by Stuart Morley
During the 1970s (particularly the latter half of the decade) there was a growing awareness by both central and local government of the need for direct intervention in local economies — partnership schemes involving the private sector, but in particular direct development by local authorities became commonplace in urban areas. During the 1980s, by contrast — despite increased levels of unemployment and urban dereliction — the private sector role has been stressed by central government at the expense of the local authority role. This has been reinforced by grants and tax incentives to the private sector and increasing financial constraints and controls on local authorities. The culmination of central government policies is the growth of non-elected urban development corporations in many urban areas, and the proposals of new controls on local authority borrowing and expenditure and new (constrained) powers on economic development by local authorities, which will also affect the private sector and proposals for joint development.
Conservative government policies in the 1980s
The 1980s heralded a marked change in the economic and political outlook. The deep recession of the early 1980s caused dramatically increased levels of unemployment, particularly in manufacturing industry, but the political response was very different from that of the preceding decade. To some it seemed that there were similarities with the mid-1970s in so far as the economy was weak, the demand for industrial property was depressed, and private-sector developers were therefore reluctant to become involved in industrial schemes or inner-city renewal. The financial institutions’ slow but growing disenchantment with property as an investment, particularly industrial (and to a lesser extent office) property, served only to reinforce this pessimistic view. Increased, or at least continuing, direct intervention by local authorities therefore seemed a natural result — merely continuing the role started in the mid-1970s. However, the Conservative Government considered such direct intervention as politically undesirable.
The Government’s philosophy was, wherever possible, to reduce state intervention, lessen controls and bureaucracy and allow market forces to return, so that the private sector rather than the public sector could provide a solution. It was considered that this would provide a much healthier and sounder basis for economic growth and a prosperous future.
New initiatives were introduced in the early years of this period to encourage the role of the private sector and lessen or bypass the role of the state. There are many examples — the introduction of enterprise zones, urban development corporations, industrial building allowances, urban development grants and the abolition of industrial development certificates, office development permits and the Community Land Act, together with various circulars reducing local authority planning control.
One of the first of these measures was the introduction in 1980 of 100% industrial building allowances (IBAs) for small factory units up to 2,500 sq ft in size. Despite increased action by local authorities in the latter half of the 1970s, a 1980 report (Coopers & Lybrand Associates/Drivers Jonas) identified a continuing shortage of small industrial units throughout the country, so the Government turned to tax incentives for the private sector to overcome this problem; 100% IBAs were introduced for a three-year experimental period, later modified and extended for a further two years. This enabled a developer to offset against tax the full development costs (excluding land) of a scheme.
For high-taxpaying individuals (the marginal rate of tax was 75% until 1984) this was clearly a very significant incentive and resulted in a dramatic change in private-sector provision of small industrial units. (A DOI survey in 1982 of 22 local authority areas showed an increase in the provision of small industrial units from under 200 in 1979-80 to about 700 in 1981-82. This expansion was almost entirely due to increased private sector development.)
Methods of financing local authority development
Although local authority involvement in the provision of small units was reduced compared with the pre-100% IBA era, nevertheless, local authorities continued to develop with an emphasis on very small units, either directly or in partnership with the private sector on a lease and leaseback basis.
Where authorities took on the development role, a variety of financing methods were available, although increasing central government control over public-sector expenditure has limited the use of such methods in the past few years. In most cases shrinking capital expenditure cash limits forced local authorities to consider the following alternatives to finance development: (i) revenue (for small schemes), (ii) capital receipts, (iii) leasebacks, (iv) deferred purchase, (v) the use of LA development companies and, last, barter schemes and planning gain.
(i) Revenue
The use of revenue to finance small items of expenditure has been a possibility for some local authorities. Section 137 of the 1972 Local Government Act has been widely used by local authorities for economic development, with some authorities fully committed to the product of a 2p rate. In 1975-76 only about 35% of all councils appear to have made use of section 137, but by 1984-85 the proportion had risen to 75% and economic development and employment promotion measures were by far the largest single use of section 137 powers (Widdicombe 1986). The Government’s response to the Widdicombe Report proposes major changes to local authority powers. The 1989 Local Government and Housing Bill contains a new economic development power with no revenue expenditure limit, other than the overall constraint of the new community charge. As the level of commercial rates will now be set by central government (UBR) this means that expenditure on economic development can be financed only out of the community charge — ie a much smaller financial base than that which currently exists.
(ii) Capital receipts
Capital receipts have been a considerable source of capital for local authorities to finance economic development, as indeed was the case in the 1970s, but of course this depends very much on the land holdings of particular authorities. Although originally, under the 1980 Act, 100% of capital receipts could be used to supplement capital allocations, this was progressively reduced to only 30% from 1985 (20% for housing). This meant that only 30% of the capital raised by selling an asset could be used to supplement capital allocations in that same financial year and 30% of the remainder in the next financial year etc. This became known as the cascade effect and meant that with a programme of disposals over a number of years, local authorities could build up the potential for substantial capital expenditure. The idea of notional capital receipts has also been important. Leasehold disposal of land (eg where a ground rent is received by a local authority landlord in a traditional partnership arrangement) is treated as if the freehold capital value were received if the lease were for more than 20 years.
(iii) Leasebacks
Leaseback finance, where local authorities lease sites to finance houses, develop the scheme as an agent and then leaseback the completed development, counts as “prescribed” expenditure and therefore is caught by the centrally imposed cash limit. Where an authority lease the completed scheme back as a means of “borrowing” capital, the value of the freehold out of which the lease was granted (ie equivalent to the total capital sum “borrowed”) counts as notional capital expenditure against the local authority’s cash limit. However, the capitalised value of rents received (notional capital receipt) will partially or wholly offset the capitalised value of the rent paid (at least this was the situation before the percentage of capital receipts — notional or actual — that could be used to boost prescribed expenditure in the year of receipt was reduced to 30% in 1985, but the “in and out” provisions of Circular 5/87 may offer some help here). Furthermore, the finance house could benefit from IBAs before 1985, as it held a leasehold interest which in turn meant that the local authority benefited, indirectly through reduced “interest charges”, or rental payments.
(iv) Deferred purchase
Before July 1986, deferred purchase agreements were effectively outside the capital expenditure control system. These agreements usually involved a merchant bank developing property for a local authority (or appointing the authority as agent to carry out the scheme itself) without any lease being granted and without the capital being borrowed by the authority. The bank’s only security, therefore, was the name and reputation of the local authority. Because no lease was involved, deferred purchase agreements spread the capital cost of major schemes over the repayment period, as only the annual payment counted against that year’s cash limit. Since July 22 1986, this is no longer the case (except for a one-off project up to £3m in cost every five years) and the total cost of the work now counts as prescribed expenditure in the year in which the scheme starts, regardless of when payments are made.
(v) LA development companies
An alternative approach, increasingly used by local authorities, has been the use of “arm’s length” agencies called economic development companies. As these companies are legally separate from their parent local authorities, they have been outside the Government’s expenditure controls and so can raise finance from the private sector, transfer expenditure from one year to another and are not constrained by the regulations governing capital receipts. They can also be more flexible and rapid in decision-making.
However, the 1989 Local Government and Housing Bill proposes that such companies, if controlled or merely influenced by local authorities, will count as if they were part of the local authority itself, and therefore expenditure made by such companies will count as expenditure made by the authority and come within the new control system.
Effect of central government initiatives
Until recently, local authorities found ways to continue some involvement in the provision of small units despite the increasingly strict control on their capital expenditure. However, as discussed previously, the main thrust in new development until 1985 came from the private sector. The 100% IBA scheme achieved the Government’s objective of increasing the supply of small industrial units as a means of encouraging the growth of small firms. It also demonstrated the success of using public money to subsidise — and therefore stimulate — the private development sector rather than local authorities. Nevertheless, it was an indiscriminate and open-ended subsidy and did not encourage a detailed assessment of demand by developers. Much of the assistance was, therefore, probably poorly targeted, leading to overdevelopment and high vacancy rates in some areas and insufficient supply in other locations where it was perhaps more needed, but less viable (Adams 1987).
Perhaps as a result of this experience, the city grant (and its predecessor, the urban development grant) requires a very careful assessment of the need for each scheme by the DOE. There are obvious benefits of this approach, but also problems. First, it relies on a willing developer; it involves considerable time and bureaucracy; and there is no way of enforcing the take-up of grants once they have been agreed. It also tends to encourage marginal schemes in the more attractive and least difficult areas to develop (Hart 1984).
Where local authorities own little developable land, city grants can be a useful means to encourage implementation, but where they own land and viability is questionable, some form of partnership arrangement, usually a lease and leaseback, has been the favoured solution by many authorities. For very small units, or where demand is weaker, or the location is less attractive to the private sector, direct development is still pursued by authorities, but generally only as a means of last resort (Morley et al 1989). At least the Government now appear to recognise that this is necessary “for the foreseeable future because of the continuing reluctance of the private sector to invest in this kind of activity. It appears that private-sector institutions are no longer prepared to make this sort of investment, even in the least depressed part of the assisted areas…” (DOE 1986). But for many authorities direct development is possible only where capital assets can be sold to finance a rolling programme, as controls on capital expenditure make this very difficult otherwise (as discussed above).
The changes to the Use Classes Order (and the consequent potential loss of industrial premises to business use) and the loss of industrial land to residential and retail warehouse use, coupled with the economic recovery over recent years and increased output by manufacturing industry, point to shortages of industrial premises in some areas.
Once again, this may well require greater direct intervention by the public sector to provide space and/or further tax and grant incentives to encourage the private sector to do so. For small industrial units, these shortages are already evident in many areas (Association of District Councils 1987).
At the macro level, the Government’s new-found enthusiasm, since the 1987 General Election, for the inner cities and urban renewal has resulted in a rash of mini UDCs in preference to giving local authorities greater powers and finance through the Urban Programme, for example. (The Chancellor of the Exchequer’s 1988 autumn statement shows a £17m cut in the Urban Programme, but increased funds allocated to UDCs.) Nevertheless, some entrepreneurial authorities such as Birmingham and Leeds have initiated large-scale partnership arrangements with the private sector through the formation of joint companies.
Problems with the present capital control system
Gradually, most of the methods discussed earlier of bypassing central government controls on capital expenditure have been brought within the control system, thus constraining local authorities’ freedom to invest in development schemes.
Nevertheless, the DOE Consultation Paper of July 1988 considered that the 1980 system of controls over net capital expenditure had major deficiencies.
(i) It failed to ensure that capital expenditure was consistent with Government expenditure plans owing to the amount of expenditure generated by capital receipts and the difficulty of forecasting their level (they have grown significantly, which ironically is a separate DOE objective). The “overspend” has been as high as 44% of planned gross expenditure.
(ii) The capital expenditure cash limit for each local authority does not take account of the capital receipts available owing to the “cascade”. It is probable, therefore, that some authorities have excessive spending power and others too little. Spending power from capital receipts has increased to £3.5 bn a year, which is greater than the rate at which new receipts are being realised. In 1987-88 capital receipts were forecasted to be 53% of total local authority spending power (although some receipts will be used to repay debt but central government have no control over how much).
Capital expenditure after 1990
The proposed system detailed in the 1989 Local Government and Housing Bill therefore has been devised to exert more effective control over expenditure and borrowing in aggregate and its distribution between areas and services (see Alan Aisbett’s article in our issue of July 22, p 61). At the same time, it aims to reduce the size of the public sector by asset sales and to provide the basis for longer-term planning. The new system will control credit to finance capital expenditure and ensure a reduction in local authority debt from asset sales. Capital expenditure will be financed in three ways:
(i) Borrowing or its equivalent. By whatever method money is obtained (except from (ii) or (iii) below), it will be treated like borrowing as it has the same economic effect. So, for example, lease and leaseback and deferred purchase schemes will count as being equivalent to borrowing.
(ii) Government grants or contributions from third parties.
(iii) Local authorities’ own resources such as revenue contributions, profit from trading undertakings and capital receipts (the proportion not used to redeem debt or set aside to meet future commitments).
Central government will give each local authority a credit approval limit (covering (i) above) which is in effect similar to the existing spending limit. This limit will cover the next financial year and will give an indication of the minimum credit approval for the following two years. Credit approvals may be increased by supplementary approvals covering particular projects or programmes.
Capital expenditure above the limits implied by the credit or borrowing limit can occur through (ii) and (iii) above. Where capital receipts are used, there is a significant change from the existing system. The proposal is for a 50% time-limit on the use of capital receipts for new capital investment, the remainder is to be used for debt redemption or to be set aside to meet future capital commitments (in which case future credit approval will be reduced) or as a substitute for future borrowing. This limit can be varied by the Secretary of State and the limit for housing receipts will be only 25%. These restrictions on the use of capital receipts have been set by taking account of accumulated capital receipts under the existing system (the cascade effect) and mean the abolition of the cascade after 1990.
Under the new system, central government will be able to take account of individual local authorities’ ability to raise money through capital receipts when setting the credit approval limit for each local authority (not possible under the existing system). This is a two-edged sword, and while it may assist some authorities with few capital assets, it will mean other authorities having low or even zero credit approval limits taking account of accumulated past capital receipts and potential future receipts. This could mean a significant cut in many local authorities’ capital programmes owing to (i) the end of the cascade system and less total spending power from capital receipts, (ii) some authorities selling fewer assets than the DOE calculates in setting their credit approval limits and (iii) the absence of tolerance between years which will therefore encourage authorities to play safe and underspend to avoid acting ultra vires.
Conclusion
There is a long and logical history of direct local authority involvement in property development. It enables authorities to exert greater control over the development process and to benefit from the financial reward of property development, depending on the degree of risk they share. But probably the most important reason, in the 1980s particularly, is that in many areas they have no alternative. This may be because of their compulsory land acquisition powers or because certain areas are initially “no go” for the private sector without local authority involvement. In some cases this has forced direct development by the public sector with no private-sector development involvement.
It is ironic that at a time when local authorities’ spending is severely restricted (between 1979-80 and 1988-89 capital spending has fallen by 60% in real terms) — and their ability to become involved in property development is limited — the problems of the inner city have increased, requiring greater public-sector involvement to underwrite private-sector development risks.
Present central government policies appear to envisage a continuing contracting role for local authorities, with increasing emphasis on UDCs to overcome the land-assembly/infrastructure problem and on private-sector developers or English Estates (or WDA in Wales and SDA in Scotland) to undertake the development role.
The new capital control system will further limit local authorities’ scope for involvement in property development which in turn will affect the private sector.
References
Aisbett, A (1989) Public/Private Sector Joint Ventures. Local Government and Housing Bill Effects. Estates Gazette, July 22 1989.
Adams, D (1987) The Nature of Demand for Small Premises. Estates Gazette, August 1 1987.
Association of District Councils (b) 1987 A Blueprint for Urban Areas? 1987.
Coopers & Lybrand Associates and Drivers Jonas (1980) Provision of Small Industrial Premises.
Department of Industry.
DOE (1986) UK Regional Development Programme 1986/1990 as quoted in A Blueprint for Urban Areas. Association of District Councils 1987.
Hart, D (1984) “Attracting Private Investment to the Inner City”. The Hackney Demonstration Project. Joint Centre for Land Development Studies. Reading University.
Morley S, Marsh C, McIntosh A and Martinos H (1989) “Industrial and Business Space Development: Implementation and Urban Renewal”.
Widdicombe (1986) The Conduct of Local Authority Business. HMSO.
