How Plaid Cymru's National Infrastructure Commission for Wales would work - an essay by Eurfyl ap Gwilym, Chief Economic Advisor
To be economically and socially successful any country needs a modern and efficient infrastructure. Without investing in such infrastructure a country is unable consistently both to raise productivity and to compete in international markets. Failure to raise productivity also leads to lower wages and flagging standards of living over time. One of the persistent failures of the UK government has been not to invest sufficiently in infrastructure particularly in what are perceived to be peripheral regions such as Wales. It is noteworthy that the major investments underway and planned are concentrated in the south east of England with Crossrail and Crossrail 2 being the most noteworthy examples. In the case of the UK Government it has been its adherence to the dogma of having to balance the books as quickly as possible that has limited the funds available for capital investment. While such an approach has a knock-on effect on the funds directly available to the Welsh government for capital investment that government in turn has failed to take a proactive approach to finding other ways of funding such capital investment. In the run-up to the 2011 National Assembly elections Plaid Cymru proposed its Build4Wales plan which set out in detail how a Welsh government could tap capital markets and other sources for additional funding. This plan was the culmination of four years of work and was based on expert advice from major banks, the construction industry and one of the big four accounting firms. It is a matter of regret that in the intervening five years the Welsh government has been slow to innovate in the field of capital investment.
In explaining what this innovative approach is expected to achieve, it is perhaps worthwhile to look at the context and background of the constraints to public sector investment in Wales.
Although housing is currently very expensive, it is generally considered desirable for people to aspire to own a house, for most the biggest capital investment they are ever likely to make. Because it would be impossible for all but the most wealthy of individuals to purchase a house out of their current income, and because it would take a very long time to save up the money necessary to purchase a house, a mortgage market has developed which allows individuals to buy houses and live in them as they gradually pay off their debt over a number of years.
The situation of governments is not so different. If they want to undertake large amounts of capital expenditure to invest in new schools, hospitals, roads etc. they must either use current income, save until they have enough money, or borrow the money over the years and repay as they use the facility.
In the case of the Welsh Government in general, it has limited borrowing powers. The Wales Act 2014 has given the Welsh Government borrowing powers to invest in capital projects from 2018. Ministers will be able to borrow to invest in any devolved area of responsibility, up to a total limit of £500m. Early access to borrowing powers has been granted to help finance the costly ‘Black Route’ enhancement to the M4. As well as being limited in its borrowing capacity, the Welsh Government cannot tax to increase its income. If it saves then it lays itself open to the possibility of the Treasury taking back the money on the basis it is unspent as it did recently - the Treasury’s housekeeping can lead to perverse incentives against prudence. So something that most individuals take for granted, and is generally thought to be a good thing, the ability prudently to borrow long term to buy an expensive capital asset and pay for it gradually is denied to the Welsh Government.
It is true that Westminster came up with an alternative; PFI, which in essence is a form of glorified inefficient and expensive hire purchase. Given the lack of any alternative form of funding, many parts of the UK reluctantly undertook capital projects using PFI because they had little choice. The Treasury has now acknowledged that PFI often represents poor value for money, hence the cancellation of the Building Schools for the Future programme in England. In April 2011 the National Audit Office added its criticism to PFI and drew a number of valuable lessons which are reflected in Plaid Cymru’s proposals. To its credit, Wales financed very little using PFI (about one tenth of the amount of Scotland, and less than 1 per cent of the UK total). However, this has meant that Wales has a substantial backlog of capital projects in the public sector.
This means that the Welsh Government (and the Welsh public sector generally) has an urgent need to find an alternative way of investing in its infrastructure. In addition it must try to do so within its funding allocation under the Barnett formula given the current financial challenges which the UK faces. The challenge of increasing capital investment is an urgent one. The last Welsh government dragged its heels in introducing innovative funding. The Wales Infrastructure Investment Programme, established in 2012, has not gone far enough in delivering the infrastructure projects Wales needs. It has also come under scrutiny for not having delivered due to the absence of an underlying economic strategy.
It has been pointed out by a range of bodies such as the OECD and the CBI there is a strong case for such investment particularly when interest rates are so low. It is estimated that the payback on infrastructure investment can be as high as 3 to 1 i.e. for every £1 invested there is an economic return of £3. At the time of writing (April 2016) UK Government 10 year gilt yields are lower than 1.5 per cent i.e. they are approaching a negative rate in real terms which makes the case for investment even more compelling.
A NEW APPROACH AND A NEW ENTITY
It is to meet this financing challenge, as well as to provide a mechanism for improving public sector procurement and management and driving down costs, that Wales needs a new approach and a new entity. A National Infrastructure Commission for Wales (NICW) would have the following key characteristics:
1. NICW would be a not for distributable profit private company, limited by guarantee, with a structure comparable to that of Glas Cymru. Profits retained in the company would be used to improve the company’s balance sheet and to invest in further public sector infrastructure projects in Wales. It would focus exclusively on infrastructure projects in Wales, and as its portfolio grew it is anticipated that it would build up a substantial body of knowledge and expertise in the area of tendering and negotiation, as well as in the operation and management of public sector occupied real estate.
2. NICW would be responsible for the funding and implementation of public sector infrastructure projects, such as schools and hospitals, and this could also extend to roads and housing. It would also be responsible for operating them and managing them after construction. It would represent an alternative to PFI and to direct borrowing by a public sector body. NICW would not seek to bundle together construction contracts and operating and service contracts, as in PFI, but only to be the landlord of the building/owner of the asset with a standard lease. In addition any profits the company made would be recycled into further investment in Welsh public sector infrastructure. This would make it fundamentally different from PFI. Public sector bodies would not be obliged to make use of the new entity, but it would provide an important funding alternative to conventional PFI and public procurement on the basis of their own spending priorities. NICW would seek tenders from private sector construction companies to deliver the infrastructure on its behalf, but NICW would be responsible for funding the infrastructure, managing it, and repaying the relevant debt under a long term lease arrangement.
3. Sources of funding for NICW would include:
• Capital markets;
• European Investment Bank;
• European Fund for Strategic Investment;
• Trans European Transport Connecting Europe facility;
• Infrastructure UK’s Guarantee Scheme;
• Green Investment Bank;
• Local authorities;
• The new Pensions Infrastructure Platform fund; and
• Pension Funds.
4. The establishment of such a vehicle would enable the public sector to plan capital expenditure over a longer period, and benefit from the expertise of an arm’s length body which would be focused on the infrastructure sector and delivering value for money. In the case of building a school for example, the local education authority could ask NICW to build a school on its behalf. The LEA would enter into a long term lease to occupy the school, and the lease payments made by the LEA would service the debt raised by NICW to build the school. The LEA would be responsible for the day to day management of the premises.
5. Such an approach should, over a period of time, lead to standardisation in both contractual documentation and in procurement procedures and requirements, lowering costs and increasing transparency and certainty, and enhancing the likelihood of the efficient delivery of public infrastructure. For local education authorities, health trusts and other public bodies it provides access to a centre of expertise, which although private has a public sector mission, capable of delivering capital projects for them on a more efficient basis, resulting from being specialised in the sector, and being able to build on its funding and construction experience.
6. The Welsh Government has recently had difficulties in securing the Non-Profit Distributing (NPD) model for three major infrastructure projects due to the decision by the Office of National Statistics to give an NPD scheme in Scotland a public “on balance sheet” classification. The Scottish Government has since, in discussion with the ONS, proposed a solution, changing the structure of its non-profit distributing model that addresses the ONS’s concerns. When designing NICW Plaid Cymru would, in discussion with the Scottish Government and with the ONS, ensure that NICW is also structured in a way that satisfies the ONS’s requirements for the project to be treated as ‘private sector’ and therefore ‘off-balance sheet’.
7. The aims of creating NICW include:
a. Enabling the Welsh Government to use part of its current expenditure for capital investment in an efficient manner. This is something that the Treasury normally welcomes as being a prudent approach. Since Wales has done very little PFI compared to the other parts of the UK it has more room to invest in capital projects.
b. Enabling access to private sector finance on a fairer and more efficient basis than PFI at a time of severe government borrowing constraints
c. Creation of a specialist company experienced in procurement and negotiation with contractors, resulting in a more efficient delivery of public sector infrastructure projects, and the driving down of costs, another aim of the Treasury
d. Profits made by the company would be retained for further investment in the public sector, another aim of the Treasury.
8. This approach has therefore specifically been tailored to meet a number of the Treasury’s key goals as well as the needs of the Welsh Government. It would have the added advantage of providing demand in the construction industry at a difficult time, protecting and creating jobs and investing at pricing levels which should be very competitive compared to a few years ago.
AREAS FOR INVESTMENT
In the first year of a Plaid Cymru government a programme for investment will be developed. This will include:
• modernising our public transport network with improved rail links across the whole of Wales
• improving our trunk road system, with investment in the M4 and A55
• modernising our telecommunications network, delivering superfast broadband to all;
• investing in our energy infrastructure, setting up a network of local energy grids with an increased emphasis on renewables.
• investing in energy renewables including hydro energy projects in all parts of Wales;
• embarking on an unprecedented home energy efficiency programme;
• improving port infrastructure in all parts of Wales
• upgrading and developing education facilities and modernising school buildings;
• expanding investment in health, such as building three new diagnostic centres and;
• building an additional 10,000 new and affordable homes.
This would be an ambitious programme aimed at rebuilding Wales.
The capital investment budget of the Welsh Government as set by the UK Government is £1.5bn for the current year (2016-17) rising to £1.7b in nominal terms by 2020-21. In preparing financial estimates for NICW the lack of planning for shovel-ready projects means the ‘Rebuild Wales’ programme will have to be implemented over a decade.
In developing our investment plan we have taken a bold but prudent approach. We will seek to raise £7.5bn over a period of ten years from the range of sources listed earlier. Wherever possible we will seek to use this money as match-funded co-financing leveraging in extra investment from other parties.
We will borrow over twenty five years. On that basis the debt service cost (including paying off both the interest and the capital), rises to peak in 2026, when it will be approximately 4 per cent of the Welsh budget. When the ten year programme is completed the servicing cost falls as a percentage of the budget as the Welsh budget grows both in nominal and real terms. The fact that the debt will be paid off will allow future governments to determine their own borrowing programmes.
The financial forecasts made for the debt servicing of NICW are based on prudent assumptions, have been incorporated in the detailed costings of Plaid Cymru’s manifesto which have, in turn, been independently assessed by Professor Gerald Hotham and Professor Brian Morgan of Cardiff Metropolitan University and judged by them to be ‘reasonable and in line with HM Treasury’s projections of expenditure and its implications for Wales’.
RELEVANCE OF NICW TO THE WIDER UK
The Treasury has acknowledged that PFI is not good value for money and is looking for an alternative at a time when the public finances of the UK are exceptionally constrained and yet there is the need to provide a growth stimulus, not least in the construction industry. While the Welsh Government has comparatively more capacity to transfer current spending to capital investment because of the low level of earlier PFI commitments, the approach advocated here would be equally applicable in the rest of the UK.
It is to be hoped that as the details of this approach become clearer, and in the seeming absence of any other researched suggestions as to how Wales and the wider UK might meet its future public sector investment challenges, this approach might garner cross-party support.