Counting the cost of capital cuts

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Cutting infrastructure spending is not a long-term solution to our financial problems. It simply replaces a visible financial deficit with a hidden maintenance backlog

It’s a sobering thought that government borrowing for 2011-12 was £126bn or 8.3% of national income. While this is down from the 11.2% of national income recorded in 2009-10, a recent Financial Times article explained that deep cuts in capital expenditure explained almost all of the year’s reduction in borrowing.

Cutting spending on infrastructure is not just a UK phenomenon – in November 2010 the US Congressional Budget Office set out the planned reductions in infrastructure spending over the coming decade. US transport-related spending under the American Recovery and Reinvestment Act will fall from $20bn in 2010 to under $5bn a year from 2015 onwards.

Globally, Western governments are taking the course of least resistance in trying to balance their budgets. The result is that infrastructure spending will occupy a smaller percentage of government spending in coming years.

But this isn’t really deficit reduction. At some point the stock of infrastructure will need to be repaired – at best we are just replacing a visible financial deficit with a hidden maintenance backlog.

Given infrastructure investment is one of the drivers of economic growth, the fall in capital spending bodes ill for long-term competitiveness. At the same time that Western nations are cutting their capital budgets, China is planning to spend £100bn to build 28 underground rail systems.

Closer to home, local government borrowing has collapsed. It’s not yet clear if this is due to councils temporarily running down their internal balances or the start of a longer-term fall in underlying capital spending.

With an average of 28% revenue grant reductions and rising demands, councils will certainly be looking hard at whether they still have the revenue headroom to support the long-term costs of existing capital programmes. This is a real pity, given the independent Eddington Review concluded that it’s these local infrastructure investments that typically generate the highest economic returns.

It is certainly not as if councils have been profligate. As every finance director knows, long-term local authority borrowing is only for capital purposes and is very strictly controlled through the Prudential Code.

Addressing this issue is neither simple nor quick. But three long-term actions could help.

Firstly, councils need the certainty that they can afford the long-term costs of paying for infrastructure. Reforming the business rates system, and allowing councils to retain those taxes helps achieve this. Local communities are best placed to understand local businesses’ infrastructure needs and where targeted spending will make a difference. The sooner there is genuine business rates reform the sooner councils can start investing in their local areas.

Secondly we should recognise that, unlike central government working through its vertical silos, councils can look at their areas in an integrated way. Bringing together education, housing and transport capital budgets and asset planning results in long-term choices and better economic outcomes.

Finally, a period of stability in the government capital financing systems is badly needed. There have been six changes to the Public Works Loan Board terms of trade in the last few years, at a time when councils are trying to make long-term funding decisions.

Most governments face competing pressures as they struggle to rebalance their economies, and, of course, deficit reduction is a serious challenge. But good quality, modern infrastructure is going to be important as the UK seeks to deliver a longer-term sustainable economy.

Mark Luntley is working with the Local Government Association and Local Partnerships to develop a collective agency to finance council borrowing

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