4. Fiscal frameworks and public investment financing in Wales

Abstract

This chapter, divided into two parts, explores the challenges surrounding fiscal frameworks and public investment financing in Wales. Part 1 features the constraints that the Welsh Government and Welsh local authorities face in their fiscal frameworks, and how these affect the ability of governments to fulfil their responsibilities, including in public investment for development and growth. Part 2 makes a case for introducing a coherent public investment framework for regional development in Wales, particularly given a need to optimise limited resources. It explores ensuring co-ordinated public investment in light of Brexit, discusses existing and new investment financing practices, and calls for making the most out of City and Growth Deals. It also offers insight into building capacity for stronger place-based public investment and highlights some innovative sources of public investment financing, including land value capture, green procurement and participatory budgeting.

Introduction

Welsh capacity to invest in its regional development agenda – one that promotes growth plus inclusiveness – faces two significant challenges. The first is a constrained fiscal framework, characterised by limited devolution (including with respect to expenditures), and limited revenue-generating capacity, which contributes to a large fiscal gap. Combined, this affects the ability of the Welsh Government and Welsh local authorities to generate sufficient revenue to self-finance the majority of their investment needs and to bridge the investment gap created by several years of austerity measures. The second challenge is limited sources for financing regional development investment. Wales relies on two sources. The first source of investment financing comes from the Welsh Government department budgets, used to meet national and subnational sector policy aims. The second source, specifically targeting regional development, is the European Union (EU) Structural and Investment Funds (ESIF) as well as EU competitive funding. For the 2014-20 programming period, it received approximately GBP 700 million annually from EU financing sources (of which approximately GBP 300 million were directed to regional development through the European Regional Development Fund [ERDF] and European Social Fund [ESF]) (Welsh Government, 2020[1]). Post-Brexit, the United Kingdom (UK) government has promised a level of investment financing equivalent to that received from the EU (House of Lords, 2020[2]). The exact value, and the terms and conditions for the disbursement of the intended replacement for European funding (e.g. block grant transfer, competitive funding or a combination of both), however, remain unknown at the time of writing this report. To manage this uncertainty, Wales will need to enhance and ensure the sustainability of its finances. Doing so means strengthening the coherence of its fiscal institutions and rules in order to improve its capacity to attract public and private investment, and support inclusive growth. It also means ensuring that public investment funds are maximised and used as effectively as possible.

The Welsh Government aims to build its investment capacity for regional development, making the most of limited resources and identifying ways to attract additional ones. Over the past years, it has engaged in several consultations and studies to explore new revenue sources, including external resources and private finance (National Assembly for Wales, 2019[3]; Auditor General for Wales, 2018[4]). This chapter is presented in two parts. Part 1 focuses on Welsh fiscal frameworks at the national and subnational levels and their role in supporting or impeding investment for regional development. It explores the degree of fiscal devolution in Wales and examines the sources of its fiscal gap. It also offers insight into mechanisms to help reinforce these fiscal frameworks, such as territorial equalisation, optimising revenue sources and increasing local financial capacity. Part 2 examines the investment frameworks that support regional development. It analyses the main components of a proposed national investment framework and how it can add value by aligning objectives and priorities across sectors and levels of government. It also examines how to support more place-based investment. Finally, this section explores the potential for Wales to use a series of innovative financing mechanisms to help fill its investment gaps.

Part 1: The role of fiscal frameworks in Welsh public investment capacity

For Wales to realise its regional development agenda, one that values growth, inclusiveness and emphasises a place-based approach, reinforcing the existing fiscal and financial arrangements will be necessary. The Welsh Government is aware of the constraints on its ability to implement this agenda, including a weak tax base, an enduring fiscal deficit and a strong reliance on intergovernmental transfers from the UK government.

Fiscal frameworks – all arrangements, procedures, rules and institutions that underlie the conduct of government budgetary policies – are the foundation for government capacity to finance investment in the short, medium and long terms, and to ensure inclusive growth (Kim and Dougherty, 2018[5]). At the national level, they set the budgetary parameters and spending vision for the whole country; at the regional and local levels, they shape fiscal outcomes and directly affect investment, business productivity and growth. Across the OECD, subnational governments are responsible for approximately 41% of total public expenditure, and they collect, on average, 32% of tax revenue (OECD, 2020[6]). This provides subnational governments with considerable scope to affect their country’s fiscal and economic outcomes through policies that contribute to determining how private stakeholders and citizens spend, pay taxes and invest (Kim and Dougherty, 2018[5]).

To a large extent, Welsh fiscal prospects depend on the UK government’s fiscal position, as this determines the size of the budget grant transferred to the Welsh Government. It also depends on the revenues raised from devolved taxes. Predictions vary regarding the impact of Brexit on the UK and, as an extension, Welsh fiscal health. Recent reports estimate that a no-deal Brexit could lead to a decrease of 2% of UK gross domestic product (GDP) per year (Nabarro and Schulz, 2019[7]) and this decline could be further affected by the COVID-19 crisis. This means that fiscal settlements in Wales will most certainly need to be reviewed in accordance with political decisions to ensure a stable future for Wales.

In recent years, the Welsh fiscal framework 1 has improved. This is linked to an increasing share of own-source revenue and greater borrowing powers attributed to the Welsh Government and local authorities. Yet, there is still room for further improvement. This is particularly true if fiscal frameworks and budget capacity are to meet the challenge of increased pressure arising from greater public service demands and the need for climate change action, as acknowledged by the Welsh Government in its draft budget for 2020-21 (Welsh Government, 2020[1]) and unforeseen expenditures arising from COVID-19.

As an investment-support mechanism, the Welsh fiscal framework faces three significant constraints:

1. Limited fiscal devolution, which affects the ability of all levels of government to set and finance investment priorities.
2. A fiscal gap between spending and revenues.
3. Limited revenue-generating capacity, which compounds the fiscal gap at the Welsh government and local authority levels.

This section explores these challenges and the mechanisms available to the Welsh Government to address them, including territorial equalisation to reinforcing local tax revenue, borrowing powers and increasing financial and administrative capacities of local authorities.

Potential links between limited fiscal devolution and Welsh regional disparities

Devolution in Wales is an ongoing process that began in 1998. While political and administrative devolution were relatively quick to take hold, fiscal devolution has been slower and is more limited, with the most recent step taken in 2017 (Box 4.1).

Box 4.1. Fiscal devolution in Wales

Fiscal devolution began in 1998 with the Government of Wales Act, which devolved the Council Tax (a hybrid property/household tax) and Non-Domestic Rates (NDR) (non-domestic property rates) policy to Welsh ministers from 1999. More recently, the Wales Act 2014 granted limited borrowing powers to the Welsh Government and, separately, responsibility for the budgetary management of NDR was transferred on 1 April 2015. The act also devolved the Land Transaction Tax (LTT) and Landfill Disposals Tax (LDT) as of April 2018. Finally, the devolution of Welsh Rates of Income Tax (WRIT) went into effect in 2019. This resulted in a reduction of UK rates by 10%, which the Welsh Government could reapply at the same rate or higher. For the moment, the Welsh Government has maintained 10%. At the same time, the UK government retains responsibility for most aspects of the WRIT, including collection and administration, setting the personal allowance and income thresholds, and taxing income from savings and dividends. In exchange for the tax revenue generated by the devolved taxes to the Welsh Government, the UK government reduced the block grant funding it provides Wales by an equivalent amount.

Figure 4.1. Timeline of fiscal devolution in Wales

Thus far, the result of the Welsh fiscal devolution process appears mixed and somewhat unbalanced. On the one hand, there are indications it is increasing. This is evidenced by the periodic adjustments to the devolution agreement over time and an increase in measures of regional authority in the UK. Wales’ cumulative score in the Regional Authority Index (RAI),2 went from 2.0 in 1990 to 15.5 in 2010 and 17.5 in 2016, out of a maximum of 24.0. This is positive as it gives some indication of the degree of change in the Welsh Government’s decision-making power and capacity to devise and finance policies within its jurisdiction. On the other hand, the application of fiscal decentralisation in Wales remains limited and there is an imbalance between devolved spending responsibilities and revenue-generating opportunities.

In general, decentralisation in the UK is low compared to other OECD countries when measured by subnational government contributions to GDP and total tax revenue (the higher the contribution, the more a country is considered to be decentralised) (Figure 4.2). Within the UK, the degree of fiscal devolution varies among the devolved nations. Since Northern Ireland, Scotland and Wales obtained their own elected assemblies and government in 1999, various degrees of “devolved” powers 3 were granted to each. With time, the devolved institutions in Scotland and Wales have taken on greater powers, compared to Northern Ireland where devolution was suspended several times. Scotland has full legislative powers over a wide range of policy areas, whereas in Wales these are more limited, focused mainly on secondary legislation (OECD, forthcoming[9]). This is one explanation, for example, as to why Scotland’s score on the abovementioned RAI grew more than that of Wales in the same period. Like Wales, Scotland began with a score of 2.0 in 1990, which, in 2016, was 20.5 (compared to 17.5 in Wales) (Hooghe et al., 2016[10]). The difference between Scotland and Wales is attributed to Scotland’s higher ranking in indicators related to institutional autonomy (vis-a-vis the UK government), the capacity to set the base and rates for major taxes and the degree of independence of the region’s legislature and executive. Such imbalances may exacerbate inequalities among the devolved nations (Northern Ireland, Scotland and Wales) and England.

Figure 4.2. Decentralising and recentralising trends in the OECD over the 1995-2018 period

Within Wales, devolution in spending responsibilities is limited. A spending increase in Wales may not reflect a change in effective responsibility – i.e. decentralisation – because a large share of spending remains undertaken by the UK government.4 Thus, a distinction must be made between total expenditure for Wales (including by the UK government) and total expenditure by the Welsh Government and local authorities.5 While Figure 4.2 illustrates that decentralisation in the UK as a whole is around the OECD average, when this is broken down and examined at the regional level, the story is slightly different. Figure 4.3 highlights national averages of regional spending. It indicates that the UK’s three devolved nations account for a low share of total public spending when compared to regions in the OECD and the EU (OECD, 2020[12]) – pointing to the fact that actual devolution at the UK subnational level remains low.

Fiscal devolution is also unbalanced between the decentralisation of spending responsibilities and the decentralisation of revenue (i.e. the transfer of revenue-generating capacity versus grants). Decentralising revenue is often less popular with higher levels of government than decentralising spending as it can mean relinquishing income sources. Yet, it appears to be more strongly associated with GDP growth than spending decentralisation and potentially even more so in a context of fiscal gaps (Kim and Dougherty, 2018[5]; Asatryan and Feld, 2014[13]). Furthermore, recent empirical evidence indicates that revenue decentralisation could be associated with smaller regional economic disparities by encouraging growth and convergence dynamics in lagging regions (Bartolini, Stossberg and Blöchliger, 2016[14]). The Welsh Government and local authorities are responsible for a wide range of service and administrative responsibilities (Annex 4.A), representing a significant amount of expenditure. This is not matched by equally strong revenue devolution (explored below). Care needs to be taken to ensure balanced devolution of spending and revenue responsibilities – and ideally, spending and revenue decentralisation should match (though they rarely do). Otherwise, there is a risk of exacerbating territorial inequalities, including in the accessibility, type, diversity and quality of services that subnational authorities are able to provide, as well as in investment capacity. Approaching fiscal decentralisation in a balanced fashion can help address a fiscal gap, as has been the experience in Belgium (Box 4.2).

Figure 4.3. Regional government spending contributions as a percentage of total public expenditure and national GDP in OECD and EU countries

Box 4.2. Balancing spending and revenue decentralisation in Belgium

Belgium’s 6^th state reform of 2014 marked a major change in the intergovernmental framework by transferring additional responsibilities and strengthening the financial autonomy of Belgium’s three regions: the Brussels-Capital Region, Flanders and Wallonia. This reform is a continuation of a process of decentralising decision-making power to the federated entities that began in the 1970s.

This latest reform transferred additional responsibilities to regions in several areas and significantly increased regional own-source tax resources in order to reduce the vertical fiscal gap. Since 2014, the Brussels-Capital, Flemish and Walloon regions can levy a regional personal income tax (PIT) by means of an additional regional tax on the PIT. This tax is in addition to a fraction of the national PIT that is already shared with regions and to 12 other own-source taxes (e.g. registration duties, inheritance and gift taxes, etc.). The fiscal reform also increased the regional tax powers related to tax bases, tax rebates, exonerations and refundable tax credits. Furthermore, the reform transferred additional responsibilities to regions, particularly in the areas of mobility, labour market policy and justice. In parallel, the Flemish and Walloon regions are engaged in local government reforms within their own jurisdictions, aiming to increase the autonomy, scope of action and revenues of municipalities.

As a result of the reform process, the share of the revenue and expenditure of regions in Belgium in terms of GDP increased by slightly more than 4 percentage points between 2010 and 2016, and by 7 and 8 percentage points in total public expenditure and revenue respectively over the same period.

Source: OECD (2020[12]), Pilot Database on Regional Government Finance and Investment: Key Findings; OECD/UCLG (2019[17]), 2019 Report of the World Observatory on Subnational Government Finance and Investment – Country Profiles, http://www.sng-wofi.org/reports/SNGWOFI_2019_report_country_profiles_DEC2019_UPDATES.pdf.

Managing a large fiscal gap: Spending responsibilities

Approximately 60% of total public expenditure on services in Wales 6 is financed by the Welsh Government and local authorities, with the remaining 40% funded by the UK government (HM Treasury, 2019[18]; ONS, 2019[15]). Most expenditure responsibilities are shared among levels of government and the distribution of spending responsibility for Wales is uneven (Figure 4.4). None of this is unusual. In any decentralised system, many tasks are shared to greater or lesser degrees among levels of government. What is striking, however, is the limited level of expenditure in economic affairs, which includes economic development, transport, communications, energy and construction, as defined by the COFOG 7 classification. In 2017, on average, almost 14% of OECD subnational government spending focused on economic affairs (OECD, 2020[6]), compared to 9% in Wales (the Welsh government and local authorities combined) for the same year (ONS, 2019[15]; Welsh Government, 2019[19]).

In terms of budget allocation, economic affairs accounted for 15% of the Welsh Government budget spending in 2017, compared to 21% on average among regions in EU and OECD countries (OECD, 2020[12]). This may be one factor contributing to the below-UK-average performance of the road transport network in most Welsh small regions, as well as to the low performance of public transport efficiency and labour productivity in the metropolitan area of Cardiff (Chapter 5). At the local authority level, economic affairs represent 6% of their spending, compared to 12% on average for local governments across the EU (OECD, 2020[6]). The fact that Welsh local authorities spend less on economic affairs than the Welsh or UK governments (Figure 4.4) is to be expected. Yet, this may signal limited development capacity in key areas that promote their growth. In light of the Welsh Government’s regional development agenda, this foreshadows significant future budget pressure on the Welsh Government and local authorities.

Cuts in UK government spending arising from the fiscal and economic crisis and the austerity measures that followed, further strained the Welsh Government’s spending capacity. These cuts had an uneven impact on sectors with a role in regional development, such as transport, education and training, environmental protection and in science and technology. Public investment in these areas was below the UK average in 2017 but relatively higher in economic development and public order and safety (Ifan, Siôn and Poole, 2019[20]). This undoubtedly reflects strategic decisions taken by the Welsh Government in the face of budget cuts. However, it also reflects limited devolution – specifically in those sectors with lower-than-average capital expenditure that are only partially, or not, devolved. Analysis suggests that spending on UK government programmes that have an incidence on economic development in Wales is significantly lower than comparable spending in England. For instance, capital expenditure by the UK government on new public infrastructure is lower in Wales. This is especially true in transport (76% of UK average) and science and technology (75% of UK average) (OECD, 2019[11]; ONS, 2019[15]). From a purely fiscal point of view, unless budget levels and own-source revenue increase post-Brexit, Wales’ reliance on transfers for investment in economic development will likely continue, with long-term consequences on investment levels. The strain also affects the sub-municipal level where many town and community councils lack the human resources and/or specialised expertise (e.g. legal or procurement) to expand core service provision or take on the management of public assets. While sub-municipal governments may have reserves and long-term assets, their capacity to manage their spending, along with local taxation, is limited (Auditor General for Wales, 2018[21]).

Figure 4.4. Total public expenditure on services in Wales, 2017-18

To overcome its fiscal imbalance, the Welsh Government has undertaken a combination of fiscal consolidation measures and reduced public spending, leading to strong austerity effects. This has resulted in a drop in the deficit from 23.5% of GDP in 2013 to 19.4% of GDP in 2017 (Ifan, Siôn and Poole, 2019[20]; ONS, 2019[15]). Despite this, in 2017 Wales ranked second in the UK in terms of total public sector 8 expenditure as a share of GDP. Furthermore, its total public revenue per capita is among the lowest in the UK over the past 20 years, resulting in one of the UK’s highest total fiscal deficits per capita (Figure 4.5) (Ifan, Siôn and Poole, 2019[20]). Given this situation, fiscal consolidation measures are expected to continue. To address this, boosting the Welsh tax base and the relative performance of the Welsh economy is necessary.

Figure 4.5. Total public expenditure and revenue as a percentage of GDP in UK regions, 2017-18

Managing a large fiscal gap: Revenue-generating capacity

One side of the fiscal gap is generated by expenditure requirements. The other is the result of limited revenue or revenue sources. Revenue diversity at the Welsh Government level is low (Figure 4.6). Currently, up to 80% of Welsh Government revenue is composed of a block grant from the UK government (determined by the Barnett formula). An additional 6% of the Welsh Government’s total budget comes from specific grants from UK government departments (Welsh Government, 2018[23]). Investment is mostly funded by grants from the UK government, borrowing and external financing (e.g. EU Structural Funds). Among regional governments 9 in the EU and OECD, grant revenues account for 50% of total revenue, on average (OECD, 2020[12]). This relatively high rate of revenue centralisation affects the Welsh Government’s fiscal autonomy and limits its ability to spend on its identified expenditure priorities.

The opportunities of the Welsh Government and local authorities to generate own-revenue through taxes, user charges and fees are limited (Figure 4.7). First, the UK centralisation of tax revenue is a constraining factor. Second, the Welsh tax base is low. Third, own-source taxes are limited and new, and fees and user charges are used sparingly. Looking only at the Welsh Government’s revenue, devolved taxes – the Land Transaction Tax (LTT), Landfill Disposals Tax (LDT) and Welsh Rates of Income Tax (WRIT) – are expected to account for approximately 14% of its revenue by 2019-20 (Welsh Government, 2020[1]). While this adds to the revenue base, it is well below what is seen among regional governments in the EU and OECD, where the share of tax revenue as a portion of total revenue averages 35% (OECD, 2020[12]). Adding to this are fiscal revenues from the Council Tax, and Non-Domestic Rates, collected at the local level. In 2019, in total, tax revenue in Wales represented approximately 17.5% of its total revenue (Ifan, Siôn and Poole, 2019[20]). This can support greater fiscal autonomy in terms of spending decisions but the level is significantly lower than the 2018 average 10 of 44.4% for subnational governments in the OECD (OECD, 2018[24]) and does not itself bridge the fiscal gap. The balance between own-revenue (and particularly tax revenue) and expenditure is a factor of political accountability and a key driver for more place-based policies and responsiveness to people’s needs (OECD, 2019[11]).

Figure 4.6. Breakdown of regional government revenue by type in OECD countries, Northern Ireland, Scotland and Wales

The Welsh Government’s underlying financing principle is to rely first on transfers before resorting to borrowing or other private finance schemes (Holtham, 2019[26]). This is partly due to the constraints posed by its fiscal deficit and its low share of own-revenue but also because the UK’s system of fiscal control caps 11 Welsh Government spending. When the Welsh Government does borrow in order to bridge its fiscal gap, most of it is through the UK Treasury’s National Loans Fund. The Welsh Government can borrow up to GBP 150 million per year for capital expenditures and carry up to a total of GBP 1 billion in capital expenditure debt at any given time. It can also borrow up to GBP 200 million annually for current expenditures, with a limit of GBP 500 million indebtedness at any given time (Audit General for Wales, 2018[27]).

Figure 4.7. Main tax and grant revenue streams in Wales

The situation for Welsh local authorities mirrors the Welsh Government’s dependence on transfers and its limited revenue generation capacity (Table 4.1), as they are heavily reliant on transfers from the Welsh and UK Governments. In 2017, 61% of total local authority revenue came from current grants, including the Revenue Support Grant (RSG, accounting for 56% of total grants) and specific grants (e.g. a housing benefit and police grants, accounting for 36%). The remaining 8% of transfers were capital grants to finance investment (capital expenditures). In addition, Welsh local authorities can raise tax revenue through Council Tax (their main source of tax revenue) and Non-Domestic Rates (NDR).12 NDR receipts, mainly collected by local authorities, are channelled to the Welsh Government and are then distributed to local authorities through needs-based funding allocations. There are no highly polarised revenue models between the different local authorities as the distribution of NDR has an equalising function. Some additional revenue comes from UK government department-specific grants for non-devolved functions and from capital receipts for financing current and capital expenditure. Capital transfers (i.e. from the UK and Welsh Governments, European Structural Funds and National Lottery funds) and borrowing made up the bulk of investment financing in 2017-18, followed by own-revenue and capital receipts from the sale of fixed assets belonging to local authorities (e.g. land, council homes).

Table 4.1. Local Authority revenue by category, 2017-18
	Local currency (GBP thousand)	Percentage of local authority revenue	Percentage of Wales regional GDP
Grants and subsidies	5 517 295	61	7.9
Revenue support grant	3 107 570	34	4.4
Specific current grants	1 985 126	22	2.8
Capital grants	424 598	5	0.6
Council tax	1 192 917	13	1.7
Non-Domestic Rates (NDR)	1 002 491	11	1.4
Tariffs and fees	1 242 743	14	1.8
Capital receipts	79 216	1	0.1
TOTAL	9 034 662	100	12.9
Note: Local governments include the 22 unitary authorities. The council tax figure corresponds to amounts to be collected from the council tax, after council tax reductions and discounts. NDR correspond to the share of distributed NDR net of reliefs. Tariffs and fees correspond to total income from services. Capital grants correspond to capital grant and other contributions, including Major Repair Allowances and grants from European Community Structural Funds.
Source: Author’s calculations based on Welsh Government (n.d.[28]), Local Government Finance, StatsWales, https://statswales.gov.wales/Catalogue/Local-Government/Finance; OECD (2020[16]), OECD Regional Statistics, Database, https://stats.oecd.org/Index.aspx?DataSetCode=REGION_DEMOGR

User charges and fees are frequently used by subnational governments in the OECD to generate additional revenue and are quite common at the regional and local levels in Finland, France, Switzerland and the United States (US). Welsh local authorities derive 14% of their revenues from this category, which is aligned with the 2018 OECD average of 15% for subnational governments (OECD, 2019[11]; StatsWales, 2018[29]; OECD, 2020[6]). Generally, subnational governments have significant leeway in the collection of such revenue. They may face restrictions in certain sectors, however, such as in education and energy, (OECD/UCLG, 2019[30]), and they can also be limited by their own ability to deliver services to which user charges and fees apply.

Despite few financial levers to cope with austerity, over the past decade, Welsh local authorities have strengthened their autonomy. This is evidenced by the reliance of Welsh councils on local tax rate increases to compensate for the reduced RSG (Ogle, Luchinskaya and Trickey, 2017[31]). The share of tax revenues increased, from 19% for the NDR and Council Tax combined in 2007-08, to 24% in 2017-18, which was mirrored by a decrease in the share of grants received – from 65% to 61% in the same period. However, local authorities that rely more heavily on grants were only partially able to offset the reduction in transfers received from the Welsh Government, based on the revenue they could derive from the Council Tax (Holtham, 2019[26]). This widened the fiscal gap, particularly for most deprived localities with more limited capacity to collect taxes.

Reducing the fiscal gap at the local authority level is necessary to ensure that local debt can be managed in a sound and sustainable fashion in the future. With the decrease of capital transfers from the Welsh Government since 2008, local authorities increasingly rely on unsupported borrowing and on their own-revenue to fund investment. This increased pressure on their ability to raise future income to pay off their debts. Local borrowing 13 is mainly composed of prudential or unsupported borrowing (making up 77% of total borrowing) and supported borrowing (22%), which attracts central government financial support (Audit General for Wales, 2018[27]; StatsWales, 2018[29]). The share of unsupported borrowing in local investment funding nearly tripled between 2008 and 2018 (mostly from the Public Works Loan Board). Recently, the cap on local borrowing to build housing was fully lifted in an effort to enhance local-level borrowing capacity. In 2017, local borrowing 14 amounted to GBP 431 million, or 0.6% of Wales’ regional GDP (StatsWales, 2018[29]).

This fiscal gap is expected to be exacerbated in the face of the COVID-19 crisis. In the short term, the crisis is straining subnational spending given demands on public service delivery (Box 4.3). In the medium and longer terms, it will strain revenue for both the Welsh Government and local authorities. In the Welsh context, such setbacks should be financially compensated by similar drops in tax revenue in England and automatic adjustments of the Barnett formula. There are, however, several factors that may exacerbate the crisis’ impact in Wales. These include the share of the population that is aged and/or infirm, its reliance on the tourism industry and the large share of small- and medium-sized enterprises (SMEs). An automatic adjustment of UK government transfers through the Barnett formula may not cover the financial impact of the COVID-19 crisis in Wales. To fund its coronavirus response, the Welsh Government has been relying on unallocated funds from the Wales Reserve Fund and reallocating further savings from other areas of the budget (e.g. EU-funded projects). It has also planned to borrow GBP 125 million for capital spending purposes in 2020-21, close to its annual borrowing limit of GBP 150 million. However, current borrowing rules do not allow it to cover the cost of new planned day-to-day spending, including financial responses to COVID-19, through borrowing (Cardiff University, 2020[32]).

Box 4.3. Managing the impact of COVID-19 impacts on subnational finance

The COVID-19 pandemic and the subsequent economic crisis has a direct incidence on national and subnational government budgets. In the short term, locally delivered public services must be maintained and often adjusted to meet the requirements of the health emergency. In the medium and longer terms, the revenues generated by subnational taxes (e.g. income, property, corporate) will presumably decrease in the years to come. Subnational governments may also suffer from a strong decrease in user charges and fees, resulting from the decline or closure of numerous public services and facilities.

These setbacks are common to countries across the OECD and beyond. The pressure of the crisis on subnational government finance depends on a series of factors: the exposure of each location to COVID-19, the fiscal flexibility of subnational governments to absorb the exceptional stress, the existence of rainy-day funds or set-aside reserves, and the scope and efficiency of support policies from higher levels of government. The OECD has listed a range of measures that subnational governments can implement in the short, medium and long terms to face these challenges:

Short-term measures to adapt subnational finances to the emergency can include increasing health- and social-protection-related public expenditure, postponing (national) account closures as well as the adoption of next year’s budget.
In the medium term, subnational government priorities should be focused on managing the economic, social and public finance crisis. This includes developing policies to compensate subnational revenue drops and help subnational governments cope with large expenditure increases arising from greater demand for social benefits, support to vulnerable groups, the general economic recovery, etc. It also means addressing a potential subnational debt crisis and anticipating a fiscal exit strategy.
In the long term, subnational policies might need to focus on increasing the resilience of social and economic systems, to ensure preparedness for future shocks. Financially, this could mean increasing investment in healthcare and other public services. It could also lead to rethinking multi-level governance and financing systems to make them more robust.

Note: The report on which this box is based was released in early April 2020. It does not take into account the development of the COVID-19 crisis or responses past that time.

Source: OECD (2020[33]), “The territorial impact of Covid-19: Managing the crisis across levels of government”, https://www.oecd.org/coronavirus/policy-responses/the-territorial-impact-of-covid-19-managing-the-crisis-across-levels-of-government/.

Addressing the fiscal challenges: From territorial equalisation to building local financial management capacity

The limitations arising from the Welsh Government’s fiscal framework combined with a need to ensure long-term, place-based investment makes optimising its fiscal opportunities imperative (e.g. by reconsidering its equalisation system and expanding own-source revenue). A stronger fiscal framework would provide a more resilient foundation for leveraging access to external financing and enhancing Welsh national and subnational capacity to invest in regional development.

Striving for territorial equalisation

Equalisation policies help address disparities generated by differences in revenue-raising capacity and differences in public service expenditure (Box 4.4). In the first category, unequal tax-raising capacities come from differences in per capita GDP across jurisdictions. In the second, they are linked to specific geographic factors (e.g. mountains, islands, isolated or low-density areas, etc.) or special groups such as children, the elderly, the disabled, etc. that can contribute to a higher cost per service unit, raising the overall cost of public services. In most instances, the effect of equalisation on managing fiscal disparities among subnational governments is substantial across the OECD. For example, across OECD countries, it has diminished fiscal disparities from 29% to 10% (as measured by the Gini coefficient or variation coefficient). Furthermore, it has helped countries such as Australia, Germany and Sweden virtually eliminate revenue-raising disparities (OECD, 2019[11]; 2013[34]).

Box 4.4. The pros and cons of fiscal equalisation mechanisms

Equalisation mechanisms can be applied through transfers from the central/federal government to subnational governments that are financially weak (vertical transfers) or through horizontal from the wealthiest subnational governments to the poorest (horizontal transfers), or both. Equalisation schemes also aim to establish national standards that ensure equal access to local services and a minimum level of quality for local public service provision. While most OECD countries use various equalisation arrangements that combine horizontal and vertical equalisation with tax revenue and cost equalisation, vertical equalisation tends to prevail. However, equalisation is frequently the subject of technical and political debate and is often contested for its complexity and lack of transparency. An additional concern, particularly with respect to horizontal equalisation, is that it can reduce subnational government incentive to develop its own-tax base among the poorest and wealthiest local authorities. This is because poorer local governments may rely too heavily on the grant system to provide an adequate revenue base and wealthier ones may be reluctant to develop their tax base if they feel they will insufficiently benefit from the revenue generated.

Source: OECD (2019[11]), Making Decentralisation Work: a Handbook for Policy Makers, https://doi.org/10.1787/g2g9faa7-en; Blöchliger, H. et al. (2007[35]), “Fiscal equalisation in OECD Countries”, https://www.oecd.org/ctp/federalism/39234016.pdf.

Given the territorial disparities in the UK, including in Wales, and the associated impact on spending and revenue-generating capacity, additional consideration should be given to using equalisation arrangements to address these. This is just as true between the UK and the Welsh Governments, as it is between the Welsh Government and local authorities. In the UK, revenue allocation to the three devolved nations aims to guarantee similar levels of public services. It is calculated using the Barnett formula, which is based on increases in spending incurred by the UK government in England and then redistributed to Northern Ireland, Scotland and Wales, based on population shares. At the Welsh local authority level, intergovernmental transfers are based on a Standard Spending Assessment (SSA) for each service area across local authorities (Box 4.5) (Holtham, 2019[26]). As part of the 2019-20 settlement, the Welsh Government provided additional top-up funding to ensure no authority faced a reduction of more than 0.3% (Welsh Government, 2019[36]).

Box 4.5. Calculating transfer allocations to the Welsh Government and local authorities

The Barnett formula for Northern Ireland, Scotland and Wales

Most of the UK government funding allocated to the devolved administrations is determined through the Barnett formula (applied since 1978 in Northern Ireland and Scotland, and 1980 in Wales). Each devolved administration’s block grant is calculated by taking the previous year’s grant and adding a population-based share of the changes in planned UK government spending on those comparable functions and services that have been devolved. This aims to ensure that the devolved administrations receive a population-based share of any changes in what the UK government is spending on the public services in England that are devolved in Northern Ireland, Scotland and/or Wales. It is estimated, however, that the formula tends to reduce the Welsh grant relative to English spending over time, because of higher expenditure per head in Wales than in England. Therefore, increments per head result in a smaller proportion of the Welsh grant than of English expenditure on the same items.

The formula was amended twice in recent years to adjust to the Welsh context. The first amendment was in 2015 and introduced a “funding floor”. This was in response to the findings and recommendations of the Holtham Commission, which reported that Wales needed additional funding in recognition of its more dispersed population and greater prevalence of poverty. This funding floor should ensure that block grant funding for the Welsh Government does not fall below 115% of equivalent funding per head in England. In reality, this threshold has only been crossed twice since devolution (in 2008 and 2009). At present, Wales gets around 120% funding per head. The formula was amended a second time in 2017, following the devolution of fiscal powers to the Welsh Government. The Welsh Government’s block grant was reduced to reflect the fact that revenues from devolved and partially-devolved taxes now go directly to the Welsh Government rather than the UK Exchequer. At the same time, a needs-based factor was included in the Barnett formula providing the Welsh Government with an additional 5% on top of new allocations. This needs-based factor will be increased to 15% if the relative funding position falls to 115% of equivalent funding per head in England.

The Standard Spending Assessment (SSA) for Welsh local authorities

Intergovernmental transfers for Welsh local authorities are made through the Revenue Support Grant (RSG), whose calculation is based on a SSA for each service area. SSAs are intended to reflect variations in the need to spend which might be expected if all authorities responded in a similar way to the demand for services in their area. The SSA is conducted annually based on three elements: i) the allocation of distributed Non-Domestic Rates (NDR), based on the population; ii) Council Tax income, based on a standard council tax figure, multiplied by the number of chargeable dwellings within the authority; iii) a “balancing” sum, which tops up the amounts available from NDR and Council Tax, and enables an authority to spend its SSA.

Source: Audit General for Wales (2018[27]), Guide to Welsh Public Finance, https://www.audit.wales/system/files/publications/guide-to-welsh-public-finance-english.pdf; Holtham, G. (2019[26]), “Enhancing public investment capacity in Wales, A paper prepared for the OECD report to Welsh government”, Unpublished.

There are three main arguments for rethinking the Welsh fiscal equalisation system. First, the RSG tends to weaken the incentive for business development in a given local authority. Conversely, Non-Domestic Rates could have the potential to provide them with a significant instrument for local economic development. Second, it is estimated that equalisation grants do not sufficiently support the local authorities in rural, more sparsely populated areas (e.g. Powys), putting them at an even greater disadvantage due to their specific needs (OECD, 2019[37]). Third, an equalisation system is fundamental for ensuring that greater decentralisation does not lead to greater territorial inequalities at the local and regional levels.

These arguments favour striking a new balance between fiscal incentives and fiscal equalisation in Wales. This is a problem encountered by many countries wishing to reduce or eliminate subnational disparities in fiscal capacity (Chan and Petchey, 2017[38]). The OECD recommends designing and implementing equalisation policies that help promote balanced development throughout a territory, as long as the transfers advance the tax and development efforts of subnational governments (OECD, 2019[11]). Equalisation mechanisms can be designed to only capture a part of subnational tax revenue in order to reward policy efforts and to unlock additional benefits for local authorities that engage in local development policies. Some countries have also opted to disentangle grants that serve several purposes at once and develop separate ones, for instance for subsidising services (Blöchliger and Kim, 2016[39]).

Fiscal equalisation cannot meet both equity and efficiency targets in isolation, particularly when it comes to addressing territorial disparities. It should be accompanied by regional development programmes with allocations based on regional performance and needs (OECD, 2019[11]). Monitoring mechanisms to report on the impact of equalisation on inequality and other economic outcomes are important in order to support such a system (OECD/KIPF, 2019[40]; Blöchliger et al., 2007[35]). Estonia’s system of revenue equalisation is relatively recent and tries to combines equity functions and fiscal incentives. Germany and Norway have developed strong fiscal equalisation systems that tend to enhance local tax incentives by focusing on vertical redistribution and partial equalisation of local tax revenue (OECD/UCLG, 2019[17]).

Optimising user charges, receipts and borrowing

Welsh local authorities have discretionary power to set fees for a selected range of services (e.g. leisure, parking, cremation and burial), yet they tend to avoid doing so. This links to a philosophy of universalism in provision of public services (Holtham, 2019[26]) that prohibits local authorities from charging more than the cost of provision in some areas (e.g. taxi licensing, building control fees, local land charges), or charging at all in others (e.g. children’s social care, household waste collection, library book provision and lending). It also results in fees set by the Welsh Government with little local discretion (e.g. adult social care, fees for planning applications and alcohol and entertainments licences) (Thomas, 2016[41]). Easing these constraints would enable local authorities to set new fees as income-generating opportunities. For instance, the use of congestion charges has been rejected several times, while it could constitute a useful measure not only for cities like Cardiff and Swansea, but also for national parks (e.g. the Brecon Beacons and Snowdonia).

Another possibility is to facilitate the development of commercial instruments to generate additional income, an approach being used by English local authorities (Thomas, 2016[41]). Although the power does not yet exist in Wales, it is mentioned in the proposed Local Government and Elections (Wales) Bill. This could give more flexibility to local authorities to raise revenue from local services. Moreover, fees set at the national and UK levels are often less reflective of the true cost of running services, whereas giving more power to local authorities in this area could prove more effective (Thomas, 2016[41]). Greater powers to set tariffs and fees can also encourage local authorities to improve their own performance in monitoring and evaluating public service delivery and the potential income this can generate.

Local authorities also receive capital receipts from the sale of fixed assets (e.g. land, council homes, etc.), which are dedicated to financing capital expenditure. A Welsh Government directive extended the use of capital receipts over the 2016-22 period (Welsh Government, 2018[42]). Some local authorities, such as Powys, have already developed a capital receipt policy to optimise this new revenue opportunity (Powys County Council, n.d.[43]). It would be important to consider extending this possibility into a longer-term option (i.e. beyond 2022) and making it available to other public bodies, such as Partnership Boards.

Introducing higher and less restrictive borrowing limits could also address fiscal challenges. Based on the revenue from devolved taxes and income tax rates, which will generate approximately GBP 2.4 billion annually in the years to come, one could reassess the borrowing capacity of the Welsh Government (currently set at GBP 1 billion) up to a certain prudential share of this amount (Holtham, 2019[26]). The Welsh Government provides revenue support to local authorities for borrowing costs incurred to fund capital schemes, as long as the schemes align with the Welsh government’s objectives (e.g. highway maintenance, part of the 21^st Century Schools Programme).15 Additionally, more flexible use of Financial Transactions Capital (FTCs) (capital transfers from the UK government), which make up around 14% of the Welsh government capital resources, could also ease access to borrowing and loan repayment. FTCs are currently restricted to loan and equity investment in the private sector, and a part must be repaid to the UK government. However, FTCs could have a broader fiscal impact if they could be used to lower interest on loans (Holtham, 2019[26]). This approach has been taken by the Development Bank of Wales (National Assembly for Wales, 2019[3]). The COVID-19 crisis renders these considerations even more urgent and calls for exceptional measures to enable subnational governments to meet their expenditure requirements, including through greater use of their borrowing powers (OECD, 2020[33]; 2020[44]).

Shifting towards a new tax policy framework

The Welsh Government recognises the need to shift away from a grant-dependent system towards enhanced own-source revenue, and updating the tax policy framework – particularly in its design and implementation – can help achieve this. As a step in this direction, the Welsh Government launched its Tax Policy Framework, based on five principles (Welsh Government, 2017[45]): i) raise revenue to support public services; ii) deliver policy objectives, particularly to support jobs and growth; iii) be simple, clear and stable; iv) be developed through collaboration and involvement; and v) create a more equal Wales.

To achieve these principles, reliable forecasts are necessary. A few years into the process, it remains difficult to assess the impact of fiscal devolution on the Welsh economy as well as on the impact of its fiscal policies. Aligning the statistical methodology among the devolved nations, and increasing collaboration among them, as well as with the UK’s Revenue and Customs body, the Office for Budget Responsibility, and the Scottish Fiscal Commission could be valuable (ONS, 2019[15]). Enhancing the collaboration among such bodies with the Welsh Government, including the Welsh Revenue Authority (WRA) could also help to generate quality data on Welsh devolved revenue.

There are plans to enhance fiscal decentralisation among Welsh local authorities as a means to encourage them to promote local economic growth, place-based policies and financial self-sufficiency. Addressing the design of the Council Tax and Non-Domestic Rates could be part of a comprehensive review of the local government funding system, particularly as further adjusting the UK/Welsh devolution settlement may not be a viable option at this time.

The margin for manoeuvre with the Council Tax appears relatively narrow due to the low tax base in many local authorities, in particular those experiencing population decline or stagnation (Chapter 3), and the already high rates in response to the decline in transfers (Holtham, 2019[26]). Despite this, consideration is being given to several aspects of the Council Tax to make it more effective, including revaluation and more buoyancy, updating tax bands and the progressivity of the tax rates, and collection efficiency and accountability. In the face of growing needs and the perspective of greater powers devolved to local authorities, it is necessary to determine how and when to put these considerations into practice. In addition, an increase in the share of local tax revenue usually goes hand in hand with enhanced accountability and better financial management (Blöchliger, Bartolini and Stossberg, 2016[46]). One way to accomplish this is by improving the standardisation and regularity of national and local public finance statistics.

The design of the Non-Domestic Rates (NDR) is also being reconsidered. Currently, the system does not provide specific incentives for using NDR to pursue policies supporting businesses or to favour commercial development. This is despite legislation that permits such actions. The finance minister has invited local authorities to come forward with proposals for taking a gain-share approach to increasing rates revenues – with a limited response (OECD, 2019[37]). The case for reforming the NDR to boost local resources relates to the English model of business rates retention. Through this model, English councils retain 50% of their rates revenues including the rates growth element. This reasoning, however, has to be tempered by other reports that point out the negative consequences of such a reform. Furthermore, past analysis of this scenario in Wales suggested that such a scheme would only generate small own-revenue gains (Holtham, 2015[47]). Yet, this option could be advanced by progressively devolving NDR retention to subnational structures with sufficient human resource and financing capacity. As a new revenue stream, this would enable financing specific development projects and generate funds for further investment.16

Another option under discussion is diversifying the range of newly devolved taxes to include a vacant land tax, a social care levy, a disposable-plastic tax and a tourism tax. All of these could help sustain quality local services. International experience shows that among these options, tourist taxes are particularly successful at the local level and tax receipts could directly support the growing tourism business in Wales.17 Over the last 15 years, there has been a general increase in the number and scope of tourism-related taxes, fees, charges in the EU and OECD (Box 4.6) (OECD, 2014[48]).

Box 4.6. Tourist taxes, fees and charges: Examples from OECD countries

Tourist taxes, fees and charges are quite common in OECD countries. Although generally small, tourism taxes can complement local government revenues. Tax collection mechanisms vary across countries and they are levied on a variety of bases (“per person, per night”, “per room, per night”, or as a proportion of room costs). They are generally administered at the subnational (primarily municipal) level and tourist tax receipts can be shared between regional and municipal bodies (as practised in Spain) or with other public bodies.

Greece introduced an Overnight Stay Tax in January 2018 to help reduce public debt. Visitors pay the tax to hotels and accommodations. In January 2019, Japan introduced a “sayonara tax” (paid by international visitors when they leave the country), whose revenue will contribute to Japan’s tourism infrastructure before the 2020 Summer Olympics in Tokyo. New Zealand introduced an International Visitor Conservation and Tourism Levy (IVL) in July 2019. Collected through visa fees and via the new Electronic Travel Authority, the levy supports environmental conservation and the development of tourism infrastructure. Scotland has recently introduced legislation allowing municipal governments to levy a tourist tax. This follows an extensive consultation exercise started in late 2018 and still underway (legislation is not expected until 2020-21).

Source: OECD (2016[49]), OECD Tourism Trends and Policies 2016, https://dx.doi.org/10.1787/tour-2016-en; OECD (2019[50]), “OECD Interviews in Cardiff 24-28 June”, OECD, Paris; OECD/UCLG (2019[17]), 2019 Report of the World Observatory on Subnational Government Finance and Investment – Country Profiles, ww.sng-wofi.org/reports/SNGWOFI_2019_report_country_profiles_DEC2019_UPDATES.pdf.

Increasing local financial capacity by working in partnership

Empowering Welsh local authorities as autonomous fiscal and financial actors can also contribute to redressing fiscal framework challenges. Increasing their own-source revenue and encouraging them to borrow to finance their investment, however, puts a spotlight on their administrative and financial management capacities, including for investment. Financial management capacity – the ability to ensure the effective use of internal and external resources with integrity (including cash management, proper costing and budgeting, transparent procurement processes, internal controls and internal and external audits) – is an essential lever for increasing subnational government fiscal autonomy (OECD, 2019[11]).

Pooling resources to deliver services, sharing costly administrative functions and sharing specialised expertise (e.g. to support innovative financing mechanisms, technical financing instruments, or land-based finance) frees revenue for other expenses, thereby contributing to greater fiscal capacity. This can be supported through inter-municipal co-operative arrangements (OECD, 2017[51]; Forman, Dougherty and Blöchliger, 2020[52]). There are several, positive experiences among Welsh local authorities that have joined forces to co-operate in financing functions. For example, the Conwy and Denbighshire county councils (who already share a joint Public Service Board) proposed to jointly implement and manage a financial ledger and other financial systems. Several other local authorities (e.g. Bridgend and Vale of Glamorgan, Rhondda Cynon Taff and Merthyr, and Monmouthshire and Newport) are also sharing internal auditing services. Furthermore, partnerships have been organised around procurement functions, including a pilot between Carmarthenshire and Pembrokeshire, Joint Head at Flintshire and Denbighshire, and also a Regional Contractors Framework in South West Wales (Welsh Government, 2019[19]). This type of collaboration should be encouraged as a means to help build necessary fiscal and financial management capacity. It is all the more important in times of crisis and austerity, as a collaboration between local authorities themselves can help mitigate the costs when it benefits all local authorities within the region (Downe and Taylor-Collins, 2019[53]).

Part 1: Conclusions and recommendations

Fiscal settlements between Wales and the UK pose a number of challenges for the Welsh Government. Spending and fiscal devolution remain partial, limiting the ability of the Welsh Government and local authorities to cope with a significant fiscal gap. In addition, after years of austerity, transfers throughout the fiscal system have declined, while the tax base has remained low. Combined, this has undermined own-source revenue-generating capacity at the national and subnational levels in Wales. In the early days of fiscal devolution and post-Brexit, it is important to closely observe and monitor the progress being made in terms of sustainability of own-source revenues, at both the Welsh Government and local authority levels. It is expected that fiscal resources will remain relatively low compared to other OECD countries, putting Wales in an ever more constrained situation. To address these fiscal challenges, the Welsh Government must consider optimising revenue sources as a whole. Proposed fiscal reforms could offer some limited relief through slight revenue increases, and contribute to increasing financial management capacity of the Welsh Government and local authorities. To maximise the benefits of fiscal devolution, however, a stronger fiscal framework will be necessary – one that not only includes the modest ability to raise own-source revenue but also additional access to borrowing and a diversified revenue base.

Box 4.7. Recommendations for strengthening the Welsh fiscal framework

1. Optimise the Welsh Government’s capacity to reduce its fiscal gap and improve fiscal health

Expand spending devolution to the extent possible, making sure shared responsibilities for economic development are clear among levels of government.
Diversify Welsh own-revenue sources and make use of existing fiscal levers (e.g. tax rates, user fees, etc.) to fill the fiscal gap.
Strengthen the fiscal management capacity of the Welsh Government and local authorities, including by monitoring revenue-raising capacity in order to produce long-term fiscal forecasts.
Encourage local authorities to pool resources and work in partnership to build their administrative and financial capacity.

2. Further reform the subnational fiscal framework to increase own-revenue

Optimise and diversify local taxes and tax bases to increase own-revenue among local authorities (e.g. vacant land tax, Non-Domestic Rates retention and tourist taxes).
Review the fiscal equalisation system to reduce territorial disparities, support local authorities with a low tax base and encourage local economic development.
Ease borrowing restrictions for the Welsh Government and local authorities, and make them more flexible, in order to help address fiscal challenges in the short and medium terms.

Part 2: Investment frameworks to support regional development in Wales

Since the advent of devolution in 1997, the Welsh Government has placed investment for regional development at the heart of its policy framework (Welsh Government, 2017[54]). This came at a time of difficulty, however. The economic and financial crisis, in addition to structural challenges related to industrial transition and ageing, severely affected the capacity of the Welsh Government and local authorities to meet investment needs, especially in key development sectors such as education, transport, infrastructure and telecommunications (Ifan, Siôn and Poole, 2019[20]). Over this period, European Structural and Investment Funds (ESIF) have helped Wales make up for an investment financing shortfall and meet its capital expenditure requirements by actively supporting a regionally-based investment approach. The Welsh Government has also built strong investment management capacity within its departments. Moving forward, as Brexit foreshadows a reshaping of the system for financing investment in regional development, ensuring sufficient financial capacity and effective mechanisms is even more critical for the Welsh Government to implement its ambitious development agenda of growth plus inclusiveness.

It will be important to continue building on Wales’s significant experience in managing and administering investment funds. It will also be important to identify additional mechanisms that help maximise limited resources and public investment capacity in order to meet regional development objectives. This section explores the importance of an integrated approach to investment across sectors and among levels of government. It then moves on to examine how strengthening capacities and expertise can support place-based investment by all levels of government post-Brexit. Finally, it examines the potential for Wales to use innovative financing mechanisms to help fill its investment gaps. The section concludes with a series of recommendations to better support the Welsh Government and local authorities invest in regional growth, productivity and well-being.

Developing a coherent investment framework for regional development in Wales

Until now, Wales has managed two investment streams for implementing its regional development agenda: one from its own budget and a second from EU funds. Public investment (capital expenditure) by Welsh departments is financed from the Welsh Government’s general budget. Public investment linked to EU programming and financed through EU funds is managed by the Welsh European Funding Office (WEFO). In addition to this, a significant share of investment targeted to regional economic activity takes place or is planned through the City and Growth Deals. These all contribute to regional development – the challenge is to ensure this is done strategically and coherently to maximise effectiveness. To accomplish this, reviewing the investment co-ordination structure with relation to Brexit, strengthening investment practices and building on the experiences of City and Growth Deals would be valuable. Finally, finalising and implementing the proposed National Framework for Investment can help align these different opportunities and priorities to better serve regional development.

Reviewing the investment co-ordination structure with relation to Brexit

The Welsh Government is confronted with rethinking the structure for investment co-ordination in a context where its future financial capacity is uncertain, post-Brexit and due to the COVID-19 crisis (O’Brien and Pike, 2018[55]). At present, the Welsh Government’s investment budget, powered by transfers, is prepared on the basis of funding forecasts for investments made by the UK government. Since 2000, European Structural and Investment Funds (ESIF),18 and especially European Regional Development Funds (ERDF) and European Social Funds (ESF), have sustained additional Welsh regional development financing (Welsh Government, 2017[54]). In light of Brexit, it is expected that the UK government will establish an intended replacement for European funding (Box 4.8).

Box 4.8. Financing regional development in Wales: The intended replacement for European funding

The terms and conditions governing the intended replacement for European funding remain uncertain. A key question is whether this fund will be allocated to and administered by the Welsh Government, or whether the UK government will choose to deal directly with local or regional bodies (which may circumvent the devolution agreement between the UK and Wales). An additional question remains: will the intended replacement for European funding operate on a multi-year or annual basis?

In keeping with the structure of EU funds, the Welsh Government and its partners strongly advocate a replacement that is based on multi-annual funding. This facilitates medium and long-term investment programming and planning that can be necessary for large and costly infrastructure projects. It also advocates retaining autonomy over how the funds are spent, as per its devolution agreement. When allocating investment funds to support balanced regional development, it would be important to consider specific criteria, including differences in population growth, or the initial levels of funding received via ESIF (for instance, this could be achieved through an Indexed Per Capita (IPC) formula). Further criteria may be also used, such as local and regional socio-economic characteristics, in order to have a more distributed approach.

The UK government might allocate regional development funds on a competitive, auction principle, thereby spurring more competition across regions and local authorities. This would redefine the conditions of eligibility of UK regions and, consequently, the financing amounts received by Wales.

Source: National Audit Office (2019[56]), Investigation into Devolved Funding, https://www.nao.org.uk/wp-content/uploads/2019/02/Investigation-into-devolved-funding.pdf; Holtham, G. (2019[26]), “Enhancing public investment capacity in Wales, A paper prepared for the OECD report to Welsh government”, Unpublished; Regional Investment Project Steering Group (2019[57]), A Wales Regional Investment Policy for the Future, https://gov.wales/sites/default/files/publications/2019-09/a-wales-regional-investment-policy-for-the-future.pdf.

It is unclear how the intended replacement fund for European funding will be regulated, allocated and distributed, affecting the capacity of the Welsh Government to undertake long-term and medium-term planning. To manage this uncertainty, a new investment strategy has to be sufficiently flexible to evolve together with the country’s governance structure and rules post-Brexit. One essential condition for the Welsh Government to plan a coherent investment strategy is a multi-annual approach to regional development funding. It provides necessary stability and reassurance for investors and long-term investment planning. Understanding the difficulties that arise from the devolution settlement between Wales and the UK, it would also be important for the Welsh Government to undertake a long-term approach to investment based on its own budget sources. Multi-annual funding also offers visibility and predictability with respect to resource availability, particularly for financing long-term and high-value projects, such as large infrastructure. This can help ensure that investment is effectively channelled throughout Wales, regardless of political events (Spackman, 2002[58]). For instance, the Dutch Multi-Year Programme for Infrastructure, Spatial Planning and Transport (MIRT) features what it calls “adaptive scheduling”, a method for allowing more flexibility in finding a collective solution to problems that may arise over the course of investment project implementation (Dutch Ministry of Infrastructure and Water Management, 2018[59]).

A shift away from European funding for regional development investment also calls into question the future role and function of the Welsh European Funding Office (WEFO).19 WEFO has administered EU funds until now, playing a crucial role in co-ordinating EU investment for regional investment. Over the course of the three last EU programming periods, it has amassed extensive knowledge and experience in managing and administering large sums, complex projects and diverse stakeholders. It has developed strong expertise in portfolio development, project management and project assessment, as well as effective monitoring, control, verification and record-keeping functions. Moreover, since it works closely with the Welsh Government departments, it has a track record in fostering cross-sector relationships, helping align policies and supporting the investment needs of diverse policy sectors (Auditor General for Wales, 2018[4]; Holtham, 2019[26]; Welsh Government, 2019[19]).

To co-ordinate future public investment for regional development in Wales, the Welsh Government may wish to transition WEFO into an investment funding office for regional development that undertakes similar functions as WEFO and maintains its location in the office of the First Minister. These activities would include ensuring that investment decisions are aligned with regional development strategy/objectives and that the input of subnational, private, third-sector and other stakeholders is considered. It would be responsible for managing EU replacement funds through the National Framework for Regional Investment in Wales (proposed).

The new structure will need to make sure sector-driven investment that draws on the investment funds is integrated or, at a minimum, coherent across relevant policy sectors and with national development objectives. Beyond this, it could also facilitate a cross-sector co-ordination function. The Welsh Government could, for instance, extend the scope of policy sectors funded through the future fund for regional investment by including rural policies and health,20 two sectors that were addressed through separate EU funding streams (OECD, 2019[50]). Furthermore, it should also maintain its monitoring function and support regional-level or subnational investment (e.g. to realise Regional Economic Frameworks). In that sense, it would be important that such a body remain independent of departments in order to maintain an oversight/co-ordination role for the full investment cycle. It could easily partner with, complement, or evolve into a structure responsible for regional development thereby improving the co-ordination between strategic planning and investment implementation. Mechanisms for co-operation for regional development are further developed in Chapter 5 of this report.

Building on existing investment financing practices and introducing new ones

The current moment presents a tabula rasa to Wales in terms of its investment framework. It has a unique opportunity to adjust investment conditions that have been considered weaker while maintaining those that have worked successfully. To some extent, this is already underway. For example, Wales can now reconsider how it designs the investment process to mitigate or avoid some of the criticism associated with EU funding mechanisms, including excessively bureaucratic systems, high administrative burden, lengthy procedures to obtain funding and uncertainty in verification, control and audit processes etc. (OECD, 2020[60]).

The Welsh Government also has the opportunity to avoid the criticism that public investment financing is difficult to access and use due to the multiplication of funding streams (OECD, 2019[50]). This may be particularly true in the case of local authorities and private sector actors for whom borrowing may be easier in terms of administrative burden and timing. Regional development funding should align with the Welsh Government policy as part of the existing funding mix, rather than separate from it. With a shift away from the strategic investment framework associated with EU Cohesion Policy, the Welsh Government has the opportunity to ensure that regional development and investment priorities advance Welsh development objectives at a national level, as well as at a more “granular” regional one. For example, to support more integrated regional investment, bonus mechanisms could be envisioned that prioritise cross-sector and cross-government projects.

There is also a possibility to design investment frameworks and guidelines that are sufficiently flexible to encourage collaboration and investment across borders, certainly between Welsh jurisdictions, but also cross-border partnerships with UK regions or cities. In both instances, it would be important to set clear parameters, for example the types of bodies eligible for funds (i.e. statutory and/or non-statutory), the conditions for funding (i.e. reporting, communication, accountability, and transparency) and co-financing requirements. For instance, co-financing rates could vary from one project to another based on specific needs – as opposed to the strict 50% co-financing rates associated with EU Cohesion Policy financing for all projects in Wales. This could encourage local authorities to design projects in close collaboration with other partners – ideally on a regional level – and to permit a higher local authority contribution to co-financing percentages by pooling together their own investment funds. In designing these incentives, the future investment management structure should build on WEFO’s experience in bringing together diverse stakeholders as part of the EU funding process, in particular for setting investment objectives and priorities in joint projects (OECD, 2019[50]).

Special attention must also be paid to financing infrastructure investment given its cost and complexity. It requires well-established priorities, clear guidelines and transparent processes. The Welsh National Infrastructure Commission for Wales (NICfW), established in 2018 to support infrastructure planning over the long term (up to 30 years), could be an important body for supporting the co-ordination of infrastructure investment at the national level. To this end, its role could be extended beyond providing advice and recommendations to the Welsh Government on economic and environmental infrastructure needs. The NICfW could also build strong relationships with regional development actors (e.g. Chief Regional Officers [CROs], City and Growth Deal executive boards, and potentially corporate joint committees [CJCs]) to incorporate the subnational perspective into its work. The Welsh Government may want to consider clarifying and strengthening its mandate by establishing formal links with the UK National Infrastructure Commission, and possibly the Infrastructure Commission for Scotland. In addition, it could provide advice to all levels of governments and other stakeholders on potential synergies, conflicts, duplication and investment gaps (Regional Investment Project Steering Group, 2019[57]).

Moving forward as investment structures shift post-Brexit, it would be very important to ensure that the responsibilities and expectations of parties involved in the investment processes are clear: the Welsh Government and local authorities but also City and Growth Deals stakeholders, regional partnership boards, the private sector, universities and third-sector organisations. Doing so contributes to setting realistic and accessible financing conditions. Given the number of actors in the investment space, establishing clear rules of engagement for investment becomes extremely important. This goes hand in hand with clearly articulated objectives and expected outcomes for each level of government. In Germany, for instance, the Joint Federal/Länder Task for the Improvement of Regional Economic Structures provide incentives for Länder as regards their regional investment policies, based on jointly-established priorities and rules for financial support (Box 4.9).

Box 4.9. The Joint Federal/Länder Task for the Improvement of Regional Economic Structures in Saxony-Anhalt

Saxony-Anhalt (Sachsen Anhalt) is located in the eastern part of Germany, part of the group of “new” Länder, which were re-established in 1990. Chemicals, food and machinery make up the majority of regional industries in Saxony-Anhalt. Thanks to its regional development policy, it has experienced strong growth and economic recovery since 2000, with a decrease in unemployment and an increase in investment, even though the latter remains below the national average for all indicators.

This growth was supported by two factors: the contribution of EU funding towards investment in regional development and a strong regional policy, supported by a common federal-state regional policy support scheme – the Joint Task for the Improvement of Regional Economic Structures (GRW), Germany’s main instrument for regional policy. The GRW was established in 1969 by the Federal Ministry for Economic Affairs and Energy (BMWI) to foster investments in economically lagging regions. The Länd can set their own priorities for investment, depending on the level of funding available. In recent years, due to a decrease in transfers from the federal government and the EU, Saxony-Anhalt had to arbitrate among several priorities and reallocate funding, with a shift towards priority sectors such as energy and research. At the same time, the scope of GRW broadened to include the regional management of networks and support for services. Through the GRW, Saxony-Anhalt finances regional development by securing half of its funding from the federal government, and the other half from the Länd itself. In the funding period 2014-20, an additional EUR 115 million came from European funds. These funds are used to expand the effects of national-support programmes. Transfers can be allocated according to a maximum of 30% for direct grants to enterprises and maximum 90% for promoting investments in infrastructures to sustain the regional economy.

Together, these elements make GRW a key instrument for multi-level co-ordination, priority setting and financing of regional development policy. Built on consensus, the rules for financial support are fixed jointly by the federal and Länd governments, creating an enabling framework for economic development as a basis to guide the implementation of regional development funds.

Source: Pötzsch, S. (2019[61]), Regional Policy and Regional Cooperation in Saxony-Anhalt, Ministry of Economy, Science and Digitalisation of Saxony Anhalt; OECD (2016[62]), OECD Regional Outlook 2016: Productive Regions for Inclusive Societies, https://doi.org/10.1787/9789264260245-en; Gruševaja, M. and G. Heimpold (2013[63]), “Evaluation of the main achievements of Cohesion policy programmes and projects over the longer term in 15 selected regions”, https://ec.europa.eu/regional_policy/sources/docgener/evaluation/pdf/eval2007/cohesion_achievements/final_report.pdf.

Making the most of City and Growth Deals for investment opportunities

City and Growth Deals can be a relevant territorial scale for large-scale investment. This is particularly important for regional infrastructure that is targeted to increase productivity and growth, and implement a wide range of policies with a regional foothold (Ahrend et al., 2014[64]). By bringing together a number of municipalities City and Growth Deals offer a way to manage territorially fragmented governance structures, thereby supporting growth and productivity (OECD, 2019[65]).

To make the most of City and Growth Deals for targeting investment opportunities in Wales, it would be important to further integrate City and Growth Deals arrangements in Wales’ wider regional development strategy (OECD, 2019[50]). First, the Deals provide a structure for local authorities to fund and manage large-scale regional infrastructure and other investment needs. Second, they provide co-financing contracts drawing on funds from the UK government and Welsh Government, with commitments from ERDF and the private sector. Third, they support dialogue and mutual learning and provide mechanisms to guarantee proper implementation by party. City and Growth Deals may, therefore, be viewed as a particular funding route to help deliver each region’s wider ambitions, while addressing the barriers that currently constrain investing in these regions thanks to their co-financing arrangements. It is estimated, however, that City Deal-making process and outcomes have been managed and agreed upon largely based on UK government terms and timetables (Pike et al., 2016[66]). Moving forward with any future projects within the existing Deals, it would be important to ensure that their objectives align with the objectives of the proposed National Framework, including objectives of balanced regional development and equity among Welsh regional areas It would also be important to ensure that the contractual arrangements do not contradict the devolution settlement, under which economic development and local governments are responsibilities devolved to the Welsh Government (Holtham, 2019[26]). Examples from France and the Netherlands show how contracts and deal-making can benefit all levels of government involved (Annex 4.B).

There is, in addition, room for manoeuvre to make City and Growth Deals in Wales more competitive with other UK City Deals, particularly if they wish to attract competitive funding to replace EU funds post-Brexit, for example, funds from the UK Industrial Strategy and other competitive sources. While City and Growth Deals provide a funding stream for regional and local investment, the levels of infrastructure funding in the Deals remain relatively low, compared to more traditional funding sources. The sum committed thus far to fund City and Growth Deals’ projects totals less than GBP 3 billion over a period of 15 to 20 years, compared with the annual amounts of investment in Wales (by all levels of government) that reached GBP 3.4 billion in 2017 (Holtham, 2019[26]). One of the main rationales behind City and Growth Deals is that they must help leverage additional funding from the private sector and trigger government investment that will generate spill-overs in lagging areas. For instance, in England, the Greater Manchester City Deal is experimenting with a revolving infrastructure fund, which will allow Greater Manchester to “earn back” a portion of additional tax revenue from growth in gross value added (GVA) generated by the initial investment (O’Brien and Pike, 2018[55]). Adopting similar measures in Wales would require greater financial autonomy on the part of Welsh City and Growth Deal Boards, in order to earn back and apply additional tax revenue, as well as capacity to design and implement projects that could generate such benefits.

Increasing the impact of City and Growth Deals would imply reducing the administrative burden and simplifying access financing through regional structures. At the same time, it is important to address questions of accountability, transparency and scrutiny that surround these Deals (Pike et al., 2016[66]). Doing so, for example by increasing the transparency and flexibility of co-financing contracts, could help attract new projects and facilitate reallocating funds if necessary over the course of the Deal. The introduction of citizen engagement mechanisms, such as public consultation and participatory financing mechanisms throughout Deal projects or the Deal lifecycle can provide greater transparency regarding the use of investment funds (O’Brien and Pike, 2018[55]; OECD, 2019[50]). Additional benefits of greater transparency include valuable public support for local projects. In Iceland, for instance, Contracts of Regional Plans have increased the transparency and efficiency of regional investment, and have also enabled regions to unlock competitive funding for specific projects (Box 4.10).

Box 4.10. Funding investment for regional development in Iceland

Iceland has a single-tier of subnational governments (municipalities) and an overall population the size of Cardiff. In 2013, the government renewed its regional development policy in order to make it more transparent and fit with the resources that were available. This was accomplished by introducing Contracts of Regional Plans to support decentralised funding to regional associations of municipalities. Iceland’s regional associations of municipalities develop their regional action plans in consultative fora (one per region), bringing together stakeholders from the private sector, cultural organisations, academia and others. The associations are supervised by a Steering Committee on Regional Issues, formed by all ministries, together with associations of local authorities. The steering committee provides a direct link between the central government and municipalities and guides them in the preparation of the regional plans. These plans must set out the regional priorities within national and international development frameworks. They must also have measurable goals and clear success indicators.

Funding is allocated among the regional associations based on established criteria such as population, unemployment, municipal tax base, distance from the capital and service provision (except for the capital region, Reykjavik; which receives a fixed amount). Funding comes from the Ministry of Transportation and Local Authorities, the Ministry of Education and Culture, and contributions from municipalities. Over the course of successive contracts, other sources of funding have emerged, such as competitive funds for specific projects (e.g. infrastructure, and data centres); a funding pool for cultural centres; and funding pool for climate resilience and the circular economy.

The system enables policy learning across municipalities and among stakeholders. It also helped strengthen the cohesion among municipalities as well as their capacity to negotiate directly with the central government, by not placing them in direct competition for funding. It also resulted in increased trust from the central government towards regional associations. Regions are on their 3rd wave of contracts and they are now trusted to allocate the funds emanating from diverse funding streams, such as competitive funds.

Source: OECD (2019[67]), Regional Outlook 2019: Leveraging Megatrends for Cities and Rural Areas, https://doi.org/10.1787/9789264312838-en; OECD/UCLG (2019[17]), 2019 Report of the World Observatory on Subnational Government Finance and Investment – Country Profiles, http://www.sng-wofi.org/reports/SNGWOFI_2019_report_country_profiles_DEC2019_UPDATES.pdf; Hilmarsdóttir, U. (2019[68]), Regional Plans in Iceland: Decentralization of Funding and Power to Local Authorities through Regional Associations of Municipalities.

Aligning priorities and objectives with a Welsh Framework for Regional Investment

Brexit represents not only a need but also a timely opportunity to further define an integrated approach to investment in Wales. In light of this, the Welsh Government is currently developing a Framework for Regional Investment (Box 4.11). If successful, such an approach can support investment financing for Welsh national, regional and local development plans and initiatives. By also supporting – but not substituting – the investment financing undertaken by each department, the framework could promote policy and investment coherence and facilitate effective investment programming post-Brexit. This requires ensuring that the framework includes mechanisms that can foster collaboration among public and private stakeholders, and enhance long-term planning practices.

Box 4.11. A proposed Framework for Regional Investment in Wales

The Welsh Government is designing a new regional investment framework to replace that associated with the European Structural and Investment Fund (ESIF), as it will no longer be applicable post-Brexit and once current funds are spent down. The new framework’s aim is to offer public and private investment actors – national, subnational and international – consistent guidelines and clear objectives for public investment.

Based on socio-economic analysis and stakeholder feedback, the Welsh Government identified four priority areas for investment, using these to articulate desired investment outcomes:

addressing income inequalities
promoting productive and competitive businesses (e.g. SMEs, skills, research and industrial innovation, innovation diffusion)
transitioning to a zero-carbon economy
building healthier, fairer and more sustainable communities

Source: Welsh Government (2019[69]), “Responses to OECD Questionnaire, unpublished”.

The proposed Framework for Regional Investment can ensure that goals and priorities for regional investment align and are co-ordinated across government and sectors (horizontally), and among levels of government (vertically). It would contribute to managing investment fragmentation that can arise from working in a siloed policy culture, and to mitigating the risk of wasting resources through inefficient co-ordination. It can also increase the potential for identifying cross-sector investment synergies and limit investment overlap, ensure proper investment sequencing and contribute to improved investment transparency, visibility and accountability to citizens and businesses.

This type of framework can also be used to co-ordinate a regional, place-based approach for the whole of Wales. To this end, the national framework is considering investment at three territorial levels: national, regional and local. At the national level, it will be aligned with the Wellbeing of Future Generations (WFGA) and will support the Economic Action Plan, the National Development Plan and government department programmes. At the subnational level, it is intended to support the Regional Economic Frameworks. It could also be useful for supporting local-level development programming and initiatives.

Furthermore, the Welsh Government should also incorporate the interests of the private and third sectors in this framework during the investment implementation and evaluation phases. This would enhance the Welsh Government’s relationship with the private sector, universities, the third sector, etc., to advance regional development. It can also draw on the Economic Action Plan, which promotes the use of economic contracts to enhance social responsibility 21 among businesses (OECD, 2019[50]). At a minimum, incorporating diverse interests could help ensure coherence in investment priorities among levels of government. At best, effective co-ordination of investment priorities can lead to complementary or even joint investment opportunities, reducing investment costs (OECD, 2019[65]). The Dutch and Irish governments have launched initiatives to align regional and national objectives and to drive regional policy and investment in an integrated fashion (Annex 4.B).

Strengthening Welsh national and subnational capacity for place-based public investment

The Welsh Government’s approach to the proposed National Framework for Regional Investment reflects a willingness to maximise the learning and experience gained from managing public investment and projects of diverse size and scope, for example through ESIF. This is coupled with a need to ensure that limited investment resources are well channelled and contribute to balanced regional growth and well-being. There are three immediately identifiable levers at the Welsh Government’s disposal that can contribute to this: i) increasing capacity and expertise for the design and implementation of projects; ii) enhancing the use of public-private partnerships (PPPs); and iii) using ex ante analyses and ex post evaluation to inform the investment decision process and to support investment quality.

Increase skills and expertise in designing and implementing projects

The lack of public sector investment management capacity, particularly at the subnational level, is considered a barrier to mobilising further capital funding sources for local investment in Wales (National Assembly for Wales, 2019[3]). Whether it involves co-financing, land value capture mechanisms, PPPs or bonds issuance, investment financing processes at the subnational level are complex. Often, support from the central government and other technical and financial partners is required in order to build investor confidence. Among Welsh local authorities, capacity levels in human and financial resources, and project management, are heterogeneous. This compounds the difficulties surrounding a capacity deficiency for regional development investment, particularly among rural local governments, and can compound inequalities in their ability to access funding. These issues are exacerbated in Wales since the dismantlement of the Welsh Development Agency (OECD, 2019[50]), and even more, since the financial crisis, resulting in a minimum level of in-house skills and expertise, and high turnover in procurement units (OECD, 2019[37]). This is not an irreversible situation, however. There are recent moves to support subnational investment capacity in Wales, such as establishing the Development Bank of Wales (DBW) and Business Wales (Gareth, 2019[70]). At the same time, more could be done to build on and disseminate the experience of investment actors working at the regional level, such as WEFO, and of the local authorities themselves.

The DBW and WEFO have valuable insight into investment financing for regional development thanks to their expertise in public and private financing mechanisms and management. Moving forward, the DBW could draw from its expertise in co-financing schemes between the private sector, SMEs and governments, and intervene to support local authorities at various stages of the project process (e.g. feasibility studies, negotiating with investors, reporting and monitoring and evaluation). It could also help match local authority needs with investor requirements for quality projects in the infrastructure project pipeline, for example, as it already does with SMEs and other stakeholders. Additionally, the DBW’s systems to monitor and map investment results (beyond the number of firms assisted and jobs created) in terms of secondary economic effects could be shared with the Welsh Government and used to develop indicators that capture investment outcomes (Holtham, 2019[26]; Gareth, 2019[70]). Meanwhile, WEFO has developed good practices in project management and reporting that should be safeguarded and maintained in future regional investment projects, and which could also be transferred to regional- or local-level bodies. These include setting performance criteria, clearly defining responsibilities throughout the investment cycle, separating managing and auditing functions, and ensuring the continuity and qualifications of staff. The Scottish Futures Trust provides an interesting example for strengthening local governments’ capacity and expertise of investment financing and implementation (Box 4.12).

Box 4.12. The Scottish Futures Trust

In 2008, the Scottish Government established the Scottish Futures Trust (SFT) as a centre of expertise to improve the efficiency and effectiveness of infrastructure investment in Scotland. The SFT also carries out reviews for the Scottish Government on innovative financing mechanisms and works with Scottish local authorities to reinforce capacity by transferring knowledge and carrying out independent expert reviews at various stages of investment projects.

In 2010, the SFT launched “Hub” programmes, specifically to improve the planning, procurement and delivery of smaller public infrastructure projects that support community services across Scotland (primarily in the education and health sectors). This programme was tailored to meet the specific needs of five designated hub territories in Scotland (North, South East, West, East Central and South West hubs). It operates through joint venture arrangements between local public sector organisations and the private sector (“Hubco”) in each territory. The objective is to increase efficiency and reduce the cost of community infrastructure procurement. In addition, it provides an opportunity to share skills and experience across several public sector organisations (health boards, local authorities, police, fire and rescue services, and other public bodies) and projects, enabling knowledge transfer and increasing public investment and procurement efficiency. To date, investment funded through the Hub programme amount to GBP 3.3 billion, with an almost perfect balance of funding allocation across the five “hub” regions.

Source: OECD (2018[71]), Subnational Public-Private Partnerships: Meeting Infrastructure Challenges, https://doi.org/10.1787/9789264304864-en; Northern Ireland Assembly (n.d.[72]), The Hub Initiative, http://www.niassembly.gov.uk/globalassets/documents/education-2011---2016/visits/03-hub-briefing-paper.pdf.

Furthermore, encouraging peer-learning among local authorities themselves and supporting them in pooling expertise also contributes to building investment capacity. Smaller local authorities are often very concerned with having the institutional capacity and professional skills necessary to make good investment decisions. In this sense, the willingness and ability to collaborate and work in partnership with other institutions as well as with other local authorities is crucial (Economy, Infrastructure and Skills Committee, 2017[73]). Subnational capacity can be strengthened through peer-to-peer exchanges and pooling expertise across jurisdictions (e.g. for PPPs and climate finance). More could be done in this respect, by increasing the number of co-procurement initiatives among local authorities for example. Intermunicipal and regional co-operation can also be used to identify common interests and encourage economies of scale. National associations of municipalities are very effective as capacity-building and knowledge-sharing platforms, able to disseminate good practices and benchmark local and international experiences (OECD, 2018[71]). In this regard, the Welsh Local Government Association (WLGA) could develop a working group specialising in capacity building in the management of investment projects, or access to specific financing mechanisms.

Enhancing the use of public-private partnerships

The UK is recognised as a benchmark for PPPs among OECD countries given its private finance models (Private Finance Initiative [PFI] and Private Finance 2 [PF2]). Their benefits include opportunities to expand investment capacity beyond capital expenditure and borrowing limits, and generate additional resources for investment. They can also achieve greater efficiency through innovation and expertise emanating from the private sector (Scottish Futures Trust, 2019[74]). However, the UK PFI and PF2 models are subject to increasing criticism. This criticism is based on their lack of flexibility, low value for money and the risks they represent to public authorities (McZenzie, Baker, 2018[75]; National Audit Office, 2018[76]). As a result, they have not been used in the UK since 2018 (HM Treasury, 2018[77]). Traditionally, Welsh public bodies at the national and subnational levels seldom use PPPs or two finance models. As of June 2018, the 28 Welsh PFI projects represented 1.5% of the value of all UK PFI projects, the lowest in the UK (Senedd Research, 2018[78]).

Searching for an alternative, Wales developed its own PPP model in 2014: the Mutual Investment Model (MIM) (Box 4.13), which targets leveraging GBP 1 billion of privately financed investment. Despite developing its own PPP model, this form of investment financing is still used sparingly in Wales. This is attributed to limited human capacity in terms of expertise and resource constraints (OECD, 2019[37]). These challenges are, however, not unique to Wales. In 83% of OECD countries, PPPs represented less than 5% of public sector investment between 2015 and 2018 (OECD, 2018[71]).

Box 4.13. The Welsh Mutual Investment Model (MIM)

The MIM arrangements are a form of public-private partnership wherein private partners can build and maintain public assets. The Welsh Government pays a fee to the private partner to cover the cost of the project’s construction, maintenance and financing. In return, the Welsh Government is a direct investor in the project, able to take an equity stake of up to 20% in the holding company established to deliver the project and appoint a director to the holding company’s board. At the end of the contract, the asset is transferred into public ownership.

One of the specificities of the MIM model is that it requires compliance with the Code of Practice on Ethical Employment in Supply Chains and it sets a number of conditions for the participation of the private partner. The MIM will fund three projects in Wales: the 21^st Century School Programme, the A465 Major Road Scheme and a hospital project.

The MIM is progressively gaining recognition in the UK and further afield. The Scottish Government is reviewing how it can adapt the model and the G20 adopted some MIM elements as global infrastructure standards.

Source: Welsh Government (2019[69]), “Responses to OECD Questionnaire, unpublished”; OECD (2019[37]), “OECD Interviews in Wales, 25-29 November, 2019”, OECD, Paris; Scottish Futures Trust (2019[74]), Tax Incremental Financing, https://www.scottishfuturestrust.org.uk/page/tax-incremental-financing).

PPPs often have low uptake because of real or perceived government capacity gaps. International experience shows that establishing a PPP unit specialised in subnational projects can enhance the efficiency and the use of PPP models, together with financial support for technical assistance. Australia and Germany, for example, have introduced training and capacity-building PPP programmes (Annex 4.C). Central governments also play an important role in supporting subnational capacity to develop PPPs by setting a long-term vision and clear priorities for investment (OECD, 2018[71]). In Italy, instead of a specialised PPP unit, PPP functions belong to the National Department for Planning and Coordination of Economic Policy. These functions include an educational role, an assistance role, a “policy-making role” and a regulatory role. This enables the government to introduce new institutional guidelines and “soft law” to guide public sector entities in structuring successful PPPs. These guidelines emphasise the importance of maintaining a balance between the interests of the public and private entities involved. As of April 2019, the department had assisted more than 70 Italian local authorities on PPPs (Tranquilli and Milani, 2019[79]).

To improve its delivery of MIM projects, the Welsh Government is currently reflecting on developing a commercial unit within its Treasury Department, and in parallel, a MIM equity unit in the DBW to deal with contracts (OECD, 2019[37]). The establishment of these units will be conditioned to providing the necessary resources, from the Welsh Government and the DBW, for the proper functioning of these units and to the ability to recruit highly skilled staff.

Increasing investment performance with ex ante and ex post evaluation

Evaluating investment decisions based on ex ante evaluation remains a challenge for the Welsh Government and should not be overlooked in its investment management practices. Ex ante evaluation helps identify the long-term impact and risk of public investment. This can help avoid “white elephant” investments and support identifying an investment’s social, environmental and economic impact, while also assessing which investment method can yield the best value for money. At the close of the investment cycle, ex post assessment contributes to evidence bases that support future investment decisions (OECD, 2019[65]). Welsh local authorities comply with the UK’s Five-Case Business Model that guides the preparation of business cases and offers a number of benefits to investment appraisal, but the outcomes are not consistently used to guide decision-making (Welsh Government, 2019[19]; Atkins, Davies and Bishop, 2017[80]). Even within the EU experience, where regulations require cost-benefit analysis of major investment projects financed with Cohesion Funds, the incentive to initiate new projects or to absorb EU funds often overshadows the incentive to achieve value for money in public investment (Mizell and Allain-Dupré, 2013[81]). This is a common situation among OECD subnational governments and notably among regions: performing ex ante appraisals (e.g. cost-benefit analyses, environmental impact assessments, territorial impact assessments) but not consistently using the result in decision-making (OECD/CoR, 2015[82]). Ex ante appraisals could be used to encourage actors to produce high-quality/high-accuracy assessments, instead of producing high-benefit/low-cost project estimates that turn out to be inaccurate (OECD, 2019[65]).

The use of ex ante economic evaluation tools that consider the territorial impact of public investment tends to be particularly limited among OECD countries (Figure 4.8) (OECD, 2019[65]). These tools, however, are particularly important when considering a place-based approach to investment. They offer insight into a potential investment’s territorial impact and benefit (OECD, 2019[67]), and support appraisal and prioritisation processes.

In the UK (and by extension in Wales), the procedures set out in the Green Book 22 tend to centralise decision-making and often place consultation and deliberation late in the investment project approval process (Hurst, 2019[83]). This can relegate social and environmental impact assessment, as well as public consultations, to a later stage, which increases the risk of disagreement and failure to implement investments. Ex ante assessments serve to assess long-term operational and maintenance costs from the early stages of the investment decision (OECD, 2019[65]): to include fiscal, but also financial, political, social and environmental impacts. The 2018 Green Book update introduced new criteria relative to personal well-being in the evaluation process. This should pave the way for introducing more social cost-effectiveness analysis and help measure the impact of projects contributing to the Welsh well-being agenda. To achieve such comprehensive assessments, monitoring and evaluation criteria and mechanisms need to be defined early in the policy design process and should not be limited to budget execution (OECD, 2018[84]). Economic project appraisal in Ireland and Italy have focused on these aspects (Annex 4.C).

Figure 4.8. Indicators of performance of public investments

Rigorous ex post analysis, including of outcomes, contributes to the overall effectiveness and efficiency of public investment and the quality of future investment choices (OECD, 2019[67]). Evaluation processes for regional development investment should pay particular attention to avoiding duplications when evaluating cross-sectoral projects, which was raised as a concern within the current Welsh Government administration (OECD, 2019[37]). The Welsh Government could also make better use of its current investment evaluation framework through increased public consultation, long-term project assessments, social impact analyses and ex post evaluation mechanisms with an outcome-based approach. Together, these can indicate whether the investment has supported meeting development objectives. New Zealand manages this through its Long Term Investment Plan Assessment Framework (Box 4.14).

Box 4.14. The Long Term Investment Plan assessment framework in New Zealand

The New Zealand Treasury has developed Long Term Investment Plans (LTIPs) as part of the cabinet policy. LTIPs are government department planning documents, with a minimum 10-year horizon and are reviewed every 2 years. The plans serve to guide departments, informing the factors driving investment needs and providing the rationale for the preferred way forward. The Treasury uses LTIP to support the development of the National Infrastructure Plan and of infrastructure more generally.

LTIPs are supported by a LTIP assessment framework. This framework is composed of a list of 10 criteria that is assessed on a 0 to 5 scale in the evaluation process: future focus; strategic alignment; service delivery; achievability; alignment of intentions; value; financial impact; procurement choices; asset performance; and capital efficiency. While LTIPs focus primarily on capital expenditure, they also consider the connections among demand, resources, services and benefits over the long term and pay attention to the consequences of investment choices on financial and service provisions.

Source: New Zealand Treasury (2017[85]), Guidance for Developing and Maintaining a Long Term Investment Plan, https://treasury.govt.nz/sites/default/files/2018-01/investmentmanagement-ltip-guidance.pdf.

Exploring innovative sources of public investment financing for Wales

In order to mitigate the impact of Wales’ fiscal framework on its future regional investment capacity, the Welsh Government will need to mobilise additional sources of investment finance, primarily from external sources and the private sector. Establishing a robust investment framework, while strengthening national and subnational investment capacities, is a step in this direction. However, the government will also need to carefully evaluate available and potential funding sources, and determine to what extent these can realistically contribute to financing regional investment priorities. In most cases, it is possible to combine a variety of financial instruments at different stages of the investment cycle. Some options explored below include land value capture mechanisms, enhanced access to private finance through climate-based instruments, and participative financing.

Land value capture mechanisms for funding

Financing investment through land value capture is increasingly prevalent in urban areas. This is generally attributed to the size of the required investments and constraints in national and subnational finance (Box 4.15). There are two broad categories of land value capture mechanisms: taxation-based schemes and development-based mechanisms, both supported by diverse financial instruments (Suzuki et al., 2015[86]):

1. Taxation-based schemes encompass the sale of public land, land taxes or taxes related to the change of land use. They aim to generate land-based revenue to finance infrastructure. This assumes that the national or local authority responsible for financing the urban development initiative is endowed with the administrative and legal capacity to set and collect the generated tax revenue.
2. Development-based mechanisms include taxes and fees, such as betterment levies, development impact fees, land readjustment and tax increment financing. These mechanisms aim to shift the costs (in part or in full) of development projects to landowners and developers, or to ensure that developers contribute to surrounding infrastructure and public amenities.

Development fees can be particularly useful to generate additional revenue in the framework of large-scale infrastructure projects and are used in about half of OECD member countries. However, as development fees force developers to bear part of the cost of new construction, they can also slow down urban development and should therefore be used with caution (OECD, 2017[87]). Land value capture mechanisms are suitable in a variety of contexts and have been applied successfully in several Latin American and European countries (e.g. development fees in the US, sale of land use rights in Brazil, public land leasehold in the Netherlands and land taxes in Australia and Denmark) (OECD, 2017[88]).

Box 4.15. Why use land value capture mechanisms?

Land value capture provides an opportunity for local authorities to generate additional sources of revenue from land developments to finance investment projects, completely or in part. In addition, land value capture mechanisms can also encourage local authorities to increase their tax base by taxing commercial or residential developments, and provide incentives to focus investments on the most efficient locations.

The rationale behind land value capture is that it enables governments to secure uplifts in land and real estate value associated with public interventions, which otherwise would be captured by private developers and landowners. It is a tool particularly adapted to financing urban regeneration projects, as well as public transit and transport projects, including railways or metros, which tend to have a strong impact on the value of nearby land and real estate.

Source: Albrecht, D. (2016[89]), Local Financing and Land-real Estate Capital: What Options and Conditions for Implementation?, http://www.uclg-localfinance.org/sites/default/files/instruments/UCLG_Study_Land_valuation_EN.pdf; Peterson, G. (2009[90]), “Unlocking land values to finance urban infrastructure”, http://documents.worldbank.org/curated/en/723411468139800644/Unlocking-land-values-to-finance-urban-infrastructure.

Successfully implementing land value capture mechanisms is based on a series of prerequisites: transparency and accountability, a strong legal framework and institutional structure, as well as specific skills and expertise to ensure equity objectives. The risks related to each value capture mechanism can and should be addressed directly with all relevant stakeholders (businesses and communities), through clear and transparent communication (Blanco et al., 2016[91]). In addition, the Welsh Department for Economy and Transport has a key role to play by applying an integrated methodology when implementing various forms of value capture to a location area.

Land value capture could contribute to financing public sector infrastructure investment at the local level, which could otherwise be unaffordable for local authorities, it can also generate spill-overs that could benefit broader territorial areas. To date, however, its use remains relatively constrained due to several factors, in particular the rigidity of the UK spatial planning system and low degree of fiscal decentralisation (OECD, 2017[87]). However, the growing body of international knowledge on land value capture shows that it can be used within relatively strict, national regulations. The choice of instrument is determinant, depending on the type of infrastructure to be funded. Identifying the desired time period for income generation is also relevant in order to choose instruments that will generate either recurring income or one-time income.

Welsh local authorities must carefully consider which specific instruments would be most suitable to their circumstances and needs, and look at how their choices can be efficiently combined (Olajide and Arcé, 2017[92]). These instruments could include, for instance, the use of a vacant land levy in urban eras, used in Ireland since 2017 (Urban Regeneration and Housing Act 2015). However, initial assessments in January 2019 indicate that the administrative burden of the process and the lack of adequate staff first prevented Irish local authorities from making full use of this levy (RTÉ, 2019[93]). Welsh local authorities involved in City Deals are considering mechanisms that would use non-domestic rate retention to help them pay back borrowing costs. To extend the use of non-domestic rate retention to fund large-scale infrastructure, through mechanisms such as tax increment financing (Box 4.16), however, would require an increase in fiscal powers to be viable.

Box 4.16. Tax increment financing

Tax increment financing (TIF) is an economic development instrument aimed at anticipating increases in tax revenues generated from developing new commercial/real-estate activities or rehabilitating run-down areas financed through public investment. When applied to regeneration/redevelopment projects, the public authority can take out loans or bonds pledged on the area’s potential. The tax base is frozen when TIF is introduced. Additional tax revenue is allocated to repaying loans taken out to finance local projects within the perimeter and to support additional investment in the area.

TIF is implemented by creating a specific geographic district, administered by a TIF authority (i.e. special taxing districts, development authority districts, community facilities districts or community management districts). After the district is created, the assessed property value is frozen for a period of time, usually 10 to 25 years. As new funds are invested, the property values in the district increase, as do on-site property tax revenues. The property tax increment (the new property tax minus the property tax on the frozen property values) is diverted to the TIF authority, which has to reinvest it within the TIF district.

This instrument was first introduced in California in 1952 and is now used in all US states except Arizona. It is most often applied to financing the rehabilitation of under-developed areas, the development of public spaces and facilities, or public transit schemes.

In the UK, England has been piloting TIF since 2013 by allowing the retention of Non-Domestic Rates by local authorities, through the Business Rates Retention Scheme. However, their main use remains limited to support recurrent service expenditure, instead of investment funding. In 2010, Scottish legislation also introduced TIF. To assess the feasibility of expanding TIF use, the Scottish Futures Trust is developing criteria that will apply to local authorities for submitting TIF proposals such as: identifying a geographic area of development that would lead to sustainable and inclusive economic growth; and identifying public assets to be funded by TIF that are not able to be funded through traditional means (e.g. prudential borrowing). As of 2019, there were four TIF pilot-projects in Scotland (and two waiting for business case approval).

Source: OECD (2019[94]), The Governance of Land Use in Korea: Urban Regeneration, https://dx.doi.org/10.1787/fae634b4-en; Albrecht, D. (2016[89]), Local Financing and Land-real Estate Capital: What Options and Conditions for Implementation?, http://www.uclg-localfinance.org/sites/default/files/instruments/UCLG_Study_Land_valuation_EN.pdf; Scottish Futures Trust (n.d.[95]), Tax Incremental Financing, https://www.scottishfuturestrust.org.uk/page/tax-incremental-financing.

To enhance the use of land value capture mechanisms in Wales, two main issues should be addressed. First, the administrative burden associated with these mechanisms should not be too onerous for local authorities. This could be managed by an independent land commission (akin to the old Land Authority for Wales), responsible for managing the inventory and sale of land, an approach adopted by Scotland. If this requires adjusting the devolution settlement, it may be more difficult to implement (at least in the short term) in the Welsh case. Second, if a more sophisticated mechanism is used, such as TIF schemes, this implies further devolving revenue-generating capacity to local authorities, in order to generate additional revenue at the local level. In the framework of TIF instruments, the revenue generated would be retained by the TIF authority itself as a financial guarantee against a loan for financing its infrastructure project. In the case of Wales, these revenues could come from the partial retention of Non-Domestic Rates (NDR), as briefly explored earlier. Such a scheme would not entirely substitute the distribution model of NDR but would add another component – one that enables local authorities to retain a certain share of their NDR revenue. This can be applied to specific contexts, such as City and Growth Deals with ongoing redevelopment projects, where its use is still very recent (Holtham, 2019[26]).

Better exploiting green procurement and climate-related funds

Local policymakers across the OECD are working to strengthen their knowledge of and capacity to leverage alternative sources of finance for green investments. It generally requires additional investment in upskilling programmes to train government staff in managing such projects in partnership with private and third sectors parties (OECD, 2019[96]). Climate-oriented finance and investment also present opportunities to mobilise funding from international organisations and national governments, to leverage external funding from the private sector and to combine climate and inclusion objectives while financing infrastructure investments (OECD/World Bank/UN Environment, 2018[97]).

Wales has a number of assets enabling it to make use of climate-finance mechanisms, which align with its objectives of decarbonisation and biodiversity. According to recent information, the Development Bank of Wales is creating a “Green Fund” for investment (Gareth, 2019[70]). Its knowledge and expertise gained in this area could be shared with the Welsh Government and local authorities to help fill information gaps on climate finance, and available climate-driven funding streams available at the national and international levels. This could also support Wales’ requirement to report on the level of its carbon budgets every five years as part of its commitment to targeting net-zero greenhouse gas emissions by 2050 (Committee on Climate Change, 2019[98]).

Green public procurement supports environment-friendly policies and investment strategies by integrating environmental and social considerations into the procurement process. First introduced in the Netherlands and then in Belgium (Box 4.17), it has been spreading throughout Europe in the form of Green Deals. Generally, a Green Deal is a voluntary agreement between private partners, civil society and the national and/or regional government to establish a joint green project. In Wales, green public procurement could give Welsh Government, and potentially local authorities, margin to use its purchasing power in a way that upholds regional and local environmental objectives, while also benefitting the local economy.

Box 4.17. Green Deal Circular Procurement in the Netherlands

In 2013, the Netherlands’ government launched a Green Deal for Circular Procurement in order to stimulate the circular economy. The programme supports local governments, such as the city of Amsterdam, to set up PPPs and collaborate with the private sector and civil society organisations to enter purchasing arrangements inspired by circular economy principles. When they sign up to this Green Deal, organisations must commit to participating in at least two circular procurement projects and to including circular principles in their internal procurement guidelines.

This Green Deal has led to the development of a learning network – co-ordinated by a consortium of Dutch partners – that mixes public and private actors and shares knowledge and experiences around the principles of circular principles. Following the success of this initiative in the Netherlands, the regions of Flanders and Wallonia in Belgium launched their own Green Deal on Circular Procurement in 2017 and 2019 respectively, with the support of the Dutch organisation.

Source: One Planet Network (n.d.[99]), Green Deal Circular Procurement, https://www.oneplanetnetwork.org/initiative/green-deal-circular-procurement; Wallonie Service Public (n.d.[100]), Economie Circulaire, http://economiecirculaire.wallonie.be/.

In addition to green procurement, the green bond market is still young but it has rapidly gained traction in financing green projects that deliver environmental benefits (OECD, 2019[67]; 2017[101]). Green bonds share the same financial characteristics of conventional bonds, with the exception of the ring-fencing or earmarking of proceeds required by the green label. They are usually issued by large-size cities or groups of cities that pool together their financing and human capacities, for example in France and the Nordic countries (Box 4.19). They are complementary to social bonds, intended to finance socially-responsible investment. However, for green bonds to be successful, governments need to develop a pipeline of quality, bankable projects.

Box 4.18. Green bonds issuance at the regional and local levels

Green bond framework for the Région Ile-de-France, France

The Région Île-de-France has made climate finance a trademark for its investors. It has been a frequent and regular issuer in the green and sustainable bond market since 2012, with eight transactions. The 6^th Green and Sustainable Bond Issuance of the Région Île-de-France, launched in June 2018, amounted to EUR 500 million. As part of the process and under the supervision of the region’s finance directorate, each sectoral department in the region is asked to identify priority projects having a high environmental and social impact within a certain budget. The finance directorate then consolidates the information across departments and finalises the budget allocation by sector. Nine eligibility criteria have been established to guide the purpose and management of the projects (e.g. environmental responsibility, social and societal responsibility, economic responsibility and governance).

Looking at the funds received from the green bond during the 2014-18 period, half went to public transport and sustainable transport projects. Social housing and facilities for education and leisure accounted for 16% and 15% respectively. Minor shares of funding were also allocated to projects related to biodiversity (5%), economic and socially inclusive development (7%), support to vulnerable groups (5%) and energy efficiency (2%).

Municipal green bonds markets in Nordic countries

The first municipal green bond in the Nordic countries was issued in 2013 by the City of Gothenburg, Sweden, to fund energy, transport, water management and waste management projects. It has renewed the experience on several occasions, almost annually since then. To support its green bond strategy, the city has developed its own Green Bond Framework, which specifies terms and conditions for the selection of eligible projects, follow-up and transparency requirements. Nordic local government funding agencies, such as Kommuninvest (Sweden) and Municipality Finance (Finland), are also regular issuers of green bonds. In general, Nordic green bond issuers rely extensively on the use of external reviews and second party opinions to support their green bond issuances, which confirms compliance with the Green Bond Principles and the climate components of the proposed investments.

Source: Région Île de France (2019[102]), Regional Finances: Key Figures, https://www.iledefrance.fr/sites/default/files/medias/2019/10/4PAGES%20Region%20IDF%20key%20figures.pdf; Climate Bonds Initiative (2018[103]), The Green Bond Market in the Nordics 2018, Handelsbanken, https://www.climatebonds.net/files/reports/cbi-nordics-final-03b.pdf; Nassiry, D. (2018[104]), “Green bond experience in the Nordic countries”, https://www.adb.org/sites/default/files/publication/408336/adbi-wp816.pdf.

Participatory budgeting and crowdfunding platforms to fund local investment

Participatory budgeting and civic crowdfunding can channel funds towards small-scale projects and, in particular, projects that traditional funders will not finance due to limited profitability. These financing mechanisms carry value related to common good and social, cultural or environmental purposes. They are particularly well suited for lower cash-value, short-term projects with high visibility and impact, such as local community projects that would have trouble raising external funding. In the case of infrastructure, participatory mechanisms can support investment for construction and restoration, for creating or improving green and public spaces, and providing community infrastructure and equipment. To maximise the impact of such instruments, local authorities can match the amounts committed through participatory and crowdfunding budgets with a certain share of their own budget, and replicate the exercise on a regular basis (annual, bi-annual, etc.). These instruments need to be analysed in the light of local contexts and they can be combined with other instruments at several stages of the investment process. For instance, donation crowdfunding can secure early-stage investments and build support among the local community. Later in the process, as the project’s scope is defined and financial conditions are established, equity crowdfunding markets can become suitable, in combination with other local revenue streams, to finance the project’s construction (Gasparro, 2019[105]).

Participatory budgeting, a practice considered “laboratory federalism”, can stimulate community engagement and involvement, generate project ideas emanating from the community itself, and strengthen inclusive governance, which can be of interest to Wales. It may contribute improving the quality and the efficiency of public policies at the national and subnational levels, by increasing transparency, and making infrastructure and services more relevant to the community (OECD, 2019[11]). It is applicable to local authorities of all sizes, with varying degrees of participation, and is particularly suited to highly vulnerable areas where the social fabric is at risk. It enables citizens to choose how to spend a predefined sum of funding, most generally for investment purposes, in specific sectors (often culture, environment, sport, etc.). Local authorities should have control and ownership over the participatory budgeting process and effectively manage citizen participation to ensure success. Local governments are responsible for ensuring citizen input is properly taken into consideration and projects are effectively implemented, in order to guarantee the sustainability of the initiative. In more participatory processes, the citizens are engaged at the early stages of the process – i.e. when determining the sum allocated and the sectors concerned. Several local governments across the OECD have piloted with participatory budgeting and some cities have institutionalised it, with a fixed share of their investment budget subject to the citizen vote (Box 4.19).

Box 4.19. Participatory budgeting at the local and national levels

Local-level participatory budgeting in Paris, France

Since its launch in 2014, Paris’ experience with participatory budgeting has been positive. Through an interactive and easy-to-use web platform, Parisians decide on the use of 5% of the city’s investment budget, amounting to EUR 500 million in 2014-20. As of February 2020, 2 160 projects were implemented through this process and the web platform allows citizens to follow implementation progress step-by-step. Participatory budgets have flourished in Paris with a growing number of sub-categories, from participatory budgets in public schools to participatory budgets in sub-municipal districts (arrondissements) and in social housing.

Local and national level participatory budgeting in Portugal

There are approximately 118 participatory budget initiatives at the local level in Portugal, which account for approximately EUR 91 million of total investment between 2007 and 2017. Lisbon’s city council was one of the first to develop “green” participatory budgeting, with a budget of EUR 5 million. In addition, Portugal is the first OECD country to initiate a nationwide public participatory budget, the Portugal Participatory Budget (OPP). The OPP is conceived as a democratic, direct and universal process that allows civil society to decide on public investments in different government sectors. These sectors include culture, science, adult education and training, and agriculture, for a total of 38 projects (as of 2017). In the two Autonomous Regions of Azores and Madeira, the sectors were different and the participatory budgeting concerned justice and internal affairs. More than 900 proposals were submitted by the citizens, primarily in the sector of culture. People can vote by SMS or on the Internet, for one national and one regional project each. The 2017 OPP pilot phase was allocated EUR 3 million, split between distinct allocations for national projects and regional projects. The 2018 OPP budget was raised to EUR 5 million. In 2019, a “light version” of the OPP was organised, based on previous project submissions, due to the large number of electoral processes that year.

Source: Ville de Paris (n.d.[106]), Le mode d’emploi du Budget Participatif, https://budgetparticipatif.paris.fr/bp/la-demarche-sommaire.html; OPSI (n.d.[107]), Portugal Participatory Budget, https://oecd-opsi.org/innovations/portugal-participatory-budget/.

Civic crowdfunding provides another opportunity for Welsh local authorities to finance community-level infrastructure and services. Crowdfunded projects are financed by a group of individuals instead of private sector entities. It is increasingly used by SMEs and entrepreneurs across the OECD as an alternative financing instrument (OECD, 2015[108]). Civic crowdfunding emerged at the beginning of the 2010s as crowdfunding for local projects and infrastructure of benefit to a community. Crowdfunding models vary, ranging from donation-based to municipal bonds. Donation-based crowdfunding models offer limited opportunities in terms of amount and scale, and should be reserved for social projects led by local authorities and town and community councils. Projects requiring larger financing contributions can rely on crowdfunding in the form of municipal bonds (Davis and Cartwright, 2019[109]). Municipal bonds are a more regulated type of crowdfunding where investors are guaranteed a stream of future interest payments over the period of the bond, in addition to the invested amount paid back in full. They are used by local governments in the US to finance projects such as green space improvements or school upgrades (Future Cities Catapult, n.d.[110]).

Crowdfunding could be relevant to support the Welsh community and well-being agenda, under the form of local authorities partnerships to improve public spaces and infrastructure. Recently, the Valleys Taskforce launched a proposal for a partnership funding arrangement between the Welsh Government (main funder) and Blaneau Gwent, Bridgend, Caerphilly, Merthyr Tydfil, Neath Port Talbot and Torfaen, to which each community contributes to a specified amount (Caerphilly Country Borough Council, 2020[111]). The terms of this fund remain to be defined. However, it could serve as an example for other Welsh local authorities who wish to engage in local regeneration and development projects. Recent academic work on the use of crowdfunding for urban infrastructure has highlighted that crowdfunding is most often used as an engagement mechanism, to demonstrate social support and with the aim of attracting additional funding. It is not used as a mechanism to increase investment financing/resources. In addition, the participation of subnational governments in crowdfunded exercises is essential to support the costs related to the construction of the projects being funded as well as to the longer-term operation/maintenance costs.

Part 2: Conclusion and recommendations

Developing a coherent investment framework at the national level in Wales can bring significant benefits in terms of maintaining a sustainable investment strategy for regional development. The transition towards a new structure for investment co-ordination post-Brexit could be a key driver to ensure that investment decisions are aligned and that the inputs of all stakeholders are taken into account. Streamlining financing processes at the level of City and Growth Deals, and integrating these arrangements further into broader regional economic strategies, will also be crucial. By developing its National Framework for Investment in regional development, the government can ensure that all government levels and stakeholders work together towards a common goal. To reach its objectives, public investment in regional development in Wales must also be supported by in-house technical capacities and in particular strong capacities to design and implement projects, expertise to expand the use of the Welsh MIM, and adapted ex ante and ex post evaluation mechanisms. Under these conditions, the Welsh Government and local authorities will be in the best position to explore the available sources of funding for investment, including innovative sources such as land value capture instruments, climate-related finance and participatory-funding mechanisms.

Box 4.20. Recommendations for action to optimise Welsh public investment resources for regional development

1. Address investment strategy fragmentation for better-co-ordinated investment post Brexit

Adopt the proposed National Framework for Investment and use it to support investment initiatives across sectors and among levels of governments.
Transition WEFO into an investment administration and management body for regional development, maintaining its location in the office of the First Minister.
To the extent possible, implement a multi-annual approach to financing investment projects for regional development.
Encourage cross-sector or cross-jurisdiction projects, including cross-border co-operation and with specific incentives for local authorities.

2. Ensure all levels of government have sufficient capacity to support place-based investment

Increase capacity and expertise of local authorities in the design, implementation and evaluation of investment projects through knowledge transfer from WEFO and the DBW (among other agencies).
Create an appropriately resourced PPP unit with sufficient resources and continue strengthening the use of the MIM.
Ensure that ex ante analysis comes early in the investment cycle and that ex post evaluation includes outcomes,

3. Pursue additional sources of investment financing for regional development.

Make City and Growth Deals more competitive with other UK City Deals by reinforcing their ability to leverage additional revenue and by improving their transparency and accountability.
Promote the use of external financing mechanisms by local authorities (e.g. climate finance and land value capture) on a case-by-case basis and subject to mutually agreed-upon preconditions.
Encourage the use of participatory budgeting and crowdfunding as complements to local authority financing for small-scale investment projects with high local visibility (e.g. community infrastructure, green and public space improvement, etc.).

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Annex 4.A. Allocation of responsibilities in Wales

Annex Table 4.A.1. Responsibility sharing across levels of government: Wales
Main responsibility/sector and sub-sector	Welsh local authorities	Welsh Government	UK Government
1. General public services (administration)
Administrative services (marriage, birth, etc.)	X		X
Public buildings and facilities (townhouses, etc.)	X	X	X
Administration and operation of general services (not assigned to specific functions)	X	X	X
Basic research activities (not assigned to specific areas)	X	X	X
2. Public order, safety and defence
Police	X	X	X
Firefighting			X
Civil protection and emergency services		X (Emergency services, Welsh Ambulance)	X (Civil Protection Mechanism)
Road traffic control/Traffic signs and lights	X	X
Defence (military and civil)			X
3. Economic affairs/Transport
Road networks and facilities (highways, national, regional, local)	X	X
Parking	X
Railway networks and facilities (national, regional, local)		X	X
Airports (international, national, local)		X	X
Ports (sea and fishing; inland waterways)	X	X	X
Public transport (road)	X	X
Public transport (rail and tramway)	X	X	X
Special transport services (e.g. pupil and student transport)	X	X
Employment policies/services		X	X
Support to local enterprise and entrepreneurship		X
Agriculture, rural development, irrigation		X
Telecommunications/IT		X	X
Manufacturing and construction		X	X
Mining	X	X	X
Tourism	X	X
Commerce		X	X
Energy (electricity and gas)		X	X
4. Environment protection
Parks and green areas	X	X
Nature preservation		X	X
Noise and vibration abatement	X	X
Air pollution		X	X
Soil and groundwater protection		X	X
Climate protection		X	X
Waste management (collection, treatment and disposal)	X	X
Sewage (wastewater management)		X
General drainage	X	X
Street cleaning	X
5. Housing and community amenities
Drinking water distribution	X	X
Public lighting	X
Urban heating
Housing (subsidies)		X
Housing (construction and renovation)		X
Housing (management)	X	X
Urban and land use planning	X	X
Urbanism
6. Health
Pharmaceutical and medical products		X	X
General and specialised medical services and paramedical services		X
Primary healthcare (medical centres)		X
Hospital services (general and specialist)		X
Preventive healthcare		X
Public health services		X
7. Culture, recreation and religion
Sports and recreation	X	X
Libraries	X	X
Museums	X	X
Cultural activities (theatres, exhibition halls, zoos, botanical gardens, etc.)	X	X
Cultural heritage/monuments		X
Media/Broadcasting and publishing services		X	X
Religious affairs			X
8. Education
Pre-primary education	X	X
Primary education	X	X
Secondary education	X	X
Higher education (universities, other tertiary education institutions)		X
Vocational education and training (VET)		X
Special education	X	X
Research and development		X	X
9. Social welfare
Social care for children and youth	X	X
Support services for families	X	X
Elderly care	X	X
Care for disabled people	X	X
Social exclusion/poverty (policies and benefits)		X
Immigrants			X
Integration of foreigners	X	X
Social welfare centres	X	X	X
Housing subsidies/benefits		X
Unemployment subsidies/benefits			X
Total number of ascribed responsibilities	38	64	28
Total number of exclusive responsibilities	3	26	3
Source: Welsh Government (2019[19]), “Responses to OECD Questionnaire, unpublished”; OECD international experience with equalisation mechanisms: Some examples.

Estonia

In 2017, in order not to discourage municipalities from increasing their revenues, the Estonian government established an equalisation threshold. Even though a municipality’s “estimated costs” (financing needs) have decreased due to higher local revenue, the corresponding share of the equalisation grant that it receives cannot decrease by more than 2% annually (OECD/UCLG, 2019[17]).

Germany

Over the past 15 years, Germany’s fiscal federalism has undergone several rounds of reform. Until 2020, there were two processes of equalisation at the Länder level: a vertical equalisation scheme, from the federal to the regional level, through a system of shared tax (VAT); and a horizontal equalisation scheme based on a system of shared taxes between states and funded by the Länder themselves, to ensure public services are equitably delivered in all regions. Wealthy Länder financially contribute to the revenue pool, and the funds are then redistributed to Länder with lower-than-average fiscal capacity (according to a formula based on per capita tax revenue of both the Länder and the municipalities). As of 2020, this system has been transformed. The new system shifts the former horizontal compensations, which are being abolished, into the vertical distribution of shared taxes (VAT). By doing so, it emphasises a reliance on shared taxes and the role of the federal government in the equalisation system to correct horizontal imbalances (Buettner and Krause, 2018[112]).

Norway

Norwegian municipalities all share the same extensive responsibilities, but they generate significantly different levels of tax-based income. However, there is limited scope to increase local tax revenues. The fiscal equalisation system was developed on the principles of a partial equalisation of local taxes and a distribution of general grants to equalise expenditure needs (which can vary given differences in geography, demography and social characteristics). The system, however, does not subject municipal own-source revenues (e.g. property tax, hydro-power revenues, aquaculture revenues) to equalisation, as these are becoming increasingly important to municipalities, especially smaller ones (OECD, 2019[11]; OECD/UCLG, 2019[17]).

Annex 4.B. Developing a coherent investment framework: OECD international experience

Contracts and deal-making

France: State-Region Contracts

France has a long history of contractual arrangements linked to the decentralisation of specific tasks to regions, departments and, to some extent, municipalities. State-Region Contracts (Contrats de plan État-Région, CPER), launched in 1984, initially aimed at building regional capacity through a long process of negotiation between subnational governments and the central government’s deconcentrated bodies. These contracts established the objectives, implementation and funding modalities for specific tasks. They can also have an incidence on financial transfers from the central level to the subnational one. France is now in its 6th generation of CPER and, through this process, regions have developed extended capacities and responsibilities in terms of economic development, employment and vocational training, including larger budgets and new actors involved (e.g. academics, civil society).

Other types of contracts have also blossomed: State-Metropolis Pacts were launched in 2016 in order to empower and support investment in metropolitan areas; between 2016-18, 485 contracts for rural development were signed to revitalise rural areas through initiatives in social cohesion, economic attractiveness, access to public services, mobility solutions, access to digital technologies, and the ecological and energy transition (OECD/UCLG, 2019[17]; Charbit and Romano, 2017[113]; CGET, 2017[114]).

The Netherlands: City Deals

The Netherlands has recently introduced City Deals signed between the central government and subnational governments, as part of its New Urban Policy (Agenda Stad). They are designed to pool together existing funding streams to stir investment in Dutch cities in priority sectors. Dutch City Deals are not exclusive and Amsterdam has signed no less than six separate City Deals on different topics and in partnership with different combinations of other Dutch cities. For example, the first deal was signed for the development of a roadmap for the future economy and the second on climate adaptation. City Deals in the Netherlands are considered a way to encourage greater collaboration at the local and regional levels on topics such as economic development, clean energy and digitalisation, and to promote learning and innovation (OECD, 2019[67]).

Aligning policy, planning and investment frameworks

“Project Ireland 2040”

“Project Ireland 2040” provides an overarching policy and planning framework for the country’s social, economic and cultural development. This framework helps align the country’s investment decisions with its planning framework to support better co-ordination and more efficient planning of public infrastructure investment across the country. It weaves together a detailed investment plan – the National Development Plan 2018-2027 (NDP), and a 20-year spatial plan, the National Planning Framework 2040 (NPF), to shape the future growth and development of the country to 2040. This provides the structure for the Regional Spatial and Economic Strategies (RSES), which are prepared by the country’s three regional assemblies and take into account the high-level frameworks and principles in the NPF and, in turn, informs local city and county planning and economic policy. The RSES take a cross-sector approach, combining a spatial strategy, an economic strategy and a climate strategy, and set the parameters for a number of funding sources – including the Urban and Rural Regeneration Funds, the Climate Response Funds, the Disruptive Technologies Fund and various enterprise funds. Each of these strategies is prepared with input from local authorities and other relevant stakeholders (such as government departments, state agencies, infrastructure and economic bodies) (e.g. the Minister and Department of Housing, Planning and Local Government, and the Irish Department of Public Expenditure and Reform) to set a regional co-ordination framework.

RSES inform decisions related to future regional public infrastructure aligned with the 10-year National Development Plan in order to enhance access to further funding opportunities. The investment framework is now in the process of being translated into an implementation and monitoring structure, with the concrete objective to enable and drive regional development and investment (Bradley, 2019[115]).

The Multi-Year Programme for Infrastructure, Spatial Planning and Transport in the Netherlands

In the Netherlands, the Multi-Year Plan for Infrastructure, Spatial Planning and Transport (MIRT) is an investment programme set up by the Ministry of Infrastructure and Water Management, with the objective to improve coherence among investments across several areas: spatial planning, economic development, mobility and liveability. In addition, the MIRT is organised in “area agendas” (to be referred to in the future as “regional agendas”), where co-operation among national, provincial and municipal governments and third-sector actors can take place.

Any Dutch ministry and regional partners (provinces, municipalities, transport regions, or district water boards) can launch and/or participate in MIRT programmes. Each submitted project must pass through a MIRT Consultation Committee, guided by regional agendas, before being finalised in a collective agreement. This programme is funded through two funds emanating from the ministry: an Infrastructure Fund and a Delta Fund for water projects. The MIRT also set a framework with rules and procedures to access national investment funding in order to guide project proposals and project selections (Dutch Ministry of Infrastructure and Water Management, 2018[59]; Government of the Netherlands, 2019[116]).

Annex 4.C. Strengthening public investment management capacities: OECD International experience

Improving PPP performance with specialised units

Australia

In Australia, PPP units exist at both the national and regional levels. At the national level, Infrastructure Australia was established as an independent agency to provide advice on Australia’s infrastructure priorities. Infrastructure Australia and the Australian government have jointly prepared and endorsed national guidelines for the delivery of infrastructure projects, to promote the use of good practice approaches covering three main modes of project delivery: traditional contracting, alliance contracting and PPPs. At the state level, three states have established PPP units (New South Wales Public-Private Partnerships, Projects Queensland and Partnerships Victoria). These units provide a wide range of services, including training in PPP contract management (dedicated to public sector employees) and fora where PPP contracts managers, from public and private sectors, can share best practices (World Bank Group, 2020[117]).

Germany

In Germany, Partnership Germany (ÖPP Deutschland AG) was established in 2009 as a central unit to provide advisory services to government entities (e.g. federal government, federal states and municipalities). In 2017, Partnership Germany was converted into “PD – Consulting Agency for the Public Sector”, a wholly publicly owned limited liability company, extending its consulting activities beyond PPP contracts alone. PD’s particular focus today is to help local authorities implement public investment projects. Among other activities, PD manages a database of PPP projects all across Germany and organises an annual summer school dedicated to knowledge transfer among public sector practitioners. At the state level, Länder have also developed regional taskforce (e.g. in Bade-Württemberg) or networks of expertise (e.g. Lower Saxony), hosted in the Ministry of Economy or the Ministry of Finance, universities or regional investment banks, depending on the Länd (Federal Ministry of Finance, n.d.[118]; Niedersaschsen, n.d.[119]).

Economic project appraisal in Ireland and Italy

Ireland

In Ireland, up-front investment prioritisation, planning and appraisal enable better value for money and performance monitoring. Robust appraisal brings analytical discipline and baseline data provides the platform for subsequent performance monitoring and evaluation. Ireland publishes all investment plans starting with the National Development Planning Process. Government departments and state agencies publish sectoral plans, which are consistent with the overall financial allocation. These set strategic policy and frame the context for major projects.

Individual projects must also stand up on their own merits. The central government issues rules on the type of appraisal that must be undertaken for a public investment according to the investment’s financial scale. Compliance with this framework is a condition of delegated control over capital budgets. Government departments are free to adopt their own sector-specific frameworks, consistent with the overall rules (OECD, 2018[84]).

Italy

Italy has a new planning procedure to ensure more efficient and effective infrastructure spending, which includes economic project appraisal. The process is transparent and verifiable and the quantitative and qualitative decision-making criteria are explicit. Expenditure departments must prepare sectoral appraisal guidelines to define standard procedures for project appraisal in different investment sectors (e.g. mobility, energy, water management, etc.). The Programming, Evaluation and Analysis Unit (NUVAP) is responsible for providing methodological support to national and subnational (including local) public administrations, defining national standards for the evaluation of the economic and financial aspects of projects and spreading best practices (OECD, 2018[84]).

Notes

← 1. The Welsh fiscal framework is composed of regulations relating to matters such as interactions between the Welsh and UK fiscal policies, intergovernmental arrangements and grants, borrowing limits and fiscal forecasting.

← 2. The Regional Authority Index (RAI) is a measure of the authority of regional governments in 81 democracies or quasi-democracies on an annual basis over the period 1950-2010. Regional authority is measured along ten dimensions: institutional depth, policy scope, fiscal autonomy, borrowing autonomy, representation, law making, executive control, fiscal control, borrowing control and constitutional reform.

← 3. This is in contrast to “reserved powers” which remain at the level of the UK parliament.

← 4. The contribution of the UK government to expenditure made for Wales can be misleading and must be considered with caution. For instance, over GBP 480 million of UK capital expenditure was spent on defence in 2017, allocated as Wales’ share of the UK total, but very little was actually spent in Wales (Holtham, 2019[26]).

← 5. According to the definition used by the Office for National Statistics (ONS) in the Country and Regional Public Sector Finances Release (UK Office for National Statistics, 2019[120]), public expenditure is determined to be “for” Wales “if the benefit of the service derived from the expenditure is thought to accrue to the residents of Wales”. It is also defined by the ONS as identifiable expenditure. Conversely, non-identifiable expenditure is defined as “expenditure on services that is incurred to benefit the UK as a whole and cannot be identified as benefiting a particular country or region of the UK” (e.g. defence). In the Country and Regional Analysis Methodology (UK Government, 2019[121]), non-identifiable expenditure is apportioned to devolved nations based on several indicators, such as population and GVA. Out of the total of identifiable and non-identifiable expenditure, part of these come from the UK government, some from the Welsh Government and some from local authorities.

← 6. Of this 59%, the Welsh Government is responsible for 33% and local authorities for 27%.

← 7. The Classification of the Functions of Government (COFOG) comprises 10 functional areas: general public service; public order, safety and defence; economic affairs; environmental protection; housing and community amenities; health; recreation, culture and religion; education; social protection.

← 8. Public sector refers to the general government sector, composed of total amount spent or received by the UK government, Welsh Government and local authorities, for Wales.

← 9. This average is based on revenue of the regional government sector (or state government sector in federal countries) only, in 20 EU and OECD countries, not including the local government sector.

← 10. Weighted average.

← 11. All borrowing by publicly owned entities in the UK is treated part of the fiscal target the Public Sector Net Borrowing (PSNB). No distinction is made, as in other OECD countries, between general government borrowing, which has to be serviced from future taxation, and the borrowing of state-owned entities with their own-revenue and balance sheets. For these purposes, the Welsh Government is treated like a department of the central government (Holtham, 2019[26]).

← 12. Council Tax is a hybrid tax based on levied on the banded value of residential properties and household composition. Non-Domestic Rates are based on the assessed rental value of the property.

← 13. Local authorities and town and community councils can determine their own affordable borrowing limits within the framework set by the CIFPA Prudential Code, which sets indicators of affordability, sustainability and prudential rules for all local authorities at the UK level (Holtham, 2019[26]). They can borrow to finance capital expenditure only (golden rule).

← 14. Excluding Major Repair Allowances (MRAs), which are funding paid by the central government to local housing authorities to maintain the housing stock.

← 15. Local Government Borrowing Initiative (LGBI).

← 16. A first agreement to retain part of the gains generated through development project was passed in 2019 with local authorities participating in the Swansea Bay City Deals.

← 17. COVID-19 presents opportunities and challenges regarding the introduction of tourist taxes. While crisis situations can facilitate introducing reforms, such as a new tax, the revenue that will be generated may be substantially lower than planned due to the impact of the crisis on the tourism sector.

← 18. Until 2020, European Structural and Investment Funds (ESIF) include the European Regional Development Fund (ERDF), the European Social Fund (ESF), the Cohesion Fund (CF) – all three of them compose the EU Cohesion Policy –, as well as the European Agricultural Fund for Rural Development (EAFRD), the Youth Employment Initiative (YEI), and the European Maritime and Fisheries Fund (EMFF).

← 19. WEFO is a special agency created by the Welsh Government to fulfil administration, management control and audit functions, as well as the creation of partnerships between public or private entities (sponsoring authorities). As a “Managing Authority”, WEFO is responsible for the efficient management and implementation of the ESIF programme.

← 20. The delivery of health services is generally the responsibility of member state, and does not fall under the prerogatives of EU funding. However, to overcome its budgetary limitations in facing the COVID-19 crisis, the Welsh Government has been able to reallocate funding from EU projects which are no longer taking place into daily expenses related to the crisis (Cardiff University, 2020[32]).

← 21. To be eligible for public financing, the investment project proposed by firms must demonstrate commitment to four requirements: growth potential, fair work, health promotion and reducing the carbon footprint. In return, the national framework could support those companies that align with the Welsh Government’s objectives (e.g. decarbonisation).

← 22. The Green Book is issued by HM Treasury to guide UK subnational governments on approved techniques and approaches to appraisal and evaluation issues.

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