The level and quality of investment in economic and social infrastructure directly influences future macro-economic performance. It must not only be sufficient relative to the economy’s infrastructural requirements, it must also be efficient in selection and execution terms.
Providing a publicly-provided asset involves front-loading its cost during inception, construction, and mobilisation stages, which while they can involve long gestation periods are concentrated at the beginning of a project. Such projects can be postponed at often far less political cost than cutting current programmes that have built up a user constituency; postponement of investment likewise provide greater savings to near-term, rather than long-term budgets. The other side of that coin is that project benefits are spread over its entire life, often rising with time. A cash-based public expenditure system fails to register these future benefits.
These features result in an in-built bias against investment within the public expenditure planning and management system. Generally, as a consequence, levels of public investment have been sub-optimal, and often totally inadequate, falling well short of the needs of an economy that steadily has become structurally over-dependent on debt-financed consumption.
Moreover, the planning, prioritisation, and delivery of public investment projects have often been woeful, causing further economic damage. Examples abound: the white elephant of the Millennium Dome; more recently the massive cost over-runs on the Network Rail railway electrification programme.
To be addressed these related problems require inter-locking institutional reform.
From 1950 to the late seventies, public net investment, expressed as a ration of gdp, never fell below 3.2%; between April 1966 and March 1971 it exceeded 6%, peaking at 7.4% during 1967-68.
That ration then collapsed progressively to less than 0.5per cent of GDP by 1988-89, or barely one per cent of total public expenditure. This coincided with the Lawson boom that seriously overheated the economy. Infrastructural capacity became a media issue as the creaking and antiquated railway infrastructure of London and south-east, for example, was recognised as patently inadequate to the task and a threat to the capital’s continued economic growth. An overlapping technical and political consensus soon emerged that public investment had fallen below an economically optimal or sustainable level, and that it needed to increase again.
And, indeed, public investment from that record low base did recover in the early nineties to 1.9% of gdp. But recession had by then begun to damage the public finances again, compounded by historically high interest rates. In order to regain a balanced budget or surplus, the Major government found it politically easier to cut future planned investment than to make inroads into existing current programmes involving visible reductions in services and jobs. Consequently, investment fell back again to below 1% of gdp during the remainder of the decade.
After the election of new labour in 1997, a rules-based fiscal framework was introduced. The golden rule permitted borrowing to fund investment over the duration of an economic cycle, but not current spending. A second sustainable investment fiscal rule was also introduced that held that public debt should be kept at a stable and prudent level, which was taken to mean reducing net public debt, as a proportion of gdp, to below 40%.
It was felt that the rule was necessary in order to safeguard against uncontrolled levels of public investment pushing up the debt burden to the point that it failed to provide the government with sufficient fiscal reserve elbow room to counteract future economic shocks by a fiscal expansion. Concern was also expressed that the financial costs of such investments imposed excessive claims on future taxation revenues contrary to inter-generational fairness, especially where the benefits were social rather than financial or economic .
A tendency to discriminate against investment expenditures remained under new labour’s cash-based fiscal framework, given the front-loading of investment costs into the short term and their immediate impact on net debt. Public investment will invariably generate benefits more in the long term; there is little relationship between public investment and gdp outturns within a defined short term time target horizon. Nor was there any particular evidential justification for a 40% ratio.
In actuality, the impact of the Great Financial Crash (GFC) – largely an external shock resulting from leveraged international lending on sub-prime US mortgage assets – on the public finances rendered the sustainable investment rule redundant: it was recognised that public borrowing needed to increase in order to prevent a re-run of the 30’s depression. Ironically, or, perhaps, inevitably, because of unbridled financial liberalisation linked to the ascendancy and over-reach of neo-liberalism, it was scuppered by excess private, not public debt.
The ordering of the golden and sustainable investment fiscal rules, in addition, produced a perverse incentive for public infrastructure assets to be procured off-balance sheet. This was through Public-Private Partnership (PPP) arrangements, including the Private Finance Initiative (PFI). Their up-front capital costs, depending on their accounting treatment, were not counted as public expenditure; and thus generally did not add to either the fiscal deficit or net public debt. This was despite their bequeathing of long-term financial public revenue liabilities, with client authorities having to pay annual reoccurring charges covering financial, provision, maintenance, and private profits.
Underspending of departmental capital budgets proved to be even a more serious brake on achieving a higher investment outturn. For example, during 2005-6, recorded net public investment was more than ten per cent less than the £26bn that had been projected two years earlier.
Overall, net public investment under New Labour, measured as a proportion of gdp, recovered only slowly to exceed 2% in 2004-2005, peaking at 3.4% during 2008-10, still well below average post-war levels.
With the advent of the coalition government in 2010, with George Osborne as chancellor, investment again bore the brunt of cuts in public expenditure made to reduce the public deficit. The golden rule was jettisoned. His fiscal austerity programme led to massive cuts to capital programmes. The landmark 2010 public expenditure review reduced the housing capital programme by over 40% in cash terms. This was during a period when total new housing supply was collapsing to levels not experienced since the second world war.
That said, since 2010 the net public investment/gdp ratio has been stable at around 2.1%, actually higher for much of the new labour years. The problem is that gdp numerator has hardly risen in the wake of the GDC. With excess corporate saving there is an investment dearth that should have been, and needs to be, offset by substantially higher sustainable levels of productive public investment.
In that light, subsequent efforts to restore the public finances to balance and to reduce the public debt ratio were stymied by continuing recession, muted recovery, and then stagnation. Mechanistic and varying – and often obtuse – fiscal targets were missed and extended. It became clear that the macro-economic justification for austerity was conflated with a political objective to shrink the state, confirmed when a conservative majority administration was elected in 2015.
The brexit referendum result in June 2016 further unsettled the economy, and led directly to the replacement of David Cameron as prime minister by Theresa May, who promptly consigned osborne to the backbenches. The austerity tone softened, but not definitively. It was only the debacle of the 2017 election result that reduced the conservatives to a minority government that the realisation dawned that continuing austerity might not be economically, socially, or politically sustainable.
Public investment levels were maintained and even increased in both the Phil Hammond 2017 budgets at least in future planned levels – which do not necessarily, or often, translate into realised levels – but to not the levels required by the macro economy. They will continue to be constrained by a fiscal mandate that requires the structural or cyclically-adjusted deficit to fall below by 2% in 2020-21, supported by a supplementary target requiring public sector net debt to fall as a share of gdp between 2019-20, and 2020-21.
The achievement of target will again depend on the performance of the macro-economy linked to brexit developments, but its setting discourages the allocation of resources to needed infrastructural projects, such as Crosssrail2, or the expansion of a publicly-financed and enabled affordable housing programme sufficient to overcome Britain’s broken housing market. Such public investment requirements cannot be divorced from the downward secular productivity trend, which needs to be reversed overt the medium term if the public finances are to improved in a sustainable way.
Securing and maintaining an optimal level of public investment: a minimum investment fiscal rule supplemented by institutional reform to improve the selection, prioritisation and delivery of projects.
It has become clear that such austerity contributed to the period of prolonged recession and stagnation that the UK has suffered since the GFC. Escape from it requires higher sustained levels of both public and private investment. An extension of the rules-based approach to macro-economic policy to public investment planning is thus required. The achievement of an optimal level of public investment in economic and social infrastructure requires the remaining bias against investment spending within the cash-based public expenditure planning system to be lifted.
Economically damaging pro-cyclical variations in investment levels must also be discouraged. The institutional tendency for departments to under-spend their capital budgets also needs to be overcome.
The golden rule, which allows public investment to be financed by borrowing, should, therefore be reinstated and supported by a minimum investment rule that aligns future investment levels to assessed macro-economic requirements. It should also be supplemented, however, by linked institutional reforms to improve the quality and delivery of public investment: in short, more ‘good’ productive investment, less ‘bad’ wasteful grandstanding projects.
Certainly the economic rationale for a net public debt figure to reduce in any one particular year– like the new labour’s previous 40% sustainable investment rule – is not clear, particularly where different sources of marginal additions to the debt can vary in economic impact. In essence, if investment projects, whether directly publicly-funded or privately-financed but publicly-subsidised, are correctly selected and prioritised they should either add to future economic output or save future maintenance costs in excess of their investment costs.
It is also important that a investment fiscal rule and/or a re-ordering of the golden and sustainable investment rules are progressed in way which commands credibility and confidence with the financial markets.
The responsibility for setting a minimum rule could be delegated to an independent body of economists and others possessing both the experience and expertise to assess the optimal level of public investment within the economy, as well as the requisite credibility with the wider financial and economic community.
This body would exercise this delegated task on a similar basis that the Monetary Policy Committee exercises its delegated interest rate policy remit. Such independence would be consistent with public investment levels being set in accordance with macro-economic requirements rather than contingent political pressures.
The primary aim of a such a rule would be to align investment in economic and social infrastructure with the needs of the macro-economy and to protect such investment from cyclical and contingent public expenditure pressures. A rules-based approach that required investment planning to respond to infrastructural funding requirements rather than to cyclical pressures should reap substantial efficiency gains.
These should spring from two inter-linked sources. First, the achievement of greater certainty in fiscal planning; uncertainty about future allocations still undermines efficient public planning and programming of projects. Second, boom-bust tendencies in the construction industry could be smoothed if such greater fiscal certainty was complemented by a greater degree of partnership planning between the public and private sector of investment.
The institutional and policy environment should incentivise both public and private providers of infrastructure to develop positive supply-side practices in relation to supply chain management and the training and use of labour. This should help to avoid the worst pitfalls of boom-bust in the construction industry that has so bedevilled past progress and to contribute to the achievement of more balanced growth in spatial and distributional terms.
The extension of a rules-based approach to public investment planning should also act as a check to inadequate public planning, programming and management of investment programmes. For instance, if the minimum investment rule was breached due to a departmental under-spend of its capital budget, its permanent secretary should be obliged to write an open joint letter to the chancellor, explaining why this had occurred, attached with the remedial measures. Any repetition would require both the chancellor and the offending department to report to the Public Accounts Committee.
Such a rule, however, does present some clear challenges. If the current definition of public investment remained unchanged, it could provide an in-built bias in favour of direct public procurement. Departments would come under pressure by the rule to fund a certain level of directly financed public investment and to choose direct financing of investment when an alternative procurement route could be more efficient. This would be inconsistent with the establishment and maintenance of a level playing field, where procurement routes were chosen due to their whole project-life efficiency relative to other options. It could mirror, but in reverse, the bias that the sustainable investment rule can exert in favour of private financing of infrastructure.
This reverse bias could possibly be avoided by widening the definition of public investment to include all investment on defined economic and social infrastructure assets, regardless of financing source. To do this, however, could throw up some formidable measurement and definition issues. The contribution of the private sector contribution to the total investment figure would also not be under the direct control of sponsoring departments. On the other hand, the disciplining effect of such a rule should be beneficial. And by highlighting under-spends, whether of public or private origin, relative to an investment target set with regard to infrastructural funding requirements, should help to induce a policy environment conducive to their correction.
The sheer scale of public investment requirements with, for example, HS2 projected to require up to £56bn, and Crossrail 2 up to £32bn, compared to the expected outturn cost of c.£15bn for Crossrail 1, which threaten to crowd out other desperately economically needed infrastructural improvements to the cross-pennine routes less amenable to part private financing, underscores the imperative for the public planning of major infrastructure to be co-ordinated more effectively; for example, if the provision of Crossrail 2 is not sequenced with the delivery of HS2, there is a risk that the central london tube network will be overwhelmed. Crossrail was funded by a third contribution of a business rate levy, of TfL, and of central government. Land value capture mechanisms could provide collateral allowing costs to be borne public borrowing linked to tangible repayment streams.
At another level, the complementarity of fiscal and monetary policy could be strengthened by the re-focusing of the QE bond purchasing programme towards productive investment directly, rather than relying on QE acting on asset prices through an indirect wealth transmission effect on output and growth. For example, the Bank of England could purchase the bonds of a National Infrastructure Bank encompassing housing investment activity.
If the housing operations of the Bank were effectively designed, implemented, and then managed, it could potentially lever-in substantial private housing investment including pension monies through the application of appropriate risk sharing mechanisms underpinned by carefully designed guarantees. The housing assets provided as a result should rise in value in real terms and generate rising real income yields over the long term, making such assets attractive to pension funds as a match to their long term liabilities.
Project selection and delivery
Poorly selected projects will generate sub-optimal economic outcomes, even where their contractual arrangements, their structuring of public-private inputs relative to project circumstances, and their execution is efficient. More usually, however, the processes that result in projects being poorly selected continue to impact upon the delivery stage.
All these considerations underline the need for robust, transparent, and credible appraisals of the both the net and relative economic worth of projects. Greater accuracy and transparency in the production of these should help to maintain financial market confidence in institutional rule-based arrangements that safeguard public investment at a level consistent with sustainable long-term economic growth.
Such an optimal ranking of the relative macro-economic worth of competing projects is, however, difficult to achieve for many reasons. These include the complexity of the wider policy environment in which such selection and prioritisation has to take place, the existence of not only competing multiple objectives, but also contingent political pressures that can favour some projects for reasons other than their economic worth.
On top of all this there are capacity constraints within the public sector in relation to the implementation of such processes. And, project appraisal methodologies, like all economic tools, are also only as robust as their underlying assumptions allow them to be.
The institutional environment in which project selection and prioritisation occurs needs to be put on a firmer footing. Departments should be required to produce an annual Departmental Investment Plan (DIP) in consultation with the national Infrastructure Commission. This should prioritise projects according to their estimated economic and social return.
The National Infrastructure Commission (NIC) should also be tasked to expand the pool of personnel skilled and experienced enough to conduct the project appraisals underpinning the plans. Partnerships with universities and the private sector could also be developed in order to develop the methodological base and to enlarge and deepen the skill set of those undertaking the appraisals.
The National Audit Office should audit each DIP and the methodological base applied to rank projects.
The achievement of both economic efficiency and social justice requires a public investment programme that enjoys greater certainty of funding. The fiscal framework needs to be developed to provide greater institutional protection to public investment levels from contingent short-term pressures on the public finances. This could be done either through the establishment of a dedicated minimum investment rule, or by a re-ordering of the golden and sustainable investment rules, or by a combination of both.
The achievement of an optimum level of infrastructural funding through greater fiscal certainty secured by an extension of rules-based macro-economic management must go hand-in-hand with the attainment of greater efficiency in the selection and execution of public investment projects. More robust and transparent investment appraisal methodologies need to be applied to assess the relative economic and social returns offered by projects, and so to rank them in order of funding priority. Greater accountability and transparency could be obtained by requiring sponsoring departments to work in partnership with the National Infrastructure Commission to publish annual Departmental Investment Plans that incorporate auditable information on project selection and ranking.