Navigating a no-growth Budget

Anyone looking for increased government investment in the autumn Budget was always likely to be disappointed. Last summer’s comprehensive spending review had already done the heavy lifting, raising capital investment in real terms by over 3% per annum by the end of the parliament.

So fast is the planned increase in capital spending that the Office for Budget Responsibility (OBR) expects departments to underspend by nearly £10bn in 2026/27. Construction might have had enough investment announcements, but it still needs to be confident that allocated funds will be spent as planned.

This is starting to happen. Latest data from the ONS has shown that government investment is on a rising curve, even as consultants and contractors flag that programmes are delayed. Output for the non-residential new-build segment was up by over 20% year on year in Q3 this year while both housebuilding and commercial building shrank. Currently, it is the private sector that needs support.

Readers will now be familiar with the analysis that the autumn Budget was focused on the priorities of politicians and bond holders over the interests of tax payers and business. £26bn of additional tax has funded additional spending totalling £11bn pa by 2029/30 and will increase fiscal headroom to a more comfortable £26bn.

Unfortunately, due to many factors, some of which are outside the control of the government, sustainable growth feels like a distant dream

This has not been achieved by fiscal drag alone. Measures targeting business investment including the removal of Capital Gains Tax relief on employee ownership trusts and changes to writing-down allowances on investment will extract over £2.5bn in additional tax per annum by 2026/27.

With business being taxed further, it is reasonable that government policy will maintain the conditions that support investment. It has intervened for infrastructure, underwriting investment in Sizewell C with a Regulated Asset Base model for example, but in the commercial and residential sectors, where risks are more predictable, growth is the answer.

Unfortunately, due to many factors, some of which are outside the control of the government, sustainable growth feels like a distant dream. If the UK does meet its GDP growth mission target, it will only be because the performance of other G7 countries is even worse.

The OBR has not only downgraded its growth forecasts to 1.5%, but it has also assessed that recent Budget measures will have no material impact on growth. Based on the OBR’s latest assessment, residential and business investment will fall for at least two more years before staging a recovery in 2029/30.

By contrast, consumption – the beating heart of the economy – will fall at an accelerating rate throughout the forecast period, cancelling out any initial gains from net trade or government activities.

The main trigger for the downgrade is productivity growth, cut by 0.3% to 1% per annum. This has been flagged for months, well in advance of the Budget, reflecting a long-standing, deeply-rooted problem.

No additional measures have been brought forward in response to the downgrade. The government believes that planning reform and infrastructure investment alone can unpick the puzzle.

Business has a role too of course, but the private sector growth engine needs fuel – increased real earnings, increased return on investment. The OBR’s assessment of the headwinds that the private sector faces are hard to ignore.

For schemes that are viable, attracting the industry capacity to build them will become increasingly challenging to find

Not only are returns on capital forecast to fall from 12.5% to 11%, but real household income could grow by no more than 0.25% per annum over the period, squeezed by a combination of inflation and increased taxes.

This leaves private development in a difficult position. Demand is likely to continue to be below par, even as central government rolls out its ambitious investment plans – growing at 3% per year. For schemes that are viable, attracting the industry capacity to build them will become increasingly challenging to find.

This is the phenomenon of “crowding out”, where the scale of opportunity associated with public sector programmes diverts resources including capital and supply chain resources away from commercial investment, creating scarcity and pushing up costs. The OBR examined this issue in considerable detail in 2024, concluding that both output and the value of private sector capital stock would decline.

In practical terms, private sector developers are increasingly competing with the public sector for contractor capacity. The government has the advantage of long-term funding which can support a steady stream of workload across schools, hospitals, defence and more. It can appoint collaborative frameworks that reduce the cost of winning work and can potentially pay more to deliver the wider benefits of social and economic infrastructure.

Clients have some control. If teams can succeed in delivering workable business cases, projects will proceed. No wonder the public sector client is in pole position to become the client of choice.

Private sector clients, facing deep and persistent challenges associated with demand, affordability and viability, can offer their supply chain far less certainty, lower profitability and potentially a higher risk profile, making development a more difficult and more contentious proposition. Real estate investment trusts are reported to be retreating from direct development to focus on asset management as a better deployment of capital.

While the public sector can shape policy to move its key programmes forward, private investors have been left exposed to the vagaries of supply and demand

One outcome of this retreat from development, being crowded out by the public sector, could be a growing reliance on a smaller, more flexible, and competitive but ultimately less well-funded supply chain, further increasing risk. In turn this could trigger a negative feedback loop – fewer projects, reduced industry capacity and ultimately less of the growth that government has been so desperate to promote.

The key point from the no-growth Budget is that market conditions are unlikely to change quickly. While the public sector can shape policy to move its key programmes forward, private investors have been left exposed to the vagaries of supply and demand.

Developers, particularly in the middle tier, need to plan for nimbleness and adaptability, accessing new sources of industry capacity, energy and ingenuity to deliver the opportunities that they find, even as the state’s role in construction markets expands.

Simon Rawlinson is a partner at Arcadis