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Funding and Financing UK Infrastructure

Infrastructure and the use of the word has become commonplace in the UK, permeating most sections of society to become a subject of discussion in offices and over dinner tables across the country. This is great for those of us who live and breathe it, but perhaps the phenomena itself tells its own story.

The economic crises of 2008 and a change of government in 2010 left politicians in the UK searching for a path out of recession and a tangible policy to accompany it. This policy has been to concentrate capital spending on investment that will create jobs and stimulate economic activity, and the underlying narrative used has been to invest in infrastructure.

Who is Going to Invest in New Infrastructure?

The UK government and other western democracies were faced with the conundrum that in order to deliver more and better infrastructure that will stimulate wider economic growth in the private sector, considerable sums of money are required upfront before a return on investment can be realized. In the UK, with reluctance to borrow more on the nation’s credit card to pay for infrastructure, the solution was to look to the private sector to invest and share the burden with the government.

Reconnecting the Relationship between Infrastructure and Society

A feature of many developed, complex economies is that the various components that make up societies get siloed at a point immediately downstream of central government (business, law, education, health services, transport, etc.) never to come back together until they reach the level of individual people. From a planning and infrastructure perspective, the intrinsic link between the places where people live, work, and play and the creation of the infrastructure that allows this to happen has been lost through the increasing compartmentalisation of funding streams and public policy. Further, over time planning has become specialized to discrete subjects, such as land use, transport, industrial uses, or economics rather than considering all facets, simultaneously, from a place-based perspective. This results in tensions at a local planning level between the funding and associated policy pertaining to a discrete subject, and actual needs of different places. Re-creating the link between infrastructure and societal need is the simple ethos that Parsons Brinckerhoff has been bringing to infrastructure and place projects in the UK.

Parsons Brinckerhoff’s Role in Promoting Infrastructure Investment in the UK

Parsons Brinckerhoff supported this thought process in 2010, in partnership with the Chartered Institution of Highways and Transportation (CIHT) and Balfour Beatty, and working with various UK central government departments, local government, and UK professional institutions to produce a report entitled Infrastructure Funding and Delivery: An Action Plan for Change.1 This report set out in its recommendations to government, an underlying change of approach and mindset for infrastructure funding and delivery.

A key recommendation was the creation of local infrastructure funds that would be used specifically to finance or “forward fund” infrastructure that directly facilitated both new community development and the regeneration of existing developed spaces. Forward funding in the UK is defined as capital invested by the public sector that will ultimately be returned to the public purse. The local infrastructure funds would recoup their investment when the developments they facilitated were realized, through a number of legal mechanisms, such as an allocation of taxation, similar to tax-increment financing in the US.

The report led directly to the UK government announcing a Growing Places Fund in September 2011, which is a £750 million fund allocated to Local Enterprise Partnerships (LEP) to allow them to forward fund public and private infrastructure that facilitated economic growth. LEPs were set up by the coalition government in the UK in 2011 with the intent to include the private sector in the decision making of where public investment should be made.

The strategy was for the funds lent to infrastructure schemes to be repaid to a local revolving infrastructure fund when the developments facilitated through the fund repaid the initial loans, thereby creating a virtuous circle of local infrastructure investment (Box 1). The initial £750 million has been topped up with a further £500 million from central government with a commitment to channel more cash to economic geographies that develop successful revolving funds.

Using Parsons Brinckerhoff’s Global Experience to Devise a New Funding Model for the UK

In compiling An Action Plan for Change, Parsons Brinckerhoff in the UK looked to our global experience to understand how investment in public infrastructure was achieved in other jurisdictions. The transit-oriented development (TOD) concept that Parsons Brinckerhoff has extensive experience working with in the US was used as a base from which to develop a similar model for the UK. The basic concept of TOD is applicable in the UK as we similarly assess, at various stages throughout a project, whether the economic activity stimulated by a new transit/transport scheme generates sufficient tax revenue and developer contributions to repay the investment. The UK model recommended in An Action Plan for Change diverges from the US TOD model to allow for the different taxation systems of the two countries and the inability to levy a specific local tax within a discrete geography in the UK.

Concept of Total Viability within a Discrete Economic Geography

The US TOD financial model shows where additional economic benefits will be created and where revenue can be raised to pay back initial investment and financing costs needed to deliver critical infrastructure. Taking that into consideration, the public sector in the US can, in theory, then decide whether to directly invest the money in the transit scheme, or to pass on the funding and responsibility for financing to the private sector through a public-private partnership (P3) concession or similar alternative finance vehicle.

This model has a few similarities with the UK’s Private Finance Initiative (PFI) pioneered in the early 1990s but with a direct link between the additional economic benefit and the revenue sources that will repay the specific infrastructure investment.

Having recreated the link between places and the infrastructure that serves those places, the next logical step was to test whether, when taken together, the investments in infrastructure and place (social infrastructure) resulted in a net financial benefit (i.e., whether in total they were financially viable). We then further refined the concept to divide infrastructure investment into three types of projects within an economic geography:

  1. Where the private sector could or would invest on its own
  2. Where the private sector would jointly invest with the public sector
  3. Where only the public sector could or would invest

Dividing the projects into these categories gives clarity to the cash flow required to invest in an infrastructure program. It helps to define when the public sector needs to act alone to deliver the infrastructure versus providing gap financing to cover periods of negative cash flow. This gave politicians confidence that the infrastructure needed to stimulate economic development is affordable and viable within a given timescale.

Next Steps: Attracting Wider Private Sector Investment in Infrastructure

Many of the recommendations made to the UK government in An Action Plan for Change have been acted upon both directly and indirectly through policy changes, changes in the way the infrastructure schemes are funded, and changes in the assessment of infrastructure’s wider value on societies. To further accelerate economic growth, the next step recommended in An Action Plan for Change is to attract private investment to a portfolio of schemes within an economic geography.

The large UK P3 pipeline signals strong private sector demand for individual infrastructure projects with self-contained risks and clear revenue streams. However, attracting private investment across a programme of schemes defined within a discrete economic geography has proven to be quite elusive. As the UK government’s spending will be restrained for the foreseeable future, accelerating investment in infrastructure to stimulate economic growth by attracting private sector investment will remain a top priority for the government and infrastructure professionals alike.

There are encouraging signs that will help to accomplish this objective in the longer term. For example, developers in the UK are currently able to pay into “allowable solutions” funds for renewable energy in lieu of delivering on-site renewable generation. In these instances, the renewable energy is generated in large-scale projects remote from the site. This concept could be further developed and applied to private sector funding for transport infrastructure. An example of allowable solutions for transport would be the private sector investing in a mass transit system in one part of city that frees up traffic capacity in another part of the city, allowing for additional real estate development in that part of the city. The financial profit from the new real estate development would then be channeled back to the private sector investors in the mass transit system.

In summary, there is currently a surplus of private capital around the world’s money markets looking for infrastructure projects in which to invest. The UK government is trying to attract it to infrastructure in the UK. Parsons Brinckerhoff works with such investors to help them find tangible projects to invest in. However, outside the infrastructure directly associated with real estate development, it is proving difficult to find transport infrastructure investments with a direct or proxy revenue stream. Parsons Brinckerhoff in the UK has gotten close to cracking this in the last two years by employing different proxy methods. If we can continue on this trajectory, we will be ahead of the game in supporting the acceleration of infrastructure investment in the UK.

 

Notes:

  1. Download the report at http://www.pbworld.com/pdfs/regional/uk_europe/infrastructure_funding_report_021512.pdf

Image Header Source: Matt Buck (Creative Commons)