Leading indicators: could change in fiscal rules unlock funding for 1.5 million new homes in the UK?

Leading Indicators is a column written by RICS chief economist, Simon Rubinsohn. This month, could taking a balance sheet approach to fiscal policy help the UK government realise its housebuilding ambitions?

In the UK, the government has committed to building 1.5 million new homes over the next five years.  Data from the RICS construction monitor shows sentiment in the private housebuilding sector remains cautious, despite the rhetoric about lifting supply. Meanwhile, the fiscal rules as they currently stand provide little scope for the public sector to help tackle the housing challenge. A change to the way government considers assets on its balance sheets – specifically, those providing a long-term return for taxpayers – could provide more latitude for action.

UK Chancellor’s rules designed to keep debt on a downward path

The new Labour government continues to draw attention to the fiscal black hole of £22bn that, it argues, is the legacy of the previous Conservative administration. Prime Minister Kier Starmer has warned of ‘tough choices’ ahead, while Chancellor Rachel Reeves talks of ‘difficult decisions’. Against this backdrop, speculation is rife about which taxes will be raised in the 30 October 2024 Budget to ensure that the fiscal rules are met.

To recap, the two current rules the Chancellor is promoting are that:

a)       government should aim to balance current spending and revenues in any year and

b)       debt as a share of GDP should be falling at the end of the five-year forecasting time horizon.

This provides a little more flexibility than parameters in place when Jeremy Hunt was the Chancellor; at that point, there was no distinction between current and capital spending in the first rule. But the overarching need to ensure that debt is on a downward trajectory in the medium term imposes a constraint irrespective of where the expenditures are allocated.

Could using net worth as a tool in fiscal policy help balance public finances?

Inevitably, against this backdrop, attention has turned to alternative ways of sourcing funding for some government initiatives. Speculating about redefining public debt to exclude Bank of England bond portfolio losses is one element of this. Another is tied up with the recently announced review of the pensions system. Meanwhile, there has also been some discussion as to whether the narrow focus on the current budget and public sector debt should be enhanced by an estimate regarding the impact on public sector net worth of any policy measures that are implemented. And it so happens that the Chancellor in her speech at the Labour Party conference raised the prospect of amending the fiscal rules to move on as she put it ‘from just counting the costs of investment in our economy to recognising the benefits too’ albeit steering clear of mentioning net worth. Alongside this, the OECD in its latest assessment of the outlook for the UK economy also addressed the issue suggesting that the Treasury could take account of ‘what the government owns as well as what it owes’ to get a broader understanding of the debt picture.

The concept of focusing on public sector net worth is, of course, not a new story and is more importantly not necessarily a free pass to open the spending spigots. Analysis in the commentary How accountants can help save public finances shows that net worth is currently negative in virtually all G7 economies including the UK to a greater or lesser degree, Canada being the exception. That said, the authors do note ‘the current picture might not be quite so bad. Governments are notoriously poor at accounting for their assets, especially property holdings, which are often valued (if they are valued at all) based on their historical cost or current use rather than their market value’.

The Institute for Fiscal Studies also looked into the issue last year in its Green Budget 2023. They ran through some of the benefits and costs of using net worth as a tool for fiscal policy. On balance, they concluded ‘that the benefits of moving to balance sheet targeting might be insufficient to justify the potential costs involved’. However, they added that ‘there is, nonetheless, a strong case for considering public sector net worth as part of a broader suite of fiscal metrics – particularly when assessing asset sales and purchases, and other balance sheet policies’.

Is the government’s housebuilding ambition realistic?

Which brings me to the issue that I want to focus on in this commentary, the Labour government’s commitment to building 1.5 million new homes over the lifetime of the parliament, spearheaded by planning reforms and the release of ‘grey belt’ land. The broadest measure of supply (in England) is recorded annually through the net additional dwellings statistics, with the most recent figure showing 223,400 new units added in the year to March 2023 (the figure for the year to March 2024 will be published in November).

For the record, the highwater mark for this series was 248,590 in 2019–20 (albeit it only goes back three decades). Meanwhile, the narrower but more timely housing completions data, which excludes conversions and change of use, shows that just 153,800 homes were finished in the 12 months to the end of March 2024. Critically, both measures highlight the yawning gap between where we are currently in terms of delivering homes and the ambitions of the new government.

Private sector outlook highlights limited capacity to complete 1.5 million new homes

A key challenge, even with a fair wind on planning reforms, etc., is the ability and willingness of private housebuilders to ramp up supply in a manner that would come close to the government’s target. Recent results from the sector like those of Barratt Developments are inevitably still capturing the downbeat mood in the market over much of the past year, and there is a sense that the environment will improve over the coming years. Nevertheless, even with a tailwind, getting to 300,000 housing completions on a sustained basis is going to be difficult.

One reason for this is a capacity issue within the construction industry. The Q2 RICS UK Construction Monitor suggests that, despite the weak trend in housebuilding specifically, labour shortages continue to be reported by around half of respondents (with more drawing attention to challenges in recruiting specific professional and trades skills). Moreover, given the ageing demographic of those working in the sector, the picture is likely to worsen as things stand over the coming years.

Could a balance sheet approach support the financing of affordable homes?

A second reason is, as others have discussed, that the primary aim of housebuilders is unsurprisingly to return a profit for shareholders. While the sought after stronger economy and potentially lower interest rates will create a better environment for new homes sales, the private sector has never got close to 300,000 new dwelling completions even with the assistance of the Help to Buy subsidy. Meanwhile, the biggest gap in supply is arguably in the affordable segment of the market, which typically is only a small part of the housebuilders’ offer and unlikely to increase without additional grants to support it.

This is where thinking about fiscal policy from a balance sheet approach might be particularly helpful. The last time total new home completions (from both private and public sector) exceeded 300,000 was in 1969–70 when government building numbers almost matched those from the private sector. Given this, I am beginning to think that there is a strong case for looking at the construction of assets with a long-term return for taxpayers (in this case in the form of rental income) in a different way from other forms of expenditure.

Building homes and adding to government assets

As I draw to a close, some may be looking back to the Liz Truss experiment and wondering whether any lessons were learned from that period. I would first draw a distinction between large unfunded tax cuts and expenditure on assets that can deliver a long-term return. Second, there is a critical issue in how initiatives that raise borrowing levels, when fiscal deficits are large, are managed. The sidelining of the Office for Budget Responsibility and Bank of England by Liz Truss and her Chancellor at that time in the face of a such a significant policy shift arguably compounded anxiety in financial markets. Whether such a debacle would have followed if a more measured conciliatory approach had been pursued, remains a point of contention.