"Infrastructure is a fascinating sector because it is fundamentally about realising the most basic needs of society." © www fotodiscs4u co uk
This is the third part of our special report on infrastructure. Click here to read the first article in the series, "The money’s not the problem."Click here to read the second article in the series, "political projects."
It is a fact that a gap between the need for global infrastructure and the capacity of tax and tariff payers to finance it is increasing. Investment in infrastructure among OECD nations has declined in recent decades. Urbanisation, population growth, management of high consequence natural phenomena and other factors will drive demand for new and improved infrastructure.
According to McKinsey Global Institute, $57 trillion of global investment is required in the world’s roads, railways, airports and utility lines between now and 2030. We need to be spending $3.7 trillion a year (4 per cent of global output) to reach this target, and at only $2.7 trillion a year we are a long way from achieving this. The nascent, fragile and long-awaited recovery underway in the UK and the US will only accelerate demand. Bridging the gap between infrastructure demand and the capacity to deliver it will require vision and innovation from politicians, regulators, engineers, financial institutions and citizens.
Infrastructure is a fascinating sector because it is fundamentally about realising the most basic needs of society—clean air, water, transportation and energy—that can support economic growth. But it is also aspirational because infrastructure is about developing new cities, and enabling iconic sporting events and the legacies that can succeed them. We see this today in the legacy left by the 2012 Olympic Games in east London.
Delivering this infrastructure requires the adroit application of physical science to design and construct, but also of social science to agree the consents required by regulators and citizens. It is true that the global recession significantly deferred infrastructure demand but it also altered the terms of the debate about infrastructure.
Over the past five years in Europe and the US, the stimulative implications of infrastructure projects have been debated as much as the physical utility of roads, railways and power plants. John Maynard Keynes has been invoked by both supporters and critics of fiscal stimulus. Among the many benefits of the recovery, however regionalised and fragile it may be, is that it enables us to view these projects in terms of their physical performance, their capacity to support growing economies and to improve quality of life.
The main question being asked in response to this is: how to pay for it all? The capacity of the traditional financiers of infrastructure—namely governments, utility customers and commercial banks—is inadequate to meet the demand. Governments across the world are becoming more constrained from increasing deficit spending. The role of banks in project finance under Basel III—the reforms of financial regulation set by the Bank for International Settlements that are currently being implemented—remains to be seen. However, we can predict that the cost of securing letters of credit, important tools for project finance, may well increase.
There are signs that some institutions are willing to take up some of this slack in infrastructure finance. Export credit agencies—which help provide finance for domestic companies to operate overseas—are shifting some of their direct loan and credit insurance capacity from manufacturing to infrastructure projects reflecting the role of project development in trade. The Export-Import Bank of the United States, for instance, has increased the proportion of infrastructure projects in its portfolio significantly in the last five years. Sovereign wealth funds have also increased investment in infrastructure projects, with approximately 56 per cent of sovereign wealth funds currently investing directly or indirectly in infrastructure. This figure is up 16 per cent from 2011 and is showing no signs of slowing down, according to London-based research company Preqin.
Perhaps the most interesting development and greatest hope for infrastructure finance is the involvement of pension funds. Infrastructure provides some unique attributes that are attractive to pension funds: they match long-tenured assets with the long-tenured liabilities within pension fund portfolios and can provide stable long-term cash flow. The level of direct investment by pension funds in infrastructure finance is still small, with only about 1 per cent of pension funds invested directly, according to the OECD.
Pension funds are raising infrastructure funds at a historic rate. Many seem willing to play a vital role in bridging the gap in demand and capacity that is necessary to increase economic opportunity and improve quality of life globally. The key question will be which nations can develop the frameworks required to enable these investments to move forward quickly. The introduction of this financing is welcome and timely, but the dynamics of traditional infrastructure planning, design, construction and operation must evolve to accommodate this investment.
Until this is realised, the true extent to which this financing approach can have a positive impact on the way we fund global infrastructure will not be fully understood. This potentially inhibits the growth needed to bridge the gap we have in infrastructure investment, if we are to reach the 2030 target of $57 trillion of global investment, and thus avoid potentially damaging long-term societal and environmental impacts in both the developed and developing world.
