IN THE 1920S the Lambert Flying Field in St Louis, Missouri, was a hive of innovation and celebrity. It became the first airport with a traffic-control system, waving flags at pilots. Charles Lindbergh flew airmail from it before making the first solo flight across the Atlantic. Today the airport is old, obscure and drab. So in 2017 it joined an experimental privatisation scheme, a key plank of President Donald Trump’s effort to revamp America’s infrastructure. By 2019, according to a confidential note seen by The Economist, a project to modernise it had attracted 18 bids from the great and good of the infrastructure-investment industry.
At the end of that year, however, the mayor of St Louis abruptly cancelled the project. Four days later the privatisation of the Jacksonville electric utility, in Florida, was also pulled, derailing another big public-private partnership (PPP). In both cases investors had spent tens of millions of dollars preparing bids. For one, the double whammy symbolises all that is wrong with America’s infrastructure procurement. “It’s Lucy and the football,” he says, referring to a character in Peanuts, a comic strip, who torments Charlie Brown by holding a ball out to him, only to pull away as he goes to kick it, so he always falls on his bottom.
Such unpredictability could come back to bite governments, just as they promise an infrastructure boom. America’s president-elect, Joe Biden, has pledged to spend $2trn on roads, bridges and electric-car charging points. Green projects make up 30% of the European Union’s €750bn ($918bn) recovery fund. China has set aside 10trn yuan ($1.5trn) for new projects, and many Latin American and Asian governments plan to splurge. Yet most countries have struggled to realise such promises in the past. Can they succeed this time?
Covid-19 may temporarily divert funds: governments may need to bail out struggling urban-transport systems, for instance, meaning there is less to spend on other projects. But the pandemic also explains governments’ enthusiasm for infrastructure: it can boost growth, both in the near term and further out. According to the IMF, increasing public investment by 1% of GDP across advanced and emerging economies would create 20m-33m jobs and lift GDP by 0.25-0.5% in the first year, and up to four times that after the second. It’s about finding “quick wins”, says Catherine McKenna, the infrastructure minister in Canada, which is bringing forward some of its 12-year, C$180bn ($140bn) plan, to create jobs. In the long term, spending could remove supply-side bottlenecks and make the economy more resilient to shocks.
It helps that, in the rich world, interest rates are low, allowing governments to finance investment sprees. And pension funds and insurers, starved of the safe yield they need to meet future liabilities, are eyeing the steady cashflows from infrastructure assets. Rajiv Shah, who runs the Rockefeller Foundation, which recently committed $1bn to renewables and health projects, says these forces together create an opportunity to “reshape the modern economy in many parts of the world”.
This new faith in infrastructure is taking two forms. First, governments are fast-tracking funds for maintenance and upgrades. These have the advantage of being shovel-ready projects that do not get ensnared in long procurement processes, says Jean Bensaïd, infrastructure chief at France’s finance ministry. One-fifth of his country’s €100bn infrastructure plan aims to make buildings energy-efficient, revamp transport links and bolster care facilities. Moreover, the pool of potential projects is vast. Catching up on America’s backlog of highway and bridge repairs, for example, would cost 3.5% of its GDP.
The second type of spending is on new capabilities. The pandemic’s effect on remote working and e-commerce has shown the need for investing in digital infrastructure, such as fibre networks or data centres. McKinsey, a consultancy, estimates spending on these must rise by 6-11% annually over the next decade to match growing usage. Money is also going towards green projects, such as offshore-wind and electric-transport infrastructure.
All this is good news, given vast unmet needs. The Global Infrastructure Hub, a unit of the G20, reckons the world will need $82trn of investment, in 2015 prices, by 2040. Based on trends at the end of 2019 it will muster $69trn. Yet, keen as governments and investors are this time, they have struggled to get projects going before.
Signal failures
Infrastructure investment has been flagging for years. Public and private spending on “economic” infrastructure—transport, utilities and telecoms—fell from 3.8% of global GDP in 2013 to around 3.4% in 2019, reckons McKinsey. Spending on “social” infastructure, a measure that includes schools and hospitals, has also declined.
The long view looks worse. In rich countries public investment, a proxy for infrastructure investment by governments, has declined from an average of 2.4% of GDP in the 1990s to less than 2% after 2010—a historic low, says Manal Fouad of the IMF. It has fallen in emerging economies too (see chart 1). Wear and tear means the public-capital stock has not kept pace with the economy. In the rich world, for instance, the stock, as a share of GDP, has fallen by nearly ten percentage points since 1992.
China is an exception. In 2019 it spent $1.3trn on economic infrastructure—more than America and western Europe combined. Its public-capital stock rose from 154% of GDP in 1992 to 165% in 2017.
Not all of its spending was wise, though. In 2016 experts at Oxford University found that over half of its infrastructure investments “destroyed” economic value. Many generated less revenue than their cost of borrowing, leaving local governments with huge losses. The government has since sought to limit waste. Yet the jury is still out on whether the splurge was “economically destructive in aggregate”, says Michael Bennon of Stanford University.
The story in America, by contrast, is one of too little spending. In 2017, the latest year for which figures are available, federal, state and local spending on infrastructure was 2.3% of GDP—a record low. Although some economists argue that America’s roads are not in a bad way, other areas, from bridges to broadband, need serious funding. Even a partial shutdown of the 111-year-old Hudson River rail tunnel in New York, say, could cost the economy $16bn over four years, according to the Regional Plan Association, a think-tank.
Political rows over execution have been a big obstacle. President Barack Obama’s Recovery and Reinvestment Act, which earmarked $133bn for infrastructure and energy projects in 2009, failed to greatly expand the capital stock, largely because it focused on small maintenance projects that could pass through Congress. Mr Trump’s $200bn plan was hobbled by disagreements over the distribution of cash.
Some hoped institutional capital could plug the gap. Worldwide, over 16,500 private infrastructure transactions have closed since 2015, with a big chunk done through specialist funds. These have raised $710bn since 2008, according to Infrastructure Investor, a trade publication. A record $220bn is still unspent. Surveys suggest investors want to commit yet more cash. Annual returns, at an average of 9% since 2010, have been good; meanwhile, commercial property, a rival alternative to bonds, has been rocked by lockdowns.
The trouble is that most private investors prefer milking existing assets to building new ones: “secondary” deals have made up four-fifths of the total value of their infrastructure transactions in recent years (see chart 2). PPPs have fizzled. When these took off in the 1990s they were seen as offering the best of the public and private worlds. As investors put up the cash, governments did not need to fork out capital upfront, yet could still regulate the service and gain control of the assets at the end of the contract. Outside expertise, it was hoped, would lead to speedier execution. Investors, for their part, would gain from the state’s ability to bear big risks, through subsidised insurance or guarantees.
Yet in Britain, the birthplace of the idea, the value of new PPPs fell to next to nothing in 2017. Even India, the world’s top recipient of private investment in PPPs in 2008-12, has hit the brakes. Critics lambast them as being “too expensive, opaque, slow and rigid”, says Georg Inderst, an adviser on infrastructure to institutional investors. Worldwide, private investment in new PPPs fell to $30bn in 2019, from $55bn in 2010 (see chart 3).
Why has building infrastructure been so hard? Experts point to three longstanding stumbling blocks: politics, poor execution and precarious funding. Start with politics. In democracies the need to unlock public funds, or reward private capital, means governments must run transparent, years-long processes that can overlap with several electoral cycles. “To proceed, a PPP needs hundreds if not thousands of supporters; but a handful of people can kill it,” says the infrastructure boss of a Wall Street firm. Ideological shifts can derail entire programmes. After entering office in 2018, Andrés Manuel López Obrador, Mexico’s president, cancelled most publicly tendered energy projects, preferring to work through state-owned utilities instead.
A second problem is faulty execution. Many governments lack the skills or will to marshall projects. Hans-Martin Aerts of APG, a Dutch pension fund with €538bn in assets, laments a lack of “bankable dealflow”: grand announcements are seldom followed by detailed lists of projects. Misaligned incentives and poor monitoring often cause costs to swell. Nine out of ten mega-projects overrun their budget and schedule—by an average 70% and 61%, respectively. Harsh terms can lead bidders to accept wafer-thin margins and shoulder too much risk, prompting them to cut corners. Investors in Britain’s Royal Liverpool Hospital lost their shirts after Carillion, its main contractor, collapsed in 2018. “It was in such bad shape, so badly built, that it was not viable,” says Paul Smith of CMS, a law firm that tried to rescue the PPP.
Even when projects are completed, governments can move the goalposts. Frank Kwok of Macquarie, a bank that held a stake in an Asian airport group, says unstable regulation in some areas can create uncertainty for investors. Delayed increases to fees charged by airports in India, for instance, have made such investments seem risky, despite booming traffic.
A third reason why infrastructure plans are so hard to realise lies in the capital structure of many “greenfield” projects. They are often highly leveraged and dominated by construction firms, which want to sell out in two or three years, rather than long-term investors. Thin equity layers, coupled with short exit windows, leave little buffer to absorb shocks, says David Neal of IFM Investors, an asset manager owned by Australian pension funds. Rosy revenue forecasts worsen matters.
At first glance, none of this bodes well for the latest infrastructure craze. Yet governments and investors are wising up to common pitfalls, suggesting that past failures need not be repeated. No country has been perfect, but each could learn from the others. Governments could lure capital by tailoring contracts to provide more certainty. In 2009, for example, Britain started tendering the huge cables that link offshore wind farms to the coast, under a regime that gives investors a guaranteed return on costs. At the start “there were about four people in the room,” says Gavin Tait of Amber Infrastructure, a fund manager. “Now there are hundreds.” Elsewhere, bundling tiny projects under standardised contracts helps lower costs, says Matthieu Muzumdar of Meridiam, an asset manager.
Other countries strive to protect projects from politics. Canada has set up an arm’s-length infrastructure bank, which crafts innovative financing schemes with the private sector. That has galvanised interest from American and British investors, says Ms McKenna, the minister. Australia’s “asset-recycling” programme provided political cover for lucrative privatisations. Between 2014 and 2019, its federal government offered a 15% top-up to states selling assets if they used the proceeds to finance new projects.
Will the boom stick?
Governments that start small and keep their word seem to whet investors’ appetite for more ambitious plans. Colombia’s road-concession scheme, which began in the 1990s, has lured in an expanding cast of international funds and developers. The fifth iteration, which will spend $15bn and also covers airports, is “the largest in Colombia’s history”, says Manuel Felipe Gutiérrez, who runs its infrastructure agency.
Smarter procurement is being matched by more enthusiasm from investors. It helps that digital and renewable assets are friendlier to private capital. There is a stronger political imperative to build them: whereas few people march to upgrade a road, climate change draws millions, says Jim Barry of BlackRock, an asset manager. They are often profitable, and so rely less on fickle state support. Most big wind and solar farms no longer need subsidies; the roll-out of 5G networks is financed by telecoms firms. And they are easier to build. Investors usually stay away from mega-projects because they are mind-bogglingly complex, but controlling costs on “mini-projects” like data centres is a piece of cake, says Adam Petrie of AMP Capital.
Accordingly, investment has boomed. Connor Teskey of Brookfield, another asset manager, says its renewables portfolio has doubled over the past five years, to $50bn. Altogether the sector makes up 57% of infrastructure deals, up from 40% in 2010, according to Preqin, a data provider. The share of telecoms has tripled, to 9.3%.
The biggest change, though, is that investors are savvier. Once buyers of boring assets in secondary markets, the largest pension funds now want to build their own. This is partly out of necessity. As more capital goes towards infrastructure, brownfield assets attract fierce competition, making it hard to meet allocation targets. In 2013, for instance, CDPQ, a Canadian pension fund, acquired a portfolio of wind farms from Invenergy, an American developer. It then bought the firm itself, becoming America’s second-biggest wind-farm developer, and has taken on Montreal’s light-rail project. After snapping up Plenary Americas, a PPP developer, in March, it aims to double its portfolio to $60bn by 2025, mostly by building assets, says Emmanuel Jaclot, its infrastructure chief.
Winds of change
Investors are also paying attention to innovation. Macquarie, for instance, monitors new technology; it recently helped Cadent, a British gas-distribution firm that it owns, conduct pilot projects to inject hydrogen into its pipe network. Other investors are seeding joint ventures. Sidewalk Infrastructure Partners (SIP), a firm backed by Google and Ontario Teachers’ Pension Plan, seeks to reimagine how cities work. Its first project, in Michigan, is a prototype of the road of the future, using cameras and sensors to fill the “dead space” between buses and trams with autonomous vehicles, says Jonathan Winer, its co-founder. Another involves “virtual” power plants that pay people to lower heating or dim their lights.
Smarter ways to invest, then, could help governments and investors realise their infrastructure ambitions this time. Still, projects can occasionally be wrecked. A cautionary tale comes from Sidewalk Labs, the Google unit from which SIP was spun out. In 2017 it was chosen to redevelop Toronto’s waterfront. The plan had involved heated pavements and connected devices to monitor traffic—before local opposition killed it in May 2020. Investors and developers can look forward to landing on their backsides less often than Charlie Brown. But they can still be caught out. ■
This article appeared in the Finance & economics section of the print edition under the headline “In the works”
Source: Finance - economist.com
