Sunday, September 20, 2015
Even at low rates, infrastructure's not as easy as it looks
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

HS2.jpg

My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Even without going as far as Churchill – “If you put two economists in a room, you get two opinions, unless one of them is Lord Keynes, in which case you get three opinions” – we expect economists to disagree. Consensus is rare, debate and disagreement the norm.

If there is one thing on which you would get something close to consensus, however, it is that the current period of very low interest rates presents an ideal opportunity for governments to borrow and spend on essential infrastructure.

After all, there is no country in the world, not even China after its public investment boom, which could not improve its infrastructure. Britain could certainly improve her roads, railways, schools and hospitals. There is a pressing need for new investment in power generation. The economic effect of building new infrastructure is to generate more employment and economic activity directly, as well as improving the economy’s performance over the long run.

Not many sensible economists would agree with Jeremy Corbyn’s “people’s quantitative easing”, if it ever becomes a policy – and it was good to see Mark Carney put his head above the parapet to attack it – but plenty think there should be more infrastructure spending.

Fiscal multipliers associated with infrastructure spending are higher than for other public spending; in American parlance you get more “bang for your buck”. It looks like a win-win. So why is it not happening?

The first thing to say is that more is happening than has been the norm in recent decades. Taking what was achieved in 2010-15 and what is planned for 2015-20, public sector net investment this decade, averaging £31bn a year in real terms (2014-15 prices), is about a fifth higher than under the Blair-Brown Labour governments from 1997 to 2010, where it averaged just under £26bn a year.

Public sector net investment was much lower in the 1980s and 1990s than now and, while it rose strongly in the late 2000s in the run-up to the London Olympics and in response to the crisis, this was always seen as temporary. Had Labour been re-elected in 2010, it was with a plan to cut public investment even more aggressively from those temporarily high levels than the coalition ended up doing. Not since the period from the mid-1960s to the mid-1970s, when it was swelled by investment by the then nationalised industries (now private sector investment) has it been consistently higher than in the current decade.

Even so, previous governments did not have the benefit of current very low borrowing rates. The yield on 10-year gilts is currently just under 2%, while the 30-year yield is just over 2.5%. Factor in 2% inflation, the official target, and borrowing is very cheap indeed.

So why is there not more of it to fund higher levels of infrastructure spending? The first reason, I think, is that borrowing is borrowing. The budget deficit, while falling, is still large; £88bn or 4.9% of gross domestic product last year. Even if the payback from public investment is larger than for other government spending, the initial effect would be to push the deficit higher.

At times in recent years, when the deficit was barely coming down at all, that was a luxury the Treasury did not think it could not afford. It is still wary. Markets are more concerned with the overall numbers for the deficit and debt than the composition of it.

There is also the political reality of infrastructure versus other government spending. More infrastructure may be good for us, and indeed is essential in the long run. But it is often fraught with political difficulties. Indeed, it is often unpopular. Look at the row over HS2 and the pressure to abandon it, or the third runway at Heathrow, or new nuclear power stations. Anybody who has trundled through miles of coned areas while a “managed motorway system” is being installed is not filled with love for infrastructure.

Though complicated by the issue of nuclear weapons, George Osborne’s announcement of a £500m investment at the Faslane submarine base on the Clyde, guaranteeing jobs, was met with this response from Nicola Sturgeon, the Scottish first minister: “If the chancellor's got £500m to spend then I think he'd be better advised to spend it on health, education, giving young people the best start in life and reversing some of his cruel attacks on the most vulnerable.” Politically, £12bn of welfare cuts and tiny public sector pay rises alongside a huge increase in infrastructure spending would be a tough sell.

Treasury officials are meant to worry about debt and they will never be as relaxed about the prospect of adding to it as economists who do not have to carry the can if things go wrong. Long-term interest rates are very low now, and Britain is fortunate in that the average maturity of government debt is longer than in most other countries. But even under existing plans, more than £500bn of gilts will have to be rolled over in the next five years; new ones issued to replace those maturing. It may be that this can be done on terms as favourable as now but nobody can be sure of that.

Perhaps the strongest argument against turning on the infrastructure taps is that, while we may have got a bit better at these things, the history of massive cost overruns and public sector project disasters is a sobering one. Just because infrastructure spending is cheap to finance does not mean it will be value for money. White elephants and unplanned budget-busting outlays are part of the territory.

A new study by professors Bent Flyvbjerg of Oxford and Cass Sunstein of Harvard, looking at more than 2,000 big projects around the world, found that four-fifths of them “get tripped up by a malevolent hand that hides the true costs of and benefits, resulting in massive economic losses to taxpayers and businesses”.

None of this means things could not be improved. I still like the proposal of the LSE Growth Commission two years ago for an infrastructure strategy board, planning commission and bank to take the politics out of infrastructure and ensure it can be funded in partnership with the private sector. A big disappointment in recent years has been the failure to get more pension fund and insurance company money into infrastructure.

There is also scope to do a lot more on housing. The government is in something of a battle with housing associations at the moment. But they, rather than councils, will deliver the social housing Britain needs. If that means guaranteeing more borrowing by them, the public finance rules should not get in the way of that.

Even housing runs up against Nimbyism, planning delays and lack of skills, of course. There are, or should be, imaginative ways of tacking all these things. But we should not pretend it is easy. We discovered during the crisis that “shovel-ready” infrastructure projects are not a tap waiting to be turned on. Like many apparently easy things, it is a lot more complicated than it seems.