UK faces tough choices to finance infrastructure ambitions

There is an urgent need to spend more on critical infrastructure like power stations and hospitals. But with public finances under pressure, the government needs new ways to raise money
Man in hard hat by scaffolding

The UK’s latest National Infrastructure and Construction Pipeline promises £650bn of infrastructure schemes over the next decade. You can’t fault the government’s ambition – but where will the money come from? 

Across the UK, world-class infrastructure will be the foundation to “build back better, uniting and levelling up the country as we recover from the pandemic”, the government says. Highways, rail, airports, hospitals, schools, digital networks – the list is long and the ambition is huge. 

The UK isn’t alone in its vision for a golden era of infrastructure spending that will bring jobs and prosperity. The US, for example, plans to spend $1.2tn (around £900bn) over what President Biden has called “the decade of infrastructure.” The European Commission has unveiled a major infrastructure investment strategy aimed at mobilising up to €300bn (about £250bn) of investments in global development by 2027. Infrastructure spending has had a huge role to play in China’s meteoric economic rise over the past three decades; on the back of slowing growth, it’s once again turning to such investment to stimulate the economy.

Future-proof infrastructure

Ambitions are one thing – financing them is quite another. As the world emerges from the pandemic, state spending and government borrowing are already at record levels. Taxation is high and the cost of borrowing is going up after many years of cheap money. Inflation has returned with a vengeance: high energy prices and a shortage of resources and materials are pushing up the cost of all projects. The need to future-proof infrastructure for climate change and to meet commitments around the UN’s Sustainable Development Goals (SDGs) adds many billions to the cost of construction. 

Still, investment in infrastructure is critical and cannot be delayed. Essential infrastructure has been starved of investment over the past decade in the wake of the banking crisis. In the UK, for example, the backlog of spending on NHS buildings is estimated at more than £9bn, simply to address crumbling hospitals and clinics. The repair bill for schools in England is put at £11bn. 

Greater alignment between users and payers will need to be found if governments are to deliver on their infrastructure agendas

Against this inauspicious background, loftier ambitions are already being scaled back. Projects like High Speed 2 and Crossrail 2 have been clipped back as spending priorities have shifted. Again, the UK isn’t alone: the US infrastructure programme, while still huge, has been reduced from the original proposal because of a backlash over higher taxes. 

The UK government has indicated that it hopes at least half of the targeted £650bn infrastructure spend will come from the private sector. The new UK Infrastructure Bank (UKIB), set up in the wake of Brexit to replicate part of the role traditionally adopted by the European Investment Bank (EIB) in the UK, will play an important role in building bridges with business. 

The Government believes the UKIB will be more aligned with its policy aims, including the ‘levelling up’ agenda and the green economy, and be more targeted than the EIB. The aim is for the UKIB to assume project start-up risk before attracting traditional investors once the project is up and running. 

The bank is due to publish its first strategic plan in June, including investment priorities. It has an initial £12bn of capital to deploy as well as £10bn of government guarantees. 

It made its first investment in February when Tees Valley Combined Authority agreed a 50-year loan of £107m to fund its South Bank Quay project. This would transform part of a former steelworks into a 450-metre quay to service the offshore wind sector.

“It’s not just renewable energy projects that could be considered for these sorts of loans,” says Mark Casey, a specialist in banking and finance and legal director at Womble Bond Dickinson. “Transport infrastructure – which has always been a hard sell in terms of attracting private sector investment – is an essential part of the road to net zero. If authorities get their pitch right, whether it’s for local bus services or other transport links, they might be able to kick off projects with the UKIB-backed funding.” 

The UKIB will have to meet subsidy rules, though its proposed offering of 60 basis points above gilts is considerably cheaper than the commercial market.

PFI out of favour

Governments have previously leaned heavily on schemes like the private finance initiative (PFI) and its successor, PF2, to form private sector partnerships for infrastructure projects. However, such schemes have fallen heavily out of favour, mainly because of legacy costs to the public sector which many considered excessive. For example, PFI deals financed £11.8bn of hospital buildings across England; over 30 years these arrangements will cost the NHS £79bn in repayments. 

Although reviving PFI will be difficult politically, many believe that some form of public-private partnership is critical to secure the infrastructure investment required. Daniel Woolf is a principal consultant at AECOM, the global infrastructure consultancy firm, and a former infrastructure finance policy lead at the CBI. He thinks that championing private finance delivery models should be given priority to fill the void left by the death of PFI. 

“Public-private partnerships can be an effective mechanism to raise investment for infrastructure,” says Woolf. “They are still widely used in countries like Norway, Netherlands and Australia. Unfortunately, in the UK PFI has become synonymous with a small number of high-profile failures, which detracts from its many strengths.” 

There are a number of options, depending on what type of project is involved

Woolf says it would be helpful for the next National Infrastructure and Construction Pipeline to set out infrastructure projects that will seek private finance and the private finance delivery model that will be utilised in each case. This would restore confidence in the government’s appetite to facilitate private sector investment and finance in UK infrastructure and provide a clear pathway to participation for businesses. This document could also be showcased globally to highlight and promote projects that Britain is driving.

“The solution has to be multifaceted,” says Woolf. “There are a number of options, depending on what type of project is involved and over different timeframes.” 

For example, the Thames Tideway Tunnel project was financed using an innovative regulated asset base model, which resulted in a lower cost of capital and an increase in consumer bills of £13-£25 per year, considerably lower than the original estimates of £70-£80 per year. However, this model might not be appropriate for other projects. 

Time for honesty

Richard Threlfall, global head of infrastructure at the consultancy KPMG and a former adviser to the secretary of state for transport and the deputy prime minister, says it’s time for “political honesty” about the state’s ability to fund infrastructure investment. Users should be expected to directly bear more of the cost. 

“Governments everywhere are under pressure to pass more of the cost of infrastructure to users, but they are worried about the political backlash,” says Threlfall. He notes that in the UK, the energy regulator has been supported by government in its refusal to lift the energy price cap, even as dozens of energy firms face collapse. 

“No one wants to pay more for something they regard as essential, like power, water or the drive to work. But greater alignment between users and payers will need to be found if governments are to deliver on their infrastructure agendas and in particular their net zero commitments.”

Renewing long-term public-private partnerships is essential, he agrees. “The question of intergenerational fairness is critical. If we build roads, bridges or airports that last for 30, 50 or even 100 years, there is an argument for defraying some of the payment to future generations.”