Sorting out the public finances – Part 3 : Re-nationalisation, pensions and infrastructure

One of the funny things about democracies is how sometimes there can be a cross-party consensus amongst politicians that the public is wrong on a major issue and can be safely ignored by them, one and all. Opinion polls continue to show that 70% of the British public want to renationalise the privatised utilities – water, gas, electricity, railways. This is not a rejection of capitalism – they are clear that they don’t want to renationalise British Airways, Rolls-Royce, BP or Jaguar Land Rover. But they clearly feel that our national infrastructure should be under public ownership. And yet even Ed Milliband, the most overtly left-wing and populist Labour leader for thirty years, see such ideas as beyond the pale. This generation of politicians (and senior civil servants and journalists) has grown up accepting that the Thatcher settlement is inviolable – that to undo what she did would take us back to the 1970s. Even those who do argue for renationalisation seem to accept that it’s an unaffordable pipe dream. But what if the public is right? What if it’s time, after 30 years, to think again about nationalisation? Maybe each generation needs to think, pragmatically, about the right solution for its era, rather than fetishising the solution to the last one? And what if renationalisation is perfectly affordable and could actually improve the public finances?

In this political debate, we are often stuck in the narrative of thirty years ago. A Cold War narrative, in which domestic politics was just part of a black and white global struggle between Communism and Capitalism. And, as we know, Capitalism won. Like the fall of the Berlin Wall, the privatisation of our national infrastructure was an icon of this victory. Not only could even our drinking water be privatised, but millions of British people could buy shares for the first time as the privatisations made capitalism truly popular. And clearly, privatisation achieved a lot. £100 billion of investment into our water infrastructure. Being able to get a new telephone line when you wanted it, rather than going on a long waiting list. But thirty years later, it is worth revisiting this narrative – the world is no longer a black and white struggle. In a world of state capitalism and after the 2008 humiliation of the uber-liberal economists, are there are new types of nationalisation to offer the public?

Indeed, the “private sector” which owns much of our infrastructure is in fact often the public sector of other countries! For example, our largest water company, Thames Water, is owned by the governments of China and Abu Dhabi. Or look at the UK government’s recently agreed thirty-five year contract with the “private sector” to build a new nuclear power station in Somerset, guaranteeing a revenue of over £80 billion, with a minimum price for the power produced, set at roughly twice the current market price. Such contracts have been deemed necessary to secure private investment in long-term assets. There were two “private sector” investors in this deal – the French government (owner of EDF) and the Chinese government (owner of the two Chinese nuclear corporations). If the “private sector” is not a foreign Government (through a government owned company or sovereign wealth fund), then it is often a foreign public sector pension scheme. For example, London’s High Speed Railway to the Channel Tunnel is owned by two of Ontario Province’s public pension schemes. Globally, there is now some $50 billion of overseas public sector pension funds invested in infrastructure, mostly from North America but also from north European countries. The trend is growing – earlier this year, the world’s biggest pension fund, the Japanese Government Pension Investment Fund, allocated some of its giant £750 billion fund to a joint venture with the Ontario Municipal Employment Retirement Scheme to buy up Western infrastructure. However, these funds do not like to build new infrastructure – they look for mature assets in developed countries producing strong financial returns from low-risk assets. They often find these in the UK, which attracts a fifth of all global pension fund investment in infrastructure. Our regulators have become very good at ensuring that overseas investors get the low risks and strong returns that they desire. (But they have lost the confidence of the public. For example, polls suggest that less than one in five people now trust energy companies to act in the customer’s interest.)

For all the debate about nationalisation, it is worth noting that, in fact, much of our infrastructure is not privatised at all. Network Rail, which owns and operates England’s track, was officially reclassified last year as a part of the public sector, bringing to an end a long and unhappy period clinging by its finger tips to its private sector status. Scottish Water has never been privatised. Nor has Northern Ireland Water. The UK’s motorways are owned and operated by the Government, paid for by taxes, rather than charging tolls, like many countries in Europe. Many of our airports are still owned by local authorities, including Stansted, Manchester and Birmingham. Councils still own nearly 2m homes.

So, if this debate about nationalisation or not isn’t so black and white, what could a new narrative look like? After the Great Financial Crisis, perhaps we should think about all this in terms of national balance sheets. How can countries match their future liabilities (like future pension costs) with their assets (like owning water companies which produce predictable cash flows to cover those pension costs)? This is, in effect, what other countries are doing when they are buying our infrastructure assets and companies. They are anticipating future liabilities (e.g. pension costs for Canadian public servants or social costs in the Middle East when oil revenues dry up) and acquiring assets which can cover those liabilities. They are putting the resources on their balance sheet to productive use. If this makes sense for them, why aren’t we doing the same? Infrastructure is all about assets (creating investments like roads which fuel economic growth) and liabilities (like repairing railways when they wear out, or replacing power stations when they reach the end of their life). Given the UK consensus that we need to invest massively in our infrastructure, after decades of under-investment, we are in danger of seeing infrastructure merely as a lot of liabilities ( hundreds of billions needed for power, rail and roads). This comes on top of many other liabilities on the national balance sheet, not least the £900 billion of future public sector pension liabilities which are unfunded. Add these to the £1.5 trillion of national debt predicted for 2018 and the future, like that of much of the West, looks gloomy. It is pretty challenging. But if we think about the nation’s balance sheet in a more joined-up way (across the public and private sectors and across assets and liabilities), we can begin to see things differently and, potentially, more optimistically.

One way to do this would be to see if we can solve four problems with one solution. The first problem is that we need massive capital investors, with a long term commitment to improving the UK’s infrastructure. The second problem is that we need our public sector pensions to be properly funded. The third problem is that we need the owners of the UK’s infrastructure to be acceptable to the British public and trusted by them. The fourth problem is that Government sits on hundreds of billions of assets on its own balance sheet, doing nothing with them. In finding a single solution to these four problems, we have some strong starting points. We have a regulatory system for our utilities which is good at guaranteeing investors a predictable and healthy return on their investments. We have the examples of overseas public sector pension funds, paying premium prices to get a slice of the UK infrastructure market to match their future liabilities. We also have the examples of overseas governments putting the current wealth on their balance sheet to productive investment in the UK. These starting points suggest that one solution to the problems we face would be for UK public sector pension funds to own the UK’s infrastructure. When such pension funds own private sector companies, we see that as private ownership. For example, when the Local Government Pension Scheme currently buys a a stake in a company, we don’t see hysterical headlines saying that the company has been nationalised. The pension funds have capital to invest, they are subject to statutory requirements to maximise investment returns and they invest in companies with the best private sector management. But given that very little of the privatised utilities are owned by UK public sector pension funds and, even more problematically, most of the UK public sector pensions are unfunded (i.e. have no money at all), how could this solution possibly work?

Well, if we assume that the UK Government is willing to intervene with all its financial and statutory firepower, here are three illustrative examples of how UK national infrastructure could be owned by UK public sector pension funds. (I am not arguing for these solutions – I am just arguing that we should have an argument!):

1. Renationalise energy and water and return their ownership to local authorities – There is only one funded public sector pension scheme in the UK (assuming that we see universities as in the private sector). That is the Local Government Pension Scheme. This has assets of some £150 billion. Unlike the North American public pension schemes, it only has 1% invested in infrastructure. The LGPS is in effect paid for by taxpayers. 20% of the council payroll is paid into the pension scheme. Given increases in life expectancy, the liabilities of the scheme increase 10% every decade. The LGPS currently operates 99 local funds, all with expensive advisors and overheads. A first step would be merge these into one consolidated fund. A second step would be sell-off 75% of its current assets, releasing £110 billion of cash. This would be the war chest for the third step, which would be to purchase the currently privatised utilities in water and energy. £110 billion should be sufficient to buy the water companies, National Grid, the energy generators and the power network companies. The remaining wealth of the LGPS is available for future investment in new infrastructure. The companies bought by the LGPS continue to be privately-owned – in the same way as other companies owned in part or full by public sector pension funds. The companies would still be regulated and Government would still underwrite contracts for major new infrastructure, as it does now. The regulator (and Government) would have a duty, as now, to ensure that the companies can make an acceptable return for their shareholder, equivalent to what the LGPS would have earned on its current investments. But the public would know that the single shareholder in energy and water is now the LGPS. It is in the public’s interest for this shareholder to make a strong return. A strong return will reduce the pension deficit for local councils, which in turn will reduce the contribution required from the council tax. In effect, this makes all council tax payers shareholders in the nation’s energy and water companies. For those with a sense of history, this returns energy and water to their municipal origins.

2. Fund the Armed Forces Pension with public housing and land – The Armed Forces Pension is currently unfunded, but has future liabilities of £125 billion. Here’s a way to fund the scheme. The ownership of all council housing stock could be transferred to this new Fund, including outstanding debt. All of the 1.8m homes would be sold on the open market as and when tenancies reach a natural end. At an average market value of £120,000, this would generate some £220 billion over a 15-20 year period. Of this some £30 billion would be used to pay off the outstanding debt on the houses. Of the balance of £190 billion, £90bn would be used to replace the sold-off properties by building 1.8m brand new social homes, providing the £50,000 capital subsidy that each one needs. It could then own these new homes, but have them managed by housing associations. This would leave a net cash surplus of £100 billion to go into the new Armed Forces Pension Fund. In addition to council housing, Government could transfer to new Fund the £40 billion of repayable grant that sits on the balance sheets of housing associations. It could ask for interest on the grants at, say, 5% per annum, generating a new income stream of £2 billion per year, or the repayment of the £40bn grants, funded by the sale of existing properties when tenancies naturally churn. In addition, it could transfer all surplus military land, adding many more billions of development land. Suddenly, we would have a new force in the land – the Armed Forces Pension Fund, with up to £140 billion of financial assets, land worth billions and over £250 billion of housing assets (i.e, the open market value of the 1.8m new social homes it built and owns) , focused exclusively on meeting the country’s housing needs. By rebuilding the council homes it sold off, it would add 1.8m new homes to the country’s housing stock, doubling the number of homes built during the period. After this, it’s mission would be build private homes. It would have a statutory duty to maximise returns on its assets from housing development. Ist would be obliged to put to work its massive financial muscle and the MOD’s surplus estate to transform the country’s housing supply. The Fund’s assets and revenue, along with its long term focus, would give it the financial strength to build homes ahead of demand and to develop at scale and over decades, e.g. creating new garden cities and suburbs.

3. Fund the NHS Pension with transport assets – The Government could create a funded scheme for the NHS, focused on transport. It could establish this fund by gifting two major assets overnight. Firstly, it could transfer Network Rail, with its assets of some £50 billion and annual profits of £2-3 billion. Given there are no private shareholders, no compensation would be due. This ownership could extend to other major new rail projects, such as High Speed Rail. Given the massive scale of investment in the UK’s railways over the next few decades (even before High Speed Two, capital spending will be the highest since the Victorian era) this asset base will rapidly expand, as will the profits. Secondly, Government could transfer ownership of the Highways Agency and the national road network into this NHS Pension Fund. This network has an asset value of over £100 billion. The Government could give the NHS Pension Fund the £2-3 billion per annum share of the current Vehicle Excise Duty (VED) which goes to the Highways Agency. However, given that this tax base will decline (given carbon efficient cars), the NHS Pension Fund could be asked to introduce tolling onto our national roads, as a replacement for VED. This would replicate European charging – so only those who use the national roads pay. On this basis, the NHS Pension Fund would be able to raise funds to improve the UK’s road system, where investment has been only half of that of our European competitors in recent decades. A regulator for both road and rail would allow the NHS Pension Fund to make a normal commercial return from its ownership of roads and rail. If it’s returns were better than predicted by the regulator, this would reduce the pension contributions needed from the NHS and, hence, from taxpayers. These two assets together would make a big dent in the £300 billion liabilities of the NHS Pension Fund. Given that NHS pensions are cash positive in this period (i.e. there is a large fairly young workforce paying in more now than is paid out), the NHS Pension Fund could put current surpluses to good use to create future assets.

Similar solutions can be found across the Government’s balance sheet. For example, maybe the ownership of school buildings should be transferred to the Teachers Pension Fund. Gradually a rent could be introduced payable by schools as tenants to the Teachers Pension Fund, creating a revenue stream. The Pension Fund could be the source of capital investment for those wanting to open new schools, as well as a residuary body for school buildings which have outlived their usefulness. Or, maybe the (funded) Universities Superannuation Scheme should be obliged to buy a substantial tranche of Student Loans debt, sharing some of the risk in whether students are able to pay off their education debts by finding well paid careers.

The idea would be to have the benefits of capitalism, e.g. the obligation on the capitalists (the pension funds) to make a good financial return; the opportunity to use today’s private capital (i.e. people’s savings) to invest in assets which make our economy more prosperous in the future; keeping companies under private management and ownership. But also to ensure that the UK’s future infrastructure investment needs can be served from UK capital, including the dormant assets sitting on the UK Government balance sheet, and that we have big players who are obliged to invest in the UK. This mirrors the retrenchment of banks after the 2008 Crisis, where they now largely balance their assets and liabilities in their own country, rather than being spread all over the world.

What would this all achieve? Would the public feel better knowing that privatised companies are owned by the NHS, Armed Forces and Local Government Pension Schemes? Would the public recognise that that strong profits from these companies were keeping down taxes, which would otherwise have to rise to pay for pension deficits? What would it be like if the UK had 3 new financial giants stalking the land, with hundreds of billions to invest in new housing and infrastructure? Would the cost of capital fall, cutting the cost of investment? How could we still have competitive pressure – e.g. by having separate operating companies (e.g. regional railways, existing water companies, etc) with incentivised managers competing to achieve the highest customer service and operational efficiency, underpinned by a regulator which penalised under-performers and public sector funds obliged by law to achieve regulatory standards and strong financial returns? Could there be a fairness debate, which says today’s population should pay a bit more for their utilities today to generate profits paid into pension funds for their old age, rather than just leaving the bill to be picked up by future generations? There is a lot to think about and this piece is just a thought experiment to spark debate. But perhaps in a General Election year, the UK public deserves some fresh thinking about renationalisation. Who knows, they may even demand it.


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