"The urgent priority should be reversing the decline in overall capital investment, preferably offset by further reductions in the Government’s departmental running costs."
VICE ADMIRAL SIR TIM LAURENCE, PA SENIOR ADVISER
The Government needs to invest in badly needed transport links and cut day-to-day bills.
The Government’s recent announcements on infrastructure spending (on the railways) and risk guarantees (for other major projects) are welcome. But do they go far enough to kick-start the economy? Alas, that seems unlikely.
Further measures will have to be launched around the time of the Autumn Statement. The urgent priority should be reversing the decline in overall capital investment, preferably offset by further reductions in the Government’s departmental running costs. This, I believe, could provide the kick-start the UK economy needs without compromising the wider economic strategy.
The underlying problem is that, in the last Spending Review, the Government’s capital investment programme was savagely cut. In 2014 it will be nearly 30 per cent less in real terms than it was in 2010 (in cash terms down from £51.6 billion to £40.2 billion). Yet the Government’s running costs will increase slightly over the same period, and if debt repayments are added in, the picture is much worse. In effect, investment for the future is being radically cut back in order to help pay the day-to-day bills.
What can be done? The first step is to make it more attractive for private investors to back public projects. That’s what the risk guarantee scheme is all about. It gives investors confidence that the Government will step in if projects go wrong, especially during the risky construction phase. In theory, taxpayers’ exposure will be limited, because not all the projects will face difficulties at the same time. The scheme’s success will depend on how many investors calculate that projects which had looked out of reach now seem a decent bet.
Next there is lending to Public Private Partnerships (many traditional “PFI” schemes) struggling to secure funding. Up to £6 billion of that lending was announced recently for hospitals, housing, transport and education. Most of the money should be recovered in the medium term.
PFI projects are out of fashion in the UK, even if in other parts of the world there is a healthy pipeline. They have delivered many superb facilities, but they have taken too long to procure and investors have in some cases taken excessive profits. The costs are often prohibitive and the contracts are usually too inflexible to scale back in times of austerity. It’s like buying a Bentley on credit then realising that all you needed (and could afford) is a Ford Mondeo.
But can the Government use private finance in other ways, avoiding the PFI pitfalls? I would say yes – there are many variations of PFI. In Scotland a “non-profit-distributing” model has been developed which caps private sector returns and thus reduces overall costs. More broadly, surplus public land and buildings can be offered to investors to create “asset-backed vehicles”, where the value of assets put into the scheme helps to offset some of the capital costs of a new project.
Local authorities, and to some extent NHS trusts, have their own borrowing powers, often using the Public Works Loan Board to finance local projects. There are other specialist schemes such as “Tax Incremental Finance”, which allows a local authority to retain business rates which can be used to finance borrowing for capital purposes, and the “Community Infrastructure Levy”, which ring-fences a portion of the private developer’s money for investment in the public realm.
Depending on how these mechanisms are structured they may well, in one way or another, add debt to the Government’s balance sheet. However, it is important to draw a distinction between debt for capital investment purposes that leads to economic stimulus, and debt raised to cover day-to-day running costs. The latter should clearly be avoided.
Meanwhile, under the rules for measuring debt used across Europe, and to an extent around the world, providing that adequate control, risk and reward is held by the private sector partner, it is possible to invest private finance in public services without it being recorded as government debt. The key determinant is value for money, which should always reflect the economic stimulus achieved. As debt obtained through private finance markets will be invariably more expensive than government borrowing, it is important to pass the risk of overspending to the private sector, thereby reducing government costs. This is a contentious area, and measuring value, risk transfer, private sector financing costs etc takes experience. This is one reason why the projects criticised most are often the early pilot projects.
This brings us back to the Government’s own spending through Departmental Capital Budgets. The decline must be reversed, preferably in exchange for further reducing departmental running costs. A 3 per cent cut in those costs would free enough funds to restore capital spending to 2010 levels, not just on flagship programmes but also on less photogenic projects with a more immediate economic impact: green retrofits to public buildings, local road and rail schemes, the application of new technology to everyday challenges. Such schemes would put young and unskilled people into jobs quickly and often would help reduce running costs. Paying for them might be tough to implement. But if it helped to kick-start the economy and gave the UK some of the infrastructure facilities it so badly needs, the short-term pain might be well worth it.
Vice Admiral Sir Tim Laurence is a Senior Adviser, PA Consulting Group