EEF blog

The Spending Review announced £1 billion of Government funding plus ‘significant’ proceeds from the sale of assets to capitalise the Green Investment Bank (GIB). Details as to how the GIB will work are to be announced in the Spring. By itself this ain’t going to be enough.

Ernst and Young estimate the GIB would need to be capitalised to the tune of £4-6 billion to 2015 to meet the UK’s climate and energy goals. To be sure, funding alone won’t be enough from the Government in the absence of a coherent and stable climate and energy policy regime.

Forget about £ for capitalisation, the GIB’s funding issues appear even more fundamental. The £4-6 billion is supposed to help unlock investment of £250-450 billion to 2025, compared with a current expectation of only £50-80 billion. Where’s the extra money going to come from? Realistically it has to be the private sector. The Government’s modest £1 billion (so far) reflects the steep challenge of bringing the public finances under control. Fair enough.

So, private sources: Bonds, deposits, potentially equity to support the GIB; plus direct debt or equity through co-financing. The GIB Commission, which published its report in July, discusses most of these. Let’s look at just one – bonds. The GIBC suggested that issuing bonds was the major way the GIB could draw in funding from major institutional investors like pension funds or insurance companies – perhaps the majority.

But issuing bonds means in addition to holding assets, the GIB would also have liabilities – just like a real bank. Majority ownership along with any Government conditions of control on the GIB would indicate the Government controls ‘general corporate policy’. The problem is that these liabilities will then be counted in Public Sector Net Debt (PSND), which the Government is publicly committed to have falling by 2015/16. PSND is defined as financial liabilities less liquid assets.

The GIBC is at least partly alive to the issue, noting that all the GIB’s investment decisions would be made independently from the Government. Unfortunately, with majority ownership, that is unlikely to be enough.

There are ways around this. The Government could pledge to sell a majority of its shares by the end of the Parliament (thus not hurting its debt goals). The problem with this is that the GIB might be a couple of years away from investing, longer before it issues bonds, and much longer still until investment returns that might attract private buyers starting rolling in.

Another idea would be to devolve the Government’s shareholding to individual taxpayers, again by the end of the Parliament, perhaps with a further restriction of say 5 years on on-selling. This ‘green shareholding’ could even help build popular enthusiasm for the GIB.

A third idea could be setting the GIB up to only issue third-party guarantees, much in the way the Government does currently with the Enterprise Finance Guarantee (EFG). To my knowledge, EFG-backed loans do not add to Public Sector Net Debt (PSND). Rather only the expected cost of the guarantees shows up, as government expenditure, which in excess of revenue leads to the flow of Public Sector Net Borrowing (PSNB). Only this small flow, not the whole value of loans, adds to the stock of PSND. PSNB is defined as the difference between total expenditure and receipts or equivalently the change in net financial liabilities.

The question remains though, whether dropping majority ownership will be enough to lose the GIB from the Government’s accounts, or, in the case of the guarantee option whether the GIB will be able to meet its mission. That’s because the Government wants the GIB to pursue an ambitious, largely public (at least for now), aim – financing green investments with sub-market risk-return profiles.

Could the Government force the GIB to retain this mission without a majority ownership and without falling within the definition of influencing ‘general corporate policy’?

And if the Government gave guarantees only, will that allow enough green investment? It might make finance for green investments available that isn’t there currently – but perhaps at a price that chokes off demand for such finance.

If all these fixes fail or are unacceptable to the Government e.g. because it doesn’t want to do things ‘off balance sheet’ – what then? It seems to me that keeping the GIB in the public sector, even if it issues bonds, will cause a hit on PSND – but it’s much less clear what the impact will be on PSNB. That’s because at the same time as creating financial liabilities (bonds) it would be creating financial assets (giving out loans and guarantees).

The Government’s major fiscal goal is to eliminate the structural fiscal deficit (the structural element of PSNB) over the course of the Parliament. For PSND, the goal is only that this will be falling by 2015/16. Given the PSND hit would likely come before 2015/16, this should still be achievable.

Whatever option the Government ultimately goes for it needs to keep in mind the scale of the investment challenge it is trying to address.

The government can promote business growth and investment by improving access to finance

SMEs in particular are still struggling to access the funding they require, so it is encouraging that the Prime Minister noted in his speech on Monday that opening up access to finance and getting banks lending will be crucial to drive growth. Government should promote access to finance through facilitating greater transparency around lending policies; encouraging increased competition in the banking sector; and promoting alternatives to bank lending.

The government could take better advantage of green opportunities if more resources are given to the Green Investment Bank

The scale of investment needed to really capitalise on the opportunities in green technologies will not be met by the current plans for a £1bn Green Investment Bank. The government should be more ambitious: estimates suggest that the development of a low carbon infrastructure and low-carbon technologies will require £5bn of funding over the next five years.

The government will maximise the returns to its investment, if it is clear about its plans, and the kinds of support that will be available.

In many areas of government spending, greater details are required. Particular areas the government should clarify include which types of adult apprenticeship will be funded by the £250mn announced; and how funding to help firms commercialise their innovative ideas will be allocated. 

Martin Wolf believes the government's Spending Review plans are like going climbing without a rope:

If businesses are to invest so strongly, they need to believe that demand will remain robust, come what may. In sum, a credible Plan B is not an optional extra. It is a necessary condition for a successful Plan A

Yet it remains depressing that investment spending was slashed at a time of slack demand, when the government can borrow so easily. That is classic Britis short-termism.

The decision to leave its “Plan B” to the Bank of England is another gamble. When the long-term interest rate on government bonds is down to 3 per cent, the impact of more “quantitative easing” is likely to be minimal.

This government has, in essence, decided to go political rock climbing without ropes.

We agree with his two key points: that business investment has to be part of a credible 'Plan A' on the economy, and that the benefits of additional QE are likely to be minimal.

All this week, we've been setting out our 'Plan A' for the economy - simple, targeted ways the government could help ensure we see a boost to [rivate sector investment in the coming years (see the links below).

But the QE point bears discussion.

Essentially we have two concerns about additional QE. The first £200 billion didn't have a great impact on the wider economy or money growth (in psuedo-eco speak, the transmission mechanism wasn't operating properly), so what makes either the Bank or the government confident that a ride on the QE2 be anymore successful?

And while the benefits of further QE are likely limited, the risks may not be. More QE could help push up asset prices, either here in the UK or abroad via carry trades. And this would just store up problems for the future.

So our view isn't to rule out QE altogether, but to pursue a proper 'Plan A' that will help boost investment and rebalance the economy.

Going for growth in the UK  

Monday: A 'Plan A' for growth 

Tuesday: The UK is OK (for now): Putting growth into context

Wendesday: Growth Plan Part I - A better partner to business

Thursday: Growth Plan Part II - A stable and predictable business environment

Friday: Growth Plan Part III - Investing in the future of growth

The government can work better with business if it develops a more nuanced understanding of the contributions to growth from different sectors of the economy.

The forthcoming manufacturing framework must demonstrate an understanding of manufacturing’s contribution to the economy and recognise that, given manufacturing’s high capital intensity and global exposure, certain policy levers will have a differential impact on the sector compared with the rest of the economy.

The government can catalyse private sector investment by targeting funding more strategically.

Government investment in port infrastructure, for example, would help attract additional foreign investment in the UK low-carbon economy. Similarly the £1bn commitment for carbon capture and storage should enable the development of low carbon industries in the UK, though experience from Canada suggests that the government needs to move more quickly.

The government can get more from its suppliers by engaging with business at an earlier stage, and becoming a more collaborative partner.

Rather than focus on short-term cost savings, changing the culture of procurement and upgrading the skills, expertise and experience of public sector procurers will help bring long-term value for the economy.

On Monday, we published the EEF/Infor report Investing in Recovery - Innovation Monitor 2010. With the government announcing support for low-carbon technologies, Rex Vevers, Finance Director at Ceres Power writes about how the government still needs to do more to support the development of innovation. Spun out of Imperial College in 2001, Ceres Power has developed a wall-mounted fuel cell combined heat and power product (CHP) that replaces a conventional domestic gas boiler and is designed to generate up to 90% of a typical home’s electricity requirements and all of the hot water and central heating requirements. They employ over 120 staff at our fuel cell mass manufacturing facility in Horsham and their technology centre in Crawley.

Ceres has been developing its core technology since 2001, and we produced our first wall-mountable residential CHP prototype in September 2007. In September this year, we demonstrated our CHP product operating in a home-like environment and delivering despatchable low-carbon power. Units will be installed in houses for commercial field trials throughout next year and the final product will be launched on the market with British Gas in mid 2012.

Today, the main risk facing high technology manufacturing companies is securing sufficient  funding to complete the product development and field trials phase and launch the product onto the market; the second  ‘so-called’ ‘D’ in the RD&D journey.

To commercialise innovative high technology products, it is necessary to take laboratory prototypes from early stage R&D and, through a rigorous product development process, turn these prototypes into products that can be manufactured in volume and are commercially viable.

This so-called ‘product development’ process involves significant investment in people, engineering, tooling, volume production equipment and widespread field trials. This process is expensive, requiring investment of £ tens of millions and in many cases the establishment of a global volume-capable supply chain to deliver the value-engineered components and systems to achieve commercial viability (in terms of price and product reliability).

SMEs have traditionally used early-stage equity funding (together with funding provided by supply chain partners and government grants/loans) to finance the product development stage and reach volume product launch, after which other sources of funding can be accessed. Whilst reasonable financial support is available for initial/early stage R&D via small R&D grants, the significant investment required to commercialise and scale-up the technology (incl. product development, field trials and purchasing tooling & volume machine costs) is either no longer available or prohibitively expensive.

There is a significant risk that, the original innovation and early stage R&D work is conducted in the UK but the expensive, high risk and time consuming product development & commercialisation phases are conducted outside the UK.

This would result in the final products being imported into the UK and as a consequence the long term value -added jobs and wealth creation occurring outside the UK.

We believe that if the UK is to really develop a world class high-tech manufacturing base, the Government will need to rethink its strategy and approach to assisting UK companies’ progress through the very expensive and lengthy product development & trialling phase of their growth cycle.

If this does not happen, the UK will no doubt continue to spawn potentially interesting new innovations, but fail to keep these companies through to commercialisation and product launch.

The real high value sustainable jobs are only created during the product development phase and through to volume market launch. Early stage innovations create very few significant sustainable manufacturing jobs, these are created when these innovations are converted into commercial products that are designed, manufactured and sold from the UK. This has long been a problem with the UK and it requires a new strategy to reverse this trend.

On Monday, we published the EEF/Infor report Investing in Recovery - Innovation Monitor 2010. With the Comprehensive Spending Review to be announced later, Craig Naylor, MD at Northern Tooling Reclamation Ltd, talks about a few of the business support schemes at risk today, including the Manufacturing Advisory Service, Knowledge Transfer Partnerships and Innovation Vouchers. Located in Wetherby, NTR is a small, precision tooling and engineering company that employs 26 staff.

In 2005, we began a process of improving the business by putting technology at the heart of the processes we use. We are essentially a craft-based business – every order is a one-off tooling repair. We hoped that a MAS intervention that drilled down into the detail of our business, would lead eventually to a technology-driven KTP.

But working with MAS and, ultimately, Bradford University, we opted for a two-year KTP to deliver process improvements and time-cost savings.

The project was successful – so successful that it was completed within 14 months, even though we were responsible for covering the costs of the KTP for 24 months. But given the success of the programme, it was a cost worth bearing.

We had planned for the technology-based KTP in 2008, but then that was put on hold by the recession. With the recovery underway, we’re planning a technology transfer with Huddersfield University that will allow us to grow the company by expanding into overseas markets.

While we’re very upbeat about KTPs generally, this project involves significant costs, both in terms of funding the KTP, but also in terms of cash not available to the rest of the business. And it isn’t without risk – if the technology transfer doesn’t work, then we’ve spent time and money a small company like us can’t afford.

That’s why we opted to use Innovation Vouchers. It’s not a lot of money, only £3,000, but it covers half the costs of a pilot-run with Huddersfield to help ensure they can deliver for us.

That £3k matters – we want to spend about 20% of profit on R&D, but we’re financially constrained because of limited profits, so spending £3k instead of £6k matters and allows us to pursue others strands of growth, such as investing in new CNC machines.

While KTPs were simple to use, we had to jump through too many hoops to use Innovation Vouchers, even though it’s significantly less money than what’s involved with a KTP. But Innovation Vouchers helped de-risk a bigger investment in our company’s growth.

On Monday, we published Investing in Recovery a joint EEF/Infor report that draw on our 3rd annual Innovation Monitor survey to show how manufacturers are investing in innovation and are driving the broader recovery.

To back up the stories in our report, UK manufacturers are going to be blogging on their approach to innovation - what drives them to innovate, what investments are the making and has it made a difference to thier business.

These posts will be from firms in their own words, and hopefully it will show that even in an era in cutbacks, manufacturers and government can take simple steps ensure the UK economy benefits from our investments in innovation.

Any comments on the posts - or the EEF/Infor report - can be made via our twitter account @EEF_Economists, or via email.

Manufacturers on Innovation

Tuesday: Andrew Churchill, MD, JJ Churchill Ltd - 'Our business plan is built on an explicit drive for innovation'

Wendesday: Craig Naylor, MD, Northern Tooling Reclamation Ltd - 'Government funding helped de-risk a larger investment in our company's growth'