The level and quality of public infrastructural investment must meet macro-economic and social requirements and be efficient in selection and execution.
The establishment of the Infrastructure Projects Authority (IPA) in 2016, and the National Infrastructure Commission (NIC) in 2017, was a move in the right direction in line with that. It provides potentially a stronger institutional footing for the effective planning, funding, selection, and execution of infrastructural projects, which, hopefully, is associated with a better shared political understanding of the role that productive public infrastructural investment must play in underpinning a future sustainable productivity-driven growth economy.
Yet the fiscal and institutional environment for the funding, selecting, and delivering of infrastructure, remains, unfortunately, unfit for purpose.
The need to change that, and how, provided the tread for the Submission that A Social Democratic Future made this month in response to HM Treasury’s Infrastructure Finance Review, which closed on 5th June, (the Consultation).
The Consultation sought views on securing private finance in support of productive infrastructural provision in such a way that the ‘benefits brought by private finance must outweigh the additional cost to the taxpayer of using private capital’, (para. 1.9), and on the future institutional options for delivering government support for infrastructural finance, including establishing a new operationally independent institution in the expected post-Brexit environment, when the UK will no longer benefit from access to the European Investment Bank (EIB).
Continuing under-investment in both productive economic and social infrastructure will retard the achievement of the step-increase in growth and productivity required to escape continuing stagnation. That is the prime issue.
This means fostering and reaping the potential productivity gains that follow the agglomeration of specialized economic activities in the largest urban areas and other concentrated clusters, including improved matches of jobs and people, the sharing of information, knowledge and innovation, as well as facilitated market access.
Bigger and more people-dense high-productivity cities, in turn, will depend upon high quality transport, digital, and social infrastructure in housing, education, and, to a degree, cultural services.
In the UK context, that means supporting primarily the densification of London, and other high-productivity clusters that could potentially conflict with regional spatial and social equity and cohesion aims, and, certainly, is in tension with them.
The post-Brexit referendum environment has further highlighted that tension, and underscored both an economic and social imperative to support and foster the recovery and rejuvenation of ‘left-behind (or neglected) Britain’ for choice of a better descriptive phrase. Coastal and smaller cities and towns, especially in sub-regions located north of a line drawn between the Humber and Wash and in Cornwall spring to mind. They have borne the brunt of decades of de-industrialisation and/or relatively stagnant or declining service sectors – the same areas that tend to the most exposed to the future loss of EU Structural Funds.
Both these strategic policy drivers put an added premium on moving to a reformed and inter-linked fiscal and institutional environment that can best deliver efficient productive infrastructural investment.
Take a sustained increase in affordable housing investment to a known broad steady-state level, planned and meshed with the targeted and planned expansion of apprentice and training opportunities to indigenous workers: although it should help to secure structural change in the construction industry and a step-change in its productivity, it is presently prevented, however, by the operation of the current public expenditure system, where housing capital allocations are constrained by rigid fiscal limits.
The current unitary cash-based public expenditure system lumps together recurrent revenue and lumpy investment expenditures producing future financial, economic, and social benefits into the future.
The construction and provision costs of providing new dwellings is consequently front-loaded as public expenditure contributing to the deficit into the short-term, leaving public investment, and the housing programme in particular, disproportionately prone to cuts during periods of fiscal stress or austerity (generally when increased counter-cyclical investment is required, as was the case in the wake of the-GFC, nut when it was by cut by 40% in the 2010 SR), and, more generally, constrained below optimal economic levels by undiscriminating unitary fiscal targets, such as when Parliament in January 2017 committed the government to reducing the cyclically adjusted deficit to below 2% of GDP by 2020-21 and having debt falling as a share of GDP in 2020-21.
In contrast, homebuyers budget to meet their recurrent mortgage costs, not the full value of their mortgage; nor are they double-counted. Nearly all first-time buyers could not purchase if the same accounting treatment was applied to them.
The Fiscal Remit imposed on the NIC by HM Treasury – itself constrained by that same discrimination against investment expenditure, intrinsic within the current cash-based unitary public expenditure system – sets a gross public investment funding envelope or limit of between 1.0% and 1.2% of GDP in each year between 2020 and 2050, within which NIC recommendations for economic infrastructure must adhere, after taking account of existing funding commitments, including HS2, CrossRail 2, and Northern Powerhouse Rail. This is even though that existing commitments – combined with expected maintenance spending on existing assets – will consume an estimated 1.1% of GDP between 2020 and 2025, and 0.9% between 2025 and 2030.
Very limited fiscal space, over the short-to-medium term, therefore, will be left for the NIC, by its own reckoning, to recommend new and additional projects, such as the upgradations and new additions to the intra-and inter-urban transport network needed for the posited benefits of HS2 for London and other urban conurbations to be substantively harnessed.
Likewise, projects that could step-up the productivity of under-performing urban agglomerations such as the West Midlands, currently held back by congested and inadequate public transport connectivity, closer to European average levels, will almost certainly be stuck on the drawing board or stillborn.
Its constrained Fiscal Remit will also undermine any effort of the NIC to select, rank, and sequence projects – given their lumpiness and interdependency – efficiently.
For example, it is unlikely that the London transport system could cope with increased HS2 numbers without the prior of completion CrossRail at the London Euston terminal end.
Most HS2 passengers arriving and departing at Birmingham will still also need to get to the terminus station by public transport, unless they can walk to a central destination or get a taxi to a poorly connected destination within the West Midlands conurbation.
Already, productive infrastructural projects have been pared back due to fiscal constraints linked to the achievement of short-term fiscal targets. Trans-Pennine Rail provides a recent example with likely significant sub-optimal economic effect on the Greater Manchester and West Yorkshire economies.
Another problem with the current fiscal rules is that debt raised by Public-Private Partnerships (PPP)’s to construct assets – within the current cash-based public expenditure planning system (if it meets defined accounting tests) – is not recorded as public spending or debt.
Unless public procurement and PPP’s are put firmly on a level playing field, the ‘fiscal illusion’, as the Office of Budget Responsibility (OBR) in 2017 described the Private Finance Initiative (PFI) programme, which Budget 2018, PF1/2 curtailed, risks repeat.
Private finance will then continue to be used to meet the infrastructural funding gap, even where it involves net higher public costs and hence public debt and borrowing over entire project lifetimes.
Alternatively, private financing of new water and energy assets under the current Regulated Asset Base will rely upon their ultimate funding on hidden subsidies and higher charges on consumers, with resulting regressive incidence on household budgets.
The effective development of the NIC’s proposed analytical framework for comparing the whole life costs and benefits of private financing and traditional procurement on an objective whole-life project basis, accordingly, and in addition, also depends upon inter-linked fiscal and institutional reform.
The Submission recommended integrated reform across three primary areas: the fiscal rule framework; the institutional environment governing the selection, ranking, and delivery of productive economic and social infrastructure projects; and tackling the root causes of the rising relative real cost of providing of such infrastructure.
Fiscal Rule Reform
The 2019 Spending Review (2019SR) should increase the NIC’s current Fiscal Remit funding envelope and disentangle it from unitary cash-based fiscal targets, while the NIC should provide evidenced assessment of the future volume need for public investment, and its sequencing, to the Treasury.
Capital spending on both conventional and PPP’s should be freed from year-to-year financial cash-limits, but their modelled future revenue liabilities included in future government debt projections used to assess future debt sustainability.
And the IPA and NIC should ensure that choice of procurement route for future publicly supported or regulated infrastructural provision should strictly and wholly be determined by relative whole-life project efficiency, taking account of the cost of finance, according to the best-available tools and evidence-base.
The selection, ranking, and delivery of productive economic and social infrastructure projects.
It is not apparent that the impact of future technological change on the economic value attached to shorter journey times between Birmingham and London, nor the actual scope potentially available in the future for existing networks, such as the Chiltern line, to increase capacity and average journey times, were adequately addressed during the original HS2 decision-making process.
At any rate, a fully transparent evidence-base does not seem to be available to convincingly rebut rising doubts, currently raised within and outside Westminster, concerning the vfm and the ultimate economic utility of the project – attached with an expected price-tag of over 55bn – relative to alternatives.
The Thames Tideway project – a 25km tunnel, currently in the process of construction, to upgrade and expand London’s Victorian sewer network will cost an estimated final c4.2bn at 2014 prices. A Special Purpose Vehicle (SPV) bears primary construction and execution risk. That feature and an innovative patchwork of public guarantees and retention of high impact but low likelihood risks, designed to avoid expensive and inefficient risk pricing, has led many to tout it as an emerging PPP model, but the business case need for the project relative to cheaper alternatives, such as improved maintenance and repair of the existing network to prevent leakages, has been questioned.
Ultimate project risk will rest upon the consumer and the taxpayer, with its costs mainly met by increased consumer water bills. The construction of the project will both foster and pre-empt engineering and tunneling resources.
All that said, the optimal ranking of the relative macro-economic worth of competing projects is difficult to achieve in practice for many reasons.
These include the complexity of the wider policy environment in which the selection and prioritisation takes place; the related need to balance competing multiple objectives; the existence of contingent political pressures favouring some projects for reasons other than their economic and overall worth, as well as capacity constraints within the public sector to apply effectively project appraisal methodologies, which like all economic tools are also only as robust as their underlying assumptions allow them to be.
It is vital, nevertheless, that the institutional environment in which both economic and social infrastructural projects are planned, selected, and delivered is improved in step and consistent with fiscal reform.
The NIC should, therefore, be empowered to assist each government department to publish a required annual Departmental Investment Plan (DIP).
Each DIP should prioritise projects according to their estimated economic and social return, incorporating auditable information on the methodology applied to rank projects, according to their expected whole project-life return.
The IPA should also be specifically tasked and resourced to expand the pool of personnel skilled and experienced enough to conduct the project appraisals underpinning DIP’s.
Partnerships with universities and the private sector should develop the methodological base and to enlarge and deepen the skill set of appraisers.
Progress towards such an improved fiscal and institutional environment should foster efficient public planning and programming of projects and a greater degree of partnership planning between the public and private sectors.
Improved growth and productivity outcomes, balanced in income and spatial distributional terms, should follow.
But, even with their adoption, the sheer scale of future infrastructural funding requirements requires alternative and innovative public funding mechanisms.
Tackling the root causes of the rising relative real cost of providing of productive economic and social infrastructure.
The costs of providing infrastructural investment have escalated much faster than general inflation: the public investment relative price effect. The escalating cost of land as a component of housing investment since 1955 is a striking instance of its operation and effect.
The true fiscal crisis should also be recognized: the demand and need for productive public expenditures across both current and capital budgets will inevitably outstrip public willingness to pay through efficient and salient sources of taxation, at least within a current competitive political system focused mainly on the electoral short-term.
Overcoming that crisis, therefore, requires further concerted and systematic institutional and policy reform. Lateral, radical thinking across the political spectrum, capable of fostering an overlapping consensus, is required, as much as is incremental reform.
In that light, Sectoral and Departmental infrastructure strategies should identify, address, foster, and integrate joined-up policy efforts to make public investment less costly in net public expenditure terms.
Housing provides a case-in-point example where market failure and rent-capture unnecessarily increases the cost of provision. These should be identified and addressed directly, along and innovative public funding mechanism, within the DIP process.
The most direct and effective way of reducing the public cost of affordable provision is by deflating its land value component. This could be done by a mixture or combination of measures focused on ensuring that the land value of affordable housing sites are limited to existing use value plus an agreed premium of, say, 30%, backed up by stronger compulsory purchase powers and an affordable housing obligations system that is more robustly, transparently, and uniformly applied than at present.
In parallel, the future long-term rental income and sales of a steady-state affordable housing programme could be securitised to provide collaterised backing for its public funding.
At an overarching level, a dedicated funding intermediary that could take equity stakes in economic and social infrastructure, where long-term returns (for example, linked to revenue streams, such as rents rising with inflation, interest on loans, profit-shares) could be realized and recycled across the lifetime of the project.
The major issues that will need to underpin future assessments of the whole-life project efficiency of conventional and PPP projects are outlined in Table 1.