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Closing the UK's infra gap

There is a broad consensus among all main political parties in the UK about the need to invest more in infrastructure. With fiscal pressures likely to constrain the government's ability to finance new projects, Michael Wilkins, managing director, and Aurélie Hariton-Fardad, director, infrastructure finance ratings, Standard & Poor’s Ratings Services, discuss how private investors could step in to fill the void.

As a result of inadequate investment since the crisis, we calculate that the UK’s current infrastructure investment deficit is at least £60 billion – and potentially as much as £200 billion, if countries with high levels of infrastructure, such as Switzerland, are used as a benchmark. Certainly, total investment in UK infrastructure has been trending down since the mid-1980s, dropping from 1 percent of GDP in 1980 to 0.6 percent in 2008, at the outset of the global financial crisis.

Roads have seen the most dramatic decline, with infrastructure-related construction output halving since the 1980s (see chart 1). Road congestion is a big problem in the UK, generating costs to the economy and the environment, as well as to the population's quality of life. For example, INRIX, a road traffic and driver services company, ranks the UK as one of the most congested countries among the major developed economies in Europe and North America. Research estimates that over the past year, the average UK driver has spent around 30 hours in traffic jams, with that figure rising to a staggering 84 hours – more than three days – in the London commuting area.

The “multiplier effect”

Yet the benefits of investment in the sector go beyond simply alleviating the problems associated with ageing or inadequate infrastructure. More investment in infrastructure will also speed up the country's economic recovery, mainly due to the impact of the “multiplier effect”. In short, infrastructure investment generates much more than the initial spend in terms of total economic output, over the long-term. Indeed, Standard & Poor’s Ratings Services estimate that each additional £1 the UK spends on infrastructure in one year (in real terms) will increase real GDP by £1.90 over a three-year period.

This is because infrastructure investment has considerable benefits over both the short and long-term. Infrastructure spending tends to first boost job creation in the construction industry. In addition, a construction company requires materials, goods, and services from other areas. This demand consequently has a positive effect on employment in these related sectors – there is a greater demand for the services of engineers and surveyors, for example.

As the total wage bill rises, people spend their additional income on consumer goods and services, creating, again, more jobs – an induced effect of infrastructure investment. Indeed, when taking these indirect and induced effects into account, we estimate that for each 1,000 jobs directly created in infrastructure construction, employment as a whole rises by approximately 3,000 jobs.

The benefits of infrastructure spending don't stop there. Over the longer term, improving infrastructure can enhance the private sector's productivity – by improving roads and reducing transport costs, for example. A comprehensive 2009 study conducted by OECD economists reports a positive impact of infrastructure spending on growth, based on historical data between 1960 and 2005. Specifically for the UK, the findings suggest that investment in roads, railways, and electricity generation infrastructure was associated with higher output levels over the study period.

This is particularly significant given that the UK is lagging behind the rest of the major G7 industrialised economies in terms of productivity of labour. For instance, one hour of work in the US was producing more than 40 percent more than one hour of work in the U.K. (see chart 2).

The private sector will play a bigger role

The benefits of infrastructure investment are conclusive. That said, the need for more investment in the UK prompts questions about how to finance it, especially at a time when government debt is rising.

In response, the UK government has developed a national infrastructure plan that lays out its ambitions in terms of new investment. This plan includes a pipeline of projects worth £383 billion, with most of the spending in the energy and transport sectors. The government expects to publicly fund only one-quarter of its infrastructure pipeline, however. Therefore securing significant private capital investments is essential.

As a result, we have seen a wide range of investors allocating significant funds to finance new projects, including sovereign wealth funds as well as infrastructure funds. Participants also include infrastructure companies such as utilities, airports, and water companies. In addition, with regulatory requirements restricting banks' long-term lending, non-traditional lenders, such as insurers and pension funds, are also poised to contribute a larger share to the pipeline. For example, as part of the “UK Insurance Growth Action Plan,” UK insurers have agreed to work alongside partners with the aim of delivering at least £25 billion of investment in UK infrastructure over the next five years.

However, securing the necessary private capital to breach the deficit requires transparency and a better understanding of potential risks. Indeed, a recent research report from S&P suggests that there are a large number of reasons for the failure of infrastructure projects over the last 20 years, with market exposure proving to be the biggest cause of default. With this in mind, S&P has redesigned its criteria for assessing project finance debt to increase transparency and comparability of projects.

While we expect real GDP to grow by 2 to 3 percent per year over the next few years, we believe higher infrastructure investments could lift growth further and bolster the UK's competitiveness. And given the UK's fiscal challenges, this couldn't come at a better time.