By Mark Hellowell
29 April 2010
All the major parties are promising big investment in infrastructure. But with private finance paralysed and cuts in public spending, where are they going to get the money from? Mark Hellowell investigates
Cleggmania aside, media election coverage has focused almost exclusively on the three main parties’ proposals for ‘tackling’ the public deficit. Given the state of the government’s current account, journalists’ fixation on fiscal policy is no surprise.
But it might well be unfortunate. A much more important question is how the UK’s economic performance can be boosted in the longer term – and that elicits a quite different answer from each of the parties. Broader economic issues have hardly scratched the surface of public attention in the run-up to May 6.
One major gap in the popular debate concerns infrastructure policy. All three main parties regard as essential huge investments in new roads, high-speed railways, telecommunications networks and renewable energy facilities – amounting to perhaps £500bn over the next couple of Parliaments.
They all acknowledge that the sums required are high by historic standards – and much higher than could be secured now from either the public or private sectors – without major institutional and regulatory changes. The fact is that the economic context could hardly be less conducive to significant increases in investment. Potentially there is a massive infrastructure black hole. But the parties differ in significant respects over how they intend to tackle this huge financing burden.
Public sector net investment is set to be reduced in real terms over the next three years – halved, in fact, from the level set out in the 2008 Budget projections. At the same time there is a shortfall of liquidity among banks and the capital markets are still risk averse. The result is that private finance is not always available in important areas of mandatory spending such as waste disposal, where European Union targets require a major move away from landfill use. Where capital can be accessed, the price is usually high and the terms are typically harsh.
How the different parties intend to address these market failures illustrates their ideological differences – particularly on the role of central government in the economy.
The Labour manifesto is effusive about the party’s commitment to state intervention. Boosting the state’s role in creating a high-tech economy, with good transport links, green energy and broadband access for all, is a main theme in its most radical manifesto since 1997. It says it is committed to the east-west Crossrail line in London and a new high-speed railway linking the capital to the North. Of the 50 steps to what Labour calls ‘a future fair for all’, improving infrastructure is the fourth.
‘The role of government is not to stand aside,’ its manifesto states, ‘but to nurture private sector dynamism, properly supporting infrastructure and the sectors of the future.’
The mechanisms for achieving this are not discussed in the manifesto, but were outlined several weeks earlier, in documents published alongside the Budget. The National Infrastructure Strategy signals a radical change in the state’s role in providing new economic assets following 20 years of relatively limited government involvement.
In a foreword to the strategy, Lord Davies of Abersoch, minister for trade, investment and small business, states: ‘The case for action is clear.
During a period of fiscal consolidation, it is important we continue to invest in infrastructure to support the recovery and stimulate sustainable long-term growth. With new demands and the majority of our infrastructure being provided by the private sector, we need to create the right market conditions and attract new sources of private investment.’
The government’s new Treasury unit, Infrastructure UK, calculates that £150bn has been invested in the economic infrastructure of the UK in the past five years, predominantly by the private sector. Spending on that level implies £300bn over the next ten years. But IUK estimates that £40bn–£50bn will be needed annually for the next 20 years at least, suggesting up to £200bn more will be needed.
With the cuts in public investment taken into account, it seems the UK faces a financing shortfall of about £250bn over the next couple of Parliaments. Following the great divestitures of the 1980s and 1990s, most infrastructure assets in Britain are investor-owned.
Yet IUK is to provide at each Spending Review an account of the country’s infrastructure needs and a list of projects that will achieve them. Its top priority is the energy sector, which requires major investment in low-carbon power stations to meet EU targets, as well as replacing ageing facilities and depleted gas resources.
Nobody really knows what kind of technical risks are involved in providing such schemes, and the financing challenge is likely to be considerable. So it is no surprise that the government’s new-found interventionist approach finds its clearest expression in the renewables sector.
A new state-coordinated green investment bank, with £1bn of state funds from asset sales and £1bn from private investors, will provide risk capital. The bank will shoulder the bulk of project risks, particularly those associated with the construction of new facilities. The hope is that institutional investors such as sovereign wealth funds, insurance houses and pension funds, will be attracted back to project finance.
Of course, coming just a few weeks before a nail-biting election and with the likelihood of significant changes in the structure of Whitehall, the significance of the National Infrastructure Strategy – and of IUK itself – is uncertain.
However, whatever the political shape of the new administration, it will be heavily dependent on the IUK for its expertise, experience and contacts with industry. The body has to a large extent election-proofed itself. Its rapid expansion, gobbling up much of Whitehall’s capacity in managing large investment programmes, has secured its future against political change.
Originally conceived as a mere advisory body for energy and telecommunications, its writ now includes the full gamut of social and economic infrastructure, from the Private Finance Initiative to the regulated utilities. It brings together most of the government bodies that have expertise in project finance, and is led by individuals from the powerful PFI agency, Partnerships UK. James Stewart, a widely respected figure who has led PUK since its inception in 2000, has been seconded to IUK as chief executive.
PUK’s experience, capabilities and industry clout would be very hard for a new administration to replace. Charles Hendry, shadow minister for energy, told Public Finance: ‘We know that we’ll need support structures in place to do what we want to do, and the question is going to be how to provide that at the lowest bureaucratic cost.
‘IUK may have a big role to play and we are consulting on it – hearing some very positive things and also some grounds for reflection.’
But even if the body is preserved, its national strategy might be less secure after May 6. The policy document issued by the Conservatives in March, Rebuilding security, outlines an approach to energy investment that it describes as much more ‘market-based’ than Labour’s ‘big state’ methods. The document was largely ignored, although it called for a ‘radical overhaul’ of energy policy in the UK.
It does show distinct unease about price regulation. ‘Some might argue that the public policy goals that depend on the energy sector require an industry that is heavily directed by the government,’ it says. ‘This would mean a regulated utility model in which investment plans are approved and rates of return specified by the state.’
But the Conservatives, in contrast, believe that ‘the need for risk-taking, innovation and investment in the years ahead make the energy industry one which can benefit from more, not less, enterprise’.
Hendry says: ‘It is not the job of government to pick winners: we’ll set the ground rules and allow the market to decide which are the right businesses and which are the right technologies.’
Interestingly, the Conservatives also say they want to establish a green investment bank, though they do not say how much capital it would be provided with. The money will come from existing resources, suggesting a limited pot, though Hendry disputes this.
‘The scale of what we’re proposing is much larger than anything that’s been proposed by other parties,’ he says. ‘We want the bank to be the lynchpin of government involvement in the delivery of renewables – a single entity, bringing together a number of roles which are currently delivered by a lot of different agencies.’
And the cash will be used to fund new ‘technology start-ups’, in addition to its role as a source of risk capital for projects as Labour intends.
‘There is going to be scope for project finance but in areas where companies don’t exist, such as marine technology, inevitably the bank must be there to finance new business start-ups. On the other hand, we’re very clear that the bank must be a helping hand to the private sector, not a competitor to it.’
The green bank idea is also embraced in the Liberal Democrat manifesto, which provides the most radical and interventionist platform of the three main political parties. LibDem Treasury spokesman Vince Cable has put renewing infrastructure at the heart of the party’s ‘fair future’ plan, providing ‘green growth’ and ‘jobs that last’.
The LibDems ‘want to build an economy that is based on innovation and sustainability, where the infrastructure the country needs is in place for individuals and businesses to thrive’.
To this end, a new UK Infrastructure Bank will be established. It will place government at the heart of infrastructure planning, ‘directing’ finance to projects in all forms of social and economic infrastructure, as opposed to only renewable energy as the other parties propose.
Indeed, the new bank would be a powerful actor in the economy: the myriad roles within its ‘long-term remit’ are spelled out in some detail in the manifesto.
Mirroring Labour’s plans for the green investment bank, it would start with government seed funding raised from selling the Tote and student loans and borrowing against government-owned assets such as the Dartford Crossing. It might secure additional capital from auctioning airport landing slots and parts of the radio spectrum, for example.
It would have the ability to reject or accept proposals based on financial viability, and while in the public sector it would be at arm’s length from ministers.
A LibDem spokesman says: ‘There are vast sums of money in institutional investors looking for good but safe returns that are unable to find suitable investments in the UK. The bank will provide pump priming, through public money or assets, but it will be privately financed. The European Investment Bank or even the World Bank are credible models.’
Again, the question arises as to where IUK would fit into these plans. Extending IUK’s remit to include a wide-ranging banking function would be the simplest way of achieving the LibDems’ objective for a new national bank.
Certainly, IUK has the necessary banking expertise. One of its constituent parts is the Treasury’s Infrastructure Financing Unit, which was established in early 2009 to provide loans to PFI projects that had stalled due to the absence of commercial debt.
It might well be, however, that the opposition parties are still mulling over what to do with IUK, and the extent to which its orientation fits in with their policy agendas. It is certainly an unconventional government body, and has the potential to cause political controversy.
The form that it takes and the approach it wants to use in formulating policy sometimes blur the divide between public and private sectors in a way that might be regarded as problematic.
Many of IUK’s senior staff are private sector employees on secondment from Partnerships UK – which is majority owned by eight big project finance investors, including the Royal Bank of Scotland, Bank of Scotland, Barclays, Prudential and Group 4 Securicor. They are mostly corporate or project finance experts, with careers in banking behind them. They are, for sure, highly capable and respected people. But giving UK infrastructure policy over to highly paid employees of big infrastructure investors might not be universally popular.
Whether the PUK element of IUK will continue to be owned by private investors is the topic of ‘ongoing discussions’, according to Paul Bates, PUK head of communications.
One thing that IUK has so far refused to do is intervene in the project finance market to reduce the cost of capital, which is widely regarded as excessive and is ultimately borne by the public. Of the three main parties, only the LibDems have identified this as a major problem.
This is a missed opportunity, since project finance banks are currently charging a margin above their cost of funds that is up to six times greater than was normal before the financial crisis.
IUK’s focus on getting the regulatory context right, and de-risking projects for new investors through co-investment, has been widely welcomed. But the opportunism of the financial markets – enhanced by the absence of competitive tension between institutions – is a problem that needs to be tackled head on at a time of constrained public sector budgets. IUK has a stated commitment to play a major role in the wider policy-making arena – ostensibly to ensure that the impact of policy change on investors is considered. Whether it can do so as a guardian of the wider public interest or as an advocate for the industry that has supplied most of its employees remains to be seen. Not everyone will welcome the increasing influence of this body, and the strength of that influence is not certain to survive the election.
Mark Hellowell is a research fellow at Edinburgh University
29 April 2010
All the major parties are promising big investment in infrastructure. But with private finance paralysed and cuts in public spending, where are they going to get the money from? Mark Hellowell investigates
Cleggmania aside, media election coverage has focused almost exclusively on the three main parties’ proposals for ‘tackling’ the public deficit. Given the state of the government’s current account, journalists’ fixation on fiscal policy is no surprise.
But it might well be unfortunate. A much more important question is how the UK’s economic performance can be boosted in the longer term – and that elicits a quite different answer from each of the parties. Broader economic issues have hardly scratched the surface of public attention in the run-up to May 6.
One major gap in the popular debate concerns infrastructure policy. All three main parties regard as essential huge investments in new roads, high-speed railways, telecommunications networks and renewable energy facilities – amounting to perhaps £500bn over the next couple of Parliaments.
They all acknowledge that the sums required are high by historic standards – and much higher than could be secured now from either the public or private sectors – without major institutional and regulatory changes. The fact is that the economic context could hardly be less conducive to significant increases in investment. Potentially there is a massive infrastructure black hole. But the parties differ in significant respects over how they intend to tackle this huge financing burden.
Public sector net investment is set to be reduced in real terms over the next three years – halved, in fact, from the level set out in the 2008 Budget projections. At the same time there is a shortfall of liquidity among banks and the capital markets are still risk averse. The result is that private finance is not always available in important areas of mandatory spending such as waste disposal, where European Union targets require a major move away from landfill use. Where capital can be accessed, the price is usually high and the terms are typically harsh.
How the different parties intend to address these market failures illustrates their ideological differences – particularly on the role of central government in the economy.
The Labour manifesto is effusive about the party’s commitment to state intervention. Boosting the state’s role in creating a high-tech economy, with good transport links, green energy and broadband access for all, is a main theme in its most radical manifesto since 1997. It says it is committed to the east-west Crossrail line in London and a new high-speed railway linking the capital to the North. Of the 50 steps to what Labour calls ‘a future fair for all’, improving infrastructure is the fourth.
‘The role of government is not to stand aside,’ its manifesto states, ‘but to nurture private sector dynamism, properly supporting infrastructure and the sectors of the future.’
The mechanisms for achieving this are not discussed in the manifesto, but were outlined several weeks earlier, in documents published alongside the Budget. The National Infrastructure Strategy signals a radical change in the state’s role in providing new economic assets following 20 years of relatively limited government involvement.
In a foreword to the strategy, Lord Davies of Abersoch, minister for trade, investment and small business, states: ‘The case for action is clear.
During a period of fiscal consolidation, it is important we continue to invest in infrastructure to support the recovery and stimulate sustainable long-term growth. With new demands and the majority of our infrastructure being provided by the private sector, we need to create the right market conditions and attract new sources of private investment.’
The government’s new Treasury unit, Infrastructure UK, calculates that £150bn has been invested in the economic infrastructure of the UK in the past five years, predominantly by the private sector. Spending on that level implies £300bn over the next ten years. But IUK estimates that £40bn–£50bn will be needed annually for the next 20 years at least, suggesting up to £200bn more will be needed.
With the cuts in public investment taken into account, it seems the UK faces a financing shortfall of about £250bn over the next couple of Parliaments. Following the great divestitures of the 1980s and 1990s, most infrastructure assets in Britain are investor-owned.
Yet IUK is to provide at each Spending Review an account of the country’s infrastructure needs and a list of projects that will achieve them. Its top priority is the energy sector, which requires major investment in low-carbon power stations to meet EU targets, as well as replacing ageing facilities and depleted gas resources.
Nobody really knows what kind of technical risks are involved in providing such schemes, and the financing challenge is likely to be considerable. So it is no surprise that the government’s new-found interventionist approach finds its clearest expression in the renewables sector.
A new state-coordinated green investment bank, with £1bn of state funds from asset sales and £1bn from private investors, will provide risk capital. The bank will shoulder the bulk of project risks, particularly those associated with the construction of new facilities. The hope is that institutional investors such as sovereign wealth funds, insurance houses and pension funds, will be attracted back to project finance.
Of course, coming just a few weeks before a nail-biting election and with the likelihood of significant changes in the structure of Whitehall, the significance of the National Infrastructure Strategy – and of IUK itself – is uncertain.
However, whatever the political shape of the new administration, it will be heavily dependent on the IUK for its expertise, experience and contacts with industry. The body has to a large extent election-proofed itself. Its rapid expansion, gobbling up much of Whitehall’s capacity in managing large investment programmes, has secured its future against political change.
Originally conceived as a mere advisory body for energy and telecommunications, its writ now includes the full gamut of social and economic infrastructure, from the Private Finance Initiative to the regulated utilities. It brings together most of the government bodies that have expertise in project finance, and is led by individuals from the powerful PFI agency, Partnerships UK. James Stewart, a widely respected figure who has led PUK since its inception in 2000, has been seconded to IUK as chief executive.
PUK’s experience, capabilities and industry clout would be very hard for a new administration to replace. Charles Hendry, shadow minister for energy, told Public Finance: ‘We know that we’ll need support structures in place to do what we want to do, and the question is going to be how to provide that at the lowest bureaucratic cost.
‘IUK may have a big role to play and we are consulting on it – hearing some very positive things and also some grounds for reflection.’
But even if the body is preserved, its national strategy might be less secure after May 6. The policy document issued by the Conservatives in March, Rebuilding security, outlines an approach to energy investment that it describes as much more ‘market-based’ than Labour’s ‘big state’ methods. The document was largely ignored, although it called for a ‘radical overhaul’ of energy policy in the UK.
It does show distinct unease about price regulation. ‘Some might argue that the public policy goals that depend on the energy sector require an industry that is heavily directed by the government,’ it says. ‘This would mean a regulated utility model in which investment plans are approved and rates of return specified by the state.’
But the Conservatives, in contrast, believe that ‘the need for risk-taking, innovation and investment in the years ahead make the energy industry one which can benefit from more, not less, enterprise’.
Hendry says: ‘It is not the job of government to pick winners: we’ll set the ground rules and allow the market to decide which are the right businesses and which are the right technologies.’
Interestingly, the Conservatives also say they want to establish a green investment bank, though they do not say how much capital it would be provided with. The money will come from existing resources, suggesting a limited pot, though Hendry disputes this.
‘The scale of what we’re proposing is much larger than anything that’s been proposed by other parties,’ he says. ‘We want the bank to be the lynchpin of government involvement in the delivery of renewables – a single entity, bringing together a number of roles which are currently delivered by a lot of different agencies.’
And the cash will be used to fund new ‘technology start-ups’, in addition to its role as a source of risk capital for projects as Labour intends.
‘There is going to be scope for project finance but in areas where companies don’t exist, such as marine technology, inevitably the bank must be there to finance new business start-ups. On the other hand, we’re very clear that the bank must be a helping hand to the private sector, not a competitor to it.’
The green bank idea is also embraced in the Liberal Democrat manifesto, which provides the most radical and interventionist platform of the three main political parties. LibDem Treasury spokesman Vince Cable has put renewing infrastructure at the heart of the party’s ‘fair future’ plan, providing ‘green growth’ and ‘jobs that last’.
The LibDems ‘want to build an economy that is based on innovation and sustainability, where the infrastructure the country needs is in place for individuals and businesses to thrive’.
To this end, a new UK Infrastructure Bank will be established. It will place government at the heart of infrastructure planning, ‘directing’ finance to projects in all forms of social and economic infrastructure, as opposed to only renewable energy as the other parties propose.
Indeed, the new bank would be a powerful actor in the economy: the myriad roles within its ‘long-term remit’ are spelled out in some detail in the manifesto.
Mirroring Labour’s plans for the green investment bank, it would start with government seed funding raised from selling the Tote and student loans and borrowing against government-owned assets such as the Dartford Crossing. It might secure additional capital from auctioning airport landing slots and parts of the radio spectrum, for example.
It would have the ability to reject or accept proposals based on financial viability, and while in the public sector it would be at arm’s length from ministers.
A LibDem spokesman says: ‘There are vast sums of money in institutional investors looking for good but safe returns that are unable to find suitable investments in the UK. The bank will provide pump priming, through public money or assets, but it will be privately financed. The European Investment Bank or even the World Bank are credible models.’
Again, the question arises as to where IUK would fit into these plans. Extending IUK’s remit to include a wide-ranging banking function would be the simplest way of achieving the LibDems’ objective for a new national bank.
Certainly, IUK has the necessary banking expertise. One of its constituent parts is the Treasury’s Infrastructure Financing Unit, which was established in early 2009 to provide loans to PFI projects that had stalled due to the absence of commercial debt.
It might well be, however, that the opposition parties are still mulling over what to do with IUK, and the extent to which its orientation fits in with their policy agendas. It is certainly an unconventional government body, and has the potential to cause political controversy.
The form that it takes and the approach it wants to use in formulating policy sometimes blur the divide between public and private sectors in a way that might be regarded as problematic.
Many of IUK’s senior staff are private sector employees on secondment from Partnerships UK – which is majority owned by eight big project finance investors, including the Royal Bank of Scotland, Bank of Scotland, Barclays, Prudential and Group 4 Securicor. They are mostly corporate or project finance experts, with careers in banking behind them. They are, for sure, highly capable and respected people. But giving UK infrastructure policy over to highly paid employees of big infrastructure investors might not be universally popular.
Whether the PUK element of IUK will continue to be owned by private investors is the topic of ‘ongoing discussions’, according to Paul Bates, PUK head of communications.
One thing that IUK has so far refused to do is intervene in the project finance market to reduce the cost of capital, which is widely regarded as excessive and is ultimately borne by the public. Of the three main parties, only the LibDems have identified this as a major problem.
This is a missed opportunity, since project finance banks are currently charging a margin above their cost of funds that is up to six times greater than was normal before the financial crisis.
IUK’s focus on getting the regulatory context right, and de-risking projects for new investors through co-investment, has been widely welcomed. But the opportunism of the financial markets – enhanced by the absence of competitive tension between institutions – is a problem that needs to be tackled head on at a time of constrained public sector budgets. IUK has a stated commitment to play a major role in the wider policy-making arena – ostensibly to ensure that the impact of policy change on investors is considered. Whether it can do so as a guardian of the wider public interest or as an advocate for the industry that has supplied most of its employees remains to be seen. Not everyone will welcome the increasing influence of this body, and the strength of that influence is not certain to survive the election.
Mark Hellowell is a research fellow at Edinburgh University
