Sunday, October 12, 2014
Time to join the dots on infrastructure spending
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

How do we build the infrastructure the economy is crying out for and the new housing a growing population sorely needs?

Through the haze of the party conferences, I got that Labour and the Liberal Democrats want to borrow more to fund additional public investment in infrastructure – roads, railways, energy, schools, hospitals, flood prevention, etc - and social housing, with the LibDems rather bolder on this than Labour.

Superficially this makes sense. Government borrowing costs – gilt yields in Britain’s case - are very low, so why should the government not go directly to the markets to fund such spending?

The International Monetary Fund, concerned about the slowdown in the eurozone’s already anaemic growth, has called for debt-financed infrastructure spending – even in countries with debt and deficit problems – to generate activity.

Of course Britain’s government, like others, already directly funds infrastructure spending. Net capital spending will be around £28bn this year, just over 1.5% of gross domestic product (GDP). The trouble with adding to it significantly would be that borrowing for investment is not ringfenced; to the markets it would be indistinguishable from borrowing for everyday spending.

It would be seen, in other words, as weakening the commitment to deficit reduction. Nor, as recent experience shows, can we rely on governments not to cut capital spending when the public finances come under pressure.

So it is probably not sensible to think of the public purse, which will be severely constrained for many years to come, for a big increase in infrastructure and housing investment. Nor is it sensible to think of the banks, which were active in this area, and were an important source of funding for housing associations which build most of Britain’s social housing. The banks too are severely constrained.

There is another way, and on the face of it looks like a no-brainer. Globally there are hundreds of billions of pounds of institutional money anxious to find a home in infrastructure investment. Britain’s financial institutions – the pension funds and insurance companies – want long-term investments with stable returns, not sky-high ones.

Six of Britain’s insurers – Prudential, Aviva, Legal & General, Standard Life , Friends Life and Scottish Widows – a few months committed an initial £25bn to invest in UK infrastructure over the next few years. The National Association of Pension Funds has set up a pensions’ infrastructure platform, with the aim of directing pension fund money into the infrastructure.

I have been thinking about this. A couple of weeks ago I chaired a seminar on the issue at the Tory conference in Birmingham, organised by the think tank Reform and sponsored by Prudential, one of the insurers keen to do more infrastructure investment.

I have also had a long dialogue with Nigel Wilson, chief executive of Legal & General, who is a passionate advocate of institutional investment in infrastructure. What we need, says Wilson, is what he describes as “slow money investment”; housing and urban regeneration.

“Economic growth is created by modern efficient cities - we should be discussing how we build these cities instead of spending all our time discussing the timing of interest rate increases,” he says. “Urban regeneration requires slow money (20-year plus) and a lot of institutional support.”

Most of the insurers can point to some progress in increasing investment in infrastructure, including student accommodation and affordable housing. None would say there is enough. At the Birmingham event William Nicoll, head of fixed income at M & G, which is owned by Prudential, bemoaned the fact that too much institutional money in search of infrastructure investment ends up going overseas.

Priti Patel, the Exchequer Secretary representing the Treasury, took note. Lord Deighton, her Treasury colleague, its commercial secretary, is charged with driving additional infrastructure spending.

The situation is not completely dire. The Construction Products Association predicts that infrastructure spending as it directly affects the construction industry will rise from £14.6bn this year to £20.3bn in 2018. On this measure, while infrastructure spending has been flat over the past four years, it has been significantly higher in real terms than over the previous 15 years.

But it could be a lot better. A report by Scape, a construction procurement company, notes that construction output is currently 26% lower than if it had followed pre-crisis trends. Even after its recent recovery, we are building half the number of houses we need.

Why is it proving so difficult to join the dots between a government and an economy in need of more capital spending and institutions with the funds to make it possible?

One perennial issue is planning. The government has an infrastructure pipeline, just updated, with a huge number of projects and a combined value of hundreds of billions. But many projects are stuck in the pipeline and planning is usually the culprit. There is no better way to deter even long-term investors than to sink them in the planning morass.

Bureaucratic inertia is a problem. Civil servants are rightly risk averse but that risk aversion often extends to deep suspicion of the private sector. Not only that but the public sector rarely takes advantage of its economies of scale; it is highly fragmented.

Insurance companies will tell you of a social housing or other project they have successfully undertaken in one local authority, often for a low return, in the expectation that it will serve as a template for similar projects elsewhere. But each bit of central and local government does things in its own way, and each project has to expensively start from scratch.

It would be wrong, too, to pretend that everything is hunky dory on the institutional side. MPs at my Birmingham meeting pointed out that many pension funds, particularly local authority pension funds, are too small to undertake meaningful infrastructure investment. It is a point that has been taken up by Boris Johnson; combining these funds would allow them to scale up their investments.

But, with one or two exceptions, there is also institutional caution, sometimes forced on them by actuaries, trustees or shareholders. We have nothing yet comparable with the Ontario Teachers’ Pension Plan, which has substantial stakes in Birmingham, Bristol, Brussels and Copenhagen airports; HS1; Scotia Gas Networks; and energy, container ports, desalination and other projects across the world.

We are, then, missing an opportunity. Every serious long-term report on the British economy says we need much more infrastructure. The money is there. We need to make it happen.