Steve Schifferes, City St George’s, University of London

UK chancellor Rachel Reeves faces her biggest test with the government’s departmental spending plans for the three years from next April until the general election. With nearly £600 billion a year to spend, her decisions will impact on every aspect of public life and shape the political weather for years to come.

She believes the key to reviving Labour’s fortunes as its poll ratings tumble lies in boosting economic growth.

So the government has promised that its policies will increase the UK’s anaemic growth rate and enhance productivity. Reeves is looking to capital spending on big projects that will boost the economy, such as the £14.2 billion government investment in a new nuclear power plant at Sizewell in Suffolk.

Last year she revised the government’s fiscal rules to give herself the space to borrow an extra £113 billion over three years to transform Britain’s ageing infrastructure. She has already made it clear that she wants to boost transport investment outside of London, as well as invest in research and development, including green energy.

But there are challenges ahead. In the first place, the effect of infrastructure investment takes a long time to feed through. This is partly because of the lag between planning the projects and when they come on-stream.

It will take time before the full effect will be felt on productivity, which has been growing more slowly than expected. The Office for Budget Responsibility (OBR) suggested in March that the latest government plans for planning reform might increase productivity by just 0.2% in the longer term.

There are also some real trade-offs as to where the increased capital investment will go – and which sectors will benefit most. The chancellor has emphasised her commitment to putting more money into projects outside London and south-east England that have had less public investment in the past.

But London and the south-east is where productivity is highest and where further investment might have a bigger effect on economic growth.

It appears that there may be less funding for social housing, which may threaten the government’s ambitious target of building 1.5 million homes over the parliament. There may also be less available to repair schools and hospitals.

And the plans to boost defence spending on expensive military equipment – such as frigates and fighter planes – will also count as capital spending. As such, it could further reduce the amount available for infrastructure investment.

The departmental trade-offs

Despite the relative abundance of cash for infrastructure, the tighter fiscal rules on day-to-day spending mean that many departments are facing a squeeze on their budgets. The government plans to allow total day-to-day departmental spending on average to rise by just 1.2% per year in real terms during the next three years. This probably spells a real-terms cut for some “unprotected” departments.

This is because the money will not be distributed equally. The Department of Health and Social Care gets 40% of all departmental spending and is likely to be the big winner.

It has already received a big increase in the last spending round, with an 11% increase in capital spending is likely to get even more to realise an ambitious ten-year plan for improving services in the NHS in England.

If health spending were to go up by 2.5% (well under its historic average), this could mean very little increase for many other government departments. And if it is increased by 3.5% this will imply real-terms cuts for other areas.

The situation is made more difficult by the government’s decision to prioritise two other areas: defence and schools. For defence, it is committed to raising spending to 2.5% by 2027 and to 3% in the next parliament.

And for education, Reeves has pledged an extra £4.5 billion per year for more teachers, childcare places and free school meals. The decisions have a strong political dimension, as health and education tend to be the most popular spending priorities among the public.

The spending review, however, only covers half of total government spending. The more unpredictable part is annually managed expenditure, mainly on benefits and interest payments on government debt.

The Treasury sets an overall target (known as the spending envelope) on how much will be spent in these areas. But it now faces a crunch point over the unpopular decisions to cut disability benefits and keep the two-child benefit cap.

Reeves’ partial U-turn on the winter fuel payment, which will now be paid to 9 million pensioners, will cost an additional £1.25 billion a year but may have been a political necessity.

But a full U-turn on the two other issues will be much more expensive. Taken together, such a change might breach the fiscal rules, which give only £10 billion of “headroom” in a total government budget of more than £1.2 trillion. So while there will be some rowing back, the finances suggest any more major U-turns are unlikely.

To make matters worse, these spending plans are based on an economic forecast made by the OBR in March. This did not include the effect of US president Donald Trump’s tariff plans. Since then, both the IMF and the OECD downgraded their UK growth forecasts for both 2025 and 2026, and despite a recent small upgrade by the IMF, growth is still significantly lower than previously expected.

Even though Britain seems to have secured a deal with the US, the effect of tariffs on global growth will still damage the UK’s prospects as a trading nation.

This will make it harder for the government to meet its fiscal targets in the autumn budget while sticking to the departmental spending plans. The chancellor will then have three options. She can look for more cuts in benefits spending.

She could try to find other sources of tax revenue, for example by tweaking the rules on taxing pensions or extending the freeze on upgrading tax bands. Or, more radically, she could modify the fiscal rules to give herself more flexibility – for example by having only one economic forecast a year, as the IMF has suggested.

Ultimately Labour’s electoral prospects will depend on whether it has succeeded in boosting living standards. While the productivity drive could work, the UK economy remains at the mercy of wider global economic forces.

Steve Schifferes, Honorary Research Fellow, City Political Economy Research Centre, City St George’s, University of London

This article is republished from The Conversation under a Creative Commons license. Read the original article.