Labour’s fiscal crisis is already here. Britain needs a new economic model

As the bond markets watch, we are heading for the worst of all worlds: high taxes and spending cuts, low growth and high inflation. Another way is possible.

Welcome to my new Substack! This first post is an extended essay about the failure of the British economic model. In future I will publish regular columns and essays here.

1. A gilty government

Labour’s promise of fiscal responsibility did not last long. Their manifesto said they would limit spending increases to £9.5 billion a year by 2028/29. But in the Budget – published just four months after the manifesto – that went flying out of the window. They increased spending by eight times more than they had said: by £76 billion a year.

The tax rises and extra borrowing that have done so much to spook consumer and business confidence – and the bond markets – all follow from that decision. Taxes went up not by the £8.5 billion a year promised in the manifesto, but by £40 billion. And borrowing increased not by the promised £3.5 billion a year, but by £36 billion.

This is not just cynical and dishonest but deeply dangerous. We have a persistent budget deficit, even when we discount investment spending. Our stock of debt already stood at 95.5 per cent of GDP, or more than 100 per cent based on how it was calculated before Rachel Reeves fiddled the figures. But even this is an under-estimate, given unfunded public sector pension liabilities are estimated to be worth towards £1.4 trillion – around half the estimated stock of debt.

And government borrowing is no longer as simple or safe as it once was. International events, like the Covid pandemic, which prompted massive government borrowing – and now rearmament – and slower trends, like the reduction in capital flows from Asian savers to global bond markets, mean borrowing is more expensive. Rising US interest rates, driven by Trump policies like his “Big, Beautiful Bill” and uncertainty over the stability of the Federal debt mountain, have sucked more of the world’s capital into America, increasing borrowing costs for governments elsewhere.

Longer-term domestic changes matter too. Our ageing population means demand for gilts from British pension funds is falling, as existing schemes mature and defined benefit schemes close. Huge chunks of our debt need to be refinanced every year, and in 2025 the Debt Management Office must sell more than £300 billion in gilts – the second-highest sum ever recorded, and lower only than during the pandemic.

But Labour’s fiscal expansionism – justified by discredited excuses about their economic inheritance and in contradiction to what the party had promised at the election – undermined market confidence. Unsurprisingly, more British gilt sales, more bonds sold by other governments, higher international interest rates, and fewer buyers at home and abroad leads to higher prices – and perhaps, eventually, a loss of demand and failed auctions.