Not so fast
16 September 2010
By Mark Hellowell
Ministers have hugely ambitious infrastructure plans. The only problem is they don’t intend to pay for them. With capital spending being cut at an unprecedented rate, can the private sector step up to the plate? Mark Hellowell investigatesThe coalition government wants £50bn a year to be invested in infrastructure between now and 2030 – but it is becoming clear that little of this will come from the state.
Bold plans for new roads, high-speed rail and renewable energy will be included in an infrastructure strategy, to be published after the Spending Review in October. At the same time, the effort to make up for generations of under-investment in social infrastructure will continue, with new hospitals and schools.
Chancellor George Osborne, speaking on the Budget in June, said: ‘We have faced many tough choices about the areas in which we should make additional savings, but I have decided that capital spending should not be one of them.’
He went so far as to criticise previous Conservative governments for cutting investment to balance the books, saying: ‘I think an error was made in the early 1990s when the then government cut capital spending too much.’
To applause from the Tory benches, he added: ‘There will be no further reductions in capital spending totals in this Budget.’
This section of the chancellor’s statement was partly true – but wholly misleading. In reality, capital spending will fall by an unprecedented 59% over five years, from £49bn in 2010/11 to £20.6bn by the middle of the decade.
As the chart overleaf shows, this is a faster rate of reduction in capital expenditure than has occurred at any point in modern history. Even as a percentage of national income, the reduction in capital spending that occurred in the early 1990s was significantly less radical than that now being planned.
The 2014/15 projection is also 0.2% of gross domestic product (or £2.4bn) lower than that outlined in the Labour government’s final Budget, despite Osborne’s implication that there would be no new capital cuts.
This unprecedented slashing of budgets has led to an outcry from an unusually broad range of voices. Trades Union Congress general secretary Brendan Barber said: ‘Companies that lose public sector contracts will stop buying goods and services. The net result is a big loss in business and consumer confidence.’
And business leaders have urged the government to make ‘smart choices’ in its deficit-reduction plan – to return capital spending to recent levels and ‘appreciate the consequences of not giving infrastructure the attention it deserves’. CBI deputy director general John Cridland said last week: ’Just as we’re absolutely sure about the need to reduce the deficit, there’s also a certainty that failing to prioritise infrastructure spending would be short-sighted in the extreme.’
But the government is anticipating a massive transfer of responsibility for financing public infrastructure from public to private sector. Part of this shift will involve a continued role for the Private Finance Initiative, despite pre-electoral criticism from the Conservatives (Osborne called the model ‘failed and discredited’ last year).
According to figures published by the Office for Budget Responsibility alongside the Budget, the private sector is due to spend some £6.1bn under signed PFI deals between 2010 and 2012. And further deals, with a capital value of £10.1bn, should be in the final stages of negotiation by the end of that period.
In Labour’s final days of government, ministers had finally come round to the idea of creating a degree of pluralism in funding methods for public sector investments, undoing the much-criticised PFI monopoly.
In the Northeast, a new £450m hospital was planned to serve Hartlepool, Stockton on Tees and parts of Easington and Sedgefield. It was developed on the basis of public capital – the first since 1992 – with fixed-price construction contracts and a small amount of risk capital from the private sector. The idea was, at the very least, worth trying. In principle, it could have provided contractors with strong incentives to complete the project on time and on budget – the main benefit of the PFI – but with a significantly lower cost of capital.
Certainly, the annual charges the North Tees and Hartlepool NHS Foundation Trust would have paid for the project were very low compared with payments being made for PFI hospitals of a similar size, many of which are now struggling financially.
However, in June the Treasury announced that it had cancelled the project, while approving several others that were proceeding under the PFI. The trust plans to submit a revised business case to the Department of Health in 2011 – this time on the basis of a PFI scheme.
However, longer term, it is unlikely that the PFI will play anything more than a supporting role in infrastructure investment. The reality is that this financing method is badly suited to the service privatisation and marketisation models planned by the coalition government.
At the Department of Health, for example, Andrew Lansley wants to create from the NHS ‘the largest and most vibrant social enterprise sector in the world’, according to the health white paper published in July. Provider organisations within the NHS are to operate in a market context much like that of the utilities – subject to economic regulation by an independent agency rather than the control of central government.
Consistent with this, the government is to step back from playing any part in capital financing, which would amount to the state ‘picking winners’ or at least entrenching existing patterns of provision. As the white paper points out: ‘Since the first foundation trusts were authorised in 2004, none has taken a loan from the private sector for a significant capital investment.’
Now, foundation trusts are to be liberated from their borrowing constraints so that they can invest directly in improved facilities and equipment – rather than through complex and costly PFI deals. Meanwhile, private sector providers – which will play a more significant role in NHS provision than previously – can bring along their own capital, sourced however they like.
The borrowing constraint will be affordability, and the amount of directly borrowed private finance that can be raised will depend on prices imposed by regulator Monitor. What rate of return on capital will be factored into the price is not yet known.
Turning to schools, following the cancellation of Labour’s £40bn Building Schools for the Future programme, there is now a review of schools capital procurement, led by DSG International boss Sebastian James.
Preliminary conclusions are expected to be finalised sometime after the Spending Review. Building Schools for the Future was, in the main, a part of the PFI programme. Its cancellation indicates that there is little enthusiasm for the model in the context of the broader educational reform agenda.
As in health, that makes sense. A system built on markets and choice probably has little role for the PFI, which is better suited to a more stable planning environment. If, as intended, all schools become academies, the role of local education authorities will be marginalised, and authority-wide structures would no longer make much sense. Free schools, as social enterprises, might have access to new sources of capital, as foundation trusts do.
In the meantime, the coalition can bet that the current furore will die down, and ministers will get some of the credit as the new schools commissioned under Labour come on-stream.
As for economic infrastructure – transport, telecommunications, energy and water – it is clear that private finance will be overwhelmingly dominant, not least because most of this sector is already privatised.
And some areas that were in the public sector might not be for much longer. A Freedom of Information response reveals that, before the election, Treasury officials were advising ministers to pursue ‘user pays’ funding models for areas such as roads and waste management facilities. Since then a team in the Treasury has been developing these ideas. In light of the coalition’s focus on deficit reduction, ministers are likely to be sympathetic to such models, despite the controversy they would inevitably generate.”
More generally, the Spending Review is expected to confirm plans for 13 new transport projects, estimated to cost £29.8bn over five years, with £14.3bn contributed by the private sector. New high-speed rail links will account for a major chunk of this.
However, perhaps the biggest investment requirement in the UK concerns renewable energy. While
there is a broad political consensus that a Green Investment Bank is ‘a good thing’ (plans for such an entity were in the manifestos of all three of the main parties), there is an increasing degree of tension within the coalition about what form this should take.
The LibDems have always supported a maximalist position on the bank, regarding it as a key mechanism for correcting failures in the capital markets.
Financiers have so far failed to find a way of getting institutional investors such as pension funds into the infrastructure market, despite the stable, long-term returns associated with it.
But some pension funds are keen to get involved – including local government funds. The Local Government Association is considering proposals for local authority pension funds to club together to provide equity and debt for PFI projects. This is aimed at creating what LGA documents describe as ‘a more liquid, efficient and competitive PFI investment market’.
But the Conservatives, with the backing of some prominent voices in the infrastructure policy-making community, are reluctant to use state intervention, which they associate with market distortion, picking winners and crowding out private finance.
At ministerial level, the key protagonists in this debate are, on the LibDem side, Business Secretary Vince Cable and Energy Secretary Chris Huhne, and on the Tory side, George Osborne.
The LibDem manifesto outlined plans to sell the Tote, student loans and the Channel Tunnel Rail Link to provide capital for the new bank. This institution would ‘direct’ finance to wherever it was needed – not just in the renewables sector but across the infrastructure piece.
A similar plan was launched by then chancellor Alistair Darling in Labour’s final days. But Andrew Rose, head of the Treasury’s Infrastructure Finance Unit, says that is now ‘the policy of a previous government’ and is definitely ‘not on the agenda of the current government’. The public assets are still to be sold, but the proceeds will go towards reducing the deficit instead.
Some days after Rose’s comments, Cable and Huhne wrote an article in the Independent stressing the role of government in supporting infant technologies and encouraging research.
Officially, however, the coalition is considering ways of raising equity through commercial banks, and seems to be considering a much more marginal role for the Green Investment Bank generally – perhaps as an equity re-investment fund rather than as a bank per se.
As Mike Gerrard, former Partnerships UK director and now Chief Executive of the Local Partnerships agency, states: ‘The Treasury and the public sector is not good at declaring market failure.
‘Plan A is for the market to deal with the financing challenge. That is absolutely where we want to be. Things would have to change further in some fundamental way before we didn’t think that was the right way to go.’
But in advocating a greater role for this quasi-state body, the business secretary is pushing against a party that is suspicious of state action and a bureaucracy that is minded to leave things to the capital markets wherever possible.
Infrastructure policy is proving to be one of the thorniest areas for the coalition partners to work through, exposing as it does their very different views on the state’s role in the economy.
The framework for government plans will be clearer when Infrastructure UK – the Treasury body which leads government policy on capital investment – publishes its new strategy alongside the Spending Review in October.
Whatever the framework looks like, it seems unlikely to please everyone around the Cabinet table.
Mark Hellowell is a lecturer at the School of Social and Political Science at Edinburgh University