What Brexit means for the UK’s public infrastructure

18-11-2019

The UK has received support from the European Investment Bank for a variety of infrastructure projects. However, as Micaela Mihov explains, the loss of this support following Brexit may have a negative impact on the country’s public infrastructure. She argues that one of the best options to mitigate the impact would be the establishment of a UK infrastructure bank.

Since 1973, the UK has benefited from European loans through the European Investment Bank (EIB) and the European Fund for Strategic Investments (EFSI). In 2015 alone, the UK received £5.6 billion from the EIB, representing approximately one third of total UK infrastructure funding. Leaving the EU would mean losing access to EIB and EFSI investments.

This could impair the ability of the British public sector to deliver affordable housing, good quality schools, and safe transportation. To counteract these negative repercussions following Brexit, the British government has started deliberating over the establishment of a UK infrastructure bank. Setting-up a national promotional bank is a resource-intensive and lengthy task. However, its formation could be crucial for protecting the future of British public infrastructure.

A funding gap for projects of social and environmental significance

The British economy has received EIB loans, guarantees or equity worth more than 118 billion euros for a variety of infrastructure projects. Most of the EIB loans to the UK have gone towards funding projects in the energy sector, transportation, water and sewage, urban development and education. Noteworthy projects with such European backing include London’s Crossrail, the Thames Tideway Tunnel and the expansion of Manchester’s tram network. If the country leaves the EU, the UK would most likely have to terminate its membership of the EIB, as set out in the EU treaties and the EIB’s statute.

As a result of losing access to EIB investments, the UK’s public infrastructure, including projects of great social and environmental importance, could face a multi-billion pound gap. In the area of urban development, the EIB has significantly contributed to green and affordable housing projects. Recently, the EIB provided a 480 million euro loan to The Housing Finance Corporation Ltd (THFC) to build energy-efficient new housing across the UK. The THFC has since 1998 received £1.4 billion from the EIB to invest in smaller housing regeneration schemes in the UK. In the UK, 45,000 new homes are needed every year, of which not even half are being built. Brexit could, therefore, further impair the social housing situation in the country and put a burden on other underfunded public infrastructure areas.

Without EIB loans, many projects with substantial social and environmental impact would not take off. Those projects would not receive sufficient funding from private investors who consider EIB finance a seal of approval and thereby gain the confidence to act as additional investors.

The return of risky PFI projects

After Brexit, the private finance initiative (PFI) could re-emerge as a viable alternative to fund public infrastructure. In 2018, the former British Chancellor of the Exchequer Philip Hammond announced the abolishment of the PFI model. Many PFI projects in the UK, especially when it comes to hospitals and roads, have been costlier than anticipated, and some have had to be bailed out or even scrapped entirely. Furthermore, the 2018 collapse of one of the UK’s key PFI players, Carillion, and the subsequent need for the UK government to renegotiate multiple PFI contracts highlights the perils of shifting financial risks to a few private sector companies.

In the past, large infrastructure projects have been financed through long-term loans by the EIB. After Brexit, PFI will be a credible alternative, since without EIB funding, the appetite of the UK government to finance large-scale infrastructure projects with public funds is expected to fall. This means that the private sector would have to step in through new risky PFI contracts. Ultimately, the UK government would have to pay high risk premiums to private investors, which would potentially cost British taxpayers billions.

Threats to the British construction industry

The British construction industry is an important contributor to the UK economy. Construction represents 6.7 per cent of the total UK economy and employs 2.9 million people. The construction industry is a labour-intensive industry, relying heavily on skilled workers from the EU. Between 1998 and 2016 the percentage of foreign-born workers has increased from 4.1 per cent to 12 per cent. The construction industry is currently suffering as a result of insufficient demand in the pre-Brexit environment of political uncertainty and market volatility. After a Brexit that limits the free movement of EU citizens, the tables might turn: demand could pick up, but supply would fall due to a shortage of skilled workers.

Brexit could create a significant shortfall of workers, which means that there will be insufficient construction supply for the demand of public and private sector construction services. This mismatch between supply and demand complemented by costlier EU-imported materials would result in rising construction prices that would make affording public infrastructure more expensive for the British public sector.

The establishment of a British infrastructure bank

To meet high infrastructure investment demands without the existing EIB funding, the UK government has started to discuss some options. One of the long-term options is the establishment of a UK infrastructure bank. In a report published in January 2019, the House of Lords urges the government to consider a UK infrastructure bank to replace the lost EIB funding. The role of such a bank would be to act as a cornerstone investor, promote confidence for private investors and enable projects of public significance that would otherwise not take off. Hence, this new public investment bank would substitute the role of the EIB in the UK.

In theory, this idea presents itself as a worthwhile undertaking to fill the conceivable EIB investment vacuum in the UK after Brexit. Many EU countries including Germany (KfW) or Italy (Cassa Depositi e Prestiti) have a long tradition of using national promotional banks to support their economic development, including investments in infrastructure projects, SMEs or environmental sustainability. However, setting up an operational investment bank takes between 5 to 10 years. Gaining a track record and establishing a good reputation takes even longer. Another difficult question for the UK government will be how to finance this new institution with an estimated setup cost of £15 to £20 billion.

Source: ISE Blogs