Posted: 8 February, 2013 at 11:03 am

UK report card: ‘Must try harder’

UK report card: ‘Must try harder’

(This article on the government’s ideas and progress on infrastructure first appeared in ‘Infrastructure Investor’ magazine).

Economic infrastructure keeps the country running. It should be at the heart of any government’s drive for national economic growth and competitiveness, which means this is one area in which the Labour opposition has willed the Coalition government’s policy to work.

So halfway through this five-year Parliament seems a good time to prepare a mid-term report on the UK government’s infrastructure record.

The story so far

Infrastructure announcements have acted as punctuation in the economic story for the Coalition so far.

In the “Emergency Budget” a month after the May 2010 election, removing the deficit and bringing down national debt were the central imperatives to be delivered by cutting back public spending to allow the private sector to expand. The Chancellor told the House of Commons in the Budget that “well-judged capital spending by Government can help provide the new infrastructure our economy needs to compete in the modern world … I think an error was made in the early 1990s when the then Government cut capital spending too much”.

However, public sector capital spending has been halved since this first Budget and, in another four years’ time, it will only have risen again by £3 billion (€3.6 billion; $4.8 billion) a year. As Richard Abadie, PWC’s head of infrastructure who ran Partnerships UK when I was his Treasury Minister, has rightly said: “If you want to move the dial on GDP growth, it’s government investment not the private sector you need to rely on”.

Planning reform, a new national planning policy framework, banking regulation, abolition of Regional Development Agencies, energy national policy statements, proposals for a network of strategic rail freight interchanges, plans for a green investment bank and a review of PFI [the Private Finance Initiative] – all were part of the first legislative programme and spending review.

But by the 2011 Autumn Statement, concern about the UK economy going into reverse was growing and infrastructure was being billed as the silver bullet. The government published the National Infrastructure Plan – 173 pages long, detailing over 500 projects worth more than £250 billion. “We will invest in all parts of the UK, helping to promote growth across regions and nations,” the Chancellor declared in his foreword to the Plan.

This comprehensive compilation of all projects to which any consideration was being given by government or private companies was welcomed and valuable, as are the regular updates. In truth, however, it was more a wish-list than a proper “plan” or pipeline, as many of the projects lacked clear policy or firm funding behind them. Critics had a field day, pointing out in the April 2012 update that just one in ten of all the projects updated from the previous year had moved to procurement or construction and, of 229 still in pre-procurement, almost one in six had moved backwards.

By the summer of 2012 the British economy was in double-dip recession, and private sector investment was being held back because of weak demand, tight credit conditions and heightened uncertainty about the economic outlook, especially in the Eurozone. Concern was acute. The case for boosting construction and infrastructure investment had become unarguable but the government’s fiscal and political strategy denied them the option of increased capital investment, despite government borrowing costs being historically low.

The response was smart. A UK guarantees scheme worth up to £40 billion to “start critical infrastructure projects that may have stalled because of adverse credit conditions” and an extra £10 billion in guarantees for housing. This is innovative and active state intervention, which all political parties want to see work.

In autumn 2012, the CBI’s annual infrastructure survey had a blunt message. Three-quarters of businesses don’t think UK transport infrastructure will improve over the next five years and two-thirds believe the same about energy and water. Crucially, confidence in the Coalition is ebbing as only 35 percent say the government is having a positive impact on infrastructure investment, down from 43 per cent the year before. “Businesses in Britain are looking for action and we haven’t seen any yet,” declared the CBI’s director general John Cridland.

2012 ended as it started – badly for the industry and for government. Year-on-year construction output was down 9 per cent in the final quarter, the value of infrastructure work was down 2.4 per cent and 60,000 jobs were lost in the sector over the year.

The National Audit Office captures the challenge in the first recommendation of its first report of 2013 on Planning for Economic Infrastructure: “The Government need to develop the National Infrastructure Plan and its market support mechanisms to give greater confidence in the flow of viable investment. Without greater certainty on the flow of significant investment opportunities and the likely returns, investors may defer decisions to invest in potential UK projects, or invest elsewhere.”

THE RECORD SO FAR

So what is the mid-term grading for the government’s leading infrastructure policies, and what are the priority areas for attention to achieve better results?

Pension Infrastructure Platform
Announced alongside the National Infrastructure Plan in November 2011 with a government target of £20 billion funding, the National Association of Pension Funds (NAPF) have worked hard to get this important initiative off the ground.

It promises part of an answer to the big question of how to get institutional investors to replace bank funding for infrastructure. The NAPF are set to launch the PIP’s first £2 billion fund in the first half of this year with eight founding investors and aims for more. But they describe £20 billion as a “long-term aspiration” and resistance remains to funding greenfield assets. The PIP is “being developed for pension funds by pensions funds” according to Joanne Segars NAPF chief executive, emphatically asserting its independence from the UK Government’s infrastructure plans.

Mid-term grades:
Aspiration: B-
Attainment: D (for the government); B (for the NAPF)

Areas for attention:
Link borrowing guarantees to this nascent investment appetite in pensions and insurance funds, especially to help deal with anxiety and inexperience over construction risk and greenfield funding.

PF2
The PFI review took over a year and the result – PF2 – was announced in December 2012 alongside the Autumn Statement. PF2 is not a replacement for PFI but rather a revamp, based in the main on sensible changes that were already happening in newer PFI deals like the exclusion of facilities management, open-book reporting on performance and profits, use of standard contracts and the public agency sharing in profits.

PF2 aims to be the answer to banks being less willing and able to lend for the long term, though in the relatively near term the market may not require the lower debt-to-equity gearing which the Treasury says is appropriate.

The newest feature is the plan for public money to fund equity in projects alongside private sector risk capital. The government claims this is the basis for public sector profit-sharing though, of course, it also means shouldering a bigger share of the risk. I think this could however change the terms of public sector involvement and its mindset on projects, for the better.

Mid-term grades:
Aspiration: C
Attainment: B

Areas for attention:
Be tough on profit-taking, especially in refinancing deals; push public agencies to be active equity stake-holders; go further on openness before the Commons Public Accounts Committee forces this on PF2 projects; and make sure the new 18-month deadline helps speed up projects without weakening the public sector’s negotiating hand.

Infrastructure leadership
Infrastructure UK has been in place for almost three years. The National Infrastructure Plan, PFI review and infrastructure costs review programme are all sound as far as they go but the government machine has to be driven hard to deliver, and at present it’s not.

No one else can do it, so IUK must become much more than the Treasury’s infrastructure police.

The new appointment of an infrastructure minister, Lord Deighton, is a good move. As an infrastructure minister, he’s a rare breed globally. But Lords Ministers don’t matter in government, unless they are a Secretary of State. The best infrastructure minister would be the Chancellor of the Exchequer on a mission.

Mid-term grades:
Aspiration: B+
Attainment: B-

Areas for attention:
Pull your finger out and put flesh on the bones of the borrowing guarantees scheme. There is still insufficient detail on how investment decisions will be made and no published arrangements for the £10 billion housing guarantee which will give the quickest boost to economic growth.

Unblock the Whitehall part of the infrastructure system – as the Prime Minister promised – to allow the market to do its (larger) part of the job.

Infrastructure policy framework
A senior bank director responsible for infrastructure investments recently told me “investors are now asking for the first time how you price public policy risk”. The risks and costs of long-term capital have been hit by unexpected government policy decisions such as the abrupt change – then change again – in solar feed-in tariffs, the tripling of tuition fees plus core and margin university course places, or the re-banding of renewable obligations certificates.

Even policy decisions that at first sight have nothing to do with infrastructure are making it harder to put in place viable funding. The CEO of one of our largest housing associations, with a good record of raising bond finance to build new homes, says his team did three dozen presentations to potential investors in three days last year and every one asked about housing benefit cuts and universal credit.

Mid-term grades:
Aspiration: C
Attainment: D

Areas for attention:
Make the National Infrastructure Plan into a pipeline of projects with clearer policy commitments from every department and stop kicking some of the big policy calls, as with aviation or green power generation, into the long grass.

Green Investment Bank
I’ve lost count of the Parliamentary statements and progress reports on plans for the Green Investment Bank. But it finally launched at the end of 2012 to back offshore wind, waste and business energy efficiency developments and it has already made more project investments than the guarantees scheme.
The Bank’s £3 billion in government capitalisation will leverage private sector funds but it won’t be allowed to borrow until 2015, and then only if public sector net debt is falling – which it won’t be, according to the Chancellor himself in his December Autumn Statement.

Mid-term grades:
Aspiration: B+
Attainment: B-

Areas for attention:
Use the Bank to make its areas for eligible investment into a real pipeline of projects to prove the worth of this type of public-private partnership. Then argue for earlier borrowing powers, a wider funding remit and fresh capitalisation as part of the new Spending Review.

Borrowing guarantees
The UK guarantees scheme may not be a silver bullet but it could well be the key to reduce risk sufficiently to get projects moving and help overcome the reluctance of institutional investors to fund infrastructure.

The commitment and concept is clear but government’s habit is to make the simple complex and the Treasury’s instinct is risk aversion. Either or both could strangle this vital scheme, which is the single most important policy and funding weapon in the government’s infrastructure armoury.

Mid-term grades:
Aspiration: A
Attainment: D

Areas for attention:
Make this work – soon.

CONCLUSION

In summary, the government’s analysis of problems is much more convincing than its action to solve them and the gap between aspiration and attainment is too wide to command great confidence for the future.

As I say to our teenage son: “More evidence of effort and much more evidence of results required.”