Ministers say they are committed to a ‘son of PFI’ but the Budget made plain that progress on developing new infrastructure funding models has stalled
In 1943, George Orwell fretted that ‘the very concept of objective truth is fading out of the world’ – a prospect that scared him more than the bombs that were falling as he wrote. I felt much the same on Wednesday as I watched the chancellor give his Budget statement. All chancellors mislead the public of course. And the Budget speech is not much more than a piece of political theatre – especially now that most of its economic substance is well trailed beforehand. I was nonetheless taken aback when George Osborne stated his ‘commitment to deal with Britain’s record debts’ – a puzzling phrase when the country’s debt to GDP ratio is well below the historical average.
For a chancellor to distort the truth for political gain is a familiar thing. But for a Budget speech to include a lie that could well damage a stagnant economy seemed to me rather unusual – the sort of thing that senior politicians ought to avoid for fear of drawing criticism. In fact, it was ignored (or accepted as self-evidently true) by most reporters.
On occasion, the dishonesty in the chancellor’s message was reflected in some rather tortuous grammar. We were told, for example, that the government ‘have eliminated the structural current deficit by 2016/17’. Now, it may be possible for a government to plan to eliminate the deficit by 2016/17; it might even forecast (with some authority) that it will do so; but to achieve today a target for several years hence is a feat beyond even the cannier mandarins of Great George Street.
Deficit reduction remains, of course, the central political project of this government. I say a political task because the government does not seem very interested in deficit reduction as an economic priority. As David Cameron reminded us earlier in the week, the government is not averse to adding to the country’s debt liabilities so long as they do not threaten the Treasury’s fiscal rules. Ministers are proposing a new plan to engage sovereign wealth funds to finance projects on the road network. At the same time, direct capital spending is due to fall year on year until 2017.
Off-balance sheet borrowing is harder than it used to be, however. The structural problems faced by banks mean that most are unable to lend, and even when loans are made the interest rates are high and the terms restrictive. So ministers want non-bank institutions to fill the gap – putting less of their money into government gilts (which cost the Treasury little but have an immediate impact on the fiscal targets) and more into infrastructure directly (which will cost the public purse much more, but won’t trouble the bean counters at the Office for National Statistics, at least for a parliament or two).
Actually, the Budget papers make clear that little progress has been made on this agenda. A new ‘pension infrastructure platform’ has been established, run by UK pension funds, and the government hopes it will make the first wave of its investments next year. But the National Infrastructure Plan published last November envisaged some £170bn of new investment over the three years to 2015, and this now looks very ambitious.
The Treasury says that a separate group of pension fund investors has presented proposals for increasing pension plan investment in infrastructure ‘during the construction phase’. The original plan was to have something much more concrete by the time of the Budget. Pension fund investment will be required if a new ‘son of PFI’ model is to be developed, which the Treasury has promised to have up and running by the summer. And there is some urgency here. Ministers like Education Secretary Michael Gove have announced major building programmes. But with capital budgets collapsing there is no realistic means of funding them.
The changes required to make a PFI-like structure work in a post-banking environment are in the hands of Geoffrey Spence, the head of the Infrastructure UK team at the Treasury unit. A former adviser to Alistair Darling (and a major influence on Treasury policy during the most dangerous days of the post-Lehman crisis), he is well qualified to do this but his task is incredibly complex. Pension funds like to invest in standardised assets that are more or less riskless. They don’t have the expertise or resources to look at individual deals, ascertain the credit risk is and ensure that it is appropriately managed.
In truth, infrastructure projects in the UK experience very low rates of default, but credit ratings normally fall just short of that required by pension funds. There are two key ways of enhancing those ratings. One is to shift credit risk to the government – for example, by providing government guarantees that debt investors will get their money back after projects or built, or ensuring that the state bears the first losses on defaults. There has been a lot of debate about this over the last year. But with more risk borne by the public authority, it becomes more likely that investment ends up scoring on public budgets and the national accounts. So guarantees are taboo.
The other option is to shift risk to the sponsors of projects – the investors that put in the equity capital and have a strong incentive to ensure projects are well managed because their cash flows are at risk. This appears to be the option favoured by Spence and has clear advantages from ministers worried about missing their fiscal targets. But increasing the ratio of equity to debt in funding the cost of projects might prove to be expensive since equity normally costs more than debt (whatever the finance theorists might say).
In his Budget speech, the chancellor boasted about historically low interest rates on government gilts. Last summer, the Treasury select committee, which I was advising, asked the chancellor to use that advantage to expand direct investment , and reduce reliance on expensive and inflexible forms of investment. Officials read the report and provided a balanced response – and they committed to a ‘fundamental reform’ of the PFI model. That much-maligned acronym is on the way out, but the commitment to off-balance sheet financing remains. I am reminded of another Orwell quotation: ‘What can you do against the lunatic who is more intelligent than yourself, who gives your arguments a fair hearing and then simply persists in his lunacy?’
