerated by the utter shambles of recent days. We can’t know what the final catalyst might be, or the timing and sequence of events leading up to an early election, probably after a new leader of the Labour Party is chosen, but a crisis of confidence in financial markets is very likely to be at its centre.
Is an Economic/Financial Crisis Therefore Now Unavoidable?
There is an alternative view to this pessimism, which was articulated best by Ambrose Evans Pritchard (AEP), distinguished Daily Telegraph journalist, in his “In Defence of Rachel Reeves” piece on 27th November. He claims that the pessimists who warn of an approaching UK financial and economic crisis have “lost their minds”. AEP provides three reasons why the outlook for the UK is better than commonly perceived:
*The Labour government has continued the Johnsonian policy of raising the historically low level of UK public sector investment. Reeves has rightly not cut capital spending in this Budget, thus helping to promote higher UK economic growth.
*Although the UK’s public finances have deteriorated dramatically in the last 5 years they are not in as bad a shape as some other major economies, including the USA, France, Japan, and Italy.
*The global economy is on the verge of an explosion of AI based productivity gains, and the UK is well placed to benefit from this.
We examine these three factors in turn:
Projected Higher UK Public Sector Capital Spending is not a Game Changer
UK public sector investment has averaged only 1.6% of GDP since the late 1970’s, compared to the 3-4% level of most advanced economies, resulting in relatively poor infrastructure and contributing to poor productivity growth. The Johnson administration committed to higher capital spending, and Labour has raised the level further to 2.6% of GDP over the next five years. This is good in principle but with the level still below our competitors is not a game changer, especially to the extent that the programme includes spending on HS2 and net zero related projects that are likely to deliver low or even negative returns. Furthermore, it is UK business investment that is the key driver of growth – comprising close to 60% of total investment compared to 10% for the public sector. Business surveys show investment plans have increasingly been shelved in recent months, while actual business investment declined in both Q2 and Q3.
High Off Balance Sheet Liabilities mean that the UK’s Public Finances are No Defence Against a Crisis
It is true that the UK’s national debt to GDP ratio, as conventionally measured, is lower than some other advanced nations. The UK is around the 100% level compared to the US and France at over 120%, Italy at 135%, and Japan at 235%. However, such “whataboutery” does not mean that financial markets will not turn on the UK first. The USA currently has higher debt levels and higher deficits than the UK but has an administration that is implementing a clear and credible plan to increase economic growth with urgency and authority. Italy currently has its most stable government in decades and now has lower public sector deficits than the UK. Japan has a higher domestic savings rate than the UK and 88% of its government bonds are owned by residents and not foreign investors, compared to less than 70% for the UK.
Most critically, UK public sector net worth as a % of GDP is the second worst of the major western economies*. Net worth is measured by subtracting public sector liabilities from public sector assets. The UK has a relatively low value of public sector assets – a function of decades of low investment – as well as a relatively high level of liabilities – mainly a function of large unfunded pension liabilities. UK public sector net worth is negative to the tune of over 100% of GDP, with only Italy of the advanced economies worse than this. France and the US also have negative public sector net worth but at much less than 100% of GDP. International investors are well aware of this. Our hard-won reputation for political stability and fiscal prudence is eroding faster than any major nation except possibly France. I find no comfort here and neither do the bond markets. UK 10-year bond yields are around 4.5% at time of writing, notably higher than in France and Italy (both 3.5%), Japan (1.9%), and even the US (4.1%) which according to AEP has a much more reckless fiscal policy than the UK.
Is the UK on the Verge of being Rescued by an AI Productivity Miracle?
This is potentially AEP’s most potent argument. He quotes various AI experts, and the IMF and the Bank for International Settlements, which postulate that AI could raise advanced economies’ productivity growth by 1-1.5 % p.a over a prolonged period and that this boost may have already started. Furthermore, the UK is relatively well placed to benefit, with the world’s third largest AI industry, the largest data centre in Europe, and – thanks to Brexit! – a more favourable regulatory approach to AI than most of the competition. If this is true, then the outlook for the UK economy – and thus the public finances – would certainly be transformed. AEP postulates a scenario where the initial impact of AI is highly deflationary, thus leading to much lower interest rates and greatly reduced fiscal pressures. I hope this is true….
However, although I am horribly unqualified to prognosticate on technological matters, I have severe doubts about this happy scenario. Firstly, it is reckless to draw up a Budget that gambles on a rapid pick up in productivity in the next 2-3 years from whatever source. Secondly, there are other knowledgeable sources that are much more sceptical about the AI productivity revolution. Some very shrewd and successful investors** are betting heavily that AI stocks are in a bubble which will burst because the demand for generative AI will be much less than hoped for. There are credible reports*** that true end demand is weak, and so far, the returns on projects have been very poor. Thirdly, to the extent that the AI revolution does continue its momentum it will require a vast increase in electricity supply. This is where the UK’s comparative advantage may hit a brick wall, as it collides with the UK’s dangerous**** pursuit of net zero purity. Other economies are adopting a more pragmatic approach which prioritises economic growth over reducing carbon emissions, making the UK’s comparative energy costs ever more disadvantageous.
Conclusion
I’d like to be proved wrong, but I find the case for optimism on the UK’s economic prospects put forward by AEP unconvincing. It has been likely almost from the start that the Labour government would confront a major reckoning from financial markets well before 2029, and this truly shambolic Budget makes it all the more so.
Robert Lee December 3rd, 2025
* Public sector net worth data is from the Institute for Fiscal Studies (IFS)
**Including Michael Burry of Big Short fame, and noted contrarian investor Peter Theil
***Including MIT (Massachusetts Institute of Technology)
***The Uk’s net zero policies are not only dangerous economically. According to Sir Richard Dearlove – head of MI6 1999-2004 – in a deeply alarming article in the Spectator of 22nd November entitled Net Cost, they also pose a major threat to national security.
