March 16, 2017    6 minute read

UK Infrastructure Is in Dire Need of Repair

The Road to Recovery    March 16, 2017    6 minute read

UK Infrastructure Is in Dire Need of Repair

As all daily users of London’s Central Line would agree, it would hardly be an exaggeration to call the UK rail system a major headache. Even in the booming financial centre of the country, commuters regularly suffer from delays, overcrowding and a preponderance of mysterious ‘signal failures’. Each of these is a symptom of the broader problem that UK infrastructure faces on the road to modernisation: its power plants, broadband, rail and roads are hopelessly out of date.

The British are by no means alone in facing infrastructure mayhem, nor do they suffer the most. Back in 2009, journalists across the world were treated with headline-grabbing news about broadband speeds in South Africa. Broadband from the country’s largest telecoms company – Telkom – was pitted against a carrier pigeon with a memory stick tied to its leg. The pigeon won.

A Global Problem

Eight years later, South African broadband speeds have almost certainly improved, but global infrastructure investment remains woefully below par. McKinsey estimate that the world as a whole needs to spend an extra £800bn a year to meet the infrastructure gap, assuming current rates of growth.

£426bn The total worth of the National Infrastructure Plan’s proposals

Figures for UK infrastructure are harder to come by, but the £426bn pipeline of projects in the government’s National Infrastructure Plan indicates the scale of the challenge ahead. Equally importantly, infrastructure can help the UK address its ‘productivity gap’ – now so large that French workers produce more in four days than British workers do in 5. So much for lazy stereotypes.

Given the disdain shown by austerity governments to long-term economic investment, the next wave of infrastructure spending will have to come from the private sector. This is why EDF and Chinese investors will fund the construction of Hinkley Point C, even though the economics suggests that the government is better placed to do so. 

Equally, for the private sector, infrastructure is an appealing investment. Numerous studies have shown that the infrastructure generates higher returns for lower risk than all other asset classes (bar real estate). In fact, the private sector has historically led the way in financing British infrastructure, building the UK’s first turnpike roads in the 17th century, ports in the 18th century and the rail in the 19th. Much of today’s now-creaking infrastructure owes its genesis to the vision of the businesspeople of yesterday.

Failure of Policy

So why has business failed to fill the gap today? Policy makers in Whitehall believe the reason is fear of excessive risk. They may be right. Immensely complex rail systems like the High Speed 2 project are prone to equally immense cost overruns, often great enough to cripple the balance sheets of multi-billion pound companies. Hoping to encourage more investment, the government launched two flagship programmes in the early 2010s: the Pensions Infrastructure Platform and UK Guarantees Scheme. Both have failed to meet their targets.

Each of these schemes illustrates precisely why the UK has failed to attract sufficient private sector investment. The Pensions Infrastructure Platform –  a scheme designed to pool the resources of UK pension funds in order to reduce the risk any individual fund takes on – has become the latest in a long line of ‘market reforms’ ignorant of the old adage: if it ain’t broke, don’t fix it. When investors do want to invest in infrastructure – as in Australia and Canada – they will find their own means to spread risk and pool resources. The government does not need to do this for them.

Closer to solving the problem is the UK Guarantees Scheme, which insures investors against the enormous risks they take on when building new railway lines and power stations. Inadvertently, however, it neuters the central benefit that private investment brings. By preventing the full transfer of construction risk, private investors lose the incentive to deliver on time and to budget. The government might as well fund the building itself.

The Way Forward for UK Infrastructure

Whither, then, the UK’s infrastructure policy? A first step would be to recognise the factors that enabled private investment to succeed in the 17th, 18th and 19th centuries. Rather than insure against construction risks or engineer ways to pool resources, the UK needs to find a systematic way of guaranteeing revenue to private investors. If the potential reward for building a new road or railway line is great enough, the private sector will always find a way to manage the risk.

This can be seen quite clearly in successful private finance initiatives. Thames Tideway, the ambitious plan to build a ‘super-sewer’ under the Thames, has been successfully financed because the parent company behind the project – Thames Water – has a guaranteed revenue stream as part of its contractual agreement with Ofwat.

On the other hand, EDF have struggled to finance the construction of Hinkley Point C because nuclear power has never been a commercially viable source of energy generation. Only with significant government subsidy has it ever been possible to pay off the costs of construction over the life of the plant. 

Admittedly, revenue generation is not always a simple task. Allowing private companies to build toll roads, for example, tends to generate significant political backlash – far more so than rail franchises or energy generation. In cases like this, government should have the courage to fund construction itself, knowing that attracting private finance will not be easy.

The broader point is clear: if UK infrastructure is to attract private investors, the government must commission projects which are genuinely commercially viable, enabling investors to earn a return from future revenue streams. If the government is not able to do this, it will forever swing between the rock of underinvestment and the hard place of paying for infrastructure itself.

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