Scottish Spending Review 2011 and Draft Budget 2012-13

Chapter 4 Capital and Infrastructure

Infrastructure investment is critical to the Scottish Government's Purpose of increasing sustainable economic growth and to supporting a strong recovery. Investment in infrastructure brings both immediate benefits to our economy through supporting the construction sector and its supply chains, and long-term benefits by driving productivity, competitiveness and economic growth.

The Spending Review includes a commitment to prioritise capital spending during a challenging period for public finances, with unprecedented levels of cuts to public spending by the UK Government. We will also ensure maximum value for money from Scotland's public infrastructure investment. The Infrastructure Investment Plan will provide a longer-term horizon to complement the investment plans set out here, and will be updated this autumn.

International studies ^[1] show that infrastructure investment is an essential contributor to productivity and economic growth. The accumulation of capital increases the potential output of an economy. Public sector investment that contributes to the development of a country's physical, technological and electronic infrastructure can increase the productive capacity of the economy as a whole and drive private sector growth and investment. In the short term, this can provide a boost to economic activity and to employment, particularly in the construction sector.

Under the current funding arrangements for Scotland, the pace at which the Scottish Government can implement its infrastructure plans largely depends on the allocation of capital budgets from HM Treasury at each Spending Review. With greater fiscal responsibility, including the power to borrow to fund capital expenditure, the Scottish Government would have far greater freedom to determine the scale of capital spending.

As a result of the decisions taken by the UK Government in its 2010 Spending Review, the capital budgets available to the Scottish Government will fall by around 36 per cent in real terms by 2014-15 compared with 2010-11. This scale of reduction is unprecedented and will inevitably slow the pace of implementation of the Government's infrastructure programme.

The Scottish Government is doing all it can within our limited powers to maximise capital spend. However, we recognise that more needs to be done, which is why the Scottish Government is making the case for the UK Government to respond to the weakening economic outlook with a plan to protect the recovery.

PRIORITISING CAPITAL SPENDING

We are focused on the delivery of high quality and ambitious investment programmes and projects, despite the severe cuts in capital spending imposed by the UK Government. This will enable us to:

• make key strategic capital investments, including the Forth Replacement Crossing, the New South Glasgow Hospitals and the Scottish Schools for the Future programme; and
• support maintenance of assets in our key public services and encourage a collaborative approach to asset management across the public sector.

We are maximising the funding available for investment, including tapping into new, innovative sources of finance, leveraging in private and European funding and using borrowing powers where available. Key actions include:

• taking forward a new pipeline of revenue-financed investment worth £2.5 billion, to be delivered through the Non-Profit Distributing ( NPD) model, including major projects such as the package of improvements to the M8, the Aberdeen Western Peripheral Route and Balmedie project and the Royal Hospital for Sick Children in Edinburgh;
• maximising the use of Network Rail's Regulatory Asset Base ( RAB) to fund new rail projects including the Edinburgh Glasgow Improvements Programme ( EGIP);
• expanding the Tax Incremental Financing ( TIF) pilot programme, with three new pilots due to be selected in the coming weeks;
• launching a second wave of the National Housing Trust ( NHT) initiative, which leverages in private sector funding and council borrowing to support affordable housing;
• ensuring local authorities make maximum use of their borrowing powers within prudential limits, including to take forward TIF schemes and to support investment in housing;
• ensuring bodies such as registered social landlords and further education colleges, which have borrowing powers, are encouraged to use these, where appropriate, to support sustainable investment;
• ensuring Scottish Water continues to improve efficiency in delivering its £2.5 billion capital programme;
• preparing to make the first investments through the £50 million JESSICA Fund, managed by the European Investment Bank and jointly funded by EU and Scottish Government money;
• developing a new Cities Strategy that will support cities and their regions in attracting additional investment into priority projects;
• maximising receipts from asset sales and driving savings from improved asset management across the public sector;
• Using the Scottish Futures Trust ( SFT) to enhance value for money from capital investment, support the development of innovative financing methods and facilitate collaborative procurement and asset management across the public sector;
• Continuing to make the case with HM Treasury for early borrowing powers and access to the Fossil Fuel Levy worth almost £200 million;
• Switching over £200 million a year of our resource budget to fund additional capital investment.

USING EVERY POLICY LEVER TO EXPAND THE CAPITAL PROGRAMME

Given our concern about the effect of the rapid and deep reductions in capital spending flowing from decisions in the UK Government Spending Review and the implications that these will have for the pace of implementation of the capital programme and the strength of the Scottish economy, the Scottish Government will explore all possible means to support higher levels of infrastructure investment than would be possible through the capital budget alone. This effort will be particularly important to support recovery and sustainable economic growth, as capital budgets are likely to remain low for several years.

In general, funding infrastructure investment through public capital ensures the lowest cost of finance for a typical project. ^[2] Under the current public finance framework, the Scottish Government does not have the flexibility to borrow to fund additional capital expenditure. There is an overwhelming economic and financial case for providing this flexibility to borrow as soon as possible, and we continue to make the case with UK Ministers for early access to borrowing.

In the absence of borrowing and other financial powers, we are using all the resources at our disposal to help expand Scotland's public infrastructure programme. While ensuring these levers are used sustainably and responsibly, the Scottish Government, will work closely with the Scottish Futures Trust and local authorities to maximise their positive impact. The graph below ^[3] shows how these steps are enabling us to grow investment even as our capital DEL falls:

Figure 2: Capital Investment 2011-12 to 2014-15

REVENUE FINANCED INVESTMENT

Following Devolution in 1999, the then Scottish Executive supplemented the capital programme through the use of private finance - particularly through the Private Finance Initiative ( PFI). Over time a number of concerns ^[4] have arisen about the practical impact of the PFI model, including:

• the cost of financing;
• the scale of repayments - or unitary charge payments - from public authorities' revenue budgets over the life of contract, which is typically 25 to 30 years; and
• the potential for the private sector to make large 'windfall' profits from PFI deals, including as a result of refinancing existing contracts.

Since May 2007, based on value for money considerations, new revenue financed investments have been taken forward through the Non-Profit Distributing ( NPD) model. The NPD model seeks to transfer risk and exert private sector discipline both during the construction phase of a project and throughout its lifetime, but without the excessive profits to the private sector and financing costs to the public sector associated with past PFI projects. Key features of the NPD model are that:

• returns to the private sector are capped;
• NPD does not contain dividend-bearing equity; and
• surpluses from NPD projects can be directed in favour of the public sector.

As revenue budgets begin to recover in the medium term, there is an opportunity to use revenue finance effectively and judiciously. To ensure the future costs of revenue financed investments are sustainable, the Scottish Government will make investment decisions within a prudent and sustainable overall financial framework.

In addition to the pipeline of NPD investment, the Scottish Government will continue to make the case for greater financial responsibility for Scotland, including, at the earliest opportunity, the power to borrow to fund capital expenditure. With borrowing powers in place, the Scottish Government would be able to accelerate the pace of its infrastructure programme and undertake new investments in order to help strengthen sustainable economic growth and support vital public services.

INNOVATIVE FINANCING MECHANISMS TO SUPPORT INFRASTRUCTURE INVESTMENT

Within the existing budgetary framework, the Scottish Government, in conjunction with the Scottish Futures Trust, has looked at innovative financing solutions such as Tax Incremental Financing, the National Housing Trust and the JESSICA Fund which will help lever in additional funds to help take forward key infrastructure investment projects.

Tax Incremental Financing ( TIF) is a means of funding public sector infrastructure judged to be necessary to unlock regeneration and sustainable economic development in an area, and which may otherwise be unaffordable to local authorities.

The overarching goal of TIF is to support and guide the increasingly limited public finances by helping to lever in additional private sector capital. The TIF model allows initial borrowing through the Public Works Loan Board to fund the infrastructure to be repaid through predicted future non-domestic rate revenues resulting from the local authority's investment.

Scottish Ministers have brought forward secondary legislation under existing provisions of the Local Government Finance Act 1992 to enable up to six TIF pilot schemes.

Three proposals are already being developed. In March 2011, the Cabinet Secretary for Finance and Sustainable Growth approved the UK's first TIF scheme at Leith harbour in Edinburgh. Also in March 2011, provisional agreement was granted to North Lanarkshire Council to use TIF in the second phase of the regeneration of Ravenscraig (£73 million). The project has the potential to unlock an additional £425 million of private investment and create up to 4,500 new jobs - including 500 in the construction sector. Glasgow City Council is working with the Scottish Futures Trust to develop a TIF proposal for the Buchanan Quarter. A further round of TIF pilot projects will be announced in the coming weeks.

The Scottish Futures Trust and the Scottish Government have developed the National Housing Trust ( NHT) model which has won plaudits across the UK. The first phase of procurement is nearing completion and is looking to produce up to 700 new affordable rented homes, generating around £100 million of investment and supporting over 1,000 jobs. Plans are currently being developed with partners for further phases and new variants.

By moving from grant funding to borrowing on the back of future property sales, the NHT aims to deliver affordable homes in return for less public subsidy. Successful developers build the homes, which are then purchased by Special Purpose Vehicles ( SPVs). The SPVs are in turn jointly funded by local authorities and private partners. Participating local authorities' loans to fund these purchases will be backed by a guarantee from the Scottish Government that these loans will be repaid.

To participate in the scheme, developers or other private partners must commit to making homes available at mid-market levels of affordable rent for at least five and up to ten years before the homes can be sold. Tenants must be given the option to

purchase their home at market value before it can be sold on the open market. The NHT will not only enable local authorities to secure new affordable housing through low risk borrowing but it will also provide support for economic recovery by re-starting construction on stalled housing sites.

JESSICA funding can be used to support a range of urban regeneration projects, including new business space, wireless technology zones, green energy for social housing, renewal of derelict sites and more efficient transport schemes.

The JESSICA Fund in Scotland has been capitalised by £26 million of Scottish Government funding, matched with £24 million of European Structural Funds. The total £50 million fund is being managed by the European Investment Bank ( EIB), which will ensure that loans and equity investments made by the fund are made on commercial terms. These investments will be delivered to projects across Scotland through Urban Development Funds ( UDFs).

A key advantage of the JESSICA Fund approach is that it enables the Scottish Government to use EU Structural Funds as a source of repayable investment (loans and equity) rather than grants, meaning that funds can be recycled and continue to deliver benefits over the life of the JESSICA structure. Both the EIB and UDF managers may also leverage their own resources into urban development projects supported by JESSICA, which could further increase the economic impact of this policy.

MAXIMISING VALUE FOR MONEY FROM CAPITAL SPEND

The rapid and deep reductions in capital budgets place an ever greater emphasis on making the right spending choices and ensuring maximum value for money from each pound that is spent.

The Scottish Futures Trust ( SFT) was established in 2008 with the central aim of helping the Scottish Government achieve better value for money from public infrastructure investment in Scotland. The importance of this work has grown, given the speed and scale of planned reductions in capital DEL budgets.

SFT is active across the public sector and is delivering innovative new ways of working that will result in improved value for money, including:

• the hub initiative for community infrastructure;
• the National Housing Trust, releasing much needed affordable housing; and
• Tax Incremental Financing, which will lever significant additional investment for sustainable economic development and regeneration.

The Scottish Government is pursuing an integrated strategy for infrastructure investment, to support its Purpose of increasing sustainable economic growth. The key pillars of the strategy are:

• the National Planning Framework 2, which identifies key issues and drivers of economic change, sets out a vision to 2030, and identifies priorities and opportunities in spatial perspectives for each part of Scotland;
• the National Renewables Infrastructure Plan, a spatial framework for developing key sites of renewables activity situated in communities around Scotland, which proposes funding plans for developing these sites. This is supported by a £70 million National Renewables Infrastructure Fund to help leverage private sector investment to develop the infrastructure across the country to support offshore renewables and ensure that Scotland becomes Europe's green energy powerhouse;
• the Strategic Transport Projects Review, which defines the key strategic investments in Scotland's national transport network from 2012 onwards; and
• the Infrastructure Investment Plan, which identifies Scotland's requirements for infrastructure investment in key public services over the next decade.

The common aim of these plans is to enhance connectivity, support increasing sustainable economic growth and enable Scotland to make the transition to a successful and sustainable low carbon economy. Scotland's cities uniquely offer the potential to maximise the impact of our investments and, together with our cities, we are developing a Cities Strategy which will optimise investments across a range of portfolio responsibilities.

Asset management

Improving the management of assets across the public sector is crucial to maximising value for money from our capital spend. As announced in the Draft Budget 2010-11, the SFT has produced two reports on improving asset management across the public sector, one focused on the central civil estate, and one on the local civil estate. The local civil estate report identifies £130 million or more of potential savings over five years in the South East hub territory alone through more collaborative asset management by hub partners (local authorities, NHS Boards and police and fire & rescue authorities).

The updated Infrastructure Investment Plan, which will be published in autumn 2011, will highlight the range of activities taking place across the public sector to improve asset management and release savings. For example, the Scottish Government's Health Directorate is compiling a "state of the NHS estate" report that will benchmark asset management performance, identify good practice and set targets for improvement.

The Scottish Government will continue to drive savings through improved asset management and will:

• work with the Scottish Futures Trust and other key stakeholders to develop a Scotland-wide implementation programme for asset management activity and accelerate roll-out, based on the experience of the South East hub territory;
• take forward an Asset Management Strategy for the central estate to reduce the size of the estate by at least 25 per cent by 31 March 2016 and to achieve similar reductions in operating costs;
• work with NHSScotland to explore opportunities to improve the quality of patient services and maximise resources available for the front line by reducing running costs, expanding collaborative procurement, rationalising the estate and disposing of surplus assets;
• use the updated Infrastructure Investment Plan to highlight asset management opportunities in other key sectors, including transport (collaborative IT asset system procurement), justice (release of surplus assets created by police and fire reform and modern prison developments), and further and higher education (maintaining existing estates to ensure building life is maximised); and
• work with SFT to address barriers to effective asset management, including in relation to disposals, office accommodation, capacity of smaller bodies to manage assets and benchmarking of data.