Perspectives



Economic Review & Outlook: Implications for the UK

Reflecting back on the previous articles I have written on the performance of the UK economy for EFR brings home the depth and length of the current economic situation as very little has changed. Growth continues to be minimal, inflation continues to be higher than expected and is still well above the two percent per annum target, whilst forecasts for the future reflect short term angst but longer term promise.

This was meant to be the year when a sense of optimism returned to the UK economy with the long awaited arrival of the 2012 Olympics, two percent inflation, and two percent growth in GDP. The 2012 Olympics are here with the Olympic torch winding its way on its 8,000 mile journey around the UK, but inflation remains stubbornly high at close to four percent whilst growth is effectively zero (the last two quarters showing small negative growth, which technically means recession).

Meanwhile the problems within Europe, the UK’s largest trading partner, continue to send shockwaves through the financial markets, with the election of a new French president who is calling for a greater emphasis on growth measures, as well as the continuing problems of Greece, with the calling of a second general election after the first proved inconclusive, leading to concerns that it may have to leave the eurozone.

UK Economic Performance

The UK’s quarter by quarter GDP growth from 1990 through the first quarter of 2012 is shown in Box 1. This illustrates the depth and extent of the current economic crisis with what appears to be an oscillating convergence on zero growth following the massive falls in 2008. Assuming growth can be sustained in 2013 and beyond, historic growth rates show that annual growth of 1.5 percent can be achieved within two years, which is consistent with the Office for Budget Responsibility’s (OBR) most recent (March 2012) forecasts. These predict that GDP will grow by 0.8 percent in 2012 (the same rate as in 2011) with growth of 2.0 percent in 2013, picking up to 2.7 percent in 2014 and 3.0 percent in the final two years of the forecast. The key risks they identify to their forecasts are the situation in the euro area and a further spike in oil prices.

In its latest (May 2012) forecast for the UK economy, the Bank of England has cut its growth projections for2012 from 1.2 percent to 0.8 percent on the back of the eurozone crisis, and warned that inflation will remain above its two percent target for at least another year, citing volatile energy and commodity costs. It predicts that a return to pre financial crisis conditions will not take place until 2014, similar to the OBR’s prediction. The UK’s financial year ends in early April and the end-of-year scorecard could be summarised as shown in Box 2.

Prospects for UK Infrastructure

Whilst the general economic situation has not changed significantly over the past six months and still sits under the threat of instability arising from the eurozone crisis, as well as volatility in energy and commodity prices, there has been a renewed focus by the UK government on the merits of investing in infrastructure—particularly power and transport. The government is looking for ways to increase investment in infrastructure to compensate for slow growth elsewhere, but that does not mean the government is opening its own chequebook. It does not wish to be a direct investor in new major infrastructure projects if they can be better developed in the private sector. It is therefore looking at how it can attract investment from global investors who are interested in long term stable returns such as pension, insurance, and infrastructure funds. Much of the UK’s infrastructure is already in private hands, including water, electricity, telecommunications, gas, and aviation, but there are opportunities emerging for the private sector in areas that have traditionally been funded predominantly by the public sector.

The Prime Minister elaborated on his vision for the UK’s infrastructure and how it might be financed in a widely reported speech to the Institution of Civil Engineers in March of this year. His speech was wide ranging and provided a coherent vision of what the UK needs to achieve in the development and upgrading of all its infrastructure and how this might be accomplished. His key message was that the best way of improving infrastructure to meet our future needs is by using private capital and resources to deliver projects quickly and efficiently.

In that context, he announced a new study to look at ownership and financing options for the strategic road network in England, and suggested that adopting the approach the water sector used would bring major benefits to the maintenance and upgrading of England’s road network. It is doubtful whether this means an immediate expansion of capital expenditure on the roads through privatisation, or mass tolling of the road network, but the issues of falling revenues from existing motorists’ taxes and the need for government to reduce its debt underlines the fact that the status quo is unsustainable. Knowing this, the sooner reforms are considered and introduced, the quicker the UK will attract new investment to create the road network it needs for the 21st century.

Market Reform

Another sector that has been the subject of extensive consultation on market reform to facilitate investment is electricity. The reforms are required for two reasons. First, uncertainty and volatility in cost and future demand is compromising the ability of the private sector to construct new power generation capacity. Second, the electricity sector business model has to change to encourage the market to deliver greater low carbon capacity and energy, in line with the EU and UK climate change commitments.

There is concern in many quarters that the time taken to push these regulatory reforms through parliament and enact them in practice is holding up badly needed investment and that any further delay will compromise the UK’s ability to achieve security of supply, as some 25 percent of the UK’s current generating capacity will be retired between now and 2020. New legislation is expected to be enacted in 2013 with implementation following in 2014 which, with the long lead times on power projects from planning to commissioning, may give cause for concern.

Whilst market reforms that provide greater certainty and bring investment into new projects are welcomed by the construction supply chain, there is a concern that the effect will be similar to an Olympic starting gun. As the gun fires, resources will have to be mobilised from a virtually standing start, and there is always a risk of a false start if the assumptions in the reforms are not realised in practice. In the power sector, nuclear power development is already behind the starting assumptions following the withdrawal from the Horizon consortium of its two principals—German utility companies E.ON and RWE—whilst the development of a pilot carbon capture and storage project using £1 billion of government money has been similarly delayed following the failure of the first competition to attract a sufficiently viable proposition.

The UK power sector is likely to see a rapid increase in construction industry services in the middle of this decade with extensive investment in offshore wind and gas. The road sector reforms will also bring new opportunities if they are successful in attracting private investment. The rail sector, partially funded by the taxpayers and partially by the travelling public, continues to provide some stability. Studies are proceeding on HS2, the new high speed rail line between London and the North of England, and significant regional projects are in design or construction including the Northern Hub in Manchester, Crossrail through London, and the electrification of two important east-west routes including the Great Western Main Line.

Conclusions

In summary, the short term sees infrastructure opportunities maintaining their relative position within the shrinking UK economy. Infrastructure prospects are now expected to improve slowly, having been through a period of consolidation, as the UK economy itself recovers and greater clarity is provided on future investment needs and how they may be delivered. There is still the possibility of shock waves from the eurozone, including conflicts between the current strategy of austerity and a desire for growth. There are also continuing possible impacts of unforeseen global events which may lead to increased volatility in currencies and/or energy and commodity prices.

It is fair to say that the infrastructure sector is waiting patiently for the various policy and market reforms to work their way through the system and deliver significant infrastructure spending opportunities as we enter the “teens.” There is a concern that the reforms may not be in place quickly enough or may take time to “bed-in” before investors take advantage of the opportunities.

It will be interesting to see when the scales tip from “steady as you go” to “full speed ahead” for the infrastructure construction supply chain. A rapid expansion of the market in a short space of time brings its own challenges, not least in mobilising the necessary resources. This could be a particular issue in the power sector where capital expenditure is expected be more than three times its current annual level by 2015 as the industry races to meet the security of supply and renewable energy directive requirements once the electricity market reforms are finalised in 2013/14. The new strategy for England’s road network will, however, bring welcome relief from the lean years that have accompanied the government’s review of capital spending.

 

Image Header Source: Abby Stanglin (Creative Commons Commons)