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Sajid Javid: it’s time to tear up the old investment rules

4 January 2020

10:06 AM

4 January 2020

10:06 AM

The next Budget will signal some pretty big changes in the way government spending is distributed, with investment directed towards the parts of the country that have tended to be denied it. The shift in policy was first disclosed by the Prime Minister to James Forsyth and Katy Balls in an interview during the election campaign. The Treasury, he said, judged potential infrastructure projects in a way that always tended to point investment to London and the South East. ‘I take a different view. That this country is so underprovided for in brilliant infrastructure that you can make a good business case for many things.’ A few days later, Sajid Javid elaborated on this argument in an interview with me, only part of which was published in the magazine. Given that a pretty big shift in Tory thinking is under way, I thought I’d share some of the outtakes, for those interested.

When we met in Birmingham, I was asking him about the ‘new economic era’ he speaks about: it involves low borrowing rates, an assumption that has changed the calculus on government borrowing. This assumption transforms spending equations. With government able to borrow at 0.8 per cent and inflation higher at 1.5 per cent, then the real-terms interest rate is negative (ie, minus 0.7 per cent). Minus anything means that, in real terms, you’re being paid to borrow – and investors lose. But they’re happy with this, as long as they can be sure of getting their money back (and lending to a government offers this assurance).

‘The Treasury didn’t even have models that could compute negative yields because they’d never thought this would happen,’ he told me. ‘It just shows you how they weren’t set up for this’. Before he was Chancellor, he said, he’d lobby No11 to change its formula and do the sums using new assumptions. ‘I would be constantly challenging, saying: “Well, hold on. This is not right, I can knock up a spreadsheet in five minutes and work out a lot of it for myself!” But now I have the privilege of being in charge of the Treasury, we’ve already started making changes to models. To allow for what is, I think, a unique situation in terms of government investment.’

He’s been following the global debate about low interest rates, and thinks it a long-term trend (a recent paper by Harvard’s Paul Schmelzing, published by the Bank of England, suggests interest rates have been on long-term decline since the Medici). That rates will stay low for the 2020s is a safe assumption, he thinks. And this trend has pretty big implications for government finance.

As a former financier, Javid used to assess such investment projects. Whether or not to proceed with an investment depended on a simple equation: whether the return on investment would be (safely) greater than the cost of borrowing for that investment. If so, it meant a green light for the project. If not, a red light. Applying that formula now to UK government investment would see a flood of green lights.

In the last decade, Javid said, the Treasury had wrongly assumed that negative yields were a freak, that the cost of borrowing would shoot back up. This meant government was too risk-averse, so invested in places it thought the return was safest and highest: London and the South East. But now that the government expects to borrow at rock-bottom rates for the rest of the decade – an assertion backed by most market analysts – this now green-lights lots of other projects in the (for example) the north of England that would have been dismissed as too risky under the old assumptions.

‘In the past, the Treasury or government models have understandably looked for the highest return,’ he said. ‘And a lot of that pushed you towards London and the South East – the number of people living there, the amount of economic activity and so forth.’  Tweak the formula, he said, and all of a sudden this makes the case for investment in parts of Britain that have previously been denied it. ‘You’re not looking for those high-level returns that you looked for in the past that you got from the South East. But you can look throughout the country, and we can make many more investments’.

He spoke of  Northern Powerhouse Rail as an example. ‘We’ve already said that we will invest in the Manchester to Leeds connection. What we’re missing in infrastructure transport connections in our country is that everything’s well connected to London, but not cross-country.’ Then, telecoms. ‘Fibre-optic investment is another good example, with the 20 per cent roughly that the market won’t do, because it’s uneconomic for the market itself. We can invest a lot more quickly early on in connecting that 20 per cent.’

When we met, Javid had plenty of examples because he had been planning them for his first Budget. A whole bunch of investments would now offer a positive return to the government, because the cost of borrowing is so low. The Budget was delayed, due to the general madness, but the ideas instead poured into the 2019 Tory manifesto.

The Daily Mail article that inspired the Beatles song

One of them was ‘the biggest ever pothole-filling programme’ intended to address a longstanding British gripe. Complaining about bumps in the road (especially in the north) has been a feature of British life for decades. A Beatles song, A Day In The Life, famously refers to a newspaper report detailing 4,000 holes in a road in Blackburn, Lancashire. The time has come, Javid says, to fill them all in.

‘In our manifesto, we said we’re going to spend £2 billion on filling all the potholes. Now, I remember someone saying to me a few days ago: “Oh, potholes – you politicians are always on about potholes”. But considering the damage they do to vehicles, slowing down delivery trucks and so forth, repairing potholes offers one the highest [financial] returns that a government can make.’ In the past, he says, the approach has been piecemeal: setting aside a chunk of money to fill some holes, and stopping when the cash runs out. ‘I just said to the team, “Why shouldn’t we do all those potholes at once? Why are we waiting two or three years? If we can borrow and invest in this now, and it brings such a great economic return, why aren’t we doing this right now? Let’s do it”.’

The government, he told me, will also double the sums put into research and development and has been inspired by the Pentagon’s Advanced Research Projects Agency, or ARPA. At the time, I didn’t see the significance of his ARPA reference and left it out of the interview. I later found out from James Forsyth that ARPA is all the rage, and the idea of setting up a British version is mentioned quite a lot in No10. Dominic Cummings is so keen on it that he has been using the phrase ‘get Brexit done, then get ARPA done’. Set up in 1958, ARPA is still inspiring hits now: driverless cars caught the public imagination in 2005 when a Stanford driverless car crossed 132 miles of desert and won a $2 million ARPA prize.

When we met, Javid spoke of a US-style tech laboratory being created here. ‘The US has ARPA, which looks at the major breakthroughs in technology. The British private sector is just so great at research and innovation, I think we can partner much better, look at breakthrough technologies. And it’s something that will bring a big economic return.’

Another Budget proposal that ended up in the Tory manifesto was £2 billion spent in upgrading the estate of further education colleges (as opposed to universities). ‘I’ve long felt that under successive governments our FE colleges in particular have not benefited from the same level of investment that we’ve seen in universities and other education institutions. Some FE colleges are very dated, the original investment took place 30 or 40 years ago. There’s a lot more that can be achieved by investing in the equipment, the buildings itself. Evidence shows that even if you make FE education colleges more attractive places to go to, more people will choose them versus something else. And so that is all part of the capital investment we can make as well.’

The overall theme is one of borrowing-and-spending – but with limits (that the debt/gdp ratio is lower, at the end of this parliament, than it is now). This allows for more spending now, and if rates will be ‘low for long’ then a whole load of new investments suddenly become doable – especially in the parts of the country that gave the Tories their majority, the parts that Michael Gove describes as ‘overlooked and undervalued’. The north of England, yes, but also Wales and Cornwall – and perhaps even my neck of the woods, the Scottish Highlands. It will look a bit rum if the places that benefit from these new rules tend to be the ones which the biggest pro-Tory swings.

Javid didn’t mention Brexit in any of this, but it’s pretty clear how the government sees it all as linked. In the view of both No10 and No11, the vote for Brexit was about far more than membership of the European Union. It was about how politics was conducted, who the country was being run for and whether governments should be following formula that directed investments into the richest parts of the country, in pursuit of the highest returns. The message of Javid’s next Budget will be that the repair work starts now.

 


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