The National Wealth Fund, 'de-risking' and conditionality

‍Good morning from New Economy Brief.

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Last week the Labour government launched the National Wealth Fund (NWF), one of its flagship policies aimed at combating the UK’s woefully low levels of investment. This was accompanied by a report from the NWF’s task force on how the £7.3bn fund should be designed, governed and managed.

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Experts like the Financial Inclusion Centre’s Mick McAteer have warned that the influence of financial sector lobbyists could make the new government’s economic strategy too reliant on ‘de-risking’ private investment and lead to a ‘PFI2.0’ scandal. 

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This week we take a deep dive into the politics and economics of ‘de-risking’ and highlight a few important things to look out for as Labour announces more detail on its policies to grow and decarbonise the UK economy.

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The purpose and design of the National Wealth Fund.

Investing in the green economy is risky for private capital. Reaching net zero requires developing new low-carbon technologies and rolling out infrastructure to support new markets, such as electric vehicle charging stations and heat pump networks. Nascent technologies like these are perceived as having higher credit risk, so it's harder for businesses to borrow the money they need to expand production. By supporting technologies early on, when private financial institutions do not, public investment can grow low-carbon projects, demonstrate viability, and attract more private investment. To achieve this, the government has aligned the UK Infrastructure Bank and British Business Bank under the umbrella of the new NWF. 

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Crowding in via ‘de-risking’. The NWF has been allocated a £7.3bn initial investment to target five sectors (green steel, green hydrogen, industrial decarbonisation, gigafactories and ports) that together make up over half of the UK’s carbon emissions. It aims to catalyse further capital from the private sector by “de-risking” investments through a variety of products. This could include making loans to develop portside infrastructure, or taking equity stakes in riskier projects like recycling technologies for batteries. It could also mean guaranteeing the money investors lend, or making sure a company meets certain price or revenue targets (stepping in itself to make up the difference if need be) – all aimed at persuading the private sector to make investments in green tech that it might otherwise see as too risky.

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Taking borrowing out of fiscal rules? Interestingly, the task force suggests excluding borrowing by public development institutions when calculating public sector net debt, in order to take pressure off fiscal rules. A new paper from LSE’s CETEx – co-authored by Andy King, a former economist at the OBR – calls for something similar – exempting the UK’s public finance institutions from fiscal rules to create space for investments to address climate change and other industrial strategy priorities. It thinks the government's plans to unite the UKIB and BBB under the new NWF is 'an opportunity to implement a better approach'. (The New Economics Foundation, meanwhile, argues that £7.3 billion over five years isn't nearly enough to accelerate the transition to a clean, low-carbon future and calls for more public investment.)

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What is ‘de-risking’, and why is it risky?

Achieving the UK’s climate targets requires shrinking high-emission activities and massive investments in new green productive capacity. Funding these through private investment keeps the costs off the public balance sheet, which some see as preferable in a period of  limited fiscal room for manoeuvre. Economists Daniela Gabor and Benjamin Braun define ‘de-risking’ as government policies to redirect private investment by making infrastructure and manufacturing capacity more investible; that is, more profitable, by the state taking on many of the risks.  This could be done by providing demand guarantees for renewable energy to persuade an asset manager it’s safe to invest in a new wind farm, or by providing cheap loans (or sometimes grants) so a factory can buy new machinery and make more wind turbines.

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Stability and industrial strategy. The new government has argued that there are multiple elements of their approach that will encourage private investment. The ‘stability premium’ coming from having a government with a consistent agenda and personnel is one of these, as is the existence of the new ‘Missions’ and accompanying industrial strategy. All of these reduce what might be described as ‘policy risk’ for business; the idea that the government might get cold feet on certain projects or technologies. This kind of risk reduction is something very few economists would object to, and it is certainly true that political chaos has impacted on investment decisions in recent years.

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The private sector controls the path and pace of decarbonisation. The problem with relying on ‘de-risking’ as a way of reducing emissions is that it gives private investors the final say over whether a project gets funding or not, and they will only invest if projects are profitable. (Check out Brett Christophers’ interview on the Break Down for an explanation of why the private sector can’t decarbonise the energy system – because renewable power isn’t profitable enough.) Letting decarbonisation depend on the profitability of investment projects has coordination risks. Common Wealth’s Melanie Brusseler explains that a more disorderly transition could cause bottlenecks in the supply of critical materials, which could lead in turn to inflation and further political instability. 

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De-risking risks a slower and more disruptive transition to net zero. Making low carbon infrastructure more profitable for private investors could also make it more expensive for consumers, potentially harming electoral support for net zero. It would also make decarbonisation more expensive for the government in the long run. This is not only because a slower transition to net zero would cost the taxpayer more, but also because the government can borrow more cheaply than the private sector. Daniela Gabor also argues that “The risk is not only that our climate future will be vastly more expensive if [asset managers] are driving it, but that this future will also produce a more unequal society, where citizens equate green measures with unaffordable public services.”

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Maximising public value through conditionalities: carrots and sticks

The government is yet to release more policy detail on how the NWF will function, but its task force’s Terms of Reference report is very focused on providing carrots (incentives) to entice private capital to invest more. Sticks (conditionalities) are notably absent from the recommendations so far. Perhaps this is to be expected given the task force’s composition – most members are from the financial sector, with no representation from trade unions, industry, climate groups or other parts of civil society. Yet conditionalities will be crucial for making sure businesses and projects that get public support work in the public interest. 

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Conditionalities share the benefits of growth. Economists Mariana Mazzucato and Dani Rodrik argue that “it is not enough to guide investments in desired directions; it is also necessary to ensure the benefits are as widely shared as possible…when companies receive public investments in the form of subsidies, guarantees, loans, bailouts or procurement contracts, conditions can be imposed to help guide innovation and steer growth towards achieving the highest public benefit.” They point to the US’s CHIPS and Science Act as a recent example where government support was conditional on limiting share buybacks, making supply chains more energy-efficient and improving working conditions for staff.

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Embedding conditionalities into the National Wealth Fund. Mazzucato and Rodrik also note that to design effective conditionality, the state must be ‘autonomous’ from firms and private interests. Public institutions must “further public goals and discipline private firms as needed without being co-opted themselves” whilst remaining “sufficiently ‘embedded’ in the private sector’s decision-making processes with respect to investment, production, and technological innovation”. They warn that the absence of conditionality can lead to “parasitic relationships, or capture, whereby businesses simply get handouts and subsidies from lobbying”. (Others have warned that the proximity of financial sector lobbyists to Labour’s plans risks a PFI2.0-style scandal.)

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How will the NWF be governed and managed? We are still waiting for the details, but the NWF’s task force recommends that it should define successful investment broadly (for instance it might aim to reduce carbon emissions or create new green jobs in deprived areas), but says “private capital mobilisation should be a primary objective.” The report suggests that in order to crowd-in as much capital as possible, the NWF should be operationally independent from the government, even though this “will make it more challenging for government to enact priorities through directly controlling the deployment of capital”. It recommends that the NWF’s investment mandate be “determined by government in consultation with the fund”, and that government should be represented on an independent board, able to “influence but not veto”. 

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Things to look out for.

Many questions remain about how the NWF will work, and in whose interest. Will it use equity stakes in manufacturing firms to steer them towards other social and environmental goals, such as reinvesting profits to innovate and reduce costs? Or will it just facilitate share buybacks? Will its support come with conditions aimed at maximising public value in the economy so the rewards are shared beyond private shareholders? Will its investment mandate go any further than attracting as much private capital as possible? Will whether or not the UK hits its legal climate targets depend on how profitable our infrastructure is? The answers could determine whether the NWF becomes a vehicle for further privatisation of UK infrastructure (and the poor management this often entails) or succeeds in stewarding capital in the public interest and coordinating an orderly, just transition to net zero.