Resuscitating construction: Alternative medicine

For anyone who felt reassured by the positive data from purchasing managers last week, which found construction output growing in April, the front page of the Financial Times last Thursday will have brought them back down to earth: a slump in project finance is putting the government’s infrastructure push at increasing risk of failure.

This slump, which is hitting the financing of major infrastructure projects, with just £1.4bn being agreed in the UK so far this year, is just one of the reasons why a contraction of 3% was recorded in the sector in the first quarter of the year, pushing the country into recession. Last week Building began its analysis of the government’s prescription for revitalising the construction sector with a look at what it is getting so wrong. While chancellor George Osborne’s austerity policies have had a negative impact, the analysis showed that a reliance on both slow-burn infrastructure and private sector funding, in a climate where the private sector is hugely risk-averse, were also to blame.

This week we look at an issue that is much more important to the industry: namely what can be done instead. Undoubtedly the government is in a difficult position.
Pumping more money into construction could produce temporary growth, but the eurozone crisis shows very clearly how serious it could be if the UK’s deficit reduction strategy lost credibility. So what are the government’s options?

Public spending

While launching a New Labour-style fiscal stimulus is generally agreed (not least by Labour) to be off the agenda, it is possible for the government to re-examine its programme to prioritise spend that could help construction in the short or medium term. The government’s focus for what capital spending remains is infrastructure, despite the length of time this takes to come to fruition. Noble Francis, economics director at the Construction Products Association, says Osborne should consider bringing forward spending on repairs and maintenance, planned to take place across the parliament, to this year and 2013. Investment in either the housing sector or repairs and maintenance work is generally agreed to be the quickest to flow down from Treasury coffers into the pockets of builders.

According to the UK Contractors Group, “early and visible wins” on the 40 “priority” infrastructure schemes identified by the government, could also make a huge difference in restoring confidence to contractors hit by falling order books.

Others are calling for further reallocation of revenue spending on day-to-day services - which, at £664bn in 2012/3, is the vast majority of government spending - to capital spending. If 5% of revenue spending were allocated to capital investment, it would boost capital spend by more than 70%. Ken Gillespie, group managing director of construction at Galliford Try, says: “We need more capital investment. Where to do this is in switching op-ex [operating expenditure or revenue funding] to cap-ex. Cap-ex promotes growth in the economy, and construction improves society, the environment and gets young people back into work. Osborne has absolutely not switched enough spend yet.”

Quicker decision-making (PFI and education)

The coalition could be quicker about making the key decisions on the future of spending programmes which are still in doubt, and potentially vital policy areas, such as the Tax Increment Financing, on which more detail is urgently needed. The two most important of these areas are education and the private finance initiative (PFI).
The replacement to Labour’s £55bn Building Schools for the Future programme, the £2bn Priority Schools Programme, is still on hold, despite education secretary Michael Gove “launching” it in July last year, with all bids being reviewed.

A significant change in government spending is bound to have an effect. While the private sector is moving, it is not yet taking up the slack

Graham Shennan, Morgan Sindall

On PFI, Treasury financial secretary Lord Sassoon issued a call for evidence on how to reform it on 1 December last year following months of critical comments by government ministers. The Treasury is refusing to say when the results of that call for evidence will be published, and when anything approaching a replacement for PFI is likely to be outlined.

According to data from Dealogic, the value of contracts signed this year is 85% down on the same point in 2011. Reform may mean the government has to take more of the re-financing risk on PFI schemes, given the problems in the financial markets (see below), but that could also generate more income for the government. Indeed, part of the required reforms - ensuring that windfalls generated by re-financing schemes don’t fall in the lap of private companies - have already been tackled, but PFI nevertheless remains effectively off the table for public procurers because it is still seen as out of favour. Stephen Beechey, head of education at Wates, said: “There will be continued delays, but we need to push on to a decision on PFI. The more time we continue to navel gaze, the more delays there’ll be and we can’t get the economy moving.”

Intervention in funding markets

The government’s reliance on private finance to fill the public funding gap is a huge problem, both because of the squeeze on bank lending to small businesses, and the stalling of the large-scale project finance market. However, if the government can’t step in and pay for construction directly, there’s no reason it can’t agree to take more of the financial risk of projects. Richard Threlfall, head of infrastructure at KPMG, says: “The government needs to increase the flow of commissioning through the private sector, by creating structures which generate private finance. The government’s triple A credit rating is potentially very powerful here - it can underwrite some of the risk of projects, enabling banks to fund them.”

Quantitative easing in housing

The Bank of England has spent £375bn in the last four years on “quantitative easing” - propping up the economy by buying bonds from private banks, thereby helping their balance sheets to encourage them to lend. But despite this help, the continuing pressures on banks means that lending to small businesses - such as regional housebuilders - is once again in decline, down 6% last year.

Instead, the Bank of England could use the same programme to buy up bonds in a company set up to build homes. This non-profit housing agency, working through existing housebuilders and housing associations, could invest the Bank of England’s money directly in the economy, rather than propping up the balance sheets of ailing banks.

A housing agency would generate employment, stimulate the economy quickly, and help tackle the UK’s housing crisis. The CPA’s Francis says: “It’s patently obvious bank lending isn’t working. If the Bank of England wants to do more QE it needs to bypass the financial institutions and put the money directly into the economy.”

Green Deal

The government estimates that the Green Deal, its flagship environmental policy designed to deliver thousands of eco-upgrades to existing homes, can create 65,000 jobs. However, the policy, due to be launched this autumn, looks like being at high risk of failing because of the lack of evidence that home owners will feel sufficiently impressed by the scheme to take part.

Ensuring the immediate success of the Green Deal would give the construction sector - particularly SME builders - a huge boost. The government has already committed to a £200m package of incentives designed to try and drive uptake, but it has rowed back on any element of compulsion on home owners.

Francis says the government could incentivise greater take-up without spending money, through changes to stamp duty. Reducing the rate of duty on homes that are more energy efficient would cost the Treasury very little immediately, but send a strong signal to home owners that they are making their houses more valuable by undertaking the work.