Economics of the Bullingdon boys – wealth funds

Yesterday, Boris Johnson picked up on a topic which was announced by George Osborne the day before at the Conservative Party conference. Local authority pension funds were to be amalgamated into “wealth funds” to allow them to invest in the UK’s infrastructure. That is what the Bullingdon boys are now proposing.

Now, this seems a bit peculiar. As at the moment any infrastructure I know of (roads, railway lines, schools, hospitals) does not make any money. Pension funds, however, invest in things which give them a return. For example, investing in one of the biggest 100 companies on the London Stock Exchange would give them, on average, a 4% dividend payout. In addition to that, many companies buy back their shares and inflate their prices, thereby allowing companies to pay out 60-70% of their profits to shareholders, according to Andy Haldane, the Bank of England’s Chief Economist.

That then gives the pension funds the income it will need to pay pensions, either by selling the assets (shares) it has, or just using the income from dividends.

However, roads, railways, schools and hospitals, the infrastructure which Britain needs, does not produce any income. Neither are we planning to sell the existing infrastructure, which would produce sales receipts to pay pensions. The current railway network in the UK  is subsidised to the tune of £4bn a year, it costs us money, it does not provide a return. So these assets are unsuitable to be included in pension funds.

But new infrastructure will need to be build. The most urgent need is a replacement of our power stations, which will need to be replaced by new nuclear power stations, if we want reliable electricity production and get away from carbon emitting coal and gas power stations. The private sector is not able to provide new nuclear power, such as Hinkley Point C, at the current electricity price. So it will only be build if the state sector guarantees prices (at 2.5 times current electricity prices) and indemnifies the finance providers with government guarantees. The contractors are firms owned by the French and Chinese government. The private sector is almost completely invisible here, other than to provide the finance.

boris johnsonBoris Johnson, the Mayor of London, trying to keep the lights on.


The bill for the new Hinkley Point C power station is currently £25bn. Where would the wealth fund come in? Arguably, the wealth fund could provide all the finance for the power station. And in turn it would look for a 4% return on its investments, as it would get from the other investments it currently holds.

That would mean that the power station would need to pay out £1.0 billion to the investors just in interest (which is 4% of 25bn). However, unlike companies’ shares, the power station is a wasting asset, after about 50 years it will need to be scrapped. So in addition to the 4% interest income the £25bn will have to be paid back, just like a repayment mortgage over 50 years. That would make the annual financing costs about £1.2bn. We have previously estimated that the electricity from Hinkley C would cost the electricity users about £2bn a year. So 60% (£1.2bn of £2.0bn a year) from the sales of the electricity will have to go straight to the pension funds! For financing costs. Electricity users will pay for the public sector pension funds.

So let us be quite clear what happens here. There is virtually no private sector, no market involved. Everything is decided by the government, the builders are government owned, the pension funds are government owned, the price of the electricity is determined by the government, as is the return of the investment for the pension fund. Because unless the return to the pension fund is guaranteed, it has to invest in other assets which have a higher return and more liquidity.

The only private sector involvement would come in from the management fees of the 6 bid pension funds. A concentration of power to the biggest investment funds. (Will Blackrock be involved? Almost certainly, as one of Osborne’s Chief of Staff left the Treasury to join them in the summer!)

Now, would it make sense for the pension funds to invest in Hinkley C? Possibly, if the government could guarantee the £1.2bn per year income for the next 50 years. Because the total of the local authority pensions funds assets at the moment only amount £180bn. So one seventh of the pension investments of all local authority public sector workers would now be invested in Hinkley Point C! Quite risky, without a government guarantee.

Now, what does Boris Johnson think of the Hinkley Point C power station, is it a good investment, and be suitable for inclusion in the wealth fund? Here is what he said a few weeks ago:

We have just done this absolutely crazy deal with the French, EDF Energy, to produce nuclear energy which shows no sign of working and looks like being unbelievably expensive at approximately £93 a kilowatt hour. It is a huge amount of money we are spending on nuclear energy. Hinkley Point B (sic) [nuclear power station] does not seem to coming down the track.

We need to be looking at building many more gas-fired power stations. At the moment, I am afraid, it is taking too long.

So, Boris Johnson presumably thinks this “crazy deal” should not form part of the wealth fund?

Well, fair enough, what else then? The gas-fired power stations he is talking about are being financed by the current electricity generators, and do not need a wealth fund.

I am not going to look at the other major infrastructure investment plan, the HS2 high-speed railway line between London and Birmingham. The estimated cost is at least twice as much as the Hinkley C power station. Whereas all of the UK will benefit from the power station, as we are all electricity users, it will only be a very small portion of users who will benefit from HS2. New passengers will clearly not pay for the cost of the new line, as it would make the cost of a ticket prohibitively expensive. HS2 is therefore another state investment which is run at an economic cost (i.e., loss) to the government, will subsidise rail travel, and not suitable for investment by a wealth fund.

So what will go into these wealth funds? I cannot see any public wealth which would be suitable for inclusion in a pension wealth fund, as it never generates the income or provide the liquidity which a pension fund will need. If Hinkley C goes ahead, it should be financed differently, with the help of very low government finance, or PQE. Thereby making sure that UK electricity users do not provide extortionate interest income to either the financial sector (the current model) or local authority pensioners (if the wealth fund idea was to go ahead).

In summary, the idea of a wealth fund just another stupid idea by the Bullingdon boys, and will go the same way as the pasty tax, and should get reversed. Let us all hope so.

I would think it is high time to change the economic management of this country from the catastrophic Bullingdon Boys to capable managers of the economy. Roll on 2020.

Embedded image permalink

George Osborne, the Chancellor of the Exchequer, relaxing, before becoming chancellor

Credit: @George_Osborne twitter feed


2 thoughts on “Economics of the Bullingdon boys – wealth funds

  1. “I would think it is high time to change the economic management of this country from the catastrophic Bullingdon Boys to capable managers of the economy”

    And who might that be? The Labour party? Richard Murphy? You?


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