UK infrastructure improvements: Key issues for the 2015 Parliament

The Organisation for Economic Co-operation and Development (OECD) has stated that without investment in infrastructure of around 3.5% of GDP per year, competitiveness will be blunted and there will be detrimental implications for the quality of life of the UK's growing population.

Can this level of investment be achieved and sustained during the 2015 Parliament?

Government investment is falling…

Currently, public sector infrastructure investment totals around 1.5% of GDP, and OBR forecasts made at the time of the March 2015 Budget suggest that this will fall to 1.4% of GDP by 2019/20.

Chart 1: Public sector infrastructure investment

Public sector infrastructure investment 2010/11 to 2013/14 and forecasts to 2019/20, £ billion

This implies that, if the OECD target is to be met, around £45 billion per year will have to be found, either from additional government investment, or from the private sector, or a combination of both.

Raising the level of government investment through borrowing might seem the most straightforward option: UK government bonds are historically (and by international standards) very cheap, meaning that the government's cost of borrowing is low.

Moreover, public spending on infrastructure can lead to higher economy-wide returns than other types of government expenditure.

While Conservative plans in the run-up to the election involved eradicating the deficit before borrowing more to invest, Labour and the Liberal Democrats excluded investment from their fiscal targets. In theory, this gives scope to increase investment by borrowing more.

However, neither of these parties is contemplating adding £45 billion a year to the deficit: much more modest increases to investment spending are proposed.

In fact, since all three of these parties want to see total government debt falling by the end of the Parliament, there would be constraints on the amount of public borrowing, whatever its purpose.

Chart 2: Planned infrastructure investment

Planned infrastructure investment from public and private sources (based on national infrastructure pipeline in December 2014), £ billion, 2013/14 prices

…but the private sector is yet to fill the gap

As a result, if the 3.5% target is to be attained, much more investment will have to come from the private sector. This would be nothing new: currently, 64% of planed infrastructure finance will come from the private sector (78% if projects funded by a mix of public and private finance are included).

But the financial crisis has changed the way the private financing market operates: recent years have seen a decline in private sector investment and some previously big players have scaled back their activities.

This is partly due to a drop-off in demand for long-term finance from governments still implementing austerity programmes, partly due to uncertainty and risk aversion about the economic outlook, and partly a result of regulatory requirements that oblige banks to reduce the amount of long-term debt on their balance sheets.

For instance, Royal Bank of Scotland, previously one of the world's biggest financiers of large scale, long- term projects, has placed its entire project financing portfolio in its “non-core” arm, implying that it views this kind of investment with much less enthusiasm.

There is concern that the private sector can no longer be relied on to provide the investment required.

The Government can help to encourage private sector investment…

The previous Government introduced a number of measures to encourage private sector investment. The UK Guarantee Scheme provides government backing to schemes, meaning that they will go ahead even if a funding shortfall emerges in the future.

So far, projects worth up to £34 billion have been guaranteed, although whether or not these schemes would have found funding without the guarantees is not clear.

Pension funds typically seek long-term, reliable returns for their investors, but UK pension funds only invest around 1% of their assets in infrastructure, compared to up to 15% among Canadian and Australian funds.

The previous Government sought to encourage investment from pension funds with the Pensions Infrastructure Platform, but three years after its launch, only £330 million has been raised, and most of that has been invested in the maintenance of existing infrastructure.

The long-running public-private partnership model used in the UK since the early1990s has also been less successful at attracting investment in recent years. The revamped version of the Private Finance Initiative (known as PF2) has been criticised for its complexity, and has attracted limited take-up.

…but overcoming investors' worries about political short-termism will be a challenge

The challenge for policymakers in the next Parliament is not to devise a new scheme with which to lure private finance, but rather to convince the market that the Government is committed to projects for the long run.

This was the motivation behind the previous Government's Infrastructure Pipeline, which brings together detailed plans for private and publicly-funded investment up to the 2030s.

The Labour Party's proposed infrastructure commission would perform a similar role, but would also seek to take major infrastructure decisions out of the hands of politicians.

The political cycle, with its horizon rarely extending beyond five years, is a potent enemy to infrastructure investment. Cross-party consensus could demonstrate commitment beyond the normal cycle and bolster confidence among investors.

Party Lines

• Conservatives: plan to invest over £100 billion infrastructure over the course of the Parliament.
• Labour: will set up an independent National Infrastructure Commission to assess how to meet infrastructure needs
• Liberal Democrats: investment in infrastructure will continue to rise in absolute terms and as a share of the economy
• SNP: (…) substantial new infrastructure investment