…The Economics Of Funding Infrastructure Improvements
ONE HUNDRED AND SEVENTY BILLION POUNDS?!!!
ALL AT THE TAXPAYER’S EXPENSE?
This is the narrative you get mostly in the news in regards to High Speed Two, the UK’s “controversial” high speed rail project. Costs are exhorbitant (I will look at this in a future post) and will be footed entirely by the poor, downtrodden UK taxpayer. All of this at the expense of other underfunded public services, like the NHS, Schools and Local Councils. However, this isn’t necessarily true, and this narrative feeds into a larger story of a country unwilling to invest in itself, the future, and a path to sustainability and prosperity.
CAPEX VS OPEX
There are two types of costs that occur in life that can be seen in businesses, individuals and governments. These are typically referred to as CAPEX (Capital Expenditure) and OPEX (Operational Expenditure). It is important to differentiate between these types of expenses, as they are typically paid for in very different ways.
Operational Expenditures are ongoing expenses that occur when running a system. An example of an operational expenditure would be paying for things like staff, supplies, and energy.
Capital Expenditures, however, tend to be “one-time” costs, used to develop, build or improve an asset. An example of capital expenditures are things like buildings, roads, or in this case: railways.
It is important to differentiate, because the nature of these expenses makes the financing and payment models quite different. Let’s say for example you take out a mortgage for your house. If you are renting your house, you are not able to take out a mortgage to pay for that, as it is an operational expense, a.k.a an ongoing cost you need to contiunue to pay for acess to the property. Borrowing money to pay rent is typically a bad idea, as the money borrowed will not continue to provide benefit at the point it needs to be paid back. However, if you borrow money to purchase a home, the house continues to provide benefit for the duration of the time you are making re-payments on the loan.
Believe it or not, the same thing applies for large infrastructure projects. The government takes out loans to pay for projects like HS2, which will then be paid back over a certain number of years, during which the project will continue to provide benefit.
This is the reason why the money being used to fund HS2 cannot be diverted to the NHS. The NHS is primarily an operational expense, meaning that it is generally funded by continual tax revenue, rather than loans. This is not to say the NHS would not benefit from capital expenditure (e.g new hospitals, equipment), but HS2 essentially has no impact on the ability of the government to invest in capital projects for the NHS.
Repayments
The repayments are essentially borrowed off future economic growth, which HS2 helps to secure. As HS2 will bring in multiple pounds for every one spent, it will help to expand (or at least limit the decline) of the economy, therefore the amount of tax the government will recieve.
So sure, HS2 will cost “£1600” per taxpayer, but as it will return £2 for every £1 invested, it will boost the economy by £3200 per taxpayer. So in a way, it doesn’t really “cost” anything. Many reports omit the wider social (and economic) benefits of the scheme, increasing the value proposition further.
COVID actually increases the business case for building HS2.
Coming back to capital vs operational expenses, let’s have a look at another argument typically thrown at the project. “We can’t afford it because of COVID”.
It is likely that after the pandemic, the government will have to continue borrowing money and keep taxes low, in order to re-boost the economy off the back of a year of significant restrictions on economic and social freedoms. The only other option is to return to post-2008 era austerity, which saw very slow and uneven economic growth, something that will continue to compound existing inequalities and poverty in the country.
Currently, schemes like furlough, eat out to help out, VAT cuts, etc, are operational expenses. They offer a short term injection of cash that will be borrowed and need to be paid back at a later date, despite them not really continuing to provide value when the repayments come round. This is not to say there are not good reasons behind them, many of these schemes have saved millions from hardship during this time, but they are certainly a long term headache.
However, investment in infrastructure is a capital expense. Not only do they provide a short term injection of cash during construction, the projects continue to provide value when the repayments come around. Projects like HS2 are a great way to secure growth, while also not leaving onerous repayments for schemes who’s value has long expired.
Indeed, looking towards other big issues, such as climate change, we should massively expand the scope of construction and capital investment in the UK, to invest in carbon-free energy, sustainable transport and housing and infrastructure that is more resillient to the impacts of changing weather patterns.
Interest Rates & Bonds
It is also worth noting interest rates on lending have dropped to record lows, as stock markets and businesses have become increasingly unstable. Investors are now looking towards lending money to governments, who are very low risk borrowers. Depending on if these bonds are indexed (linked to inflation) or not, bonds agreed upon now, with very low interest rates, may actually result in the government being paid to borrow the money.
Conclusion
When looking at a project/scheme and the expenses involved in its creation, it is worth considering wether it is a capital, or operational expense, as these tend to significantly impact the economic viability of it.
Indeed, schemes could be very cheap capital-expenditure wise, but result in high operational expenses. A new railway could be built very cheaply if it used freight wagons on jointed track, being hauled along with a big rope by a tug of war team. But obviously, pound for pound, this scheme will prove itself considerably more expensive.
The UK’s inability to pull out its wallet and invest in its future is holding it back considerably. In order to keep up with the world’s latest superpowers, we need to invest in high speed rail, sustainable energy and cutting edge construction/engineering capabilities. Not only will these schemes provide a short term economic boost, as long as we are sensible, they will continue to provide benefits larger than their costs when it comes time to pay the money back.
JHrambles 