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Investing in infrastructure

24 June 2015
by Patrick Love

Infrastructure investmentWilliam Topaz McGonagall is universally acknowledged as the worst poet who ever wrote in the English language, but that didn’t stop him having an intuitive grasp of the economics of infrastructure investment. As he argued in “The Newport Railway” published to celebrate the Tay Bridge and the trains it carried to Dundee, “the thrifty housewives of Newport/To Dundee will often resort/Which will be to them profit and sport/By bringing cheap tea, bread, and jam/And also some of Lipton’s ham/Which will make their hearts feel light and gay/And cause them to bless the opening day/Of the Newport Railway. It was a win-win for people on both sides: And if the people of Dundee/Should feel inclined to have a spree/I am sure ’twill fill their hearts with glee/By crossing o’er to Newport/And there they can have excellent sport”.

At the OECD, we’re more into free verse than rhyming, so we talk about investing “to meet social needs and support more rapid economic growth”. The social needs and benefits can be vast in developing countries in particular. Take sanitation for example. In many urban areas, infrastructure hasn’t expanded as much as population, leaving millions of citizens with no access to piped water and modern sanitation, or forced to live near open sewers carrying household and industrial waste. Water-related diseases kill more than 3.4 million people every year, making this the leading cause of disease and death around the world according to the WHO.

According to the OECD’s Fostering Investment in Infrastructure, it’s going to cost a lot to keep the thrifty housewives across the globe happy over the next 15 years: $71 trillion, or about 3.5% of annual world GDP from 2007 to 2030 for transport, electricity, water, and telecommunications. The Newport railway was privately financed, as was practically all railway construction in Britain at the time, but in the 20th century, governments gradually took the leading role in infrastructure projects. In the 21st century, given the massive sums involved and the state of public finances after the crisis, the only way to get the trillions needed is to call on private funds.

There are several advantages to attracting private capital for governments, apart from the money. Knowledgeable investors bring skills and experience in designing, building and running projects. But will fund managers be willing to commit to investments with long life cycles when their shareholders are demanding quick returns and high yields?

The opportunities are there, but the infrastructure sector presents specific risks to private investors, and since private participation in infrastructure delivery is relatively recent in many countries, governments do not necessarily have the experience and capacity needed to effectively manage these risks. Fostering Investment in Infrastructure brings together the lessons (both positive and negative) learned from the OECD’s Investment Policy Review series, and lists the most useful policy takeaways for the various components of the investment environment, such as regulation or restrictions on foreign ownership, based on the actual experiences of a wide range of countries.

Some of the advice sounds like no more than common sense, but given the difficulties many infrastructure projects get into, it seems that many governments fail to take what the report calls a “holistic” view before signing deals. For example, the report warns governments to make sure that arbitration procedures are clear and coherent so that disputes that can be settled quickly and don’t end up as lengthy, costly cases before international tribunals.

Likewise, given that most infrastructures are built on or under land, you’d think it wasn’t necessary to insist on having a “clear and well-implemented land policy”. Experience shows otherwise. For example, the US newspaper The Oklahoman describes how in its home state plans to develop wind farms met opposition from the oil and gas industry over access to the surface in the early 2000s, and that now, as development moves closer to suburban areas, there are calls for tighter regulation from property owners.

As the OECD report points out, investors are going to be unwilling to commit funds if they think policy regarding the basics is likely to change over the life-cycle of the project, and even less willing when policy changes within the term of a single administration.

Apart from the discussion on core conditions, there is a detailed look at investing in low-carbon infrastructure, such as wind farms. It makes sense to look at this separately because the business model of the sector is so different from traditional energy production and distribution. For electricity generation for instance, highly centralised power stations serving a wide area are replaced by small-scale distributed generators that may only serve a single building. Feed-in tariffs are a popular means of encouraging low-carbon renewables – paying producers for extra energy they feed into the main grid via a Power Purchasing Agreement (PPA). But awarding PPA purely on a least-cost criterion can tip the balance away from renewables in favour of incumbent producers, as happened in Tanzania.

The lessons then are a mix of useful checklist and interesting insights. In a poem written not long after the one quoted above, our man McGonagall describes how if you get it wrong, you may not live to regret it: “the cry rang out all o’er the town/Good Heavens! the Tay Bridge is blown down”.

Useful links

OECD work on investment

One Response
  1. June 27, 2015

    A good argument for infrastructure , which in both the developed and developing world needs a fresh approach to the legal, social , economic and commercial constructs which will support and sustain this much needed investment.

    With global liquidity of 20 to 40 trillion sloshing around in low or negative ‘securities ‘ or in over priced equities it is time to define , quantify and better qualify the needs and opportunities for new infrastructure.

    My work on the ‘Checklist for Change’ will, inter alia, provide a ranking system for countries and regions worthy of such investment.

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