WEEKLY COMMENT 17-08-2017
By Barry Edwards
The fog is slowly beginning to lift on the process of Brexit as the British government is gradually releasing papers explaining the approach they would like to take. It appears that a transition period is now generally accepted as a necessity to manage the trading relationship that will eventually transpire. Companies throughout Europe are starting to influence the politicians to accept that it is in their interests and the EU economy to prevent sudden disruption when the UK officially leaves the EU.
Reality is now prevailing in the political debate which has encouraged proper discussion with business leaders and the concerns of all participants are producing a process that is beginning to make some sense. The Brexit negotiations and the eventual outcome will have some economic effect which will probably mean there will be a brake on the growth of the economy which is already happening. To counteract this, the UK has to start stimulating the economy by encouraging capital investment in every way it can.
The main point to make is that all the expertise and organisations that are needed to make this happen are already in place, except the funding mechanism. If the government is going to have any chance of reducing the budget deficit it cannot commit vast sums of tax revenue to finance all the infrastructure and related commercial investment required to achieve the economic growth plan that is necessary even though a large majority of the expenditure is eventually recovered in tax revenue. Therefore, there has to be a method of financing this investment without committing tax revenue initially and increasing government debt; how you do that is outlined below.
The government has established The Infrastructure and Projects Authority, The National Infrastructure Commission and The UK Guarantee Scheme; these entities all report directly to HM Treasury and/or The Prime Minister. To complete the funding part of the team The Bank of England would need to be involved to provide the collateral for the financial plan. Also, there are other organisations both publicly and privately funded that contribute new thinking and ideas. We have discussed the papers two of them have issued in the last two weekly comments.
On the 31st of October 2012, Lord Heseltine published a report at the request of the HM Treasury entitled ’No stone Unturned in Pursuit of Growth’. Lord Heseltine set out a comprehensive economic plan to improve the UK’s ability to create wealth. His independent report makes the case for a major rebalancing of responsibilities for economic development between central and local government, and between government and the private sector. You can read the report if you click on the link below;
The core of the report is the devolution of central government control over expenditure and support to the regions using the Local Enterprise Partnerships (LEP’s) already established. Some of the suggestions have been implemented but much still remains to be done. Completing the recommendations here would be part of this plan and consolidated with the other organisations mentioned above.
The key to everything is the funding mechanism, which we will explain in a moment, but the government established organisations make this whole plan vital if it is to be implemented quickly and efficiently. All it would take is proper coordination and administrative competency to have an effective capital investment programme operational within a year.
To initiate the funding plan, it is proposed that the Bank of England should establish a “Collateral Guarantee System” (CGS) – a method of utilising the assets on its balance sheet (mainly government bonds) through the issuance of guarantees for the purpose of financing infrastructure and approved commercial projects that would not otherwise achieve support or are limited by government budget commitments. The details of how this works is explained in the paper headed ‘Collateral Guarantee System 2016’ in the right hand column of this page. How the established government organisations coordinate within this plan is also explained.
Apart from generating tax revenue and not increasing government debt, the CGS also establishes an infrastructure market to provide long-term bonds for pension and investment funds. The CGS will allow substantial funds to be utilised in the early stages which would be difficult for any government to initiate with the constraints on the budget. It provides an income for the Bank of England and will help in establishing a sovereign wealth fund for the benefit of the nation in the future. Enterprise Managers will be established to provide long-term support for SME’s and sub-divisions of the CGS will support specific sectors of business that would benefit from the availability of guarantees, such as the film industry, which is a big export earner. Another important aspect is that all the investment would not be considered as part of government debt since they are collateralised by government bonds. All the bonds issued to replace the initial construction investment are sold to the private sector.
The major advantage for government is that it frees up substantial funds for other purposes helping to alleviate the austerity programme implemented since the financial crisis. It will speed up the time it would have taken for the national budget to return to balance and all the interest and repayment costs for the bonds issued will be covered by the tax revenue generated where the projects do not generate their own income with adequate sums left over for general expenditure. Since this investment will stimulate growth it will inevitably help to increase tax generation further helping to improve overall government revenue.
The projects currently outstanding that government has progressed amount to £455 billion which are analysed, categorised and rated by The Infrastructure and Projects Authority (IPA). Clearly not all of these can be processed at the same time but many more could be prepared and made ready than is currently possible. If you click on the link below you can see the report by the IPA;
Apart from those projects mentioned, there would be various commercial projects that would be encouraged to enhance and compliment the government investment which would be funded by the CGS, Once these were completed they would be funded entirely privately by equity and loan capital in which the CGS would participate. The whole purpose is to stimulate investment by a wide range of companies with the capabilities to execute and manage these projects. Many of these companies would not be able to obtain the funding required without the assistance of the CGS on terms that make commercial sense.
There is a lot of information available in the CGS document which is too lengthy to be included in this weekly comment. However, the potential to make something different materialise is clearly possible and simple to implement if the decisions are made to explore this proposal. This is only a brief overview of the proposal and there are many other aspects that need to be considered. There are a wide range of think tanks and forward thinking organisations that have similar ideas on various aspects of what is proposed here who could be consulted to refine the concept. It is suggested that HM Treasury instigate a consultation to formulate the range of possibilities that could provide the best approach for this government stimulus.
That’s all for this week.