Importance of Infrastructure Investment in the UK

Importance of Infrastructure Investment in the UK Acknowledgements In 1999, I completed the 1st year of the full-time Quantity Surveying course at Glasgow Caledonian University before moving to America in 2001. After a five-year stay, I returned to Glasgow in September 2006 and re-enrolled in the Part-time Quantity Surveying course. Ten years on from the first experience of the QS course, it gives me great pleasure and pride to be submitting one of the last pieces of work in the honours year. It has been an amazing and unexpected journey. I would not be in this position if it were not for the incredible levels of support and encouragement shown by so many and would like to take this opportunity to acknowledge some of these people. First, I would like to thank Raymond McCafferty Michael Heggarty of Cruden Building Renewals for employing me and giving me this opportunity. Their continued support and encouragement throughout this process has given me the focus and drive to continually improve my work. My colleagues at Cruden also deserve a special mention for their support during the dissertation and without the laughs during the day; this process would have been so much more difficult. Thanks guys!!! I would also like to thank Halbert Mills at Glasgow Caledonian University for accepting me back into the course and believing that I had the potential to get to this stage. During the course of this dissertation, I had some challenging times when I felt like I did not know how to develop my chosen topic. I would like to give my sincere thanks to my supervisor, Dr. John Lowe, for his inspirational input when I had these difficulties. Unfortunately, I cannot name everyone but I want to thank all my friends and family who without their support I would never have completed this piece of work. Mum, Dad, Gran, thank you so much for everything. Finally, the love and support shown by my Wife, Brooke, during this process has been a major source of inspiration. We will both be glad when the late night studying and completing of projects is finally over. Peter McLellan 1. Chapter 1 Introduction 1.1 Rationale for the Study Infrastructure forms the economic backbone of the UK. It is the fabric that defines us as a modern industrialised nation. The standard and resilience of infrastructure in the UK has a direct relationship to the growth and competitiveness of our economy. (Skinner, 2010) For the UK to retain its competitive edge, a longer-term view of investment in infrastructure must lead policy making. (Stewart, 2009) This dissertation offers an opportunity to explore and research a highly topical issue. The United Kingdom finds itself still in the midst of one of the worst economic downturns in recent memory and in a period of fiscal consolidation. As a result of this depressed economic situation, difficult decisions have had to be made by all sectors within the UK to work together to drive the country out of the recession. The recent edition of the Economic and fiscal Strategy Report and Financial Statement and budget by the Chancellor of the Exchequer, highlights the importance of implementing measures that will promote sustainable growth. Despite modest growths to GDP of 0.4 per cent in the final quarter in 2009 (NSO, 2010), the general consensus is that the United Kingdom is in the early stages of recovery. The 2010 budget, called Securing the recovery, outlines ways in which it aims to support this vision. One of these policies, is to invest in infrastructure, including additional funding for transport and local roads and creating a Green Investment bank. (UK Budget, 2010) Also, the Eddington Report, published on 1 Dec 2006, was a study jointly commissioned by the Secretary of State for Transport and the Chancellor of the Exchequer. Its role was to analyse the long-term relationships, within the boundaries of the Governments wider commitment to sustainable development, between transport and the UKs growth, stability and economic productivity. The findings of this study will be discussed and compared to the investment required to meet the future demands of the UK. Furthermore, in a recent study carried out by the British Chambers of Commerce (BCC), it revealed that inadequate energy, transport, and communications infrastructure continues to reduce the opportunity for UK businesses to grow. It also outlines that during this period when businesses play a vital role in the recovery of the economy, productivity is being affected as a result of lack of capacity, thus restricting the UKs economic potential. (BCC survey, 2010) In response to the survey carried out in 2010, David Frost, the Director general of the BCC stated the following: A countrys infrastructure is crucial to the success of its businesses. In the current environment of economic uncertainty and public spending constraints, our energy, digital, and transport networks must be up to the job if business is to deliver growth and create employment. The intriguing situation that the UK Government now face is deciding the best way to stimulate economic growth without increasing the deficit. One of the issues with increasing deficits is the Government will have to borrow to service the debt. As a result of the world-banking crisis over the last few years, there is reluctance to increase the UK debt further and therefore this might have an impact on infrastructure investment in this country. This dissertation provides an opportunity to research the level of infrastructure required in the UK and review the part it plays to the long-term sustainable growth of the UK economy. Furthermore, in doing so, the author intends to see if further investment in Infrastructure works is viable in the current economic climate. 1.2 Aim The aim of this dissertation is to assess the importance of infrastructure investment in the United Kingdom and how this impacts on the long-term sustainable growth of the UK Economy given the current economic constraints. 1.3 Objectives To review Fiscal and Monetary policy theories available to the UK Government. To review the current and future demands for infrastructure works in the UK. To understand the level of importance of infrastructure work investment to the UK economy. To understand the roles, responsibilities and options available to public and private bodies in raising capital to invest in infrastructure works in the UK. To highlight the economic and social benefits gained as a result of increased investment in chosen infrastructure sectors by utilising hypothetical cost model projections. 1.4 Outline Methodology of the Research 1.5 Dissertation Contents Chapter 2 Provides an extensive Literature review on the topic area. The author will provide a general overview of economic theory, introduction to infrastructure, and a review of the relevant studies published worldwide that reveal intellectual thoughts on infrastructure investment impact on the economy. This will be carried out in the way of both descriptive and an analytical approach to all the appropriate literature sourced to aid in this dissertation. Naoum (2007) states It is descriptive in that it describes the work of previous writers and it is analytical in that it critically analyses the contribution of others with a view of identifying similarities and contradictions made by previous writers. According to Naoum (2007), the literature review will serve two purposes. First, it allows for gathering of information to allow development of issues and themes within the chosen topic that ultimately shape the research design. Second, the literature review will help form the basis of the research design by analysing previous research designs. Chapter 3 Chapter 3 introduces the reader to the numerous research techniques available to the author and will highlight the strengths and weaknesses of each and merits of each approach, before indicating the chosen methods of quantitative analysis technique Chapter 3 examines the various research techniques that were available to the author and describes the strengths and weaknesses of each of the approaches in respect to the available data. In particular this chapter presents the reasoning behind the authors decision to adopt the quantitative analysis technique and explains how this approach was applied. This chapter also describes the source of the data and highlights any potential bias or limitations that the author experienced within the analysis. Furthermore this chapter explicitly explains the process for selecting and categorising the appropriate data prior to analysis in a consistent manner. John Hannah paragraph Chapter 4 Chapter 4 builds upon the process described in the previous chapter and examines the primary source of data to assess what trends are evident with each of the particular categories. This section goes on to expand upon the original quantitative analysis and examine a series of quantitative case studies to assess the extent of early warning events and compensation events that occurred on completed projects. John Hannah paragraph Chapter 5 In conclusion, chapter 5 summarises the findings of this research and consider if the original aim and objectives have been achieved. Finally, this chapter discusses the authors findings and proposes a list of recommendations for future studies. John Hannah paragraph 2. Chapter Literature Review 2.1 Introduction The purpose of research is to make a contribution, however small, towards understanding the phenomenon being studied and ultimately towards the total body of knowledge (Parahoo, 2006) The intended purpose of the following literature review is to provide a general background to the chosen topic that will aid in the understanding of the following areas: How the UK Economy functions and what factors drive it. Description analysis of previous research on the impact of infrastructure investment on the economy. The role the construction industry plays in the UK Economy. The information presented within the literature review will enhance the readers knowledge of the topic with a view of providing clarity and understanding on the findings presented in chapter 4. Economic Theories There are conflicts of opinion on economic theory. For instance, monetarists argue that rises in the money supply cause inflation whereas Keynesians argue that it is changes in inflation which cause changes in the money supply (Stanlake Grant, 1995) Keynesian Economics John Maynard Keynes was a British economist whose ideas have been a central influence on modern macroeconomics, both in theory and practice. He advocated interventionist government policy, by which governments would use fiscal and monetary measures to mitigate the adverse effects of business cycles, economic recessions, and depressions. His ideas are the basis for the school of thought known as Keynesian economics. Keynes solution to poor economic state is to introduce impetus spending or as the US President Franklin Roosevelt described, prime the pump. Keynes argues that the government should step in to increase spending, either by increasing the money supply or by actually buying things on the market itself. A supporter of Keynesian economics believes it is the governments job to smooth out the bumps in business cycles. Intervention would come in the form of government spending and tax breaks in order to stimulate the economy, and government spending cuts and tax hikes in good times, in order to curb inflation. Alternative Economic Theories Since Keynesian economics advocates for the public sector to step in to assist the economy generally, it is a significant departure from popular economic thought, which preceded it â‚ ¬Ã¢â‚¬  laissez-fair capitalism. Laissez-fair capitalism supported the exclusion of the public sector in the market. A number of laissez faire consequences are drawn from Says law. Say also advocated public works to remedy unemployment. Say argued against claims that business was suffering because people did not have enough money and more money should be printed. Say argued that the power to purchase could be increased only by more production and is also best known for coining the phrase supply creates its own demand (Curwen, 1997) James Mill used Says Law against those who sought to give economy a boost via unproductive consumption. Consumption destroys wealth, in contrast to production which is the source of economic growth. The demand for the product determines the price of the product, but not if it will be consumed. Alternatively, Keynes is an advocate of trying to stimulate consumption by government intervention. Views on Economic thoeries Cutting support now, as some are demanding, would run the real risk of choking off the recovery even before it started, and prolonging the global downturn. (Darling, 2009) If consumers, markets and businesses get the message that government wants to carry on spending and isnt serious about dealing with the deficit, they will start to conclude that the UK is no longer a safe place to invest in, spend in or build a business in, (Cameron, 2009) Importance of Construction industry to UK Economy A recent survey commissed by the UK Contractors Group and carried out by LEK Consulting to demonstrate the impacts of the Construction industry on the UK Economy was distributed September 2009. The main aim of this report was to specifically highlight the benefits of investing in construction. The report covered 3 main areas: Contribution of the construction industry at national and regional level. Key contribution that construction makes to national employent levels. The role that the construction industry plays in the broader economic and social objectives. The reports contention is that the construction industry is vital to the overall UK economy while still being in a recession as it provides the following: Construction is a major contributor to the UK DGP. Construction sector employs circa  £3m people throughout 300,000 firms. Construction is also an important driver for other sectors, without which there would be a loss of domestic production capacity and skills. The report, Construction in the UK economy: The Benefits of Investment, shows that construction is the best sector for stimulating employment. It also shows that every  £1 spent on construction leads to an increase in GDP of  £2.84, as the spending not only creates construction output worth  £1, but also stimulates growth elsewhere in the economy worth  £1.84. With the Chancellors Pre-Budget Report looming, the CBI is continuing to press the case for protecting capital spending by government. (John Cridland, CBI Deputy-Director General, 2009) A strong economy needs fit-for-purpose schools and hospitals, and it will be the construction industry that builds the new transport and energy infrastructure needed to shift to a low-carbon economy. (John Cridland, CBI Deputy-Director General, 2009) Introduction to Infrastructure Works Infrastructure investment impact: Previous Research Over the last 30 years there have been various economic models developed to help in the research of the impact of infrastructure investment on the economy. The in-depth empirical studies have mainly utilised macro-economic level data, which includes cross-state and cross-country data. (Straub, 2007) edinburgh paper According to the studies carried out by Aschauer (1989) he states that when analysing the importance of public investment to the productivity improvement and economic growth, added weight must be attributed to the public investment decisions made by the Government. Furthermore, the study indicates increased productivity and growth in the economy by investing in areas such as highways, sewers, streets, and water systems. To ascertain these findings, Aschauer took the average annual growth rates of total factor productivity and the non-military public capital stock in America over the period 1950-1985; Aschauers data indicated a close relationship between level of investment in non-military infrastructure and productivity. Put in Tables from study Further research in the United States carried out by Munnell (1990) analysed the impact of the stock of public capital on economic activity at the regional and state levels. In conclusion, Munnell found that the US states that had invested in infrastructure had greater output, increased levels of private investment, and high levels of employment growth. The study highlighted above, Aschuer (1989) estimated an elasticity of output with respect to public infrastructure capital in the United States during 1950-1985 of between 0.38 and 0.56. These results have been shown to be econometrically suspect and subsequent work suggests the elasticity is much smaller. The average elasticity across OECD countries for the period 1960-2001 has recently been estimated to be 0.2 (Kanps, 2004). Aschauers paper has, however, proved very fruitful in terms of subsequent research, which it stimulated. (Crafts Leunig, 2005) A number of empirical studies have looked at the relationship between all public infrastructure investment and GDP growth. On average these studies seem to indicate a positive elasticity of output to public capital of around 0.20. Put another way, a ten per cent increase in public capital stock increases GDP by around 2 per cent. (Eddington report 2006) The eddington report suggest that there are limitations to these empirical studies and the results should be viewed with caution. OECD (2003) argues that early empirical work on the link between infrastructure investment and economic performance overstated the magnitude of the impact on GDP and productivity growth (The sources of economic growth in OECD countries, OECD, 2003) In particular, studies that focus on public investment in capital and infrastructure in a broad sense, rather than on transport specifically, do not really distinguish between types of investment in terms of new build, upgrade, maintenance etc although some do make specific conclusions about the value of transport infrastructure investment. Later studies using more complex modelling suggest a positive, albeit weaker relationships between infrastructure and GDP. These include: Kocherlakota and Yi (1997), Demetiades and mamuneas (2002), OFallon (2003), and Nijkamp and Poot (2004). (see figure 1.5 eddington report 2006) In 1993, Easterly and Robero carried out further research to expand on the work in this field. Called Fiscal Policy and Economic Growth: An Empirical Investigation, it details several conclusions that support the findings expressed by Aschauers research in 1989. It tackled areas such as the rate of growth and the level of development by employing historical data and recent cross-section data. The main findings outlined that there is a strong relationship between a countries fiscal structure and the development level and that investment levels in communication and transport is consistently correlated with growth. This therefore indicates that infrastructures are important in the economic prosperity of a nation (Easterly, Robelo 1993). Put in reference Eisner (1991) highlighted that public infrastructures not only serve as an intermediate good in physical goods production, they can also be final consumption goods. For example, water and sewage systems benefit environment, better transportation saves time spent on travelling, public parks give people pleasure, etc. Canning, Fay, and Perotti (1994) found substantial effects of physical infrastructure on economic growth based on the international data set. The strategy for national infrastructure also states, The majority of empirical research indicates that there is positive relationship between infrastructure and economic growth (strategy for national infrastructure, 2010). Introduction to Infrastructure What is Infrastructure? Set-up in December 2009 to help meet the infrastructure requirements in the UK for the next 10-20 years, Infrastructure UK defines Infrastructure as key economic sectors which include: Water, Waste, Energy, Transport and communications (strategy for national infrastructure, 2010). Infrastructure networks enable people, goods, energy, information, water, and waste to move efficiently around the UK and, in some cases, across its borders. The extent, capacity and quality of these networks has a direct bearing on the economy of the UK, the environment and the quality of life of everyone who lives in or visits the UK. Infrastructure Studies in the United Kingdom Extensive research carried out in the United Kingdom has indicated the level of infrastructure required for each sector and this can be cross-referenced with studies highlighted in the previous section. For example, the findings from the research carried out by Eisner, 1991 and Easterly, Robero 1993 indicated a relationship between transportation and its impact on the growth of the economy. The Eddington report was published on the 1st December 2006 and was carried out by Sir Rod Eddington under the instruction of the UK Government. The report is an examination of the impact transportation decisions will have on the UK environment and economy. The report analyses the current global economic demands and how our current transportation infrastructure must meet the demands of the 21st century. It states that with rising population and resultant greater demands on the country, higher levels of congestion and issue with reliability will have adverse effects on the economy if the correct infrastructure is not in place. It contends that by not having the required infrastructure in place it costs businesses more money while also effecting peoples social environment (Eddington Report, 2006). As well as utilising the Eisner, Easterly and Robero findings, the Eddington Report drew on research carried out in more recent times. The studies used in the development of the Eddington Report comprised: The historical significance of Transport for Economic growth and Productivity (Crafts Leunig, 2005), Step change transport improvements (Mann, 2006), and transport and labour market strategies (Gibbons Machin, 2006) Assessing transports contribution to the economy Transport can impact on the performance of the economy in a number of different ways: Transports impact on GDP Transport can impact on the economy and will ultimately impact on overall output. Gross domestic product (GDP) is currently the best measure of the size of the economy as it measures the total value of goods and services provided. Transport can have an impact on economic output (GDP) thorugh two channels: Firstly, transport can affect GDP though a number of inputs that are used, for example transport may increase employment either by allowing greater access to labour or stimulating the creation of new firms, which can increase the number of goods and services produced and lead to an increase in GDP. Secondly, transport can improve the efficiency with which firms use inputs, in other words transport can have an impact on productivity. For instance, a well functioning transport network can raise productivity by redusing journey times. Transport investment can impact on the drivers of productivity by encouraging prictae investment through raising its profitability; facilitating labour mobility and thereby increasing the returns in investment skills; and enabling effective competition even when economic activity is geographically dispersed. Identifying the impact of transport on productivity is important because improving productivity is a key to determinant of long-term growth and living standards. These effects can either have a one -off effect on the level of productivity or a sustained impact on the growth rate of productivity. Transport can impact on the growth rate of productivity by stimulating innovation through its impact on agglomeration economies, trade and foreign direct investment. In practice these dynamics are very difficult to measure, but are nevertheless extremely valuable, as they determine how quickly the economy grows and therefore the rate of growth in GDP. Transports role in supporting quality of life Critically though, GDP measures alone fail to capture the impacts of transport on the environment or its contribution to the wider well being of society. Transports impact on the environment, for example through carbon and other emissions, can increasingly lead to unsustainable growth, as well as impacting on peoples quality of life. Transport improvements that free up wasted travel time allow people to spend more time with friends and family, and enjoy more leisure activities. An economic welfare measurement would seek to measure such broader impacts of transport on society and the environment rather than just a pure GDP measure. These benefits to general well being are known as economic welfare, or welfare. The use of existing transport networks: What benefits do provide Erenburg (1994) finds that policy measures that make more efficient use of existing transport infrastructure through pricing mechanisms or other traffic management solutions can have a significant impact on growth (linking public capital to economic performance, Erenburg, 1994) Hulten and Schwab (1996) estimate that a 1 per cent increase in infrastructure effectiveness would have an impact on growth seven times larger than a 1 per cent increase in the rate of public infrastructure investment. (the public capital hypothesis: The case of Germany, Hulten and Schwab, 1996) OECD/ECMT (2001) paper on the benefits of transport concludes that wider economic benefits may be achieved more efficiently by introducing prices which correspond more closely to costs, or by reallocating existing infrastructure more efficiently between users, or by adopting other transport policies. (Assessing the benefits of transport, European Conference of Ministers of transport, OECD, 2001) Victoria transport policy institute (2003) argues that investment in alternative modes of transport and in management strategies to encourage more efficient use of existing road capacity tends to provide greater economic benefit than expanding existing highways to reduce congestion. The study also argues that the benefits of transport improvements are heavily dependant on local circumstances, in that they will only increase economic development where inadequate transport is a significant constraint on economic activity. EVIDENCE OF CONDITIONS NECESSARY FOR TRANSPORT TO IMPACT ON THE PERFORMANCE OF THE ECONOMY Caning and Fay (1993) assert that infrastructure should not be seen as a factor of production but as a condition for high growth. Kessides (1993) notes that infrastructure does not create economic potential; it only develops such potential where appropriate conditions exist, i.e. other inputs such as labour and capital are available to drive output growth. Indeed, lynde and Richmond (1993), Trinder (2002), and OFallon (2003) assert that public and private capital are complements; that physical infrastructure requires the existence of available productive private capital in order to realise economic growth potential, and that infrastructure investment can boost the productivity of such private capital. Infrastructure investment may also feed through to increased labour productivity. Canning and pedroni (1999), banister and berechman (2000), Trinder (2002) and OFallon (2003) highlight other important underlying conditions that will influence the impact of transport investment on the economy (SEE REFERENCES FIGURE 1.7 EDDINGTON REPORT) In summary, these include: Economic conditions, a stable macroeconomic policy climate, local market circumstances, agglomeration, and labour market conditions Investment conditions; available funds, timing and structure of investment, type of infrastructure investment, location of investment in terms of network structure and political and institutional conditions, decision making, planning, sources, and methods of finance, level of investment, supporting legal and organisational policies and processes, and method and governance of infrastructure delivery and provision. Funding and delivery mechanisms for UK national infrastructure The National Infrastructure is funded and delivered in a number of ways: Commercially driven, user-paid infrastructure e.g. unregulated airport and ports where it is for the developer to decide what and when infrastructure is built. Any developments is then paid for by consumers (but prices are not regulated because competition exists) Commercially driven, user paid but price-regulated infrastructure with a stronger role for Government. Regulated airports are an example. Government supports investment in additional capacity but this is a commercial decision for airport operator (and where prices are regulated to protect from monopoly power). The energy sector also largely follows this model but prices are set by the market or thorough Government intervention. Price regulated businesses where independent regulators play a stronger role in determining the level and nature of investment. For example, water, where the regulator has an input into the nature of the investment programme but infrastructure investment in funded by users. Price regulated business that is funded by the taxpayer and users e.g. Network Rail. This is a model where the business is funded both by users and taxpayers where the DfT have a central role in setting out the outputs it wants from the railways and the level of funding to achieve that. The regulator sets the efficiency targets and prices for the company. Publicly decided and publicly funded infrastructure e.g. roads. Government decides where they should go, when they should be built and pays for them. This may include some provate finance but ultimately government rather than users pay. Clearly Government enjoys much greater control over infrastructure, but only a small part of the overall picture. Infrastructure essential for supporting economic activity and growth Many key investment projects rely on private finance either as direct investment or through mechanisms such as PPPs. In the current economic climate the Uk faces stiff competition in securing investment from private investors and from within Government budgets. In this environment, there needs to be a clear vision from Government about the future and needs for infrastructure. This will be essential to persuade the provate sector to invest in the national infrastructure and, in particular, provaste sector investors need long-term certainty in order to judge whether to commit major funds. Chapter 3 This chapter gives a brief description of the methods used for collecting independent data and why they are relevant to the research objectives. Research Strategy Quantitative Quantitative research is objective in nature. It is defined as an inquiry into a social or human problem, based on testing a hypothesis or a theory composed of variables, measured with numbers, and analysed with statistical procedures, in order to determine whether the hypothesis or the theory hold true (Cresswell, 1994). This statement is expanded on further by Bouma and Atkinson (1995), who state Quantitative data is, therefore, not abstract, they are hard and reliable; they are measurements of tangible, countable,