By Professor Stephen Glaister, director of the RAC Foundation,
The Government is clearly convinced of the need for more infrastructure to help deliver the growth agenda. They are right.
But it is unwilling or unable to increase public borrowing in order to finance it so, as the Prime Minister has said, he is looking towards pension funds and other investors at home and overseas (including the Chinese) to step in.
So far, so good.
But private investors rightly insist on a return on their investment and the ability to reclaim what they have invested: they have to fulfil their obligations to those who have trusted them with their money. Pension funds and many others are cautious investors. They will not accept high risks of losing their capital; by the same token they realise that they can only expect a relatively low return.
Investing capital in an operating infrastructure utility with the assurance from an independent regulator that charges to users will be sufficient to give a reasonable return (providing the asset is efficiently run) does create the ideal home for these investors: low and easily understood risks and steady returns. Sure enough, for decades pension funds and international investors have been financially backing these utilities on a massive scale.
But there are schemes that might produce sufficient financial returns—and more—to pay back private investors which the more conservative pension funds etc. will not touch because they cannot stomach the risks. An example is the so-called green field project; a brand new scheme which starts with a sheet of blank paper, as opposed to an established cash-generator. It is these projects which the financially nervous shy away from, wary of construction costs, planning hold-ups and forecast levels of customer demand.
The fast rail link from London to the Channel Tunnel (now HS1) was an example. In the mid 1990s this was offered to the international capital market as a fully privately financed venture. The markets were quick to say no. So the taxpayer promoted the project and took the risks. It turned out that the markets had been quite right and billions of pounds of public subsidy were needed to complete the project. However, once completed and operating as a going concern with a proven market, things looked more rosy, hence the thirty year concession recently sold to a Canadian teachers’ pension fund for £2.1 billion.
So yesterday’s announcement by the government that they will start to underwrite some of the infrastructure investors’ risks may help and is welcome.
But there are dangers. Risk transfer—that is, ensuring private enterprises offering public services really do face the consequences of their actions—has been the most difficult single issue since 1980 when governments started to create partnerships with the private sector. As Sir Mervyn King, Governor of the Bank of England repeatedly warned in respect of the banks, if investors come to expect that they will be bailed out if things go wrong but will be allowed to keep the benefits if things go well then they have every incentive to charge into the one-sided bet and no incentive to be prudent: it essentially crates a moral hazard.
Things will go wrong and the taxpayer will be liable. We have seen it repeatedly.
John Prescott rescued HS1 by underwriting a bond issue and promising that Railtrack would eventually buy phase 1 of HS1. Things went badly wrong, the guarantees were called and we know from the recent Public Accounts Committee report just how dearly it cost the taxpayer.
Another cautionary tale was the Public Private Partnership (PPP) for the London Underground. The contracts that were signed guaranteed most of the investors that they would get their money back whatever happened. So their bids grossly overestimated what they could deliver and there were inadequate incentives to be efficient. The contracts failed, the responsibilities fell back on the taxpayer and the full story of the cost to the taxpayer has yet to be told.
None of this is to argue against well-constructed, transparent contractual relationships between state and private enterprises: the allocation of risks must be clearly defined and enforced in practice, and the incentives must be carefully though through.
There are more than ten shadow tolled Private Finance Initiative (PFI) road schemes in the Highways Agency’s portfolio, some going back to the 1990s. The National Audit Office seems reasonably happy with most of them. Portsmouth, Birmingham and the London Borough of Hounslow have seen fit to sign long term contracts to maintain their local roads. And all of London’s bus services are provided by the private sector under contract to the Mayor of London, a system that has worked brilliantly since the late 1980s.
But there is another fundamental problem. This Prime Minister said in March, “We need to look urgently at the options for getting large-scale private investment into the national roads network; from sovereign wealth funds, from pension funds, from other investors… we’re not tolling existing roads; it’s about getting more out of the money that motorists already pay.”
However if there are no explicit charges then it is unclear how new investment is to be repaid: there is nothing to invest in.
Many transport infrastructure schemes are not financially viable: HS2 is officially estimated to need over £20 billion of taxpayer support, while an untolled road generates no visible cash flow. For such projects it is not a matter of financial risk: the losses are certain! Underwriting risk will not help.
Unless, that is, the taxpayer makes a credible, enforceable, promise to put in enough money to create a residual proposition that does have a chance of being financially viable. That is a genuine partnership and it is common overseas. It is in the event what happened with HS1, though not by design. It is how a number of successful private finance initiative, shadow tolled roads have been working since the mid 1990s.
The simple arithmetic dictates that the nation can have more financially unviable infrastructure if, but only if national or local taxpayers pay more—this is securing the funding. Once that is in place, the financing by pension funds and sovereign wealth funds will follow easily.
That is the package now in prospect with the announcement for the A14, a road of international importance, vital for the East Anglian and UK economies, a scheme that was unwisely withdrawn in the 2010 Spending Review. Tolling is likely to be expected to make a contribution. So will local taxes on the strength of the value it will create for local development and industry. The gap will have to be filled by the national taxpayer.
This is a good way forward; it’s just a pity that so many years have been lost with the to-ing and fro-ing. That has to stop. If this kind of sensible funding and financing package cannot be brokered—and quickly—for the A14, then it is not likely to succeed anywhere else. But if it can be made to work today’s announcement could be the beginning of many successes. For instance the nightmare that is the A303 from the M3 to Exeter and beyond could be brought up to a uniform good standard and then tolled for the immense benefit of industry and the holiday trade in the West Country.