Changing self-imposed, artificial borrowing rules, as Rachel Reeves did this week in the first Labour Budget in 14 years, cannot alter the fundamentals of the funding difficulties facing the country. The chancellor promised that by 2029-30 the government will end borrowing to fund day-to-day spending (which is always a bad idea) and that it will target public debt to fall in relation to the size of the economy, using a new, broader definition of public debt. But the government’s debt will still increase substantially under these rules—and given the challenges facing Britain there will be pressure for Labour to fund even more public infrastructure than the new rules can accommodate.
We have been here before: the last Labour government set fiscal rules and then wriggled around them. The outcome was confusion.
In 1997 the deputy prime minister John Prescott inherited the problem of how to fund HS1, the proposed high-speed rail link from London to the Channel Tunnel. The previous government’s privately financed proposition had failed to raise the money and the chancellor, Gordon Brown, was bound by fiscal rules—an idea he introduced to British economic policy in 1997. These rules precluded simply adding the cost of completing HS1 to the national debt. The story of Prescott’s solution is pertinent to the current suggestion of building a new, privately financed line between Manchester and HS2 at Birmingham, which was not mentioned in Rachel Reeves’s Budget. It is also pertinent to the completion of the HS2 line to London, Euston (Reeves announced funding to start the remaining tunnelling but was silent on completing the tunnelling and building a new station for HS2 at Euston, which is part of the original plan for the line).
Prescott contrived a government guarantee for the private borrowing needed to complete HS1, which was sufficient to attract investors. The government said that the risk of the guarantee needing to be paid was so low that the debt could be classified as off the public balance sheet. This got round Brown’s self-imposed rules, which were designed to restrict the total of public borrowing. But private investors were not confident that the project would be commercially viable, because of a fear that not enough people would use the line. They worried that the passenger revenues might turn out to be insufficient to cover the capital costs of building the scheme plus the interest on the associated borrowing.
There always was a risk that the government would need to pay the assurances on the debt. In due course the reality of over-optimism about the revenues hit home. The guarantees were called. In the final reckoning the cost was about £6bn and a 30-year operating concession was sold to pension funds for about £2bn, and so the national debt increased by about £4bn.
In the context of the disastrous public-private partnership (PPP) for the London Underground, in 2002 Tony Blair said that “the reason that we are engaged in this public-private investment partnership is so that the infrastructure work, which is urgently needed in the Tube, can be done”, adding “there is no way government through the general taxpayer can do it all”. One of the main reasons the 1997 Labour government found private finance initiative (PFI) and PPP arrangements so attractive was that the borrowing involved was classified as off the public balance sheet, on the grounds that the private sector contractors (not the government) were in control of the businesses, and so were bearing the risks.
Again, persuading the contracted private companies to do the financing on their own account enabled Brown to circumvent his own rules. Again, government guarantees eventually had to be given to persuade the private sector to sign up and—again—they were called when in 2007 the London Underground PPP collapsed. The lenders had to be repaid, with the taxpayer picking up the bill.
A major problem with many PFI and PPP contracts was that, in order to reduce the annual charges and therefore disguise the cost to the taxpayer, the terms of the contracts were very long—typically 30 years. But this had unintended consequences. Public requirements changed within the period that the inflexible contracts would be in force, and it was difficult to change supplier in the event of poor performance. It is impossible to foresee network needs decades ahead. For instance, the London mayor's introduction of all-night tube services conflicted with the contractual rights to do track maintenance overnight. Aside from this, population and economic changes are also likely but hard to predict, affecting pre-existing agreements. Voters were surprised to find that large chunks of current government budgets were pre-empted, paying for capital charges on infrastructure provided by the private sector many budget cycles ago.
Contrary to what taxpayers had been led to believe, while private lenders might finance major infrastructure projects up front, in the end it is taxpayers who pay to cover the deficit funding for commercially non-viable schemes. What’s more, investors do not care much about what infrastructure projects actually are. They care about risk and return—including the chances they will be repaid in full. As the Truss regime discovered, the issue for any government is the extent to which all the things for which the taxpayer is on the hook, now or in the future (including PFI, PPP and any other contractual liabilities), can be further increased without causing a debilitating increase in the rate of interest. The “fiscal rules” that Reeves this week officially changed are only relevant to the extent that investors see them to be effective in enforcing prudence. Changing them does not alter the fundamentals.
To spot the smoke and mirrors, it helps to put the financials to one side and think about the physical economy. We do not have many unemployed resources—things like energy, water, materials, and human resources—so if we want new and better-maintained infrastructure then we will have to consume less for a while, switching resources from consumption to investment. Increased personal savings would translate into reduced personal consumption, but that seems unlikely, as the rate of savings in the UK has been low for some years, and people will probably not spontaneously change their behaviour to start saving more and spending less. The government can use tax to reduce immediate consumption. The revenues from this can (and should) be used to fund investment in hospitals, prisons, or major transport projects for the future. The government consuming less itself also seems unlikely. That implies either higher taxation or persuading other countries to invest in the resources to be repaid with a return out of our future savings and taxation.
Consuming less now, or borrowing now to be repaid out of reduced consumption in the future, makes perfect sense if the investment pays for itself and produces a sufficient return. But that does highlight the crucial importance of investing in the “right” productive activities. With investment capital so scarce, dissipating investment resources in ways for which there is little real evidence for improved productivity or growth is problematic.
When it comes to growth, not all infrastructure investment is made equal. Meanwhile, the government faces pressure to invest in certain public services, such as prisons and social care, that are not necessarily about directly growing the economy, but which the country desperately needs in order to function. These are issues to be faced by Rachel Reeves’s new Office for Value for Money. The Treasury’s standard appraisal techniques—including cost benefit analysis—are based on the best available evidence and are analytically coherent. They will be a helpful place to start.
Governments always have, and always will, rely heavily on private sector providers for goods and services. But contracts need to be appropriate to the circumstances: they must be capable of specifying what is needed for the term of the contract; they must be manageable—so not too complicated and not too large; and they must be actively enforced. Shorter, smaller and simpler contracts are less likely to be regretted.
That is all a matter of successful procurement. The private sector may be willing to bundle in financing at a higher interest cost than conventional public borrowing—and that may be good public policy if there are sufficient efficiency savings. But private investors, whether domestic or overseas, cannot be expected to gift funding in order to absolve government from the fundamental problems with the national debt. Nor will changing investment rules alter the fact that more investment means less consumption now or at some point in the future, until such time as an investment yields its return as enhanced growth. In other words, there is no such thing as a free lunch.
