Spending on infrastructure has exceeded the amount set out in the NationalDevelopment plan but there has been a sizeable shortfall in what has actually been built, writes Jim O'Leary.
Over 2000-01, spending on infrastructure under the National Development Plan was 5 per cent more than had been provided for in the plan itself.
In financial terms therefore, the plan was on track at the end of last year. In terms of what the money actually bought by way of roads, rail track, water mains, houses and the like, it was way behind schedule, however.
A recent report by Farrell Grant Sparks* for the Construction Industry Federation estimates that the margin by which actual infrastructure spending in 2000-01 fell short of the amount needed to meet the plan's physical targets exceeded 20 per cent.
How is it that over-fulfilment of the plan in financial terms converted into a sizeable shortfall in physical terms? The explanation is rapid unit cost inflation. The Farrell Grant Sparks report indicates that the cumulative increase in unit costs over the two years 2000-01 averaged 32 per cent across the full gamut of economic and social infrastructure projects, ranging from a mammoth 62 per cent in the case of national roads to 19 per cent in the case of housing.
In other words, the quantum of infrastructure that could have been provided at a cost of €1 million in 1999 cost €1.32 million two years later, while the quantum of national roads that could be bought for €1 million in 1999 cost €1.62 million two years later.
These dramatic rates of unit cost inflation reflected in part the general rise in production costs in the construction sector, a notable element of which was the rapid wage inflation that resulted from acute labour shortages in the sector.
But other factors were at work too. For one thing, land acquisition costs soared, especially near rapidly growing urban areas. Moreover, changes in the scope and design of projects also boosted costs considerably.
The escalation of costs has major implications for the overall cost of completing the National Development Plan. Even assuming that unit cost inflation decelerates markedly, the Farrell Grant Sparks analysis indicates that the amount of money required to complete the infrastructure programme over the 2002-06 period would total €31 billion.
In crude terms, this is almost €12 billion more than the corresponding total provided for in the NDP. In present value terms, the margin - a measure of what might loosely be called the funding gap - is about €9 billion. How, if at all, is this gap to be filled?
Well, perhaps some contribution to reducing the gap in the first instance might be made by the adoption of practices and policies that would lower unit costs (for example, the more widespread use of fixed cost contracts). Then, perhaps, some contribution to bridging the gap might be made by greater private sector involvement than is envisaged in current plans for public-private partnerships.
But the extent to which either of these strategies can be expected to resolve the problem is very modest, at least from now until 2006. It follows that if the funding gap is going to be bridged, the burden will fall on the Government.
How can this be reconciled with the need to correct the recent trends in the public finances? Well, not at all, if politicians go with their instincts and follow the precedents set in the 1980s.
Then, public capital spending was severely pruned, a course of action that helped produce the infrastructure deficit of recent years.
All the evidence suggests that this would be quite the wrong policy to adopt.
The old prescription of borrowing to finance productive capital spending remains as valid as ever. Its corollary is, of course, that the current cohort of taxpayers should not be expected to bear the full costs of investment projects the benefits of which will accrue to the economy for the next 30-50 years.
What this suggests is that the Government should not be too hung up about balancing the books in next month's Budget. But before anyone runs off with the notion that this writer has gone soft on the public finances, let me swiftly add a few stringent caveats.
First, the maximum tolerable deficit should be set at a level that ensures that the ratio of Government debt to gross domestic product does not rise. My calculations indicate that this rule would allow a general deficit of around 1.5 per cent of GDP, given the likely constellation of growth and interest rates in the period ahead. This is probably 1 per cent of GDP more than what Mr McCreevy has been prepared to contemplate, at least until recently.
Second, none of the extra room created by this more relaxed fiscal rule should be used to ease the constraints on current spending. The Government's declared objective of limiting the growth in current spending in 2003 to around 8 per cent year-on-year should remain in place and be relentlessly pursued.
Third, the extra room should only be used to finance increased capital spending if the Government is absolutely satisfied that (i) there is enough capacity in the construction industry to absorb the projects concerned, and (ii) stringent cost control and project management procedures will be applied. It goes without saying, of course, that the projects concerned should have passed rigorous cost-benefit tests.
Finally, it is worth pointing out that even if an additional 1 per cent of GDP were devoted to infrastructure investment in each of the next four years, the physical targets implied in the national plan would not be met. Extending timeframes and re-ordering priorities have become the order of the day.
Jim.oleary@may.ie
* The Farrell Grant Sparks report is titled "Progress and Prospects for Achieving the Physical Targets in the Economic and Social Infrastructure Programme of the NDP, July 2002 "
