2. Providing context: The importance of governance in Welsh public investment

The Welsh Government is dedicated to a regional development path that balances growth plus inclusiveness: maximising the potential for growth throughout the territory, reducing inter- and intra-territorial disparities, and enhancing well-being and quality of life for all residents. To realise its aims, the government seeks to ensure that its public investment and governance system for regional development is fit-for-purpose and able to meet the demands and pressures that might arise post-Brexit. This includes meeting the need for sustainable, robust public investment in a context of potentially fewer resources and/or possibly more constrained use. A great many factors contribute to achieving Welsh Government ambitions. They include an integrated, whole-of-government approach to investment and regional development policy design and implementation, with clear objectives and lines of accountability; the active participation of public and private sector stakeholders, including citizens; and sufficient financial, human and infrastructure resources at the most appropriate level of government. Underlying all of this is the ability to build a partnership among levels of government that is based on trust and mutual respect. While policies and governance structures can help or hinder development, depending on their efficacy and integrity, the quality of institutional and stakeholder relationships is fundamental (Morgan, 2019[1]). Quality public investment, particularly for regional development, goes hand-in-hand with quality multi-level governance.

This report focuses on the future of public investment for regional development in Wales and is undertaken at the request of the Welsh Government. The aim is to accompany the government in building its regional governance and investment capacity in order to advance policy actions dedicated to generating stronger growth and inclusiveness. In the short term, the analysis aims to inform the implementation of the Welsh Economic Action Plan, as part of the overarching Prosperity for All strategy and development agenda. In the medium to longer terms, it aims to assist the Welsh Government as it defines its regional development policy and support the government in realising its regional development objectives, including those identified in its policy paper “Regional investment in Wales after Brexit” (Welsh Government, 2018[2]). The report’s overall analysis is based on desk research, published data, responses by the Welsh Government to an OECD questionnaire, and extensive interviews with representatives from all levels of government in Wales, as well as public, private and third sector regional development and public investment stakeholders in the UK and Wales.

The report begins by setting the scene, providing an overview of regional productivity, growth and well-being in Wales, particularly in the context of today’s megatrends associated with demographic, technological and environmental change. Chapter 4 takes an in-depth look at how Welsh fiscal and investment frameworks support public investment for regional development in a post-Brexit context and offers insight into making the most of available financial resources for regional development. Chapter 5 discusses the multi-level governance system, i.e. the frameworks, institutions and practices that support decision-making and implementation, surrounding Welsh public investment for regional development. It also examines options for reinforcing capacity to implement policy and investment decisions. Chapter 6 presents a case study on establishing economic regions, specifically in Mid and South West Wales. It sheds a practical light on various topics explored in the report’s previous chapters. Chapters 4-6 offer a series of recommendations for action.

The research and initial analysis for this report was undertaken prior to January 2020 when Brexit was formalised through a parliamentary vote and the EU Withdrawal Agreement Act 2020. At the time of writing, the data, concepts, examples and analysis remain valid despite the shift in the UK’s status with respect to the EU. Also at the time of writing, the UK government was clear in its aim to ensure that funds to replace those received from the EU would be equivalent in total value to those received from the EU. The intention is to align EU replacement funds with the UK’s strategies for territorial development (and further advance a place-based approach to regional investment). The structure, full value and allocation mechanisms for EU replacement funding to support regional development and other public investment throughout the UK territory were still evolving when this report was presented to the Welsh Government (OECD, 2020[3]).

The report was also researched and written prior to the COVID-19 pandemic. With its swift and unprecedented-in-peacetime impact on national and subnational economies and government budgets, its repercussions will continue to be felt in public finance, public investment and public services over the coming months, and – perhaps – years. The OECD estimates that for each month of strict containment measures, there will be a loss of two percentage points in annual gross domestic product (GDP). It also observes an asymmetric impact of the COVID-19 crisis within countries, across regions, in cities and among population groups, with some harder hit than others (OECD, 2020[4]). In economic terms, the crisis will be felt differently across regions, depending on their exposure to tradeable sectors, global value chains and type of specialisation (e.g. tourism, services, etc.). Small- and medium-sized enterprises (SMEs), entrepreneurs and the self-employed are particularly affected, and unemployment figures and the number of aid seekers has risen dramatically, deepening the consequences of social and territorial inequalities (OECD, 2020[4]). Subnational governments face multiple pressures arising from this pandemic. They are at the frontline for immediate crisis response given their responsibilities in healthcare, social services, education and essential public services. In the medium and longer term, subnational governments will need to juggle exit and recovery strategies, which can include managing the costs and revenue shortfalls associated with meeting the crisis head on, maintaining public investment, and ultimately applying the lessons learned and seizing the opportunities for renewal and change that a crisis can often bring (OECD, 2020[4]; 2020[5]).

As of April 2020, the full implication of COVID-19 on Welsh fiscal, public investment and public service delivery capacity was unknown. Budget measures up to that time focused on buttressing businesses, the economy and public services delivery, with a Welsh Government support package amounting to GPB 2.4 billion. The total level of support, however, is expected to increase, accompanied by some unknowns: how to generate additional budget capacity, by how much and for how long. Some options have been identified, including drawing down on its reserves; reallocating spending from current budgets and EU projects; and receiving additional grants from the UK government, for example via a temporary reform to the Barnett formula. Adjustments to and/or greater flexibility in the Welsh Government’s ability to manage its finances were also identified as valuable options, such as temporarily relaxed borrowing and “draw-down” restrictions, though these would depend on an agreement with the UK government (Wales Fiscal Analysis, 2020[6]). At the moment, the path taken by the UK and Welsh Governments with respect to Wales’ ability to meet and recover from the crisis in the medium and longer term, and what this recovery will look like, remain to be seen.

It is important to define “public investment” and “capacity”, as they can be interpreted in a variety of ways. For the purpose of this report, “public investment” refers to expenditures to finance physical or “hard” infrastructure (e.g. roads, rail, ports, government or other public buildings, etc.) and “soft” infrastructure (e.g. human capital development, innovation, research and development, SMEs, etc.) whose productive life extends beyond the fiscal year (OECD, 2013[7]; 2014[8]). These tend to be capital expenditures. For this report, “capacity” means the ability to adhere to good practices in the design and implementation of public investment. It refers more specifically to good practices in terms of institutional arrangements, technical capabilities, financial resources and policy practices that can help subnational governments achieve important goals at different stages of the public investment cycle (Figure 2.1) leads policymakers and investors through a dynamic process of strategic reflection and planning, implementation and evaluation. Ideally, at the end of each investment cycle, policymakers and investors take stock of their experience, project outputs and results, in order to appropriately adjust their investment priorities and projects and more effectively launch a subsequent cycle.

Ensuring the effective management of the investment cycle includes building or reinforcing capacity for action and intervention by all levels of government. The OECD suggests a set of capacities that correspond to each stage of the investment cycle and a set of governance goals (Table 2.1). Several of these capacities are fundamental to the full investment cycle, such as monitoring and managing risks to integrity and accountability, engaging in better regulation, and ensuring sufficient expertise (Mizell and Allain-Dupré, 2013[10]).

A well-functioning public investment cycle can help achieve desired investment outcomes while making the most of scarce public resources. To support governments in this endeavour, the OECD identified a series of 12 principles, based on the public investment cycle and the identified necessary capacities. These principles are grouped into three pillars (Figure 2.2) to guide national and subnational governments as they consider their public investment capacity and the management of their investment cycle. They are the foundation of the OECD Recommendation on Effective Public Investment across Levels of Government (2014[8]) and offer a framework for analysis, reflected in this report.

There are a number of reasons why ensuring the effective multi-level governance of public investment is important. First, in the context of declining public budgets, public investment is often cut in order to better meet current spending obligations (OECD, 2019[16]). This affects the ability of governments at all levels to close a significant public investment gap (Box 2.1). It also aggravates a pressing need for investment in new infrastructure (including green infrastructure), in upgrading and modernising existing infrastructure, and in ensuring that all infrastructure is properly maintained, fully operational and, ideally, resilient. Ultimately, infrastructure deficiencies – be they in “hard” or “soft” infrastructure – hamper productivity, socio-economic opportunities and the resilience of countries and their regions. For example, until 2015, UK investments in the transport sector as a share of GDP were lower than the OECD average and that of most other advanced economies, affecting the quality of road and transport infrastructure, and hindering UK economic development. This was exacerbated by the fact that, as of 2015-16, 40% of investment in transport was concentrated in London and South East England (OECD, 2017[17]). Investment in physical infrastructure alone is not enough to secure regional growth and development, however. It is only one of many contributing factors. Investment in human capital, innovation, research and development (R&D) and other forms of “soft” infrastructure are just as important to regional growth and development, and must be combined with “hard” infrastructure investment to maximise the potential for long-term growth (Garcilazo, E. and Oliveira Martins, J., 2013[18]).

Second, countries with higher levels of well-managed public investment increase their productivity faster than countries with lower levels of public investment (Fournier, 2016[19]; OECD, 2013[7]). They may also generate substantial savings (OECD, 2013[7]; IMF, 2015[20]; McKinsey Global Institute, 2016[21]; McKinsey Global Institute, 2013[22]). Some estimates indicate that it is possible to generate savings of about 40% on infrastructure projects through more effective project selection and delivery, and by better managing existing assets (McKinsey Global Institute, 2016[21]; McKinsey Global Institute, 2013[22]). Conversely, approximately 30% of the potential associated gains from public investment can be lost due to inefficiencies in the investment process (IMF, 2015[20]). In the long-run, increasing the share of public investment in primary government spending by one percentage point could increase the long-term GDP level by about 5% (Fournier, 2016[19]; OECD, 2013[7]).

Third, positive investment outcomes can depend on the quality of national and subnational government1 (Charron, Dijkstra and Lapuente, 2014[27]) and governance. This includes effective institutions, appropriate regulatory and fiscal frameworks, clear policy objectives and engaged stakeholders. It is increasingly recognised that quality of government can result in better economic performance, higher environmental sustainability, lower income inequality and poverty, better education and health outcomes, and higher levels of subjective happiness (Charron, Dijkstra and Lapuente, 2014[27]). Meanwhile, the low quality of government can lead to suboptimal use of investment funds. It is estimated that 10%-30% of the investment in a publicly-funded construction project may be lost through mismanagement and corruption (CoST, 2012[28]).

Finally, the quality of governance at the regional and local levels can determine the effectiveness of investment funds. In a study on the use of Cohesion Policy funds in 202 EU regions, those with a low quality of government were found to be less likely to make effective and efficient use of the funds (Charron, Dijkstra and Lapuente, 2014[27]). This can result in low growth and highlights the importance of ensuring supportive governance conditions for investment. Furthermore, evidence suggests that institutional quality and governance processes affect the expected returns to public investment and have a positive influence on the capacity of public investment to leverage private investment, rather than to crowd it out (OECD, 2018[9]). Thus, the quality of government and governance at all levels is a factor in whether investment translates into greater growth (OECD, 2013[7]) and, ultimately, citizen well-being.

Taken together, these reasons link the effectiveness of public investment with the quality of government at the national and subnational levels. They also highlight the need for quality multi-level governance systems (i.e. the public institutions, frameworks and practices) that support the capacity of all levels of government to invest successfully in regional development.

Why does this matter for Wales? First, because subnational governments (i.e. regions, metropolitan areas, cities, local governments) are important investors in their territory’s development. Among OECD member countries, almost 40% of total subnational public investment is dedicated to economic affairs (transport, communications, economic development, energy, construction, etc.) and 21% to education (OECD, 2018[29]). Economic affairs2 is the main capital spending area for the Welsh Government and local authorities combined, accounting for 30% of their investment. However, in this area, most spending (73%) is the responsibility of the Welsh Government. Housing and community, and education are the primary capital spending areas for Welsh local authorities. Investment in these areas is one driver for productivity and growth in the short, medium and long terms. Second, most public investment responsibilities are shared among levels of government – for example, the central, intermediate and local levels. The Welsh Government, itself, is responsible for 33% of public investment in Wales, local authorities for 31% and the UK government for 36%. Thus, how these levels of government interact in their pursuit of achieving development aims contributes to the effectiveness of the investment undertaken. A lack of clarity with respect to responsibilities, unaligned priorities, and limited or ineffective communication within or among levels of government can affect policy delivery and the investments that support it. Furthermore, as the largest recipient of European Structural and Investment Funds (ESIF) in the UK on a per capita basis, Wales is highly exposed to their loss, post-Brexit. Among UK regions, Wales has one of the lowest GDP per capita (in constant PPP as of 2018) and receives correspondingly the highest amount of EU funding, per capita (Figure 2.3). For the 2014-20 programming period, Wales will receive a total of GPB 2 billion from EU funding and it is estimated they will have triggered a total investment value of GPB 3.8 billion over the period (Welsh European Funding Office, 2018[30]). In addition, Wales tends to receive a lower share of EU competitive funding compared to the EU average (Bird and Phillips, n.d.[31]). Ensuring that public investment funds are optimally used and supported by effective governance and financing structures becomes fundamental to Wales’s investment capacity in a post-Brexit era. This means appropriately prioritising public investment projects, co-ordinating investment across sectors, and understanding and meeting local needs.

There is an inherent tension in the Welsh multi-level governance system. On the one hand, there appears to be a lack of trust among different levels of government, compounded by uncertainty – of the future, motives and possibilities. This is despite good intentions and the introduction of mechanisms that could lead to a new working ethos (OECD, 2019[33]; 2019[34]). It generates a degree of conflict in governance relationships and in the approach to implementing solutions to commonly acknowledged problems, including optimising governance structures for territorial development and investment. Often it appears that conflict surrounds the “how” – how to undertake policy and reform, for example in regional development or with respect to devolution within Wales. On the other hand, there is a clear capacity for consensus, evidenced by the alignment of high-level objectives between the Welsh Government and local authorities, a demonstrated ability to co-operate across jurisdictions with sufficient incentive, and a shared perspective that collaborative governance and partnership approach to policy design and implementation are desirable. This tension plays out, however, in day-to-day decision-making and policy implementation, including with respect to place-based regional development, decentralisation/devolution and stakeholder engagement.

The governance context in which public investment takes place matters. The Welsh Government is at the centre of a multi-level polity (Figure 2.4), where each level is intimately linked and interdependent in various ways, particularly in regulatory and financial terms. As the smallest and poorest of the three nations in Great Britain (England, Scotland and Wales), Wales is the most dependent on financial flows from the EU and the UK government. It received approximately GBP 5.2 billion in ESIF support over the past 3 programming periods. This makes its growth and investment planning particularly vulnerable to decisions taken at the supra-national level. In addition, disruptions at one level – between the EU and the UK, for example – can have a ripple effect on the balance of power among the rest. Of particular relevance is a constitutional inter-dependence among the supra and national levels. This originates in the constitutional basis for the devolution settlements in Northern Ireland, Scotland and Wales, which was furnished by the EU legal framework. Thus, while there is an implied bilateral relationship between the Devolved Administrations and the UK parliament, under the “reserved powers” devolution model the devolution settlements reflect the weight of EU law. In reality, the relationship is not one-to-one between the UK and the three devolved governments, but rather a trilateral relationship that includes the EU. The repatriation of these powers from the EU to the UK, post-Brexit, raises the issue of where they will be located – in Westminster or the Devolved Administrations (Morgan, 2019[1]). This is of particular concern to the Welsh Government, and it is working to establish uniquely Welsh devolved governance structures and working practices as a counterweight, including for regional development and public investment.

Changes in inter-governmental arrangements, such as those that may be ushered in with Brexit, can also lead to new internal relationships between the UK and Wales, including the possibility of recentralising the governance of regional development policy, which the Welsh Government considers would destabilise its economy (Welsh Government, 2017[35]). It also links national-level policy considerations – particularly that of regional development – to higher-level actions – notably Brexit – in two ways. First, with Brexit comes repatriation of powers from the EU to the UK, and some of these powers, with respect to regional policy, agri-food policy and environmental policy for example, could be transferred to the UK government despite their critical role in Welsh economic development policy, a devolved (i.e. Welsh) competency (Morgan, 2019[1]). It is not yet clear if this, or some more nuanced form, will be the approach adopted by the UK government with respect to regional development and its financing (OECD, 2020[3]). Second, the Brexit-related political conflicts arising between levels of government have affected inter-governmental trust, which can affect the level of co-operation necessary for successful (multi-scalar) regional development policy design and implementation (Morgan, 2019[1]). There appears to be a shift in how this relationship is managed, which may begin to foster greater trust between levels of government and lead to a stronger partnership-based approach.

Whatever the future holds, it seems clear that post-Brexit regional development policy will revolve around two critically important territorial relationships. The first is the inter-governmental relationship between the UK and Welsh Governments. Because of the current uncertainties regarding the Brexit agreement, as well as the scope of this project, this OECD report focuses on the second relationship – that which is internal-to-Wales, i.e. between the Welsh Government and Welsh local authorities, and which is also characterised by limited trust (Morgan, 2019[1]). This has severely affected the partnership approach to governance valued by the Welsh national and subnational levels of government. Limited trust (as well as weak partnerships) can reinforce a siloed way of working, which inhibits integrated, cross-sector policymaking and investment at the national level. It can also colour national/subnational relations as reform by the national level or requests by the subnational may be met with mistrust or suspicion (OECD, 2019[33]).

Welsh Government structures are continuing a transformative process that began in 1997 with a devolution referendum and the establishment of the Welsh Executive and National Assembly through the Government of Wales Act (1998) (National Assembly for Wales, 2019[37]) and the Government of Wales Act (2006), which separated the executive and the legislature. These steps in political devolution were complemented by the first step toward fiscal devolution in 2014 with the Wales Act (2014) which devolved fiscal powers to the National Assembly for Wales (Welsh Government, 2019[36]). More recent activity includes a degree of fiscal devolution through the Tax Collection and Management (Wales) Act (2016), the Land Transaction Tax and Anti-avoidance of Devolved Taxes (Wales) Act and the Landfill Disposals Tax (Wales) Act, both in 2017. As part of this process and in order to better meet its growth plus inclusiveness goals, the Welsh Government is evaluating the Welsh multi-level governance system and its ability to support regional decision-making, policy delivery (including services) and investment processes for regional development. Many of the “hard” elements are in place, including statutory guidelines in the form of the Well-being for Future Generations Act, committed institutions and strong experience managing public investment. However, there are some gaps in the multi-level governance system to which attention should be paid, particularly in the “softer” dimensions such as vision setting for strategic policy planning, monitoring and evaluation practices and, perhaps most critically, building effective long-term partnerships for policy implementation.

The Welsh Government needs to consider at least three high-level governance issues as it moves forward in realising its regional development aims. The first is a tendency to work in operational or sectoral silos, with policy driven by individual ministers and their departments (OECD, 2019[33]). The result is policy and programming fragmentation, compounding the “delivery gap”3 and limiting cross-sector policy coherence. In addition, it can dilute policy and investment effectiveness by generating an inefficient use of already limited resources. Ultimately, it makes it difficult to bring the various interests and objectives together to form an integrated, whole-of-government approach to designing and implementing government strategy. Ensuring policy coherence is critical for effective regional development, particularly when taking a place-based approach – it supports the ability to capture complementarities and synergies across policy disciplines and to maximise investment. Action in one area, such as innovation policy, will have incidence in others, for instance education and skills policy or energy policy. Ideally, these policy sectors should work together to identify how their objectives can be mutually reinforcing and where investment can be optimised by supporting the goals of more than one area.

The second is a need for policy continuity across election cycles. Since 1999, Wales has had strong party continuity in its leadership. One would expect, therefore, a strong capacity to ensure that policies requiring time to bear fruit stay in place long enough to have the opportunity to do so. The fact that this may not be the case may result from a culture of power consolidation at the individual level, rather than at the institutional level, as well as a siloed operational culture as mentioned above. For regional development policy to flourish, the capacity to sustain objectives beyond individual election cycles is important. This can depend on effective, multi-stakeholder vision setting and a strong centre of government. A lack of continuity may also contribute to a culture that places greater weight on policy design (the need for something new) rather than policy delivery (the need for giving what is in place a chance to yield results, monitoring, evaluating and adjusting when necessary) (Morgan, 2019[1]).

The third is a need to streamline the layers of policy and service intervention in the territory. This appears to arise from a tendency to add layers to what exists – a new consultative body, board or authority, a new partnership catchment area, a new strategy, framework, policy or plan, etc. The result of this “variable geometry” is a geographic footprint that makes policy and service delivery, as well as their management, complex (Beecham, 2006[38]) fragmented and potentially opaque. The Welsh Government and various partners have undertaken diverse mapping exercises with an eye on rationalising the system. A significant rationalisation may not be popular among all stakeholders but it would help better channel already strained human and financial resources, and introduce greater clarity in lines of responsibility, thereby boosting accountability. Furthermore, it may reduce “co-ordination fatigue”. Finally, it could contribute to identifying investment priorities and potential synergies across investment initiatives in order to more effectively target funds. Applying an integrated regional development policy across existing structures and plans requires strong co-ordination and high-levels of “buy-in” from local stakeholders. Without these, there is a risk of incoherence between the regional development policy and the various other structures and plans, resulting in an even more complex environment in which to design and deliver policy and services. It also renders policy evaluation and adjustment – a key component of the policy cycle – more complex. While the challenge of multiple plans and geographic footprints for development and service delivery is recognised by both national and subnational levels of government, there seems to be limited enthusiasm for seizing opportunities to address the issue (OECD, 2019[33]; 2019[34]). This can beg the question of whether there is political will or capacity to do something about it.

For a place-based regional development policy to be effective, national and subnational objectives, development needs and investment priorities must align. This requires a solid co-operative framework and the capacity of all levels of government to engage in a manner that is coherent with their role in policy delivery. For the national governments, particularly in a decentralised (devolved) governance context, the policy delivery role is increasingly a strategic one. For subnational governments, it is increasingly focused on quality implementation, be it in terms of public or administrative policy or service delivery or “hard” and “soft” investment outcomes. There appears to be significant space for the Welsh Government to adopt a more learning-driven approach to the multi-level governance processes that support regional development. This means taking a fresh look at its regional development framework, the mechanisms for policy and service delivery, including devolution, and reconsidering the relationship and role with local authorities.

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[35] Welsh Government (2017), Joint Statement from First Ministers of Wales and Scotland in Reaction ot the EU (Withdrawal) Bill, Welsh Government.

Notes

← 1. The quality of government refers to how government delivers policy – i.e. whether policies are delivered effectively, impartially and free of corruption, regardless of the policy’s nature and degree or its provision (Charron, Dijkstra and Lapuente, 2014[27]).

← 2. Based on the Classification of the Functions of Government (COFOG), “economic affairs” include agriculture and fisheries, transport, commercial development and tourism.

← 3. The space between the policy as designed and the ability of actors (in terms of organisational culture, institutional capacity and managing process complexity) to deliver (i.e. implement) it (Beecham, 2006[38]).

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