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Power to Build- Holyrood Magazine

Ben Thomson, Holyrood Magazine, 26 October 2009

It is the foundation of our economy, yet the poor quality of our infrastructure has hampered   the UK for decades.

Whether in transport, education or health, investment has not kept pace with other comparable countries.  According to Professor John Kay, Fellow of St John’s College Oxford University and one of the Scottish Government’s Council of Economic Advisers, there has in recent decades been a major decline in public investment in infrastructure.  Research shows annual spending on infrastructure has gone down from 10 per cent of GDP in 1965-75 to a low of 1.7 per cent in 2000 and is now around 2.5 per cent.  Some of this dip can be attributed to the impact of privatisation; however, this still represents a steep fall  and is in marked contrast to other European countries which have spent significantly more on infrastructure over recent years. 

As Reform Scotland pointed out in our earlier report, Powers for Growth, there is a clear correlation between investment in fixed capital infrastructure and higher economic growth.

Improving the quality of our public sector infrastructure is, therefore, vital to both our economic recovery and the performance of our public services.  Reform Scotland believes that providing such infrastructure will require a new and more flexible approach as we have set out in our report, ‘Power to Build,’ published on the October 16. 

Our innovative new model would replace the flawed PFI system with a new partnership between the public and private or third sectors called Scottish Capital Partnerships (SCP) and would provide a more effective method of financing and managing infrastructure projects.

The need to move on from the PFI has become clear.  In some respects, its record was good.  For example, the National Audit Office found that 80 per cent of PFI projects came in on time and on budget compared with only 20 per cent of projects delivered through traditional public procurement.

However, PFI has failed to live up to expectations for two main reasons.  The first is that the long-term costs of PFI are higher than public procurement because the funding is largely in the form of bonds and bank debt with commercial interest rates which are higher than government rates.  This might be acceptable if the risk associated with such projects was genuinely transferred to the private sector.  In reality, though, when it came to politically sensitive and vital infrastructure projects, the risk remained with the public sector and it was taxpayers who were left to pay back the debt when there was default on the contract.

The second main problem associated with PFI was the complicated nature of the contracts. They tended to be long – anything up to 35 years – and inflexible.  The public sector was forced to accept a bid from a whole consortium covering design, finance, building maintenance and facilities management rather than being able to select the best bits from each bid.  Furthermore, the funder was part of the consortium, on the opposite side of the table from the public sector, and with no incentive to negotiate the best deal with other consortium members for the benefit of the public.

Reform Scotland’s alternative, Scottish Capital Partnerships or SCP, is designed to tackle these problems and ensure that infrastructure projects deliver much better value for money in future.

That must start by recognising that the debt element of funding, usually around 90 per cent of the total capital, should come from government either at UK, Scottish or local level.  This would enable projects to take advantage of the lower cost of government borrowing and so reduce the cost of funding infrastructure projects. 

This public sector borrowing could be achieved in a variety of ways such as straight UK Government borrowing or Scottish Government borrowing provided, of course, that Holyrood was given such powers as advocated by both the Calman Commission and Reform Scotland amongst others.  Equally, there might be ways of using the existing local government borrowing powers to create some sort of pooling arrangement or Scottish Infrastructure Bank.  There are also ways of borrowing against future revenues from taxation, as in Tax Increment Financing (TIF), which is common in the USA, municipal bonds or road tolls.

Together with lower financing costs, the other element of a successful approach to infrastructure projects is better management.  This can be achieved if management companies from the public sector- representing a group of local authorities for example – private or third sectors bid to operate and manage projects as well as putting up the risk capital which is usually around 10 per cent of the total funding.  The public sector would agree a return with the management company so that it receives the benefit of any cost savings, efficiencies and additional sources of income in each project because  this provides an incentive for efficiency as well as causing the management company real loss if they fail to deliver.

Once agreement had been reached between the public sector and the management company, they would then work together and invite tenders for other aspects of the project.  Crucially, this would ensure the best providers were chosen for each part of the job.  The deal would also be structured in such a way that the public sector held A shares which guaranteed it retained control over the land and buildings and any potential refinancing benefits, while the management company held B shares which would deliver a return if they managed the project well.

The purpose of the Scottish Futures Trust has been very confusing since it was established two years ago.  We propose that the SFT has a clear role as the facilitator of projects that deliver value for money as well as deciding which management company is awarded the tender for each project. 

The credit crunch has meant that funding for new infrastructure projects has been limited no matter what method was adopted.  However, now is the time to put in place the right mechanisms so that as more funding becomes available we can move as quickly as possible to enable new infrastructure projects to proceed. 

Reform Scotland believes that Scottish Capital Partnerships offers a way forward to ensure that Scotland is investing in its future and we have the right environment for sustainable economic growth.