Jeremy Peat: A better way of building for future

SUDDENLY everyone is talking about the financing of infrastructure. Well not quite everyone, but this week has seen a remarkable coincidence of developments on this topic for Scotland and the UK as a whole; which could result in a significant change of approach and potentially yield marked benefits.

On Monday of this week we at the David Hume Institute organised a seminar at The Mound on financing Scotland’s infrastructure priorities, involving Peter Reekie of the Scottish Futures Trust (SFT), Professor Dieter Helm of Oxford University – perhaps the UK’s leading thinker around this subject area – and chaired by Gershon Cohen, the Lloyds infrastructure guru with real practical experience of many PFI and PPP schemes. Then the next morning Gershon, Peter, colleagues of his from SFT and a couple of other notable Scottish experts joined me with a group of MSPs, from the Holyrood infrastructure committee and elsewhere, for a fascinating round-table discussion of the way forward in Scotland.

This was all very encouraging – transparent and informed debate on a key topic, with influential MSPs participating and no barriers to what was considered. What was also remarkable, however, was that in between the events on Monday evening and Tuesday morning the Chancellor announced a rapid review of the whole approach to Private Finance schemes for the UK. This review is to be completed within ten weeks and seeks enhanced efficiency (lower costs) for delivery of the next raft of infrastructure schemes.

One common background feature to the review of infrastructure financing in Scotland and for the UK as a whole is the dire state of the public finances.

The whole PFI concept originated from a desire to move infrastructure financing “off balance sheet”, so that it did not “score” as public expenditure and hence opened up more scope for other public funding without adjusting agreed expenditure or deficit limits.

This was at the same time deemed efficient on the grounds that whilst it would cost more for the private sector to borrow than the same borrowing from the public sector, this extra cost should be more than offset by the efficiency gains, resulting from the private sector involvement and by the private sector taking over key risks associated with projects.

Listening to Reekie, Helm, Cohen et al left me in no doubt that there are some inescapable facts of life so far as infrastructure is concerned. For example: More of the right type of such investment is good news for the development and growth of any economy.

The UK and Scotland can be seen as lagging on infrastructure, so more activity here is even more than generally desirable

In the present environment cutting public expenditure is much more readily achieved, with less short-term pain but long-term harm, by cutting capital projects rather than revenue activity. (In Scotland, the public sector capital budget is set to fall by nearly 50 per cent in real terms from its 2009/10 peak by 2013/14. That can only be bad news, especially with the second Forth crossing to be achieved in a similar timescale.) The private sector is better placed to manage some risks and transferring activity from public to private can yield major efficiency gains.

Now is not a bad time to invest, given that excellent deals are available from the ailing construction sector – Reekie reckons that every pound invested now buys 20 per cent more assets than four years back. Further, as Osborne has picked up in announcing his review, pension funds are seeking secure, long term assets in which to invest, forced to seek alternatives while equities are insecure and bond returns low to non-existent in real terms.

The rational for Osborne’s review is straightforward to work out. The UK economy is stagnant. His forecast for cuts in the public finance deficit in the next year or two at least is doomed to be seen as over-optimistic. Therefore, he either cuts more, in order to work towards meeting his plan, or admits that cutting will prove a slower process than anticipated. In either instance he has no scope for big increases in infrastructure spend out of public funding.

But Osborne would love to do more, both because of the need for this activity and to show that he is doing something to mitigate the risks of double dip and the impact of slow (at best) growth on business and households. Helm has calculated that the infrastructure plans for the coalition for the next few years amount to some £500 billion. But this will have to be off balance sheet, while to add to his problems Osborne has before him a damning report from the House of Commons Treasury committee suggesting that financing the average PFI scheme cost 8 per cent, double the long term government gilt rate. This leads to paying off PFI debt costing far more than paying off direct government debt; and there is some £267 billion of repayments to private companies already outstanding.

So Osborne is seeking “a new delivery model which draws on private-sector innovation, but at a lower cost to the taxpayer and with better value for public services”. Easily said, less easily achieved. But Reekie and Helm had some very relevant thoughts – Osborne would have benefited from joining us on The Mound.

Helm’s big idea relates to the undoubted fact that the risks associated with project delivery are far greater than those when the capital asset has been created. Consequently, transferring those initial risks may justify a significant financing premium when the private sector is involved, but once the asset exists there is no such justification for any financing premium of substance. At this latter stage low risk debt should be sought – and the vast resources in pension funds could well be a good match.

The SFT model is not a million miles away from this concept and it certainly looks that, thanks to SFT, Scotland is ahead of the game in this field. It is also worth noting that, since devolution, there are no Whitehall/Westminster imposed limits on borrowing for PFI type schemes in Scotland. However, the existing debt burden in Scotland is not insignificant, with a cumulated future liability of some £28bn from the funding of £6.2bn of assets, and hence caution and the search for cost-efficient means of delivery remains absolutely critical.

In this context SFT has other thoughts which merit attention. To make more infrastructure spend affordable we should consider more pay-as-you-use and less pay-as-you-go. Rail infrastructure already is financed that way but why not some inter-urban and intra-urban toll roads? Why not enhanced user charges for phones and communications to pay for nationwide high speed broadband roll-out?

They also argue that efficiency of delivery can be markedly improved; and this is where SFT, this arms length body, should be able to deliver further real efficiency gains.

Another crucial area is prioritisation of spend. While we await the Scottish Government’s next infrastructure plan, I was fascinated to hear of arrangements in Australia and elsewhere whereby an arms length body advises government on priorities. To quote Reekie, this is “an independent body … with the specific remit of establishing a national blueprint for strategically important economic infrastructure and working with regional and local governments as well as the private sector to facilitate its implementation.”

We already have such a body in SFT. We have a recommendation from last year’s Independent Budget Review Group that SFT should fulfil a role assessing infrastructure priorities in Scotland. I am not arguing that government should cede its authority to SFT. Rather that we would all benefit from rigorous and transparent assessment, on the basis of agreed criteria, by SFT with recommendations considered by government and available to Holyrood, to better inform the final selection of projects and their means of implementation.

In sum, the Osborne review is welcome but Scotland is already ahead of the game. We should not be tied to his decisions – and the Helm thought merits our attention. Let us try to implement more well-selected projects via pay-as-you-use as well as direct financing; and let SFT generally assist the process, add to transparency and enhance efficiency of selection and implementation.

• Jeremy A Peat is director of The David Hume Institute