Briefing Burnham: Public corporations and infrastructure investment
Andy Burnham has declared that he intends to lead the “biggest rebalancing of power our country has seen” by stripping control from Whitehall and shifting it to local communities. The opportunity is clear: the UK is one of the most centralised countries in the OECD, and excessive centralisation is widely seen as a constraint on growth. But devolution will only raise growth if it changes how infrastructure is financed, governed and delivered.
The challenge for Burnham is that devolution does not automatically translate into growth. A recent FT piece highlighted the mixed record of devolution, citing challenges in Wales, Northern Ireland and Tees Valley. The question, therefore, is not whether power should move out of Whitehall, but how the institutions receiving that power can be incentivised to design projects that pay for themselves.
This matters because the funding model drives the behaviour of the institution delivering the project. If devolved authorities are mainly spending Treasury grants, the incentive is to secure allocation rather than optimise design. If they can borrow against defined future revenues, they have a stronger reason to integrate transport and housing into an integrated investable plan.
The problem with ‘other people’s money’
One governance challenge associated with the initial wave of devolution is that regional bodies often spend money allocated to them by the Treasury. When public bodies spend other people’s money (OPM) on infrastructure, they face weaker incentives to design projects around cost control, future revenues and local value capture. HS2 is an extreme example of this wider governance problem: the project’s design became increasingly detached from cost discipline and from the future revenue streams that might have helped justify its scale.
My own experience advising on regional infrastructure projects over the last few years points to the same incentive problem. One transport proposal sought to connect two heavily populated areas without enabling new housing, which made the project expensive while limiting the revenue streams that could support it. Another proposed extending a public transport network into areas with housing density below 30 dwellings per hectare. A density closer to 80 dwellings per hectare would be needed to support faster growth via agglomeration and higher revenues.
By contrast, European urban developments are typically expected to generate revenue streams to help pay for the project, while the design is shaped to minimise avoidable costs. Where an expensive infrastructure component still makes an otherwise strong project unviable, a government grant is easier to justify because the ask is smaller, the multiplier effect is clearer, and the regional authority has already optimised the scheme.
This is also better for the public finances given it relies less on sovereign debt issuance. In the Netherlands which widely practices this model, its infrastructure stock as a percentage of GDP is a third higher than the UK, with almost double the housing rate, and with a debt to GDP ratio of 44% compared to 95% in the UK.
Gilts issuance or public corporation debt?
Burnham will soon have to decide how to finance the large-scale infrastructure projects and council housing expansion he is advocating. One option is to follow the Rachel Reeves approach: issue more gilts and use public money to subsidise sub-scale projects across the country using Public Financial Institutions. Media reports suggest some of Burnham’s advisers wish to follow Reeves’ strategy and use the National Housing bank to boost investment.
But when councils start delivering assets, the public sector net financial liabilities (PSNFL) metric will rise resulting in less headroom for the fiscal rule. For this to work Burnham would need to instead move towards PSNW as a fiscal measure instead. But the bond market will react negatively to this approach as PSNW tells investors little about the government’s ability to service its debt and access the capital market. Moreover, public sector accounting ignores the cash generation of assets and accounts for them based on their replacement cost minus depreciation.
The alternative is to use public corporation debt with long maturities backed by identifiable future revenue streams. There is no shortage of capital for projects with detailed costings, credible revenue forecasts and hypothecated income streams. If a project generates a positive net present value, long-term investors are willing to buy debt backed by those revenues. Investor demand for UK public corporation debt is estimated at about £30bn a year, yet the UK remains one of the few advanced economies without a deep public corporation debt market.
Moreover, investors managing nearly £2 trillion wrote to the Chancellor earlier this year requesting a consultation on removing self-funding public corporation debt from the public sector balance sheet, as is the case across Europe. Their argument is that self-funding projects would support growth while reducing pressure on gilt issuance and the public finances.
Bond investors are comfortable buying public corporation debt when the costs, revenues and repayment mechanism are clearly set out. By contrast, issuing more gilts in the hope that future tax revenues will rise can be a riskier proposition. As Peder Beck-Friis from PIMCO recently argued in the FT, “Bond markets do not meaningfully distinguish between types of spending: one pound of investment still requires one pound of gilt issuance. Higher investment may lift growth over time and improve debt dynamics, but the link is uncertain and markets will discount it until it is visible in hard data.”
Projects vs Policy?
Burnham also needs to be careful when it comes to fiscal devolution. He should avoid too much focus on policy architecture and not enough on delivery. Policy wonks care more about the former, voters the latter. As the former Labour minister Richard Crossman warned, excessive focus on local government reform can create a “paralysis of decision-making”.
If Burnham is going to succeed, he must urgently prioritise specific infrastructure projects and use existing policy levers to support their delivery. Public bodies already have access to future revenue streams, including land sales after planning permission, business rates precepts, business rates from new locations, affordable housing receipts, car park receipts and a portion of transport receipts. Each regional authority should therefore be required to put forward ambitious infrastructure plans financed through long-term public corporation debt that can be largely self-funded from these revenues. Projects that generate little future revenue are unlikely to justify the scarce fiscal and political capacity needed to deliver them.
Burnham’s decision on the funding and financing of large-scale infrastructure and housing could transform the built environment across much of the country. He can listen to the bond market and move towards off-balance-sheet public corporation debt backed by future revenue streams. Or he can continue the current government’s failed approach prioritising subscale projects, increasing pressure on gilt issuance and weakening the public finances.
Thomas Aubrey is the founder of Credit Capital Advisory. He’s an affiliate researcher at the Bennett School of Public Policy. He is writing in a personal capacity.
