The Outcome of the Targeted Review of the Capital Spending Review – Updated Spending Allocations for 2023-24 to 2025-26

Context

In February 2021, the Scottish Government published a five-year Capital Spending Review (CSR)^[1] alongside the Infrastructure Investment Plan 2021-22 to 2025-26 (IIP)^[2], with the aim of providing a strong and coherent framework for directing future commitments and giving confidence and certainty to sectors across Scotland following the impacts of COVID-19 and the UK's exit from the European Union.

These documents focused on three strategic themes for guiding investment decisions in Scotland:

• Enabling the transition to net zero emissions and environmental sustainability;
• Driving inclusive economic growth; and
• Building resilient and sustainable places and communities.

The Capital Spending Review of 2021 followed the important work of the independent Infrastructure Commission for Scotland in 2020 and was shaped and informed by a public consultation on the draft Infrastructure Investment Plan.

It was also published during the COVID-19 pandemic, designed to offer certainty and stability for industries, labourers and supply chain manufacturers who support Scotland's construction and building sectors. The Capital Spending Review and Infrastructure Investment Plan together signalled a commitment to maintaining existing infrastructure and to redoubling the Scottish Government's efforts to invest in infrastructure to support the transition to a net zero economy – with a dedicated Low Carbon Fund of £2 billion spread over the 5 years of the plan. This certainty and ambition has been preserved in this targeted review, reinforcing the steps this Government is taking to deliver the National Infrastructure Mission.

What was not certain, however, at the time of publication of the original Capital Spending Review was the level of funding Scotland would receive from the UK Government's own spending review. In February 2021, our expectations for future years' capital grant allocations were based on forecasts presented by the Office for Budget Responsibility. Our approach was prudent, based on the modelled central funding scenario set out in the Medium-Term Financial Strategy published in January 2021^[3] and recognised the risk that the allocations could reduce as well as increase compared to that scenario.

With this in mind, the use of capital borrowing in the Capital Spending Review was not maximised at the time of publication, leaving some headroom in later years, and a number of mitigation options (should allocations reduce in the future) were described. The Scottish Government has had to deploy some of these mitigating options as the UK Spending Review in October 2021 resulted in a decrease in the Scottish Government's capital grant of £752 million between 2022-23 and 2024-25, compared to the forecast, shown in Table 1 below.

These changes risk undermining Scotland's commitment to ensuring sufficient investment reaches our infrastructure priorities. In establishing the National Infrastructure Mission, we set out an analysis showing the benefits that investment in infrastructure could have for Scotland. The constrained investment trajectory Scotland has received from the UK Government, coupled with the current impact of high inflation, places significant additional pressure on our capital programme and will curtail efforts to reduce emissions and adapt to the changing climate.

Since publication new commitments, including a number to further address the global climate and nature emergencies, have also arisen from the Scottish National Party's election manifesto and the 2021 Programme for Government, as well as the associated Bute House Agreement signed with the Scottish Green Party in September 2021. In addition, those responsible for delivering and maintaining infrastructure projects have seen a rise in supply chain costs.

As economies reopened in the aftermath of COVID-19, significant inflation, coupled with shortages in the supply of particular construction materials was experienced. The crisis in Ukraine has considerably exacerbated these pressures on construction projects. Since early 2022, significant increases in energy prices are driving further price increases and leading to great uncertainty around delivery periods for certain construction materials, including steel and residential construction products. In addition, labour shortages driven by the UK's exit from the European Union are exacerbating the challenges to infrastructure delivery.

Construction prices have been particularly hard hit. The Office for National Statistics is tracking inflation on all new work at 8%, with housing tracking well above this at 10.9%^[4]. The UK Department for Business, Energy and Industrial Statistics material price index for 'All Work' increased by 21% in March 2022 compared to the same month the previous year^[5]. This has led to increased spending forecasts and cost pressures on major capital projects and programmes, with delays in several major projects. Scotland is not alone in this situation, surging demand for commodities and constrained supply has affected most countries worldwide.

While this review sets out some actions that the Scottish Government has been able to take, the scale of these issues requires action on the part of the UK Government. This action needs to be proportionate to reflect the considerable cost increases in levels of net investment and to take action in the wider economy at a time when it is desperately needed.

Given the significant changes described above, a targeted review of the Capital Spending Review was undertaken to ensure that the Scottish Government's key priorities are still being achieved within the reduced available capital allocations and in light of new commitments and market conditions. The process involved portfolios updating their spending forecasts for both existing Capital Spending Review commitments and new commitments, reflecting the inflation and supply chain impacts, whilst considering how best to prioritise the available budget for each portfolio to maximise outcomes.

There has also been an opportunity to consider the alignment between capital spending with budget planning decisions taken through the Resource Spending Review, which has focused on the four key themes of reducing child poverty, addressing the climate crisis, building a strong and resilient economy and helping our public services recover strongly from the pandemic.