From an entitlement state to an investment state

About 50 years ago, Britain stopped investing in its future. The consequences have been stagnant incomes, runaway entitlement spending, and the squandering of future growth.

Since 1955, the level of government spending has remained very consistent. It has consistently averaged around 40 per cent of GDP per annum. While this average has been tested in some years, there’s been no secular change in the level government spending over the long run, nor in the amount spent on public services, debt, and depreciation.

What has changed is how much is allocated to two other items of government spending. Spending on public investments such as buildings, infrastructure, and utilities has collapsed, and spending on entitlements such as pensions and benefits has soared.

• From 1955 until 1975, entitlements averaged 6.4 per cent of GDP while public investment averaged 5.3 per cent. 
• From 1976 until 2024, entitlements rose to an average of 10.2 per cent of GDP and public investment fell to an average of just 1.7 per cent.

In short, what we used to spend on roads, railways, power stations, homes, hospitals, and schools has been diverted to direct cash transfers to people.  

This is a huge problem because public investment is a key driver of economic growth and productivity. Cheap energy, efficient transport, and good infrastructure are crucial to economic growth. This is because it immediately helps individual workers become productive, while also improving the return on private investments that are also key to improving productivity.

Productivity is not an abstract question. The average value produced in an hour of work is what determines national output, wages, and the tax base. And this transition after 1975 to what we call the entitlement state has been dire for productivity. In 2024, British output per hour was £45.20. By our estimates, the post-1975 falloff in public investment has reduced productivity growth by 1.37 per cent per annum. In a world where this hadn’t happened, 2024 output per hour would have stood at £87.11. 

In terms of the national economy, total British output in this more productive world would stand in the order of £5tn rather than the £2.5tn today. The economy is half the size it might have been.

To understand what this means for the average person, we can look at incomes. If we assume this more productive alternative Britain had the same output-to-wage ratio as our world, we can estimate how much the median full-time worker would take home in salary. Whereas the median 35-hour salary is £34,050 today, it would have been £65,630 in real terms had we enjoyed 1.37 per cent greater productivity growth post-1975.

Along with making us poorer, the major problem with the entitlement state is that it’s locked us into an unsustainable course of action. That’s because the heightened entitlement burden combined with low productivity growth has created a system where most households receive more in benefits than they do in taxes. 

In fact, after considering in benefits in kind alongside cash benefits, only the top three deciles of households are net contributors to the system.

This means that most households now have an electoral incentive to increase entitlement transfers. Successive generations of politicians have encouraged this, failing to adequately price in the ultimate risk of such a move and communicate it to the electorate – the long-term solubility of the public finances.

We must break this doom loop. The long-term question is not whether we can keep the entitlement state — the arithmetic of finance and geopolitics already rules that out. The question is whether the entitlement state can be unwound in such a way that preserves the basic protections of social democracy – the safety net conception of the welfare state, and care for those who are genuinely unable to look after themselves – or whether it collapses in a crisis that wipes out national wealth, scars a generation, and leaves the most vulnerable to fend for themselves.

In the SDP’s new green paper, we set out a new approach to national economic management to replace the entitlement state. We call it the investment state.

The first part of the investment state is a reallocation of government spending. Across an economic cycle, it will average 22 per cent of GDP on public services, 6 per cent on debt and depreciation, and 6 per cent apiece on entitlements and public investment. 

The second part will be a new approach to public spending. Rather than year-on-year budgets and intermittent spending reviews, we propose a new economic master department that develops and oversees the implementation of five-year economic plans to coincide with parliamentary terms. This new Department of Economic Planning will create detailed plans at the start of a government’s term, implement clear objectives, timelines, and lines of responsibility to oversee the plan’s fulfilment, and enjoy the ability to second its agents across government to ensure the plan’s implementation.

Owing to the greater efficiency of this arrangement – compared to our perennial issue with Treasury brain and lack of joined-up strategy between disparate projects across government departments – we believe we will be able to boost productivity growth by around 1.71 per cent per annum. This would increase productivity growth from today’s levels of 0.65 per cent, up to 2.36 per cent. 

Pricing in a ten-year transitional period and a three-year taper for new investments to come online, this would increase output per hour in 2055 from £54.23 to £79.25. 

Assuming the same output-to-wage ratio as today, our measures would increase the real median 35-hour salary in 2055 to £59,700. This is up from £41,160 under the current trend.

To achieve this, however, we will need to make cuts to the entitlement budget. To achieve our reallocation, in fact, we’d need to reallocate at least £128.2bn. While we can reduce this via a day one elimination of the foreign aid budget of £8.8bn – likely to key to the reallocation’s credibility, given the hardship many British households will need to endure in the short-to-medium run – we will still need to make significant cuts.

We have identified three entitlements that have experienced outsized growth over recent decades, and a series of measures that will produce £125bn in savings – bringing total savings up to £133.8bn. Over a ten-year taper period, we will make £12.5bn in savings per annum by:

1. Reduce spending on State Pensions by £4.9bn, effectively reducing the full New State Pension by around 3.4 per cent a year.
2. Reduce spending on Disability & Incapacity Benefits by £3.8bn, imposed by capping the amount the DWP can spend on these benefits as a share of GDP. By the end of the ten years, this cap will settle at a 1.25 per cent of GDP, requiring the development of clinician-led triage to ensure help is disbursed where it is needed most.
3. Reduce spending on Housing Benefit by £3.7bn, to be done by reducing Local Housing Allowance rates by 10 per cent per year. This will result in the virtual phase-out of housing benefit, to be replaced by renewed state housebuilding capacity.

To illustrate the power of our model, we have presented a sequence of three partial five-year plans that use just half of the entitlement savings produced to solve Britain’s chronic problem of housing undersupply.

Under our first plan, the DEP will create a system of brick-and-mortar subsidies to spur private construction under regulated development contracts — which also include automatic planning permissions for selected sites, along with a grant equivalent to 25 per cent of a development’s total costs — to encourage housebuilders to dramatically increase the construction workforce.

At a total cost of £115.8bn, this programme will raise the national housebuilding rate by around 450,000. At the end of the programme, it will result in around 1.3mn new homes built, of which 350,000 will be social housing units.

In our second and third plans, we will increasingly reallocate this larger construction workforce to social housing projects. Still using a maximum of just 50 per cent of the Department of Economic Planning’s public investment budget, this could largely solve much of Britain’s deficit in houses per capita compared to Europe. 

By the end of the third plan, we would have built a total of 4.3mn homes — 1.5mn private, and 2.8mn social — with two-thirds built in Southeast England and London. Altogether, these three plans would cost around £720bn over fifteen years. Owing to greater productivity from improved housing affordability, they will increase national economic output by around £230bn per year.

This illustrates the opportunity for the country by directing just half of the DEP’s newly unlocked public investment budget. It would be the tip of the iceberg — whether it be transport, utilities, industrial infrastructure, or modern hospitals and schools, our new approach would focus on improving the quality of life for the average Briton through systematically tackling all challenges facing national productivity growth.

Our approach is pro-social and pro-market. It marks an end to the zero-sum, short-term mindset that is poisoning our political life. And, critically, it is focused on the long-term: ensuring that we can pass the British inheritance on to our children and grandchildren. If that call resonates with you, you’re hearing the call to the investment state.