Can the government spend as much as it wants? - Capital Economics
UK Economics

Can the government spend as much as it wants?

UK Economics Update
Written by Ruth Gregory

While we are not convinced that capacity in the construction sector will be an immediate restraint on a big public investment splurge, the inner workings of the government could lessen the amount of money spent. So although a big fiscal stimulus is still coming, it may not be as large in practice as the government hopes.

  • While we are not convinced that capacity in the construction sector will be an immediate restraint on a big public investment splurge, the inner workings of the government could lessen the amount of money spent. So although a big fiscal stimulus is still coming, it may not be as large in practice as the government hopes.
  • One way or another a large fiscal stimulus is coming in the Budget on 11th March. We have already factored in £55bn of additional public investment over the next five years. (See here.) And recent reports suggest the Chancellor could unveil a package of investment spending worth about £70bn, or possibly even as large as the £100bn touted in the Conservative Party manifesto.
  • We estimate that the construction sector has the capacity to deliver an increase in public sector investment of roughly £50bn over the next five years before it bumps into capacity constraints. (See here.) What’s more, the government is unlikely to be able to deliver as much as it wants. After all, the government has a history of underdelivering on investment. Between 1999 and 2016, investment spending undershot the plans made in the prior year by 12% on average. Only in the two years after the financial crisis did public sector investment rise by more than the government had anticipated a year before. (See Chart 1.) That is why the OBR assumes, as a matter of course, some degree of underspending in its forecasts.
  • These underspends largely reflect the tendency of the government to be over-optimistic about project timelines and to raid capital budgets to meet day-to-day spending pressures. Meanwhile, given that any departmental overspend results in the minister having to face the House of Commons Public Accounts Committee and a lower allocation in the following year, there are clear incentives to undershoot.
  • If the government underdelivered by a similar amount (12%) over the next five years, then a £100bn rise in public investment might in practice look more like £88bn. If the government were to announce £70bn of spending, then that might be more like £62bn. And £62bn would be more like the £55bn we have assumed.
  • In fact, there are arguably greater constraints within the government now. Departments currently have 130 major projects on the go, which the Chief Executive of the civil service has argued is “too much to do it well” (although we’ve not met anyone who doesn’t say they have too much to do!). And the more time spent by civil servants and by Parliament on Brexit, the less time there is to achieve other aims.
  • Of course, the government could just hire more workers. And the recent rise in employment growth in the public sector suggests it is doing just that. (See Chart 2.) But there is a limit on how far it can increase the wage bill while still balancing the day-to-day spending budget.
  • Overall, we’ve assumed an extra £55bn of public investment spending will be announced in the Budget. That’s 0.5% of GDP a year on top of the 0.5% of GDP increase in public spending announced in the 2019 Spending Round for 2020/21. (See here.) The government may announce more than this, but taking off about 10% will provide a better indication of what could actually happen in practice.

Chart 1: Public Sector Net Investment* (£bn)

Chart 2: Employment (% y/y)

Source: IFS; *Series break in 2010

Source: Refinitiv


Ruth Gregory, Senior UK Economist, +44 20 7811 3913, ruth.gregory@capitaleconomics.com