In a new Bennett Institute report, Thomas Aubrey critiques the government's reliance on private finance initiatives (PFIs) for infrastructure development and recommends a more integrated approach using development corporations. He argues that by leveraging the Land Value Capture provisions in the Levelling Up and Regeneration Act 2023 (LURA), the UK can finance large-scale infrastructure and housing projects more cost-effectively, without the drawbacks of PFIs.
The Chancellor is in a quandary. While she has put growth at the centre of her policy programme, this growth must happen without negatively impacting the public finances. This is why Rachel Reeves has been exploring new models of public-private partnerships including a £9bn project across the Thames. In addition, the Maier Review undertaken for the Secretary of State for Transport has recommended the UK government seek private funding to help build new transport projects.
The Maier Review was rather thin on detail proposing that the Treasury adopt “a new openness towards partnering with the private sector” while noting that special purpose vehicles funded through debt and equity will play a major role in this approach. The report is also clear that any private sector financing must also be supported by public sector funding based on the assumption that such investments will result in net additional tax receipts flowing back to HM Treasury.
This shift away from solely publicly funded projects as the appropriate way of delivering large-scale infrastructure projects is understandable given the debacle of HS2 and the large cost overrun on Crossrail. Furthermore, infrastructure projects do not always result in net additional tax receipts for the government.
The introduction of private capital via previous private finance initiatives (PFIs) did bring greater clarity on the details of projects and their costs. This greater clarity has, however, come at a significantly higher cost with the National Audit Office (NAO) finding such projects estimate much higher construction prices. The NAO has also found that financing costs are between 2 to 3.75 percentage points above the cost of UK gilts. In addition, the returns to equity holders can be significant, with the M25 PFI contract for example realising returns of 31% per annum over an eight-year period. Despite these significantly higher costs, the NAO has found little evidence of operational efficiency on managing assets once they are built. Hence, it is unclear at this stage how Labour’s new private public partnership is going to deliver for the public; a concern that has also been raised by Gus O’Donnell, a former cabinet secretary, as well as Gareth Davies, the head of the NAO.
Another critical issue that does not appear to have been sufficiently addressed by the government yet is the lack of integration between transport and housing. While the Maier Review did indicate that transport projects have the potential to support agglomeration economies and meet housing demand, there is still no singular approach to the built environment. When Paris and Gothenburg decided to embark on major city expansion projects, they integrated housing with transport as part of the same project. This lack of co-ordination is one reason why the UK is so poor at delivering higher rates of housebuilding.
A further critical reason for integrating infrastructure with housing is that following the passing of the Levelling Up and Regeneration Act in 2023 (LURA), land value capture can now help pay for the infrastructure. LURA 2023 permits a public authority under certain circumstances to acquire land at values close to existing use value by ignoring the prospect of planning permission for land compensation.
Once the infrastructure is built and planning permission is granted, plots can be sold to housebuilders at higher values. This increase in land values was used to fund the wave of post-war new towns, as well as many new European urban extensions. If ministers continue to push siloed projects they will struggle to realise any gains from land value capture, which could otherwise release over £200bn over the next 20 years.
Instead of trying to develop complex and costly new PFI arrangements, development corporations could raise finance directly from the capital market contracting out the delivery of the infrastructure and housing. These projects will require the same level of detail as is the case for PFI-style projects to attract private investors to buy the bonds. Moreover, these projects will be significantly cheaper given that there is no need to “guarantee” a profit to the equity providers alongside a significantly lower cost of capital.
To ensure that these projects do not impact the public finances, the Office of National Statistics (ONS) is already required to ascertain the sources of funding for any debt issued by a public body. Hence, only projects relying on market sources such as the sale of serviced plots with planning permission, rental income and track charges should be pursued given these will not impact gilt yields.
The Chancellor should exploit LURA 2023 now and work with key stakeholders to develop integrated projects across the country. It seems Michael Gove planned to use the LURA to double the size of Cambridge through a large-scale integrated infrastructure and housing plan; but integrated projects could also be developed for the Old Oak Common to Euston high-speed line in conjunction with housing at Euston and Old Oak Common Station; as well as the Birmingham to Manchester HS2 line integrated with housing both within the two major cities as well as stations in between them. Disregarding the LURA may serve political interests, but it constitutes poor policy.
The views and opinions expressed in this post are those of the author(s) and not necessarily those of the Bennett Institute for Public Policy.
