Infrastructure investment. Buy now - pay later?

IN HER BUDGET, Chancellor Rachel Reeves mixed talking tough on financial discipline - with some painful consequences in raising £40bn in new taxation to pay for day-to- day expenditures - coupled with the belief that “borrowing to invest”, will kickstart the economy and ultimately get Britain’s debt under control through the fruits of growth.

The level of her ambition and the size of the mountain she must climb is clear in the numbers. Britain owes £2.7 trillion – an amount set to creep up each year through the rest of this parliament, and growth is expected to be no more than 2 per cent over the same period.

Paul Johnson of the Institute for Fiscal Studies is amongst those noting her gamble that this extra borrowing over the next four years, up from £59bn a year to £85bn a year, -with the interest to pay for it- will be worthwhile.“A lot hinges on how well the government spends the money,” Johnson said. “The additional investment is extremely front-loaded, which doesn’t fill me with confidence on how efficiently it will be spent.”

The Government’s strategy does seem a potentially rash bet with such large sums involved- and the vagaries and fragilities of making sound investment decisions .

The decision making basis of all governments is generally regarded as a mixture of politics, and responses to events, usually ones that politicians would like to control, but are unable to.

The politics, and policies, are either pragmatic or aspirational, with some governments wanting to set new agendas and reshape the landscape, and others happy to simply be in charge.

In one or two areas, there are established and acknowledged rules of what can and cannot acceptably be done — at least by democratically elected and accountable governments. One of these is on the matter of finance. Politicians risk quickly being criticised for imagining resources that really don’t exit — the idea of the magic money tree. And, moreover, falling foul of the institutions and the markets in no uncertain terms when they feel the government is not working with sound money, as Liz Truss and her Chancellor, Kwazi Kwarteng found to their cost. And Jeremy Corbyn and John MacDonald might well have done too.

This week, Reeves has had to seek to manage the new Labour Government’s two key aspirations.One is to increase elements of public expenditure to suit its programme in health, welfare and other social services, whilst looking after the expectations of its core supporters, many of whom work in the public sector - and at acceptable levels of taxation to pay for them. This is the ‘revenue’ side of the budget, i.e. day to day costs being paid for by day to day income — mainly from taxation.

The other aspiration is what the Government likes to call ‘infrastructure investment’, for which it is seeking to manage a different equation. This one adopts the principle that expenditure on ‘assets’ creates new capital value, and therefore is an improvement of the nation’s physical inventory, which logically means money well spent, particularly in meeting the Government’s major commitment to economic growth and wealth creation.

If this investment in infrastructure in not to be funded by the Government’s own income, the argument goes, it’s a perfectly reasonable proposition to borrow from the private sector or other governments and international institutions, because that borrowing and the interest on it has been made for a sound purpose, and is secured against producing something tangible, and in the end realisable, if it needs to be sold.

So far, so good — maybe. But if we turn our attention to the transport dimension of the equation, we can examine real world situations where things might be less clear-cut, or go badly wrong, with unwelcome consequences.

There are several weak points in the logic. These relate to the actual justification and quality of the investments and the assets they create; the genuine income streams that are generated; and the real ability for lenders to imagine that these assets can be turned into monetary value if push comes to shove. After all, the Government has to be able to service the debt it will be incurring from some kind of income stream, potentially repay (or roll over) the principal sum at some point, and convince the lenders that there is something in existence with their name on it as a tradeable asset.

There are some obvious examples of mistaken beliefs in the potential achievements and benefits that public expenditure on infrastructure investment can deliver. These range from questionable business cases and economic appraisals, to inaccurate forecasts of activity and mysterious ‘intangible’ benefits of the kind that both national road and rail schemes have often relied upon to get the green light

Regarding the justification for investment, there are some obvious examples of potential mistaken beliefs in the achievements and benefits that such public expenditure can deliver. These range from questionable business cases and economic appraisals, including forecasts of activity and mysterious ‘intangible’ benefits of the kind that both national road and rail schemes have often relied upon to get the green light — think HS2 and Lower Thames Crossing. On top of this, there is the question of managing the planning , construction and delivery within budget - something for which major transport schemes do not have an unblemished reputation. Then there may be unexpected maintenance and upkeep costs that might not have been properly budgeted for, so the asset becomes something of a liability to look after. Unfortunately, there are a number of examples in transport of decaying structures, equipment and vehicles, which despite their ‘book value’, are simply not worth keeping in service, or require substantial ‘new money’ to do so. The pothole-riddled local road network is probably a very good example. There is also the new threat of climate-related damage by storm, flood and intense heat, all causing transport asset deterioration and triggering new cost pressures

The income streams against which asset value funding may be calculated are the second potential weakness in this investment thinking. Firstly, actual revenue on the transport system has traditionally either been direct or indirect charges for the use of roads, bridges and tunnels, or the fares paid by passengers on public transport. It is a political challenge to keep these income streams at levels which are acceptable to the public at large as travellers and road users, as evidenced by the political unwillingness to raise fuel duty and rail fares. Alongside this is the difficulty of being confident that forecasts for new schemes are robust and not subject to the optimism bias not infrequently identified in transport project proposals. If actual money is not collected from users, but identified as societal and general economic benefits, the Government still needs to have a way of affording to pass the value of such benefits on to the ultimate scheme funders .Which , if from taxation, needs to be taken out of the general revenue pot forming the other part of the Chancellor’s financial juggling act, already mentioned.

Meanwhile, there is a considerable direct operating cost to be covered by large assets, which means much ‘shadow tolling’ income is pre-committed to that purpose, and therefore unavailable to also service funding and debt. Ideas such as Road User Charging — creating a new ‘pay as you go’ revenue stream — would of course clearly help here, but are another significant political challenge to confidently and reliably implement.

Finally, there is the question of the genuine ‘book value’ of all these important new assets that the suggested new framework for funding public infrastructure investment will create. Experience suggests that optimistic public accounting procedures are likely to significantly overvalue some of them at least. Untolled roads, bridges and tunnels are site-specific assets, which if required to sit in commercial accounts, might have questionable value. Once constructed, for example, HS2 from London to Birmingham has been mooted for transfer out of public hands into someone’s private portfolio, but not at anything like the full cost of its construction. The marketplace for trading such assets is small, and the potential owners hardheaded financiers .

Realisation of value was easy when whole public sector industries with good facilities, trading record, and market pedigree could be sold by privatisation — the electricity, gas, water, airline/airports and telecoms businesses disposed of by Margaret Thatcher’s 1980s Conservative government. They were unencumbered by debt when sold , though most of them have since been loaded up by new lending to suit their subsequent owners, reducing the remaining net value to very small numbers — just ask Thames Water.

Two final points. One is that, in old- fashioned individual domestic parallel thinking, acquiring an asset like a house on a mortgage is a shrewd investment for the long term, as the repayment liability is finite timewise, and having and paying off the mortgage is the better deal than paying rent forever. The lender, meanwhile, also looks very hard at the borrower’s ability to service the debt and repay for the asset -- having their earnings and ‘ability to pay’, carefully checked and stress-tested . Inflation in the values of most assets also means that there is big advantage in financing (and owning) something that ‘can only go up’ over time, whilst the debt reduces. Unfortunately, the equation is rather different when it is the Government that is borrowing and international money markets and fund managers are the lenders calculating things on a very different basis, and an ability to clear the debt is not a genuine part of the calculation .

Alongside this is an issue that arises when going down the financing and accounting path described, taking more and more of the nation’s important infrastructure out of public control and into the actual -or at least effective- hands of private or overseas government owners. Or becomes dependent upon them as hard-headed financiers, who may not be too benevolent if times get tough and repayment is a problem.

For the major part of the 20th century, a huge bank of publicly funded unencumbered assets were built up at central and local government level. Much of this has since been sold off to generate cash, starting with the Thatcher privatisations, and the subsequent disposals by various cash-strapped government departments, agencies and local councils of land and other properties . All this was the ‘selling of the family silver’ as evocatively described by former Prime Minister, Harold MacMillan.

We now, in contrast, seem to be entering the era of buying new family silver, of questionable value, on credit, in highly uncertain circumstances . It has the hallmarks of a public funding quick-fix, with an unquestioning belief in its magic properties to unlock future prosperity. It might be a smart idea. But then again, it might be a poisoned chalice. We shall see.

Peter Stonham is the Editorial Director of TAPAS Network

This article was first published in LTT magazine, LTT902, 31 October 2024.