How bad are Britain's finances? Five questions on the state of the UK economy | Phillip Inman

Labour will say the economy is in a terrible state – are they right?

The economic outlook is improving, but a recovery from last year’s recession will be long and arduous without a boost to public investment.

As President Biden has shown, businesses are reluctant to invest without government support and this applies especially to the need for green investment. Since the Brexit vote and the chaos and indecision it sparked inside Whitehall, businesses have delayed or cancelled planned investments, leading to eight years of stagnation.

Skill shortages and the prevalance of long Covid , which has prevented tens of thousands of workers from returning to their jobs, has made it difficult for employers to recruit, leading to higher than expected pay rises. Higher than normal salary increases are one reason the Bank of England has delayed cuts to interest rates.

Without a cut in the cost of borrowing, many economists believe consumers will resist spending and the economy will remain stuck on a low-growth path.

Why are public finances so bad?

The UK continues to borrow heavily to fund a shortfall in government spending.

Taxes have risen since 2021, but spending has outpaced revenue to meet commitments on health, defence, pensions and inflation-linked welfare payments.

Former chancellor Jeremy Hunt made a bad situation worse when he sanctioned expensive cuts to national insurance contriibutions and paid for them by slashing public investment and freezing departmental budgets already hit by 14 years of austerity.

Some experts say we already knew the scale of the problem – are they right?

It’s not true. The government’s independent forecaster, the Office for Budget Responsibility, lays out each year the extent of the public spending shortfall according to what it is told by the Treasury. But Hunt gave a false picture of the government’s likely commitments, prompting the OBR boss Richard Hughes to declare that the OBR assessment last year read like a work of fiction .

One instance illustrates how departments are being asked to cope with unfunded commitments. Public-sector pay review bodies have recommended teachers and some NHS staff receive a 5.5% increase this year, well above the 3.2% inflation figure in March and the current 2% rate of increase in the consumer prices index. An across-the-board rise in public-sector pay would mean the salary bill rising by up to £10bn.

A freeze on the Home Office budget took no account of the need to revamp the border control and asylum systems to cope with the extra number of people arriving in the UK.

Related: Rachel Reeves says the UK’s public finances are in a dire state – but here’s why I’m cautiously optimistic | Larry Elliott

Will Labour’s plans briefed so far make a difference?

Gone are the wild and unfunded promises of public investment during the Boris Johnson years and the reckless tax cuts under Rishi Sunak. Labour’s approach will be based on a sober understanding of what cash is needed to maintain the current infrastructure – from mending crumbling hospitals to repairing leaky school roofs – while also plotting improvements that are affordable.

The cash set aside for a national wealth fund and GB Energy – a body to support the building of wind farms and solar-panel arrays – is modest by international standards. However, rushing to spend public funds quickly has always proved wasteful.

Is there anything else they could do?

Rachel Reeves has boxed herself in with two commitments. First she has promised to recognise on the government balance sheet multi-billion-pound losses incurred by the Bank of England (which the US Treasury ignores) and to adopt Hunt’s budget rule that forces her to reduce the government debt as proportion of national income in the fifth year of the official forecasts.

Ditching both would free up large sums of money to spend on the key to driving growth – public investment.

• Phillip Inman is economics editor of the Observer and an economics writer for the Guardian