George Osborne’s big idea for growth is more spending on infrastructure. But gimmicks like ‘PF2’ are unlikely to do the trick
In 1981, 98% of spending on infrastructure was financed by the state. But over the following 15 years the situation was completely transformed.By 1997, the year Tony Blair’s New Labour government took office, private investments exceeded those of government.
The current balance, according to the Office for National Statistics, is 65:35 in the private sector’s favour. If the government gets its way, the public sector’s share will decline further.
This process is, of course, welcomed by the coalition, but it also presents a set of rather awkward policy questions. In particular, how can ministers get the infrastructure investments they want when the assets are owned by firms over which the state has no control and financed by investors with limited capital and a culture of risk aversion?
These are questions the government appears incapable of answering. The 2010 National Infrastructure Plan stated that by 2015 some £200bn would need to be invested in economic infrastructure – equivalent to an average of £40bn per year. The 2011 Plan contained the even more ambitious total of £250bn – although it was sketchier on dates, promising to deliver the accompanying pipeline of projects by 2015 ‘and beyond’.
What has happened since then? Annual investment is still way off the £40bn target, at about £33bn a year, according to figures released with Chancellor George Osborne’s Autumn Statement in December. And with ministers seemingly unable to meet the targets they have set themselves – at significant cost to national income in the short term and to the productive capacity of the economy in the long term – efforts to get investment back on track look rather desperate. There is no certainty that the rebranded version of the Private Finance Initiative – PF2 – will ever get off the ground. And the shift to a less debt-heavy model will only increase costs for the public sector.
Meanwhile, the chancellor’s promise to convert £5bn of current spending into capital will, together with other U-turns, still keep public capital investment at roughly the current level of about £48bn until 2018.
But this amount was apparently insufficient to prevent 60,000 jobs being lost in the construction sector last year, according to research by the Construction Skills Network.
Given the distribution of infrastructure assets between the public and private sectors, it is private financing of private assets that needs to happen. So far the chancellor’s promise that the country’s pension funds will come to the rescue – with a new investment vehicle delivering ‘a revolution in the sources of finance for upgrading Britain’s infrastructure and equipping Britain to win the global race’ – has failed to get the spades into the ground. To address the problem, the current focus is on state guarantees for investors, and £40bn is available for ‘priority’ infrastructure projects. This should help to attract low-cost investment.
But the history of guarantees in this country is not a happy one. The state routinely under-estimates the risk involved in projects, and the existence of a guarantee substantially eliminates the lenders’ incentive to carry out proper analysis of likely costs and revenues.
The Department for Transport’s guarantee to High Speed 1 lenders, for example, left the taxpayer with an ongoing liability when passenger revenues were lower than expected. It was a similar case with the DfT’s financing guarantee for Metronet, which took control of two-thirds of the London Underground as part of the failed Tube public-private partnership. Taxpayers ended up providing a grant of £1.7bn when the project company went into administration.
There is, clearly, a strong incentive for a deficit-obsessed government to provide guarantees as the balance sheet impact is small, but the liabilities are often huge.
In addition, the historic move from public financing to private financing, along with much-reduced state subsidies, has had a huge distributional impact, with the burden of funding shifting from taxpayers towards consumers.
As the National Audit Office reported in January, there has been no overall assessment by the government of whether the cumulative impact of the liabilities created by the £250bn pipeline will be affordable for people.
The auditors point out that the Treasury had planned to develop an overall framework for judging affordability but subsequently decided this was too difficult.
This is an issue of massive significance for the future of the British economy and yet, as recent experience with the Private Finance Initiative shows, the state is often poor at judging long-term affordability implications at the start of projects, when over-optimism rules.
In an era of fiscal retrenchment, the historic shift from public to private financing of crucial infrastructure is probably inevitable. But the government is still learning how to operate in this new environment – using a mix of regulation and more direct forms of intervention to get the ‘revolution’ Osborne is promising.
With a flatlining economy and the prospect of bottlenecks and blackouts from 2020 onwards, it is time for a clearer infrastructure policy.
Mark Hellowell is a lecturer at the Academy of Government at the University of Edinburgh
