Paul Diggle
Hello and welcome to Macro Bytes the economics and politics podcast from abrdn. with me, Paul Diggle. Infrastructure is one of the foundations on which an economy is built. Roads, bridges, power grids, telecommunication networks are all essential for the functioning of daily life, but also economic activity. But increasingly stretched public finances mean the ability of the public purse to provide and upgrade infrastructure may be limited, and new challenges such as climate change or technological progress, are changing the sort of infrastructure we need. And on a small, cramped island, such as the UK, building physical infrastructure is often fraught with hurdles from the planning process. So today we are asking how do we finance and build the sort of infrastructure that will underpin future economic growth? And to help us answer this question, I'm joined by a return guest friend of the pod, Bridget Rosewell. Bridget is an economist with huge expertise in infrastructure, cities, transport economics. She is on the board of the UK infrastructure Bank. She was a commissioner of the National Infrastructure Commission. She's also been involved in Network Rail, the M6 toll amongst many other things. Bridget was Chief Economist of the Greater London Authority for over a decade. And she was indeed my first boss when I worked for her as an economic consultancy for Volterra Partners specializing in the economics of infrastructure and planning. So welcome back, Bridget.
Bridget Rosewell
Thank you for having me. It's good to see you again.
Paul Diggle
It's wonderful to see you. Well Bridget, let's start by talking about the role of infrastructure in the economy. I've talked a little bit about it there, but tell us why it is so essential to the functioning of an economy. Why is infrastructure of such interest to economists, as opposed to being the domain of architects and structural engineers and the like?
Bridget Rosewell
Well, I think there's actually there's two really big themes that you need to get your head around if you're thinking about infrastructure. One is that although it costs, obviously to build it and prepare it and for people to use it, nonetheless it's a means to an end. So energy, for example, is both a means to economic activity. It's a means for keeping you warm. And that keeps you alive. So all of these things kind of pull into means to an end. And sometimes I think we find it difficult to think that one through/ It's a bit like ‘value added’ right? Value added starts - here's some raw materials and we add this and we add that and we add that..and in each of those stages we add something. And at the end you get a product that people want to buy. And you forget that all of those other bits are absolutely crucial to producing it.
The second thing is it's, long lasting. So that has kind of two aspects to that problem really. One is that, thinking about the length of time it might last and the returns you might get from it over time causes, you know, people struggle with that, particularly when you're thinking about investment, and you're thinking about, you know, say how how do you think in 30 year time chunks? Or 100-year time chunks? And some of the infrastructure that we've got and we still use is that old. And that's, you know, not just true for us, but it's particularly probably true for the UK. So those two things, the way that infrastructure makes other things possible and the timeframes over which you need to invest in it, causes real difficulties and when you're thinking about financing in particular. Who's going to get a return from this? How are you going to make that return, think about that return? And of course, and the third thing I suppose we might mention is that it's also geographically specific. And a lot of kind of economics 101 doesn't have time and space in it. It's all, you know, it's as if every single piece of time and space was sort of incorporated in the decision that you make. But of course, in practice the world aint like that. Time and space really matter.
Paul Diggle
And that framework you might call cost benefit analysis, and indeed you've been involved in actually helping the government at times think about, write the guidance on how to do cost benefit analysis, taking into account that long future flow of benefits. I mean, talk to us about some of the considerations that economists bring to bear in that cost benefit analysis, discount rates, wider externalities and so on.
Bridget Rosewell
So, yeah, so the the basic idea of cost benefit analysis is, after all, if you think about it, is pretty simple. It's going to cost X – and we're going to get these benefits from it. You might say that the cost part of this is the bit that comes first, and therefore it's simpler, although that is not always true - as we can see when projects turn out to cost more than you thought they were going to cost. But the bigger problem is how do you value those benefits? And if a benefit is going to come through over, say, 30 years and the value of something in 30 years time is, is less because the further away it is, the more you have to kind of cut back on what it's being valued at, because you really don't know what people are going to want in 30 years’ time. And therefore, you can get some quite arcane arguments, I guess, about what's the rate at which you push stuff back? If you think climate change is really important and happens over a long time frame, you have very low rates. So the future is almost as important as the current period. If you're thinking about something like a new laptop, which might last you five years, your discount rate is very high because you only need it to last five years. So you think about it you're going to chop 20% off its value every year so that you've by the time you get to the end of five years, it's not worth anything. If it's going to have to last 100 years or 150 years or 200 years, then obviously you're thinking about a discount rate which says that future stream of benefits is almost as important, if not equally as important, as the benefits you're going to get now. And there is a challenge to that because after all, who knows what people are going to want in 30-years’ time or 50-years’ time or 100-years’ time? And yet, equally, we have houses, roads – you know we've got bits of roads the Romans built which was 2000 years ago underneath with possibly quite a lot of stuff on top of it. But the underlying surface of that road was built 2000 years ago and laid out 2000 years ago. And indeed the geographical location of towns and cities can also date back well, certainly in almost all significant places in this country were, existed in early medieval times.
Paul Diggle
So there's this huge path dependency,
Bridget Rosewell
Exactly. So it's path dependency in the sense of how those connections were made between places, but also where the resources are. Where's the water? Where was the coal? Where was the salt? Where was the copper and tin? Tin mining in Cornwall. Copper mining in Wales. Where was the iron ore -particularly iron ore and then coal - which enabled you to build the Industrial Revolution. All of these things are very specific to a geography. And although we now think geography matters much less, I'm not sure that's really true. So for example, we've now in fact, only yesterday, today, the government has declared some data centers are critical national infrastructure. Data centers require a lot of power, and the warmer it is, the more power they require, because you have to keep cooling them down. The first computers needed massive air conditioning, then we made them smaller and smaller and smaller. But now the data side of it requires the massive air conditioning and the energy required to do that. So, that is also where you can put it and how you can use that heat or manage that heat requirement is really important.
Paul Diggle
Well, let's talk about the changing nature of what counts as essential economic infrastructure, because you've hinted there at how technological change is changing what’s important infrastructure, and you've also mentioned how climate change is possibly changing the sort of infrastructure we need both to manage climate change and also to succeed in achieving the energy transition, perhaps an aging population changes what infrastructure we need. New developments like self-driving cars may in time change what a central infrastructure looks like. And what other changes are out there or are underway that will change the nature of economic infrastructure?
Bridget Rosewell
I think that there are two things you haven't mentioned there which are changing, partly as a result of climate change, partly as a result of demographic pressure, and I don’t just mean numbers. One is water, the demand for water, and the demand for increasing amounts of water. So in the 60s or the 70s I think that the average household - average person used something like between 80 and 90 litres per person per day. Now it's 150 litres per person per day. The government would like you to get it down to 110. But nobody really knows how to do that. And indeed, you know, you can have a long shower and that uses as much water as a bath. So it's that whole question of how much water have we got? Where is it going to come from? How do you manage the natural resources that also depend on water? And of course, there's an international aspect to that as well, that in different parts of the world water stress is even higher than here. And East Anglia actually has as much water stress as some parts of the Mediterranean. So there's a whole, I think, geopolitical question about water. And allied to that, perhaps even, but certainly related, is the question of soil. And I have tried to argue that we should be treating soil and soil quality as an infrastructure asset. I have to say that people gone ‘oh really?’it's difficult enough dealing with the waterways, transport, electricity, communication stuff. But it is nonetheless an underlying asset, without which you can't grow things. And if you can't grow things, you haven't got food unless you really believe you can import everything you want - and that makes you very vulnerable, obviously. So the question of soil quality and soil management, regenerative farming, all of these sorts of things, I think these at the moment, I think are a bit too invisible.
Paul Diggle
Sort of related to water and even soil, or at least the earth, is undersea cables, because these have also struck me recently in a geopolitical context, in a kind of modern asymmetric warfare setting, it turns out, is a piece of essential international economic infrastructure that largely went unmentioned as well, but it now turns out that we're enormously dependent on it.
Bridget Rosewell
Yeah. So there's interconnectors in the sense of power connectors between different countries - and obviously, as an island, then those are inevitably under the sea. There's communications cables as well, which are equally vulnerable. And there's this proposal to run an interconnector from Morocco up through the Bay of Biscay to get to the UK, and that would be using solar power generated energy. Obviously a lot more sun in Morocco than there is here. But I mean, it's a huge amount of cabling, of which there is a shortage incidentally, and it just strikes me as being incredibly vulnerable. Vulnerable even without malicious actors, just the weather and deep water and so on. I just think it's a highly risky activity, and we should be very careful about over-reliance on this, on that kind of infrastructure investment.
Paul Diggle
Let's talk about some of the challenges with with building infrastructure at then. We'll get into financing. You there talked about material constraints. And, you know, there's legitimate questions about whether we have the skills and the labour, especially in a full employment economy, to power a large infrastructure drive. But of course, the planning system is often raised as a kind of a bottleneck. Now, there's obviously a reason the planning system exists, and we want to put legitimate limits on the ability of developers to build. But at the same time this new Labour government has talked about it as a potential area of reform to drive greater infrastructure building. What do you see as some of the key bottlenecks there, or low hanging fruit for reform of the planning system?
Bridget Rosewell
It's very interesting that if you could unwind back to the beginning of the DCO process, the development consent order process, which was designed to accelerate infrastructure investment, that's what the purpose was. So you would have a much more truncated period of, investigation by the Planning Inspectorate. And there would be specific planning inspectors doing this into the proposal of which you would already have consulted. So it would the idea was it would limit the amount of consultation. You'd have it, but you'd limit the amount of consultation to - here's a proposal - you know this - what do you think of it? Then a six-month, maximum six months’ investigation, and a decision. If we could go back to that beginning of how it worked, I think that a lot of the infrastructure proposals would be much brisker to get through the system. What's happened is that the amount of consultation and research that has increasingly been required or been delivered by the developers as they try to cover their backs against everything that could possibly go wrong, has just got bigger and bigger and bigger and you get, in particular environmental impact assessments (EIA), which are absolutely massive, and you really can't believe that they are adding value to anything. And so that inability to, if you like, strategize, what are the things that really need to be looked at here? And what are the things that actually, you know, they're minor. And although somebody could raise them, you would already have said, we don't need to deal with that. We need you to look at this, but not everything. I mean, the EIA on Sizewell is something like 36,000 pages long. How is anybody even then going to assess it? So the whole thing has just got layer after layer and has become unwieldy. So I think the biggest thing you could do, because that system existed, and was designed, for the purpose that everybody says they now want, and which is to be able to deliver internationally significant infrastructure projects more effectively. I think you just need to take off a lot of the accretion, the barnacles that have been added to the process. Go back. Look at how it worked at the beginning and say, okay, let's make sure that that system is possible without challenge, without, you know, the lawyers building it back up. I'm sure they will eventually, but we need to just unwrap all of that. That's for infrastructure projects. It's not the same as some of the normal planning things, but we had a DCO. And the other thing you could do which would facilitate that, when it was first set up, there was a separate group of planning inspectors who were charged with doing these investigations, who were more senior and able to, you know, they were charged effectively with using judgment more, stringently. And then after a year or two, they got wrapped back into the normal Planning Inspectorate. And I think that was a backward step. So I think the other thing you could do is, is reinstate that separate group. You know, this is your job. Your job is to make sure we do it right. It's properly challenged, but equally it's to make sure that it's fairly, speedy.
Paul Diggle
And obviously, one thing the the Labou government and the Chancellor, Rachel Reeves, have been keen to underline recently, especially in the lead up to to the 30th of October budget, is the scale of demands on the public finances, the fragility of the public finances. So let's get into financing of infrastructure then and perhaps talk to us about the ability of the public balance sheet to finance infrastructure. Should we be looking in the first instance to public funding - and sort of private sector funding is a second best? And therefore it's a shame that the public sector is increasingly limited. Or are there actual benefits from the private sector involvement per se, rather than it being some kind of fallback option when we're looking for sources of capital?
Bridget Rosewell
Let's just start with why we might want to have private sector funding or financing actually, and it's sort of a proportion of private sector funding is one of the ways to keep the public sector honest. Equally, public funding is one of the ways of keeping private sector funding honest. So yeah, that combination public and private, which got a very bad name because of some of the things that were done stupidly. Just because some of those hospital schemes under PFI were badly done, doesn't invalidate the principle.
You just need to work out how are you going to do it well, which isn't the same thing. So getting that thinking about why you might want a private sector investor who will need a private sector return, that's one of the things people say, oh the public sector must do it because they can do it more cheaply, because government can borrow more cheaply than the private sector, which is absolutely true. On the other hand, as you say, A there are limits to the amount that you might want to raise. But equally, the fact that you have actually to think about where the returns from this project are going to come from, which will pay back the private investor is, you know, it's not irrelevant. So take the toll road, for example, the M6 toll, which I Chair. That road has no potholes. It’s not smart. It has nice emergency lanes. The money that people pay partly goes to pay off the debt that was incurred by building it, but partly actually it's just recycled back into the road, into the maintenance and the quality of that road, rather then it's free and whatever you get to spend on the national highway network is contingent on whatever lump is being given on a yearly basis, or maybe maximally a five-year basis. The concession on the M6 toll is 2054. We've got to maintain it right the way through till then. So also you've got that long term concession.
Whereas government tends to flipflop. So one moment there's loads of money. We want you to invest in this. And the next moment there isn't any money and you can't invest in that. And that is an incredibly inefficient way to deliver any form of infrastructure, which, as we've said, it takes a long time to build it but it also has a long-term payback. So I think this isn't one size fits all. In the case of things where there isn't any revenue, then yes, there's only the public sector that can do that because there's no pricing in it, there's no revenue to pay you back. There can be contracts, of course, even if there's no charge to the consumer. So a lot of the bits of the underground system and certainly the overground system is run as a contract. The contract is defined by TfL and the Mayor of London and then the contract is bid for, and in fact I think MTR which, comes out of Hong Kong originally, run the London overground system and they run it pretty well because again there are KPIs on that - key performance indicators - things you have to do, things you have to show you're performing on. So if the public sector can be an intelligent client and have the right people in post to be that intelligent client, then you can work it as a contract. If you're building something and you want to balance risk, then having bits, some public, some private, can work pretty well as well. You need step back and think, well, what is it exactly we're trying to do here, and what's the product at the end of it? So take Hinkley, the idea there was that it was bid for on the sort of price that the builder EDF, could, sell profitably the electricity for. And that turned out to be quite high, but actually probably not enough, as it turns out, because the whole thing is turning out to be much more expensive and difficult than they had expected. If you take, Sizewell, they've done it differently. They're doing it on a regulated asset base with some engagement from government and some, hopefully, engagement from private sector investors, both in equity and in debt. And the idea is that that will help maintain cost control both on the operating cost, but also on the construction cost, because otherwise you won't get that, you won't be able to get your asset base return. So there are lots of different models out there for how you can do these things. There's a bit of a mix, but government has quite a lot of the equity in Sizewell - it doesn't in Hinkley.
Paul Diggle
I love this point that, government can sometimes be prone to flipflopping and short- termism because one point that people sometimes make about private sector involvement in infrastructure is that the private sector is somehow inherently short- termist, perhaps because it's beholden to shareholder return or quarterly reporting and so on, but actually it can equally be the case that the public sector can be short-termist, or can prioritize day to day spending over investment. And obviously there is also this broader point, as you've been talking about, Bridget, that potentially the public sector can be inefficient in the absence of market discipline and bringing in the price mechanism. So it's like hybrid models are often a best of both worlds, but they also can have their shortcomings in the absence of robust regulation and supervision, which is why they sometimes can have have a bad name in certain settings.
Bridget Rosewell
But I think the other point about all of that, of course, is that the ones that give everything a bad name are the big ones - and the big ones are inherently difficult.
There's this work which says you know, all these projects run late and overbudget and should never be done. Well, not necessarily true, because even if they did, they may still, you know over that longer period, have shown themselves to have been worth doing. I think the Jubilee Line extension is a good example of that. It wasn't late, actually, because it couldn't be. It had to be done by 31st December 1999, but it certainly cost twice as much as it was supposed to. And it's fuller than it was planned to be – so hey. So partly it's, you know, doing those cost benefit analyzes over these long periods is inherently difficult, but of course, the ones that the government gets most involved in are the very big ones, because those are the ones where the finance gap is biggest and the private sector simply can't do anything big enough. When I was working on Crossrail, I did go around some of the banks when I wasn't sure we would get any government money for it, and I went around some of the banks and investment banks and said, well, you know, what about it? Would you invest in this? Seventeen billion - could you raise that? Yes, probably we could, but only if we have full control like you would have in an oil refinery or something like that. And this, because it's all part of systems, these sort of transport and connectivity and energy investments, they're part of bigger systems, you just wouldn't have enough control to enable you to take the sort of construction risk that you would otherwise have to take. So there's also a distinction in all of this infrastructure between construction risk and operational risk.
Paul Diggle
And what can government best do in the presence of that sort of complexity and the number of different models of public/private co-oporation, what can it best do to help crowd in private sector capital? Is it things like credit structures that absorb early losses? Is it taking advantage of the cheaper financing of the public sector? Or is it just regulatory certainty?
Bridget Rosewell
Well, consistency of policy and regulatory certainty has a huge amount of benefit. Yes. And some of the problems in the water industry, for example at the moment, is that finally, the regulator’s woken up to the need to have some fairly chunky investments just at the point where they're being really horrible to investors. You know it's doesn't really work very well that. So I think that consistency of policy and a good strategic view which doesn't change too fast, and governments that resist the temptation every time that they're new to say ‘we're doing this completely differently, is going to be completely different’ would be incredibly helpful. But at the Infrastructure Bank we've been sort of working hard to try and make that the case, with the National Wealth Fund for example, so that what we've been doing so far, it's taken three years to set the bank up, get people in, get the right skills into the bank, be able to assess the projects that come in front of you – or that you go out and look for. We can build that better. We can build it bigger over time. But it's not a quick fix. So a National Wealth Fund of, you know, seven point something billion, that's not a lot of money actually in infrastructure terms. So thinking about how you can leverage that most effectively and leverage private money as you do it is, you know we can do that, but you have to leave some, government has to let the institutions exist, mature, deliver and try and stay out of the way of some of that. There far too many quangos and etc., etc., which, you know, and I have some sympathy with this position, but on the other hand, where they are using particular sorts of expertise like, technical expertise or banking expertise that you can't really very readily get elsewhere, you need to make sure that you can use that properly.
Paul Diggle
And there's a lot of precedent here for the private sector building infrastructure. You know, it was often the norm, like Britain's railways system, for example, is largely, it was northern private sector capital that spurred railway mania. Before that, the canals were privately financed and you talked Bridget about along the long history of infrastructure that we still use in this country, much of it from the private sector. So there's kind of a deep history here of private sector involvement.
Bridget Rosewell
Of course, most of those railway companies went bankrupt. Don't forget that. Some of those lost a lot of money. But I think it is horses for courses. So one of my kind of heroes is Bazalgette, who, delivered the first Thames Tideway effectively - the sewers, the main sewers which served London for about 150 years. And they were financed through the city. So the money was borrowed on the private market, but it was backed by the City of London and by some tax revenues on wine and coal that the city was able to raise – effectively council charges, I can't think what it was called. But anyway, there were some property charges which you’d then be also using to pay it back. So it was a financial model. And then there was a sort of a long-term economic model. It has to be said he completely overestimated the need - deliberately. He took the most intensely populated part of London and assumed that - which was Westminster - and assumed the rest of London was like that, and then he doubled it. But we are the beneficiaries of that. And, you know, it comes back to the long-lived nature of infrastructure. So it's only now, 156 years later, that we are needing to put in the Thames Tideway investment, now that the population of London is, what, 4 or 5 times bigger.
Paul Diggle
Bridget, I think that's a great place to end. Thank you so much for joining us. That's all we have time for this week on Macro Bytes. Don't forget to like and subscribe to the show on your podcast platform of choice. Until next time, goodbye and good luck out there.
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