Chancellor Philip Hammond is widely expected to outline a more flexible approach to deficit reduction when he delivers his first Autumn Statement today. Flexibility seems wise, given the scale of uncertainty as the UK prepares to leave the EU.
Ministers have identified investment in infrastructure as a means to boost the UK’s competitive standing. In the US, President-elect Trump has signalled a similar intent. While borrowing structures are different in the US, conditions mirror the UK where infrastructure spending has been curtailed over many decades.
The thorny issue facing the UK is funding and how to enable available capital to release the pent-up demand for new and improved infrastructure. Despite recent positive growth data, tax revenues are falling short of previous projections and borrowing is relentlessly climbing. Consequently, private sector involvement in UK infrastructure is becoming ever more palatable.
The challenge facing the government is how to establish effective partnerships with private sector investors when public finance is under immense pressure.
It has already taken some encouraging steps. Putting the National Infrastructure Commission onto a permanent footing is a clear signal of intent; green lights for Hinkley and Heathrow and continued support for HS2 are also very welcome. But more action must follow.
So what are the options? Given its limited ability to invest directly, the government recognises it must play a facilitating role. Ministers are now reportedly working to encourage pension funds to invest in large-scale infrastructure projects. The opportunity appears ripe given that UK pension funds lag behind their counterparts in Australia and Canada when it comes to infrastructure investment.
This strategy may not prove straightforward, however. Pension funds generally prefer long-term, lower risk opportunities, making them more inclined to invest in established infrastructure than new projects. Private equity investors, by contrast, have been prepared to shoulder greater development and construction risk but expect commensurate returns and the opportunity for exit post-construction and after the initial provision of service – often by selling newly built assets to longer-term investors like pension funds. As a result, ministers may need to adjust their aim, in the short term at least.
To secure private as well as foreign capital interest, the government must offer more concrete information about investment opportunities. There needs to be absolute transparency, particularly on risk-reward formulae.
Risk is often pivotal when it comes to securing investment from foreign wealth funds, as was the case with Chinese investment in Hinkley. Favourable terms may well be demanded when large quantities of capital are at stake.
The government responded to the need for certainty over future electricity pricing for Hinkley, so perhaps it is ready to consider a broader range of guarantees for other pressing infrastructure projects. The Thames Tideway Tunnel, London’s £4.2bn "super sewer", provides another example, where the government underwrote risks that have low probability but high financial impact.
Financing smaller projects is another challenge. As Sir John Armitt, deputy chair of the National Infrastructure Commission, has pointed out, smaller schemes often have more immediate impact than headline mega-schemes. They are typically more quickly delivered, yielding both a short-term stimulus to the economy and a long-term productivity benefit. The chancellor too has said he favours modest projects with high impact, such as removing road bottlenecks.
City bonds are one approach. Number 10 is reportedly looking at whether Manchester and Birmingham, with newly empowered mayors, can be allowed to issue their own bonds.
Aberdeen City Council has already launched Scotland’s first municipal bond issue to finance a £1bn programme, involving redevelopment of the city’s exhibition and conference centre, new schools, transport improvements and the building of 3,000 new homes over the next 15 years.
Meanwhile, an initial £100m bond to raise funds for local authorities is expected soon through the new UK Municipal Bonds Agency.
These devolved approaches must be worth developing, with local politicians well placed to know what might gain voter support.
Municipal bonds are typically issued in small lots, making them ideal for funding modest local projects. The US has used municipal funds for nearly two centuries to great effect with more than $3.8 trillion outstanding today.
There are several key questions for the UK government. Is it prepared to provide tax breaks to lower the cost of capital? Will it encourage bonds over funding sources such as the Public Works Loan Board? Will municipal bonds prove politically acceptable – and will they fit within governance structures protecting the public purse?
Tax incremental financing (TIF) is another possibility. TIF funds new infrastructure by setting up a local tax within the area that benefits from it. New York City created a TIF structure to fund expansion of its subway system, for example. Clearly new taxes require political resolve and deft local communications, but such a model could help fund even largescale local projects.
Innovative financing, however, will only go so far. Perhaps the biggest constraint to the flow of capital into major infrastructure projects is simply a lack of suitable opportunities. There are just not enough major projects coming through the planning and approval process to make a difference to the UK’s long-term prospects.
Financing will always be available to sensible, well-structured projects that promise a reasonable return. If the government can put this class of deal on the table, both debt and equity funding sources will be available and keen to participate.
In other words we need vision, determination and swift decisions to improve the UK’s infrastructure. We hope to hear more in this vein from the chancellor in his Autumn Statement today.