Delicate decisions

Posted on April 25, 2024

Liz Truss got one thing right. For years, Treasury orthodoxy has been stifling growth and investment in the UK. Her solutions may have been off-the-wall but the premise stands.

And, given the Labour Party’s approach to date, clarified by Rachel Reeves in her Mais address in March, there is a danger this very orthodoxy may undermine the Labour Party’s main goal – economic growth through increased incomes and revitalised public services.

Yet there are measures available to free up investment without destabilising the balance sheet. I am making four proposals.

The first has been taken up by Reeves. She has dismissed the default Treasury assumption that the public sector – with the possible exception of transport – plays a non-productive role in the economy. Private good, public bad, even to the point that yet another pizza takeaway in a shopping parade is treated in more favourable fiscal terms than investment in housing, health or education.

There is a broad recognition that might be penetrating the deeper reaches of the Treasury: specific types of public sector investment are a prerequisite to private sector growth, not a brake on it.

Second proposal: Reeves says she wants to separate investment from day-to-day spending. But she does not address what precisely ‘investment’, and by definition, ‘day-to-day’ spending, are.

The Treasury rules use conventional accounting practice which treats non-tangible spending as revenue, implicitly unproductive, and not to be paid for by borrowing, whereas spending on tangible capital is seen as investment and therefore eligible for funding by borrowing.

This may have applied to some degree in Victorian times when machines added most of the economic value and people were interchangeable. In a modern economy, however, skilled people add most of the immediate value. And we know vocational skill shortages are holding back the economy and levelling up. But our accounting systems still treat skills investment with a level of disdain and tangible capital with excess respect. Hence we have the ‘boys with HS2 toys’ squandering billions of pounds set against a criminal neglect of the further education sector over the past decade.

Public sector investment in targeted skills should be capitalised as an investment that will pay back, just as intangible R&D investment can be capitalised on a private firm’s balance sheet.

This may mean stretching another fiscal rule – reducing national debt as a proportion of GDP after five years. However, as Andy Haldane, former chief economist at the Bank of England has argued, this is inevitable if any progress is to be made at all.

Labour recognises a key stimulus for growth is housebuilding. It also wants to build more social housing, but has failed to say how. So, my third proposal relates to a mechanism for addressing this gap.

Unlike with green investment or investment in skills, where payback is built on ‘hope value’, investment in social housing provides a direct and obvious return via specific rent streams and a virtually guaranteed increase in asset value – provided houses are not subject to right to buy.

On this basis it is perfectly legitimate to exclude social housing investment from the public sector borrowing limits. This exclusion is the case in many continental countries and it is perverse for the Treasury not to take advantage. It is also perverse and a brake on growth by the Treasury not to account for assets when measuring public debt. This brings me to a revenue resource that has been grossly squandered because of these failures.

Currently, the Government is spending £31bn a year on housing allowance. This funding goes straight to private sector landlords with no capital return to the public sector. Moreover, the average rent this £31bn supports is often twice that charged by the local council.

In 2019, Nottingham City Council and Capital Economics both modelled the cost of building homes with the funds that councils transferred to housing allowance. They concluded upfront funding was needed short-term for servicing transitional borrowing but there would be payback over about 30 years. A reduced call on housing allowance and the state would hold an asset usable beyond the payback period. Some of the factors have changed, but there is still enough flexibility in the model to make it work.

The fiscal rules are not irreversible laws of physics. They are lines in the sand drawn by the Treasury to control public spending on the assumption public spending is consumptive. The same subjectivity applies to the failure to recognise that training is a long-term investment on a par with transport infrastructure.

The squandering of millions on housing allowance is not dictated by irreversible laws of the market but a conscious choice to count social housing as public borrowing.

These are all opportunities for a cash-strapped Labour Government to increase investment and for local councils to reclaim their role in regeneration and levelling up. But it needs courage and judgement to stand up to the Treasury.

Liz Truss had courage, but no judgement. Labour and Reeves will need both.

Read the full article in the MJ, here.