Keynes is back, or so it seems.
Both left and right wing movements across the West are calling for greater government borrowing to finance infrastructure projects. In the US, Donald Trump is proposing to invest $500bn. In the UK, Labour’s John McDonnell wants an even more lavish £500bn programme, equivalent to around a quarter of UK GDP. Although more modest in scale, Philip Hammond has said he intends to announce more infrastructure spending at the Autumn Statement today.
But Hammond should be cautious about this new consensus. Investment in infrastructure per se is not necessarily a boon for growth. In China, 55 per cent of recent projects are judged to be destroying economic value.
Excessive borrowing can also end up weakening growth. Studies suggest that when national debt to GDP ratios exceed 90 per cent, median economic growth rates can fall by between 1 and 2.2 per cent. And so-called “mega projects” are often fraught with difficulties. On average rail projects go over budget by 45 per cent and their demand is overestimated by 51 per cent, according to McKinsey.
This does not mean improvements to the UK’s infrastructure are not required. The World Economic Forum’s Global Competitiveness Index highlights the need for some improvements in the areas of road, rail, air transport infrastructure and broadband. But given the UK’s infrastructure investment gap is estimated to be a relatively modest 0.4 per cent of GDP, the government’s focus must lie in how to improve the quality of infrastructure spending.
This means reviewing how projects are prioritised, how they are funded, and what the role of the private sector should be in bringing projects to fruition. Projects mostly financed by the private sector, and which will operate in a competitive market, should in principle be treated positively by the government whose responsibility should be limited to ensuring the right regulatory framework. This includes areas such as airport expansion, the promotion of shale gas, and proposals to create Free Zones around UK Ports.
In many cases public finance or a government guarantee of some kind is needed. But this does not mean such projects cannot be run as efficiently as those financed wholly by the private sector – as shown by the success of Crossrail.
Its £14.8bn funding comes from a variety of public bodies, including TfL, the Greater London Authority and the Department of Transport. Contributions have also come from private sources, including the City of London Corporation and Canary Wharf. Expected to open on time and on budget, this project could improve the UK’s reputation for delivering major infrastructure projects.
Where there is no such range of external interests involved – as in the case of HS2 – problems begin to emerge. The coalition government acknowledged that private sector involvement in the financing of HS2 would be minimal, saying that “third party contributions could only deliver a small percentage of the core costs”.
This is very disappointing in light of the Shaw report, which highlighted that – for rail projects generally – options for involving private sector finance should be explored. HS2’s costs are spiralling out of control – and a lack of private sector oversight will undoubtedly be a contributing factor.
Ministers will have to come up with a new mechanism to encourage private sector finance into infrastructure projects following the abandonment of the old PFI model. This is particularly important as projects that receive private sector scrutiny at the planning stages will inevitably be more efficient and require a robust business case.
Enabling project bonds for certain proposals could be an effective way of drawing in private investment, rather than having projects “queue up” for Treasury funding. Taxpayers could be protected from private investors receiving excess profits through the use of Treasury equity warrants, whereby it receives equity if returns exceed a certain level. This would ensure that the problems associated with PFI do not occur again.
It is true that such project bonds would likely demand higher yields compared to the current cost of government borrowing. But the increased scrutiny of projects by the private sector under project bonds could help increase the efficiency of projects coming forward, avoiding the problems observed with HS2. This is certainly an idea that could be trialled by the government.
What is clear, however, is that allocating more public funds is not a silver bullet to the UK’s infrastructure problems. It is time for the government to focus its attention on the quality of infrastructure.