Cuts in capital spending need not mean fewer projects

ECONOMICS:The challenge for the public service is to negotiate hard for reduced tender prices, writes EDGAR MORGENRATH

WHILE THERE has been a justified debate about various aspects of the April 2009 supplementary Budget on issues such as the income levy, the entitlements of TDs and former ministers, and the establishment of Nama, one important aspect of the budget has been missed: the significant cut in capital expenditure.

Capital expenditure in 2009 will be some €2 billion, or 20 per cent, lower than in 2008. For the years 2010 to 2013, average capital spending will be a further €1.3 billion lower compared to the 2008 level. This is a savage cut by any standards and reminiscent of the cuts in capital expenditure in 1987 and 1988 which amounted to a total cut of 50 per cent.

Of course, cutting capital expenditure is relatively painless in the short run. Few miss something that does not exist, particularly when the decline of economic activity is reducing infrastructure capacity constraints.

However, the substantial cuts in capital investment in Ireland stand in stark contrast to the stimulus packages announced by various governments in Europe, the United States and elsewhere, which incorporate substantially increased expenditure on infrastructure. These packages are argued to improve competitiveness and create jobs so, on the face of it, cuts in Irish capital expenditure will, in relative terms, reduce our competitiveness and lead to lower employment – or will they?

The competitiveness effects are driven not by the amount of expenditure but by the infrastructure that is actually put on the ground. With the severe downturn in the economy and in particular the construction sector, tender prices have fallen very significantly. The Tender Price Index published by the Society of Chartered Surveyors has decline by more than 20 per cent from its peak and might reduce even more as projects are getting scarcer.

Likewise, land prices have also fallen back by between 30 per cent and 50 per cent. Thus a cut in expenditure of 20 per cent should actually imply no change in the volume of activity and, as such, should not affect the number of projects targeted for delivery. In that sense the cuts should be welcomed as a move towards better value for money.

However, better value for money will only be obtained if the cuts are implemented via tough negotiations on pricing rather than the much easier route of cutting the number of projects but paying for those that remain on the basis of historic tender prices rather than current tender prices.

Achieving these cost savings constitutes a significant challenge to a public service that has, for good reasons, been more concerned with achieving project delivery than cost control. This challenge will require different skills which need to be developed quickly.

The evidence suggests that, at least to a significant degree, the cuts in expenditure will result in fewer projects rather than better value for money and, as a consequence, they are going to affect our competitiveness down the line.

The National Roads Authority has just three schemes put out to tender at the moment but 18 under construction and some 41 schemes at the design stage. In other words once the schemes under construction are finished there will be almost no activity.

Of course, not all planned infrastructure projects were good projects to start with and some should certainly be abandoned. Many economists have questioned the rationale for the Western Rail Corridor, but there are also examples of questionable projects on the eastern half of the State. It is remarkable that there are plans to facilitate the avoidance of the toll on the M1 by building a bypass around Slane involving the expensive construction of a bridge over the river Boyne when a simple HGV ban would solve the local traffic problems.

The other great hope associated with the various stimulus packages is that of job creation. Given the record increases in unemployment in Ireland, these must feature highly in expenditure decisions. According to the Construction Industry Federation (CIF) every €100 million spent on construction projects will create 1,000 jobs. The net cost according to the CIF, taking into account tax receipts and non-payment of social welfare, of a construction job is €40,000. This turns out to be almost four times larger than the cost per IDA Ireland created job. In other words, €2 billion could create more jobs if used in a different way.

This highlights that job creation via public capital expenditure is expensive, which applies not only in Ireland but also elsewhere and suggests that the stimulus packages might not be such a panacea.

Dr Edgar Morgenrath is associate research professor and co-ordinator of the Transport and Infrastructure Research Programme at the Economic and Social Research Institute