George Osborne has two main objectives for government expenditure as chancellor: eliminate the deficit by cutting day to day spending and increase investment by prioritising capital spending.
As public expenditure has been reduced the chancellor has looked to the private sector to make up the shortfall. So far, this strategy has worked: 2010-14 saw cumulative growth in GDP of seven per cent, helped considerably by £40 billion growth in the private sector investment component of GDP over the same period, a rise of 16 per cent. This level of business investment was one of the strongest sources of growth the last parliament.
Infrastructure investment has led growth
What led to such a rise in private sector investment? Put simply, it was a successful strategy in infrastructure investment, manifested most strikingly in the UK’s low carbon sector. Our analysis of the December 2014 Infrastructure Plan showed that £174 billion, or 53 per cent, of the pipeline was in low carbon infrastructure: energy, transport and waste. Through a combination of carrots, in the form of the levy control framework (LCF), and sticks, in the form of the carbon floor price, the government enabled £42.1 billion (at 2012 prices) worth of investment in low carbon electricity generation between 2010 and 2014. In the context of the UK economy as a whole, investment in the renewables sector is equivalent to total growth in private sector investment over the last four years. Without it, we may not have seen any growth in business investment at all.
So, rumours ahead of the budget about cuts to the carbon floor price and the need to limit ‘run away’ renewable energy subsidies are as much a concern for the economy as a whole as the green economy. The Treasury, in its first Conservative budget for 19 years, looks to be in danger of letting its focus on the deficit trump its commitment to drive long term investment.
Cut high carbon sticks, but not low carbon carrots too
The biggest problem with the chancellor’s framing is that he’s signalling a reduction in both the carrots and the sticks. But they are intimately linked: if he extends the freeze on the carbon floor price to 2025, it would cut the cost of coal by about a third and increase the gap between fossil fuel powered electricity and renewables. This gap would have to be paid for by the LCF.
Currently, the LCF is set to rise to £7.6 billion by 2020 with 20 per cent headroom, taking the total available support DECC has to achieve its targets to just over £9 billion. If the Budget hints at cuts in the levy, or the allowed headroom, it would severely compromise the UK’s ability to deliver its carbon targets.
Put simply, George Osborne can’t reduce the carrots and sticks at the same time and achieve the same levels of investment in infrastructure he has seen in the past four years.
To provide certainty for the pipeline of projects in development, the chancellor actually needs to go beyond his current levy commitment, by announcing an extension of the LCF regime until 2030.
Support for renewables has been a success
The pressure from the Treasury to limit the LCF has arisen because support for renewable energy has been more popular and successful than anticipated. The higher levels of take up of rooftop solar and offshore wind farms, producing more electricity than anticipated, have used up the LCF pot quicker than planned. This is good news. It means the incentive framework has worked and less subsidy will be needed in the future.
There are other reasons to prioritise investment in low carbon energy. Unlike road or rail spending, where the government foots the whole bill, low carbon energy is able to lever in significant amounts of private capital. Similarly, roads and rail have limited potential for cost reduction, whereas support for renewables will inevitably fall over time. With favourable policy, utility scale solar is expected to be subsidy free by 2018, onshore wind is likely to reach that point in 2020, followed by rooftop solar in 2025.
Where’s the long term plan?
As the chancellor recently found with the £19 billion shortfall in Pensions Funds’ investment in infrastructure, anticipated under the PIP scheme , the government’s role in demonstrating and de-risking projects is a critical catalyst for private sector investment. He may have a similar problem if he continues with the plan to privatise the Green Investment Bank which currently levers in £3 private investment for every £1 of government capital committed.
The government’s capital investment is declining despite its stated intention to increase it, and low carbon policy is the closest thing we have to a long term investment plan. It has delivered a very valuable £42 billion worth of new investment over the past four years and is expected to deliver another £100 billion by 2020.
George Osborne can’t afford to take the growth of the UK’s low carbon industry for granted if he wants to increase investment across the economy. He can change the balance of incentives but insufficient carrots will endanger the biggest driver of investment.
