High speed link could leave Wales stranded

Much heat has been generated in England over the question of HS2, the proposed high speed train link between London, the midlands and north of England and possibly, in the longer term, extending to Scotland. For many of us in Wales our interest has been focused on the funding of the project and whether or not Wales will benefit from a corresponding increase in the block grant through the Barnett formula mechanism.

If forthcoming such an increase in funding could be used for much needed improvements in the transport infrastructure of Wales. This will be even more important if Wales is to compete with those regions of England which gain competitive advantage as a result of HS2.

Given that the latest estimate of the construction cost of HS2 is £42.6bn there is much at stake here. The Welsh Government’s total capital investment budget is currently approximately £1.4bn a year. If the capital spend on HS2 were over and above the normal run rate of public sector capital expenditure then Wales stands to gain as much as £2.5bn over the period of HS2 construction.

Herein lies the rub for the UK Government. If the governments of Northern Ireland, Scotland and Wales were to receive Barnett consequentials for HS2 this could amount to a total of ~£8bn, thus pushing the effective cost of HS2 over £50bn. One can see why the Treasury in its recent spat with the Welsh Government was keen to claim that Wales was not receiving an HS2 consequential as part of the increase in Welsh funding.

Although the UK Government now appears to have conceded that Wales has received a Barnett consequential for HS2 expenditure this does not mean that the Welsh Government can relax and assume that if HS2 goes ahead Wales will receive its full due.

The uncertainty is because of the way the Barnett formula is operated by the Treasury. There are precedents that may be deployed on both sides of the argument and depends on interpretation of the ‘rules’ governing the application of the Barnett formula. There are two key considerations when deciding whether or not a devolved administration receives a Barnett consequential arising from public expenditure:

• The first test is whether expenditure is in a spending area which is devolved. If it is devolved then usually the corresponding expenditure is devolved through the Barnett mechanism. Examples of this are health and education.
• A second test is whether or not the expenditure is ‘for the benefit of the UK as a whole’.

In the case of the London Olympics the Labour Government of the day decreed that the Games were for the benefit of the UK as whole and that there would be no adjustment made to the block grants of the devolved administrations. It was conceded that expenditure on some of the associated land reclamation and infrastructure improvements were specifically for the benefit of East London and after a great deal of haggling Northern Ireland, Scotland and Wales received modest additional funding although it was considerably less than the Barnett consequential.

A more promising precedent for Wales is the treatment of Crossrail. Crossrail is currently the largest civil engineering project in Europe and involves driving twin railway tunnels under central London together with building a number of new stations. The total cost is estimated to be £14.8bn. In this case Wales and the other devolved administrations receive full Barnett consequentials. While the UK Government argued that the Olympics were for the benefit of the UK as a whole no attempt was made to make a similar claim for Crossrail.

In the case of public expenditure on rail infrastructure the picture is muddied by the different treatment of Scotland and Wales. Network Rail is the body responsible for the track, signalling and railway stations in Britain. In the case of Scotland expenditure on these items is devolved and included in the Scottish block grant. The Scottish Government then determines its spending priorities and employs Network Rail to undertake any work on the rail infrastructure in Scotland.

Wales is not in such a favourable position. Spending on rail infrastructure is not devolved. A budget is determined by the UK Government for the activities of Network Rail in England and Wales and Network Rail then determines its spending priorities on an ‘England and Wales’ basis. It is perhaps not surprising that under this arrangement investment in Wales on rail infrastructure has been so low. Indeed the Welsh Government has been obliged from time to time to raid its own block grant which is not meant to cover investment on rail infrastructure in order to top up Network Rail funding in Wales. Such expenditure has come at the expense of spending on devolved programmes such as health and education.

How can the ‘for the benefit of the UK a whole’ test be applied to HS2 when the whole programme is within England? To the extent that HS2 will stimulate the economy of parts of England it might be claimed that this will also benefit to the UK as whole. Of course, a similar argument could be deployed for any infrastructure spending by the Welsh Government in Wales: if it provides a local economic stimulus it is of some benefit for the wider UK.

Unfortunately, the Treasury has a long record of looking at spending from a London-centric viewpoint and presuming that what is good for England is for the benefit of the rest of the UK as well. Fortunately in the case of HS2 a report published in September and produced by the accountancy firm KPMG for HS2 Limited sought to assess the economic benefits of HS2 for the different cities and regions of the UK. Not surprisingly the major winners were the cities on the HS2 line such as London, Birmingham, Manchester, and Leeds and the contiguous areas. In the case of Wales, Wrexham and the surrounding areas stood to gain marginally due to their proximity to Crewe. But as well as winners there are many losers including Bristol, Newport, Cardiff, Neath and Swansea. It was noteworthy that in the first release of the report the winners were identified but the losers were not. It took an FOI request from BBC Newsnight before the full list including losers was published.

The towns, cities and surrounding areas that stand to lose will suffer comparative competitive disadvantage if HS2 is built. Analysing the KPMG report of winners and losers indicates that while England would be a large net gainer, Wales would lose considerably. The KPMG analysis should bolster the argument that HS2 is for the benefit of England as a whole, that Wales will lose and should therefore receive a Barnett consequential.

So far I have concentrated on the ‘technical’ arguments surrounding application of the Barnett formula to HS2. In reality many decisions are made as a result of political negotiation and the leverage of the parties involved. The UK Government, through the Treasury, is judge and jury in its own case. A key event in the resolution of the HS2 funding question will be the next UK Spending Review. At each such review the Treasury publishes an updated Statement of Funding Policy which sets out the guidelines for the application of the Barnett formula and crucially also publishes comparability factors for the various public spending programmes. It is to be expected that the HS2 programme will be included for the first time.

While the Statement of Funding Policy is published by the UK Treasury it is meant to be agreed with the devolved administrations. The next Spending Review will take place soon after the UK General Election in 2015. It will be up to us in Wales to press the UK political parties to commit in their manifestos to Wales receiving its consequential share of HS2 expenditure. Following the election and in the lead up to the release of the Statement of Funding Policy the governments of Wales, Scotland and Northern Ireland will need to ensure that funding of HS2 will have Barnett consequentials for the three devolved administrations.