Background

In its June 2010 Budget, the Coalition confirmed that its top priority is to reduce the fiscal deficit. The October 2010 Spending Review set out how it proposed to reduce government expenditure by £81 billion over the next four years. We analysed the detail of the Spending Review in a special edition of Coalition Watch.

As a counterbalance to the effects of fiscal retrenchment, the Coalition is also considering a range of policies to promote growth in the private sector. A key element of its policy framework is the promotion of infrastructure development and renewal.

As we reported when looking at the Spending Review, government capital spending on key projects has held up surprisingly well in the context of the overall reductions in spending. But the UK's infrastructure needs are not going to be addressed by government spending alone. Very significant quantities of private sector capital will need to be attracted.

The recently-established Infrastructure UK (IUK) is a unit within HM Treasury, supported by an Advisory Council of senior business people. IUK has responsibility for advising the Government on the long-term infrastructure needs of the UK, improving planning and delivery, and identifying and attracting new sources of private sector investment in the UK's infrastructure.

One of first priorities allocated by the Coalition to IUK was to develop a plan for the future of the UK's infrastructure. This was published on 25 October 2010 as the National Infrastructure Plan 2010.

The Plan sets out the Coalition's goals for developing the UK's infrastructure by means of increased funding for infrastructure projects from the private sector. It also sets out the policy of targeting public sector investment on those infrastructure projects which provide the greatest economic benefit and for which private sector capital is not available.

The Coalition claims that this will involve (both public and private) infrastructure spending within the key sectors of at least £200 billion over the next five years.

Specifically, it:

  • sets out the Government's vision for major infrastructure investment in the UK and its plan for achieving this vision by unlocking private sector investment;
  • focuses on the infrastructure requirements in the key sectors of energy, transport, digital communications, flood protection, water and waste management and intellectual capital;
  • analyses the challenges faced by the public and private sector in infrastructure investment;
  • outlines some of the policy and regulatory changes that may be required in order to remove barriers to infrastructure investment;
  • explains the steps the Coalition is taking, in each of the key sectors, to attract private sector investment in the UK's infrastructure.

The challenge

There is little in the Plan that is new. The programme of work and the Government's commitment to infrastructure investment have been the subject of previous announcements.

What the Plan primarily does is pull all of these strands together into a single document and outline the drivers and rationale for the Coalition's thinking. It also highlights (though without at this time attempting to resolve) some of the fundamental problems for UK infrastructure investment.

The largest problems are by no means related to a lack of public money. For example, the Plan notes that:

  • although private investment in the UK's infrastructure has historically been strong, in more recent times the levels have fluctuated, with the UK dropping down the league for quality and overall competitiveness of its infrastructure (so that, for example, the World Economic Forum has ranked it 33rd in the world for quality of infrastructure);
  • the UK is one of the most expensive countries in which to build infrastructure (with, for example, civil engineering costs being almost 60% higher than in Germany);
  • there is only a finite amount of capital available on international markets for infrastructure investment and the UK is competing for it against other countries who are also embarking on major capital programmes;
  • there is a need to take steps to reduce the cost of capital, so that infrastructure investment can be attracted at the lowest long term cost to the nation.

Government infrastructure commitments

Most of the Government's own commitments were set out in the Spending Review and are repeated in the Plan. These include, for example:

  • Investment in the low carbon economy - including £1 billion and additional significant proceeds from asset sales for a UK-wide Green Investment Bank, and up to £1 billion for one of the world's first commercial scale carbon capture and storage demonstrations on an electricity generation plant.
  • Supporting regional growth - an extension of the Regional Growth Fund for three years and an increase in size from the £1 billion announced in the June 2010 Budget to £1.4 billion, as well as permission for local authorities to use tax incremental financing to fund major new developments.
  • Superfast broadband - £530 million to provide the 'best superfast broadband in Europe' by 2015.
  • Transport infrastructure - up to £30 billion of investment in transport infrastructure which includes major new rail schemes and several key road and local transport schemes across the country.
  • Flood management - £2 billion for flood and coastal erosion risk management work.
  • Scientific research - maintaining a science budget of £4.6 billion, providing £220 million of capital investment in the UK Centre for Medical Research and Innovation, and investing £69 million in the new Diamond synchrotron in Oxfordshire.

Attracting private sector investment

The Coalition aims to attract increased private sector investment through greater targeted and co-ordinated use of public funding (in projects which provide the greatest economic benefit) and by improvements in investment models, identifying and encouraging new sources of private capital and reviewing and addressing any regulatory barriers to such investment.

More specifically the Plan:

  • Recognises that steps are needed to improve the quality of data that is held in relation to economic infrastructure in order to understand the key drivers of demand, usage and cost.
  • Introduces the possibility of extending the 'regulatory base asset' model - very widely used by economic regulators to incentivise investment in infrastructure by regulated companies - to assets which are delivered within a competitive market.
  • Proposes further reforms to the planning regime including a radical overhaul of the local planning system through the Localism Bill, replacing the Infrastructure Planning Commission with a Major Infrastructure Planning Unit within the Planning Inspectorate and providing that ministers will make the final planning decision on all major infrastructure projects.
  • Indicates that although the primary purpose of the sale of relevant Government assets is to reduce the financial deficit, revenue from such sales may be hypothecated to fund the infrastructure programme.

Key sectors for investment

The Plan recognises that some of the key sectors are subject to independent economic regulation, including in particular the energy and water sectors, and notes that such regulation can impact on the investment strategies of private investors.

IUK has given initial consideration to the question whether the existing regulatory regimes continue to be fit for the purpose of responding to the future investment challenge. In doing so it has identified issues for further consideration around the duties of regulators, the lack of clarity on the long term strategic direction of the Government, the regulatory outputs by which companies are measured, and the limited liaison between regulators to share best practice on the achievement of common objectives.

Reviews into the roles and functions of Ofwat and Ofgem (respectively the economic regulators for water in England and Wales and energy in Great Britain) are already underway as part of the Coalition's wider review of public bodies. The issues identified by IUK will be considered by these reviews.

The Department for Business, Innovation and Skills may be given responsibility for developing and publishing a common set of principles for economic regulation and for coordinating work across departments to ensure that competition and consumer outcomes are delivered effectively.

Finally the Plan set outs a programme of action, the methods of delivery and the Government's commitments in respect of each of the key sectors. The key elements of the programme of action for each sector are as follows.

Energy infrastructure

  • Significantly increasing investment in energy efficiency incentives for both domestic and commercial consumption, including by means of reforming the climate change levy as a way of establishing a floor price for carbon.
  • Supporting low carbon energy sources (including new nuclear generating stations without public subsidy, offshore wind, and technologies such as biomass and carbon capture and storage) to help reduce the long-term the dependency on imported hydrocarbons.
  • Improving security of supply through investments in smart grid and smart meter technology and in liquefied natural gas terminals and gas storage.

Transport

  • Developing and promoting a competitive economy through investments in road schemes in order to manage congestion, and through the better management of existing assets, contracts, and capacity (including airport and ports capacity).
  • Working towards sustainable growth and managing climate change through decarbonising automotive transport, the construction of improved rail assets, and an investment in high-speed rail.
  • Promoting and supporting local projects through continuation of the Local Sustainable Transport Fund, and simplifying the grant streams for local transport funding.

Digital communications

  • Encouraging private sector investment in the further development and enhancement of the broadband network by facilitating the sharing of infrastructure, examining the need for regulatory changes and working with Local Enterprise Partnerships to define local projects more precisely.
  • Removing barriers to private sector investment by more targeted interventions and through policy and regulatory decisions.
  • Further releasing electromagnetic spectrum from the public sector.

Flood management, water and waste

  • Encouraging efficient use of water, delivering joint energy and water savings through new investment by the water and sewerage companies.
  • Managing the risk of flooding and coastal erosion through long-term planning, supporting local authorities in their local flood risk strategies, making information on flood risks more accessible, and developing and consulting on a national strategy for flood and coastal erosion risk management.
  • Working towards a more sustainable approach to managing and treating waste.

Intellectual capital

  • Enabling investment in science, research and innovation through provision of research facilities and equipment in universities.
  • Supporting (including by way of capital investment) the work of the Research Councils and investing in innovative technologies in and for infrastructure.

Commentary

There is little that is new in the National Infrastructure Plan.

However, this is the first time that a national plan has been developed for major infrastructure, and it is to be welcomed for several reasons. In particular, it is welcome as an example of an attempt at properly joined-up government (led at a suitably senior level within the Treasury), and an indication that the Coalition is focused on creating the conditions for economic growth.

The fact that infrastructure generally fared better than might have been expected in the Spending Review indicates that the Coalition is serious about the issue, and that this is more than window dressing.

Nonetheless, the Plan merely draws attention to problems that as yet have no resolution, and huge amounts of work will need to be done very quickly if those issues are to be resolved.

We have the following main comments on the Plan as it stands.

  1. It is important to get beyond the headlines, which are misleading. The Plan states - "The Government plans that over the next five years some £200 billion will be invested in UK economic infrastructure". This sounds impressive. But a footnote reveals that the figure has been arrived at by a simple process of aggregating all currently declared public and private sector capital spending plans in relation to that period. Since the large majority of this takes the form of private sector investment, there is no reason why the Coalition should assume the credit for it by presenting it as if it were a coherent government-sponsored programme.
  2. The Plan needs both a short and long-term focus. The Coalition has a natural tendency to think in terms of the (soon to be set in stone) five- year term of the current Parliament. But there is no reason to draw the line at five years, and the UK needs a plan which takes both a short and a long-term view of infrastructure requirements and which is unrelated to the life of any individual government.
  3. There is no question as to the scale of the task. In a detailed analysis for Policy Exchange Professor Dieter Helm estimates the required infrastructure spend for the UK over the next decade at a 'conservative' £500 billion.Or, to state this in a way which perhaps gives a better sense of its true scale, £½ trillion - the equivalent of £50 billion of infrastructure spend every year for ten years. This figure is widely regarded as reasonable and is broadly consistent with some of the work done by the sectoral regulators (most notably Ofgem) in anticipating the need for capital outlay.

It will take significant amounts of work to create the economic, regulatory and financial climate in which investors are both able and willing to commit this amount of capital to the UK in an internationally competitive market.

  1. The Coalition understands the problems but does not yet have the answers. The National Infrastructure Plan correctly identifies some of the key problems in delivering infrastructure investment on this scale. These are not new, since independent analysts have been highlighting them for some time. However, it is useful to see the Government acknowledge both their importance and connectedness. But Coalition thinking is evidently some way short of having a view on how to resolve the problems.
  2. Political and regulatory risk needs to be significantly reduced. It will be critical for the Government to create a clear and stable regulatory environment in which investors are not exposed to significant risks of policy change.

This is going to mean resolving the mess created by the multiplicity of carbon reduction and energy efficiency schemes, and also significantly reducing their byzantine complexity. The best policy approaches are clear, simple and co-ordinated. An incentive scheme provides no incentive at all where it is too complex to be understood by those whom it purports to incentivise.

In addition, the Government needs to rethink and redefine the boundary between itself and the economic regulators. Regulation still largely functions on the same basis as it did when the formerly-nationalised industries were privatised in the 1980s and 1990s. It has successfully met many of the challenges for which it was designed, but the current challenges are new and different. Regulation was not originally established as a mechanism for setting key national strategy, nor is that necessarily a role for which it is well suited. It must therefore be clear what the proper role of regulation is in relation to government, and the independent regulators must be able to operate within a framework of duties which give them a clear legal mandate and remit.

We have previously considered some of these issues in ashort article for Utility Week (co-authored with Roger Barnard) in relation to the role of Ofgem.

  1. The cost of capital matters. It will not be sufficient to find the capital needed for infrastructure investment if the long-term cost of doing so is excessive for the UK economy. In other words, given the scale of the expenditure envisaged, it is crucial to reduce the cost of financing that expenditure to the lowest level possible, so that the debt does not become unduly burdensome to the economy in the future. The Government recognises this issue and the various models that may be used for capital investment, but has as yet given few indications of how it proposes to ensure the investment costs can be minimised. It estimates that a 1% reduction in the cost of capital would be worth at least £5 billion per year in savings. As always, the devil is in the detail, and the Coalition promises a series of actions and sector-specific policy documents over the next 18 months, all of which are helpfully listed in Chapter 5 of the National Infrastructure Plan.

We will bring further commentary on those developments as they take place.