Graham Gudgin is Chief Economic Adviser at Policy Exchange.
The unprecedented problems facing the Government have overshadowed one of its most striking innovations. Brexit, Covid-19 and Black Lives Matter demonstrations have all relegated to the media sidelines the attempt to reverse a decade of austerity with a major increase in spending on public infrastructure.
The scale of the reversal of previous Tory and Coalition policy by the Johnson Government is large. Although spending on capital relative to the size of the economy since 2010 was never lower than during the Blair years, or indeed the Thatcher-Major period, what is planned for the current parliament takes it to new heights.
Even if we accept the estimates of the Office for Budgetary Responsibility that actual spending always lags behind plans, real spending in each of the next four years will be the highest ever recorded in the UK. Capital spending is projected to rise to three per cent of GDP, a level not reached since the 1970s when government was heavily involved in house building, except briefly during the banking crisis.
Although it is not easy to make definitive international comparisons, the OBR estimate that UK investment in infrastructure has long been below other richer economies, but the planned investment will bring annual investment up to the OECD average. What is striking about this is that it is backed by borrowing at a time of high public indebtedness.
Before the Covid pandemic the debt to GDP ratio had risen to 86 per cent (compared with under 40 per cent before the banking crisis). Despite that, the 2019 manifesto promised an extra £100 billion of new investment during this parliament, effectively doubling public spending on economic infrastructure including roads, broadband and flood defences. The huge current surge in public sector debt due to the measures combatting the pandemic have not deflected these plans.
The question of whether this is sustainable or wise is taken up in new report from Policy Exchange, titled Why the Government should spend more on capital. It says that the Government should spend more on capital investment. The case was already strong before the Covid-19 crisis and has been strengthened since, as financing borrowing has become more affordable.
The report highlights the importance of taking advantage of the present macro-economic environment afforded by low borrowing costs, to provide stable – and sizeable – funding for new infrastructure through an increase in capital spending by the public sector. Additional capital spending, in excess of current fiscal rules, would be sustainable and affordable.
The reasoning is straightforward. Interest rates are so low that government can finance its borrowing with little strain on taxpayers to service the interest payments on its bonds. The pandemic has helped in this respect since interest rates on bonds have fallen further than the low rates of last year.
Moreover, the Bank of England has also renewed its money-printing Quantitative Easing programme. This means that more than the current 23 per cent of government debt will be held in the Bank’s Asset Purchase Facility rather than held by the private sector.
Since the APR returns much of the debt interest to the Treasury the cost of borrowing will be even less. Much of the repayment of this debt can be delayed well into the future. The Policy Exchange report advocates a fiscal rule that targets the thing that matters, namely cost of debt servicing – a Debt Service Rule – rather targeting a debt-to-GDP ratio or caps on current and capital spending.
The pandemic may also remove for a few years the labour constraint that slows infrastructure development and raises wage and other costs. The report argues that worries about the inflationary impact of extra spending were wide of the mark even before the pandemic. Covid-19 has made such worries less appropriate.
The report argues that extra spending can be justified on two main grounds. Spending is needed because it has been low in the past, leading to congestion on roads and rail and a slow roll-out of broadband. Extra spending is in part an economic necessity to keep the UK competitive and attractive to investors but can also be justified as an amenity in the sense that we all prefer uncongested transport and good access to broadband even if the gains to the economy are limited.
Secondly, investment provides a general stimulus to the economy and is timely in the light of the Coronavirus but can also be justified In the longer term assuming the investment is well planned and cost-effective.
Boosting demand has of course assumed an urgency through the need to repair the economy in the wake of the pandemic. Here shovel-ready projects must be the focus and Robert Jenrick has asked for ones which can be delivered within 18 months. Since 2021 was already planned to be the year in which capital spending took-off with a rise in capita spending of £6 billion, the previous plans are fortuitous.
The new situation may bring private-sector projects forward, some with government financial support, but we cannot expect new projects worth more than a billion or so and the economic impact, although useful, will be small. The expectation is that many of these projects will be in green energy and located in Scotland where it is hoped that UK backing for such projects will be well publicised as an advantage of the union.
There are a host of areas where infrastructure plans could meet the desire of the Government for shovel-ready projects in the post Covid-19 economy. These include electric vehicle charging points, high-gigabit broadband and green projects as well as health-related infrastructure such as green walking and cycling routes, improving and adding to, public parks, sport, leisure and swimming facilities.
Additional infrastructure is often advanced as a way of “levelling-up” the regions, but the Policy Exchange report shows that living standards in the devolved regions and the North of England are close to the UK average once housing costs are taken into account and not far below those in London.
It is the ability of regional economies to support their own living standards that is the problem, but this is a problem for tax-payers in affluent regions rather than for the populations in the North.
New investment may help here but we should not hope for too much. An infrastructure-led development was tried in the 1960s and 1970s with limited effect. New infrastructure is clearly needed in parts of the North and Midlands but should not be built ahead of need.