Where should the government spend to drive growth?

Where should the government spend capital to drive growth? In these cash-strapped days, this might seem to be a rather rhetorical question, but with consultants being appointed for £350m worth of design work on High Speed 2, there is evidence that the extra money that the government is finding is being converted straight into industry opportunities. 

Extra cash couldn’t come too soon. January saw the downgrading of economic forecasts and bond ratings for many European economies. Both the IMF and Standard & Poors cited the absence of credible growth strategies as a key reason for their decision to downgrade. With many economies contracting in the fourth quarter of 2011, there is good reason to question whether austerity alone is the right economic medicine.

While the publicly funded schemes will no doubt pass their own business-case criteria, on what basis should overall investment be prioritised? This is the billion pound question

With the Budget due in six weeks, George Osborne will find himself in the midst of a dilemma. On the one hand, below par growth has guaranteed that the 2016 election will be fought on an austerity platform, so consistency is important. On the other, some flexibility around fiscal rules for investment, accelerated deficit reduction and the lowest bond yields in a generation could encourage the government to target investment. No doubt the newspapers will be filled between now and March with claims from single interest groups for extra spending - for roads, schools, broadband - all of which could deliver significant national and local benefits. While all of these publicly funded schemes will no doubt pass their own business-case criteria, on what basis should overall investment be prioritised? This is the billion pound question.

The November 2011 re-issue of the National Infrastructure Plan includes 40 prioritised programmes and projects, backed by additional funding to the tune of £5bn. In all, the project pipeline, including non-infrastructure investment, is worth £350bn. Potential priority investments include rail investment, a new Thames Crossing, airport investment, and electricity generation and transmission. The bulk of the programme will be funded by private finance or regulated private utilities. The investment set out in the pipeline is vital for the long-term function and competitiveness of the economy, but what will be the impact on short to medium-term growth? 

Infrastructure spending is typically a long-term game. Often the benefits are secured long after the original project sponsors have disappeared. Spending on consultants in the design of High Speed 2 will benefit the construction industry now, but won’t contribute to the wider economy before the mid-2020s. This long-term vision needs to be balanced by short-term expediency - a Plan for Now, rather than a Plan B.

So back to the rhetorical question: if there was £1bn extra to spend, how should it be spent to maximise growth? The classic response is to invest in roads - spade-ready projects that tackle congestion typically deliver high levels of benefit and generate lots of jobs though construction. These are valuable investments, making the country more efficient and reducing waste. Ignoring the carbon agenda for now, will they generate new growth and jobs? The answer is possibly, but only if the projects affect parts of the country that have the capacity to grow.  

It will be fascinating to see how growth cities use new powers to drive their economic agenda

I have recently been working with Centre for Cities - a research group that specialises in understanding the forces that drive urban dynamism - identifying the cities that are likely to succeed in the new economy. Their recent report, Cities Outlook 2012 identifies a group of cities, including Cambridge, Aberdeen, Milton Keynes, Edinburgh and London, that benefit from a skills and innovation base well suited for the knowledge economy. These cities are characterised by a high number of business start-ups, and benefit from the agglomeration of skills, businesses and access to markets in a way that only cities can. They consistently demonstrate above-average growth and are potentially good bets for investors. The corollary is of course that other locations are doing less well - and investment will be required to protect and rebalance these local economies.

Selective investment into cities with growth potential, crucially on housing and social infrastructure to strengthen the local labour pool, is politically highly sensitive. With the implementation of the localism agenda, it will be fascinating to see how these rising stars use new powers to drive their growth agenda. Further investment, whether through direct spend, Local Enterprize Partnerships or Enterprise Zones, to support these places may be the best way to secure the optimum return on that elusive billion pounds.

Simon Rawlinson is head of strategic research & insight at EC Harris