The government is stuck in a spending straitjacket of its own making. However, borrowing for investment will help to sustain future workload for construction, writes Simon Rawlinson of Arcadis

Simon Rawlinson New

Simon Rawlinson is a partner at Arcadis

You know a government needs a good news story when it announces a boost in pothole spending. Labour’s latest salvo, a cool £1.6bn, has been accompanied by both an extra carrot and a stick – with £500m being allocated to councils depending on results.

Overall, capital spending is expected to total around £130bn next year, so the pothole allocation is a significant sum, and a welcome boost to hard-pressed highways contractors. But, in the context of an economy worth £2.8 trillion, it’s an exceedingly small lever.

However, looked at from another perspective – that of revenue spending – it is very generous indeed. Following the latest growth downgrade, unprotected departments including the Home Office, Ministry of Justice and Department for Environment Food and Rural Affairs will see real-terms cuts in day-to-day spending in future and all departments have been told to cut their administrative costs by 15%.

>> Also read: Government ups capital infrastructure spending by 2bn a year in drive for growth

If cuts to welfare and a tax avoidance crackdown do not deliver results, or if growth slows as a result of tariffs, matters could be even worse. All the way to 2030, spare billions will be exceedingly difficult to find for current spending priorities. 

Given this outlook, it is hardly surprising that preparations for the spring statement were so gloomy. Worse still, what positive news there was in the October Budget has already been discounted.

So much focus has been placed on forthcoming national insurance hikes and the chancellor’s headaches about fiscal headroom that the flexibility provided by the “borrow to invest” rule was easy to overlook. 

Encouragingly, even as high borrowing costs and trade wars have blown Rachel Reeves’ plans off course, some of that legacy remains. And, better still, construction will be a beneficiary. So, as the chancellor made her welcome announcement of an additional £2bn per annum capex, she had to remind us that overall capital investment will increase by £100bn between now and 2029/30.

It is a generous increase which has proven easy to forget given current headwinds and the fact that the projects have not come through yet. Capital spending is not due to ramp up until next financial year, new procurement rules are delaying buying decisions and the clarity to be provided by a three-year comprehensive spending review (CSR) is still in the works. 

Combined with a regularly updated CSR, the operation of the investment rule should provide construction with the certainty for forward planning that it craves

The prospect of sustained growth in capex spend is an intentional consequence of the chancellor’s “ironclad” fiscal rules. The investment rule requires that public debt – now defined as net financial debt – falls in 2029/30 compared to 2028/29 as a share of the economy.

Helpfully, the chancellor has more headroom – £15bn – and the rule is less exposed to the negative effects of funding costs. Combined with a regularly updated CSR, the operation of the investment rule should provide construction with the certainty for forward planning that it craves.

However, how spending is allocated in the forthcoming CSR is very much up for grabs, as the “iron chancellor” is forced to pivot to armour and other defence material. She took the opportunity last week to announce a large upgrade in defence investment equivalent to £6.4bn per annum.

This will be a big part of the move to get defence spending up to 2.5% of GDP by 2027/28. This decision alone will change the profile of total investment growth over the next three years, increasing by 5% next year. 

That sounds great, but as an illustration of how defence spending can absorb existing resources, the Office for Budget Responsibility’s (OBR) latest report provides a very telling analysis of overspend and underspend. Defence is currently projected to overspend its £20bn-plus capital budget by 15% as the costs of the £6bn Annington Homes deal are absorbed.

By contrast, the Department for Energy Security and Net Zero is currently on track to underspend by over £2.5bn in the current year, and they are unlikely to get this money back.

Government departments routinely underspend their Capex allocations by around 6% per annum according to the OBR, equivalent to £8bn. Could it be that, like pothole budgets, departmental allocations will also be informed by results as the UK rushes to re-arm? Until we see the full detail of the CSR and the approach to be adopted by the  National Infrastructure and Service Transformation Authority (NISTA) in approving projects, the industry cannot really be sure. 

Whatever the outcome of the CSR, there are some issues highlighted in the OBR report which suggest that, even with a generous settlement, industries focused on capital spending need to keep on guard. The first is growth, which has seen a deep downgrade this year.

Future forecasts exclude the impact of tariffs and are dependent on an ambitious productivity growth assumption as well as the newly-defined contribution from Labour’s housing revolution. If the rate of GDP growth falls below forecast, then the size of the borrowing pot relative to GDP will fall.

The second is inflation. The government’s investment boost is being delivered alongside ambitious plans for housing and network infrastructure – the UK risks being over-programmed, with investment being crowded out through lack of access to industry capacity and higher prices.

Servicing the debt this year has reached a post-war high of £105bn, 4.3% of GDP and equal to the full increase in capital investment planned over the parliament

The third is our “cast-iron” fiscal rules. Headroom remains tight and, if things don’t go to plan and investment does not deliver outcomes, those rules could change again. There have been 10 sets of fiscal rules since 1997.

Ultimately, the basis of our investment rule – the size of the national debt pile – is likely to prove to be a sticking point in the government’s investment strategy. In December 2024 debt totalled £2.7 trillion, equivalent to 98.1% of GDP.

Servicing the debt this year has reached a post-war high of £105bn, 4.3% of GDP and equal to the full increase in capital investment planned over the parliament. It will only require another 0.6% increase in interest rates to wipe out the government’s extra headroom.

If that point is reached again, can a government really maintain its discipline to borrow only to invest? Can it find more spending cuts? Will business and the wider public be prepared to pay more in taxes? If and when the next crisis comes, we will find out how ironclad the fiscal rules really are. 

Simon Rawlinson is a partner at Arcadis