Chapter 3 Capital and Infrastructure
Capital investment is vital to strengthening recovery and supporting sustainable economic growth. It sits at the heart of our economic strategy. The Scottish Government views the severe cuts in capital spending imposed by the UK Government as deeply damaging. We will do all we can to mitigate their effects.
The scale of cuts will inevitably slow the pace of delivery of our infrastructure programme but we are:
- making positive, strategic capital investments, including the new Forth Crossing, the
re-provision of South Glasgow Hospitals and improving Scotland's schools estate; and
- supporting maintenance of assets in our key public services, including by maintaining local authorities' share of the capital budget.
We are using all available levers to expand the capital programme, including:
- taking forward a new pipeline of revenue financed investment worth up to £2.5 billion, to be delivered through the Non-Profit Distributing ( NPD) model; and
- innovative measures such as Tax Increment Financing, the National Housing Trust and investment through the JESSICA Fund. 1
We will ensure value for money from our infrastructure spend by rigorous prioritisation and management of capital spending and by maximising the positive impact of the Scottish Futures Trust ( SFT) across the public sector.
This chapter sets out the Scottish Government's plans for capital spending and links them to its wider strategy for infrastructure investment in Scotland. The Scottish Government views infrastructure investment as critical to its Purpose of increasing sustainable economic growth and to supporting a strong recovery. The Scottish Government is therefore deeply concerned by the speed and scale of cuts in planned capital spending at UK level, and the consequent impact on employment, public services and economic growth in Scotland. The plans set out in this chapter demonstrate our firm commitment to prioritise capital spending during a challenging period for public finances, and ensure maximum value for money from Scotland's public infrastructure investment.
International studies 2 show that infrastructure investment is an essential contributor to productivity and economic growth. The accumulation of capital increases the potential output of an economy. In the short term, this can provide a boost to a country's economic growth and employment and will increase the overall size of the economy.
More importantly, capital investment, both public and private, is an essential driver of productivity, competitiveness, and long-term economic growth. Public sector investment that contributes to the development of a country's physical, technological and electronic infrastructure can increase the productive capacity of the economy as a whole and drive private sector growth and investment.
It is for this reason that, in the 2007 Spending Review, the Scottish Government allocated record levels of capital funding to improving Scotland's transport networks, raising capacity in the health service and investing in higher and further education.
The Scottish Government is pursuing an integrated strategy for infrastructure investment, to support its Purpose of increasing sustainable economic growth. The key pillars of their strategy are:
- the National Planning Framework 2 - which identifies key issues and drivers of economic change, sets out a vision to 2030, and identifies priorities and opportunities in spatial perspectives for each part of Scotland;
- the National Renewables Infrastructure Plan - a spatial framework for developing key sites of renewables activity, which proposes funding plans for developing these sites and is supported by a £70 million National Renewables Infrastructure Fund;
- the Strategic Transport Projects Review - which defines the key strategic investments in Scotland's national transport network from 2012 onwards; and
- the Infrastructure Investment Plan - which identifies Scotland's requirements for infrastructure investment in key public services from 2008 to 2018.
The common aim of these plans is to enhance connectivity, support increasing sustainable economic growth and enable Scotland to make the transition to a successful and sustainable low carbon economy.
During the economic crisis of 2008-09, this Government also took swift action to deliver an economic stimulus, by accelerating £347 million of capital spending from future budgets, to protect growth and jobs during a sharp global downturn. This approach was consistent with recommendations from the International Monetary Fund 3 that increasing capital expenditure was an effective way to deliver an economic stimulus and build the foundation for a strong recovery.
The Independent Budget Review ( IBR) recommended that: "Given the importance of [capital spending] in supporting economic recovery and increasing sustainable economic growth, the Panel would urge the Scottish Government to take every possible step to prioritise and fund capital expenditure even in the context of shrinking public sector budgets." As this chapter outlines, the Scottish Government is using every lever at its disposal to prioritise infrastructure investment to support recovery and sustainable economic growth.
THE OUTLOOK FOR CAPITAL BUDGETS
Under the current funding arrangements for Scotland, the pace at which the Scottish Government can implement its infrastructure plans largely depends on the allocation of capital budgets from HM Treasury at each Spending Review. As discussed in Chapter 4, with greater fiscal responsibility, including the power to borrow to fund capital expenditure, the Scottish Government would have far greater freedom to determine the scale of capital spending.
Unprecedented speed and scale of reduction in capital budgets
As a result of the decisions taken by the UK Government in the 2010 Spending Review, the capital budgets available to the Scottish Government will fall by 36 per cent in real terms by 2014-15 compared to the current financial year (2010-11). The allocation of Capital DEL budgets in recent Spending Review periods is shown in Figure 3 below. This scale of reduction is unprecedented and will inevitably slow the pace of implementation of the Government's infrastructure programme.
Figure 3 Scottish Government Capital DEL budgets
Note: Capital DEL budgets for 2005-06 to 2009-10 are outturn figures. 2010-11 total is from the 2010-11 draft Budget. For 2011-12 to 2014-15, Capital DEL allocations are from the UKCSR.
The Scottish Government is deeply concerned by the speed and scale of reductions in Capital DEL budgets and their impact on public services and on the fragile economic recovery that is under way. In particular, the Government is concerned that, without effective action:
- the speed and scale of reductions in capital spending will require some projects to be delayed or cancelled, even where they are in progress and supported by a strong business case; and
- the deep reductions in capital spending will hurt the construction sector and damage the wider prospects for a strong recovery.
To lessen these impacts the Scottish Government has taken action to support capital budgets, helping to ensure the continuity of provision in key public services and maintain the pace of its infrastructure programme. Specifically, the Scottish Government has released savings arising from falling construction prices and has used these savings to fund priority investments. We have also agreed a facility with HM Treasury whereby spending in 2010-11 can be transferred to support spending in 2011-12, with an equivalent reduction in our 2010-11 DEL. This will enable us to add £100 million from the current financial year to support capital spending in 2011-12.
Capital spending plans set out in the 2011-12 Draft Budget
Faced with significantly reduced capital budgets in 2011-12 and subsequent years, the Scottish Government has undertaken rigorous prioritisation of the projects and programmes it supports. We have sought to maintain the continuity of our investment plans as far as possible, while prioritising investment to support essential public services and economic growth. The capital investments proposed in the 2011-12 Draft Budget will support:
- major investments in national infrastructure priorities;
- maintenance and capacity in key public services; and
- a firm funding commitment to local government.
The 2011-12 Draft Budget proposes major investments to support national infrastructure priorities, specifically:
- construction of the new Forth Crossing, an essential investment in Scotland's transport infrastructure. Work on this project, which has an estimated cost of £1.7 to £2.3 billion, will begin in 2011-12 to ensure that the new crossing is operational by 2017;
- the South Glasgow Hospitals - an £842 million investment to upgrade and expand the capacity for adult and children's hospital care in Glasgow and the West of Scotland; and
- Scotland's Schools for the Future building programme. In partnership with local authorities, this programme will invest £1.25 billion to improve Scotland's schools estate.
The Draft Budget 2011-12 proposes to earmark significant capital funding to support maintenance and capacity in Scotland's key public services, including health, social housing, regeneration, transport, enterprise, higher and further education, justice and rural affairs and the environment. Detailed capital investment plans are set out in each portfolio chapter.
Lastly, the Draft Budget 2011-12 offers a firm funding commitment to local government to support councils' capital investment plans. Local authorities deliver vital public services including education, policing, fire services, roads, flood defence and waste management. The Draft Budget 2011-12 allocates a significant share of the Scottish Government's capital budget to fund capital investment by local authorities, in addition to the capital investment which is financed by councils themselves. This share is in addition to the £800 million of investment that the Scottish Government is delivering through the Schools for the Future programme.
USING EVERY POLICY LEVER TO EXPAND THE CAPITAL PROGRAMME
As a result of our concern about the effect of the rapid and deep reductions in capital spending flowing from decisions in the UK Spending Review and the implications that these will have for the pace of implementation of the capital programme and the strength of the Scottish economy, the Scottish Government will explore all possible means to support higher levels of infrastructure investment than would be possible through the capital budget alone. This effort will be particularly important to support recovery and sustainable economic growth, as capital budgets will fall sharply in 2011-12 and are likely to remain low for several years.
In general, funding infrastructure investment through public capital ensures the lowest cost of finance for a typical project 4 Under the current public finance framework, the Scottish Government does not have the flexibility to borrow to fund additional capital expenditure. However, there is an overwhelming economic and financial case for providing this flexibility to borrow as soon as possible.
In the absence of borrowing powers, there are a number of levers which can be used to help to expand Scotland's public infrastructure programme. While ensuring these levers are used sustainably and responsibly, the Scottish Government - working closely with the Scottish Futures Trust and local authorities - will work to maximise their positive impact. Therefore, in addition to its planned capital investments in 2011-12 and future years, the Scottish Government will:
- take forward a new, affordable pipeline of revenue financed investment worth up to £2.5 billion, to be delivered through the Non-Profit Distributing ( NPD) model; and
- make full use of innovative measures such as Tax Incremental Financing, the National Housing Trust and investment through the JESSICA Fund.
Revenue financed investment
Following Devolution in 1999, the then Scottish Executive supplemented the capital programme through the use of private finance - particularly through the Private Finance Initiative ( PFI). Around £5.5 billion of capital investment has been delivered through PFI, particularly in the education and health sectors. However, over time a number of concerns 5 have arisen about the practical impact of the PFI model, including:
- the cost of financing;
- the scale of repayments - or unitary charge payments - from public authorities' revenue budgets over the life of contract, which is typically 25 to 30 years; and
- the potential for the private sector to make large 'windfall' profits from PFI deals, including as a result of refinancing existing contracts.
Unitary charge repayments are already a significant cost to the revenue budgets of the Scottish Government and local authorities. Based on existing contractual commitments entered into since 1997, the cost to the Scottish Government Resource DEL budget of unitary charge repayments will peak at around 2.3 per cent in 2015-16. In other words, merely to fund contracts already signed, the Scottish Government must find an additional £50 million this year compared to 2010-11 plans. This is a significant additional commitment on a Resource DEL budget which will fall by 2.0 per cent in cash terms between 2010-11 and 2011-12.
In recognition of the mounting level of unitary charge repayments across the public sector and concerns about the value for money offered by PFI projects, the Scottish Government has made extensive use of traditional capital funding to deliver major projects. Since May 2007, based on value for money considerations, new revenue financed investments have been taken forward through the Non-Profit Distributing model.
The Non-Profit Distributing model
Based on value for money grounds, the Scottish Government has made clear that it supports the Non-Profit Distributing ( NPD) model to deliver revenue financed investment. The NPD model seeks to transfer risk and exert private sector discipline both during the construction phase of a project and throughout its lifetime, but without the excessive profits to the private sector and financing costs to the public sector associated with past PFI projects. Key features of the NPD model are that:
- returns to the private sector are capped;
- NPD does not contain dividend-bearing equity; and
- surpluses from NPD projects can be directed in favour of the public sector.
Had the Scottish Government continued with PFI, the pressure on revenue budgets in 2011-12 and future years would have been greater still. This would have required deep cuts in revenue budgets for key public services and ultimately a reduction in the quality and quantity of public service provision. It would also have meant that, facing a deep and sustained reduction in capital budgets following the 2010 Comprehensive Spending Review, the Scottish Government would have little, if any, flexibility to support the capital programme and to maintain capacity in key public services.
As revenue budgets begin to recover in the medium term, there is an opportunity to use revenue finance effectively and judiciously. The Scottish Government therefore proposes that investment decisions on revenue financed investment should be made within a clear and sustainable overall financial framework, to ensure affordability over the medium to long term. The box below sets out the main assumptions underpinning this framework, and the scale of new capital expenditure that can be delivered through the NPD model.
New investment financed through the Non-Profit Distributing model
To enable a sustainable approach to revenue financed capital investment, the Scottish Government will place a cap on the maximum percentage of the Resource DEL ( RDEL) budget to be allocated in any one year to meet unitary charges. This policy will ensure that new proposals for revenue financed investments are assessed rigorously in relation to future revenue affordability as well as value for money.
Based on contracts already signed, the cost of unitary charges will peak as a share of
the RDEL budget at around 2.3 per cent in 2015-16 (or £613 million in nominal terms). The Scottish Government intends to hypothecate an additional 1 per cent of the RDEL budget, which will be top-sliced to fund new NPD projects. This policy will provide at least
£250 million of revenue support, which will be used to fund up to £2.5 billion of capital expenditure delivered through the NPD model.
The new pipeline of NPD investment will help support key projects across core public services, including:
- Major transport projects with a capital value of £1 billion:
- the Borders Railway project (£230-£290 million);
- M8 Baillieston to Newhouse, M74 Raith Junction and M8, M73 and M74 network improvements (c.£320 million); and
- the Aberdeen Western Peripheral Route and A90 Balmedie (£350-£450 million).
- Education projects with a capital value up to £750 million:
- specific projects within Scotland's Schools for the Future programme, subject to the agreement of local authorities (£400-£500 million);
- improvements to the further education college estate at Kilmarnock and Inverness (c.£100 million); and
- modernisation of the Glasgow college estate, subject to the conclusion of a robust and affordable business case (c.£200 million).
- Health projects with a capital value up to £750 million:
- the Royal Sick Children's Hospital and Department of Clinical Neurosciences in Edinburgh (c.£250 million);
- revenue support to finance projects through the hub initiative (c.£200 million); and
- individual hospital projects, health centres and mental health facilities across Scotland (up to £300 million).
The Scottish Futures Trust will deliver this pipeline of projects in partnership with the Scottish Government, local government, NHS Boards and other public bodies.
This new pipeline of NPD projects is being targeted to provide the maximum support for the wider capital programme and for Scotland's key public services. The Scottish Government will seek to deliver each project as early as possible in order to accelerate its benefits to citizens and to the wider economy.
In addition to this pipeline of NPD investment, the Scottish Government will continue to make the case for greater financial responsibility for Scotland, including - at the earliest opportunity - the power to borrow to fund capital expenditure. With borrowing powers in place, the Scottish Government would be able to accelerate the pace of its infrastructure programme and undertake new investments in order to help strengthen sustainable economic growth and support vital public services.
Innovative financing mechanisms to support capital investment
Within the existing budgetary framework, the Scottish Government, in conjunction with the Scottish Futures Trust, has looked at innovative financing solutions which will help lever in new, additional funds to help take forward key infrastructure investment projects.
The Scottish Government has been at the forefront of developing innovative schemes such as Tax Increment Financing, the National Housing Trust and the JESSICA Fund to generate new funding sources for key infrastructure investment projects.
Tax Increment Financing
Tax Increment Financing ( TIF) is a means of funding public sector infrastructure judged to be necessary to unlock regeneration in an area, and which may otherwise be unaffordable to local authorities.
The overarching goal of TIF is to support and guide the increasingly limited public finances available for assisting regeneration by helping to lever in additional private sector capital. The TIF model allows for initial borrowing through the Public Works Loan Board to fund the infrastructure to be repaid through predicted future non-domestic rate revenues resulting from the local authority's investment.
Scottish Ministers have brought forward secondary legislation under existing provisions of the Local Government Finance Act (1992) to enable up to six TIF pilot schemes to take place.
In September 2010 the Cabinet Secretary for Finance and Sustainable Growth gave provisional approval for the UK's first TIF scheme at Leith Harbour in Edinburgh. The TIF scheme will take forward four enabling infrastructure projects which the City of Edinburgh Council believes will unlock 500 acres of waterfront land. These enabling projects are:
- a new road link between Seafield Road and Constitution Street to improve access to the development area;
- a public esplanade outside the Ocean Terminal shopping centre to bring new commercial outlets to the waterfront;
- a new pier for the Royal Yacht Britannia and visiting cruise liners; and
- new lock gates at Leith docks to facilitate cross-Forth ferry traffic.
The total cost of the four infrastructure projects is estimated to be £84 million. They have the potential to unlock an additional £660 million of private investment, creating up to 4,900 full-time equivalent jobs.
The Scottish Futures Trust is currently working with two other local authorities - North Lanarkshire Council and Glasgow City Council - which are developing TIF proposals for Ravenscraig and Buchanan Galleries respectively.
National Housing Trust
The first phase of the National Housing Trust ( NHT) procurement was launched in September 2010. It aims to provide around 1,000 additional affordable homes for rent over the medium term in areas where there is a shortage in the supply of affordable housing.
Successful developers build the homes, which are then purchased by Special Purpose Vehicles ( SPVs). The SPVs are in turn jointly funded by councils and private partners. Participating local councils' loans to fund these purchases will be backed by a guarantee from the Scottish Government that these loans will be repaid.
To participate in the scheme, developers or other private partners must commit to making homes available at mid-market levels of affordable rent for at least five and up to 10 years before the homes can be sold. Tenants must be given the option to purchase their home at market value before it can be sold on the open market.
The NHT will not only enable local authorities to secure new affordable housing through low risk borrowing but it will also provide support for economic recovery by re-starting construction on stalled housing sites. Around 1,100 jobs will be maintained if 1,000 new homes are delivered through NHT.
By moving from grant to guarantee funding, the NHT aims to deliver affordable homes in return for less public subsidy, helping to deliver additional investment.
Investment through the JESSICA Fund
On 6 July 2010, the Scottish Government announced the creation of a JESSICA fund in Scotland. JESSICA funding can be used to support a range of urban regeneration projects, including new business space, wireless technology zones, green energy for social housing, renewal of derelict sites and more efficient transport schemes.
The JESSICA Fund in Scotland has been capitalised by £26 million of Scottish Government funding, matched with £24 million of European Structural Funds. The total £50 million fund is being managed by the European Investment Bank ( EIB), which will ensure that loans and equity investments made by the fund are made on commercial terms. These investments will be delivered to projects across Scotland through Urban Development Funds ( UDFs).
A key advantage of the JESSICA Fund approach is that it enables the Scottish Government to use EU Structural Funds as a source of repayable investment (loans, equity) rather than grants, meaning that funds can be recycled and continue to deliver benefits over the life of the JESSICA structure. Both the EIB and UDF managers may also leverage their own resources into urban development projects supported by JESSICA, which would further increase the economic impact of this policy.
DELIVERING VALUE FOR MONEY THROUGH THE SCOTTISH FUTURES TRUST
The rapid and deep reductions in capital budgets place an ever greater emphasis on making the right spending choices and ensuring maximum value for money from each pound that is spent.
The Scottish Futures Trust ( SFT) was established in 2008 with the central aim of helping the Government to achieve better value for money from public infrastructure investment in Scotland.
Role of the Scottish Futures Trust
The Scottish Futures Trust ( SFT) has a remit to enhance value for money for infrastructure investment in Scotland. The importance of this work has grown given the speed and scale of planned reductions in Capital DEL budgets.
The SFT is active in all sectors and is delivering innovative new ways of working that will result in improved value for money, including:
- the hub initiative for community infrastructure;
- the National Housing Trust, releasing much needed affordable housing; and
- Tax Increment Financing, which will leverage significant additional investment for regeneration.
Building upon the £111 million of net savings and benefits identified during 2009-10, the SFT has undertaken two streams of work over autumn 2010 to ensure that the capital programme is delivering value for money and maximising its impact.
The first has been the identification of potential purchasing power gains as a result of changed economic conditions since the original cost estimates for planned projects were produced. This work identifies potential savings from reduced construction prices across a range of portfolios including Health, Justice and Education and has helped to refine final cost estimates for the capital DEL budget.
The SFT will continue to work with budget holders to investigate ways to deliver further savings in capital budgets over future years.
The SFT has also carried out a review of existing operational PFI/ PPP contracts to assess potential savings. This work has identified the potential to generate savings from changes to contract management, through a shared service approach. Work in this area to realise the identified savings will be taken forward over the next six months. The SFT will also continue with its work to ensure that NPD contracts deliver better value for money.
The role and contribution of the SFT were examined closely by the Independent Budget Review ( IBR) Panel. The IBR Panel commented that: "The Panel received views about ways to improve public sector procurement practice and enhance the impact of the capital programme. ... The Scottish Futures Trust was designed to address these points in relation to public infrastructure investment. The Panel strongly supports the purpose of such a body."
The IBR Panel made the following specific recommendations in relation to SFT:
- the Scottish Government should consider enhancing the role of SFT to allow it to lead improvements in capital procurement, with savings derived from better capital procurement recycled into additional capital investment;
- the Scottish Government should consider tasking SFT to assess and report upon the potential and practicality of all the available financing options to sustain capital spending at levels supportive of economic recovery and consistent with the Government's longer-term strategic objectives; and
- the Scottish Government should consider developing SFT into a centre of expertise in the ownership, management and disposal of public assets. This would operate as a source of independent advice for all public bodies and ensure value for the public purse.
The Scottish Government has welcomed these recommendations and will work with SFT to implement them. The box below sets out our response to the recommendations of the IBR Panel.
Scottish Futures Trust - Response to the Independent Budget Review
In future the need to deliver and improve value for money will not diminish. The role of the Scottish Futures Trust in this was recognised by the Independent Budget Review. The Scottish Futures Trust has considered the recommendations of the Independent Budget Review and is developing a work programme in a number of key areas. This includes:
- identifying a number of ways in which it can drive further value from effective asset management. By the end of 2010-11 the SFT will take forward a pilot project through the South East hub territory to assess ways to improve asset management and estate planning across public bodies at a community level. It will also develop proposals by the end of the year for the Scottish Government to deliver enhanced value from centrally-held land and property assets;
- taking forward a new, affordable pipeline of revenue financed investment worth up to
£2.5 billion, to be delivered through the Non-Profit Distributing ( NPD) model and implementing innovative financing solutions to deliver additional investment such as Tax Increment Financing and the National Housing Trust; and
- leading improvements in capital procurement through the SFT's centre of expertise role and in developing approaches to optimism bias and contingency management, budgeting and procurement suited to the current economic climate.
Public sector investment is critical to the Scottish Government's purpose of increasing sustainable economic growth and the unprecedented cuts in capital spend at the UK level could threaten the outlook for the Scottish economy. The Scottish Government has set out a clear strategy to mitigate these effects. In conjunction with the Scottish Futures Trust, we will ensure that we deliver value for money in our infrastructure investments and maximise their impact. We will also look to innovative financing methods to lever in additional funding for infrastructure investment. We will ensure that our investment is targeted on priorities, and we will develop a sustainable pipeline of revenue financed projects.