Projects that offer significant public benefits boost economic activity in near and long terms, yet financing remains tricky

Author: Laurence Neville

Bridges, ports, roads and dams:  Infrastructure investment is having a moment in the sun. In the US, President Donald Trump’s pledge to close the $1 trillion infrastructure gap was one of his few clearly articulated plans. In the UK, infrastructure investment is being championed as a way to offset the economic uncertainty caused by Brexit. Europe is already ahead of the curve: in 2014, the European Commission launched a €315 billion three-year program, dubbed the Juncker plan after its president.

Meanwhile, in China, President Xi Jinping’s New Silk Road plan to connect China with Central Asia, the Middle East and Europe through road, rail and port construction is underway: the first direct freight train from the transportation hub of Yiwu in eastern China to London departed in January.  And in Mexico, President Enrique Peña Nieto recently raised his 2018 infrastructure spending target to $587 billion. He noted, “With bigger and better infrastructure, there are more opportunities to attract productive investment, generate jobs and improve families’ income.”

Why now? “There has been a realization that while central banks can print money, they cannot print economic growth,” notes Gianluca Minella, infrastructure specialist at Deutsche Asset Management. Despite unprecedented central bank policies, including prolonged record low interest rates and quantitative easing (QE), growth remains lackluster. Even where growth is firmly established, such as in the US, confidence is weak. Minella says governments recognize that fiscal policy is now needed to support growth—and “infrastructure is a key tool in fiscal stimulus.”

Jan Dehn, head of research at emerging market investment management firm Ashmore, agrees that the failure of years of monetary stimulus and public spending to spark strong rates of growth, particularly in Western economies, has led to a greater focus on the supply side of the economy—including the state of infrastructure. “In addition, the infrastructure idea is appealing because it is a very direct way that governments can generate jobs, which has gained political importance as many workers in Western economies feel that they have fallen behind in the broader economy.”


Minella: Infrastructure is a key tool in economic development.

In economic-theory terms, infrastructure investment looks like an easy decision. “Improvements in infrastructure boost demand in the short term and supply in the long term,” says Minella. “On the demand side, there is an immediate boost to GDP because of increased spending and the boost to the construction sector. The supply side has the potential to lead to a longer-term increase in productive capacity.” Ashmore’s Dehn explains infrastructure’s multiplier potential: “If the government builds basic infrastructure, such as laying electricity cables and sewage systems and water supply to a greenfield site, then it is often easier to get the private sector to put up businesses and residential investment in that area.”

A widely cited study published by the International Monetary Fund in October 2014 shows that in advanced economies infrastructure spending of 1 percentage point of GDP increases output by 0.4% in the year it occurs—the demand boost—and 1.5% four years later as a result of increased supply. “The boost to GDP a country gets from increasing public infrastructure investment offsets the rise in debt, so that the public debt-to-GDP ratio does not rise,” note the authors. “In other words, public infrastructure investment could pay for itself if done correctly.”

However, the IMF’s “if done correctly” caveat is critical. “Infrastructure spending is sometimes seen as the ‘new QE’,” because of its perceived potential to deliver wide-ranging economic benefits, notes Andrew Kenningham, senior global economist at Capital Economics. “But while it has its place, it is no panacea.”


The variables that determine whether infrastructure investment pays off are endless. It is important to accurately distinguish its objective, adds Kenningham: “One goal is Keynesian demand management, which aims to boost demand in the economy and stimulate growth.” Explicit countercyclical demand management was largely abandoned by governments in the 1980s; and, despite increased academic interest, its use has been limited in the post-crisis period because it goes against the economic orthodoxy of the past 30 years.

Moreover, it is generally accepted that the demand-management benefits of infrastructure spending depend on existing economic conditions. Efforts to reflate an economy already running at full steam will quickly meet capacity constraints and could generate inflation. “The impact of infrastructure investment depends to some extent on the state of the economy and the output gap,” says Kenningham. “There may be little room for fiscal stimulus in the US, which is running up against full employment; whereas the multiplier will be higher in Southern Europe [where unemployment remains high], for example.”

Similarly, benefits vary based on a country’s existing stock. “Infrastructure investment delivers a greater benefit to emerging markets than to developed markets,” says Alex Kazbegi, an analyst who covers Russia, the CIS, Africa and Europe at investment bank Renaissance Capital. “In emerging markets it is often possible to create entirely new infrastructure that not only facilitates creation of new industries and activities but can be simply a life changer: for instance, many areas in Africa still lack basic access to electricity and water.”


Kenningham: Infrastructure investment’s impact depends in part on the state of the economy and the output gap.

Funding is a major determinant of infrastructure’s impact on an economy. “Any increase in public expenditure which is not financed by taxes has a positive multiplier effect,” explains Capital Economics’ Kenningham. Conversely, infrastructure spending that involves little new government money may be ineffective. “[The Juncker plan in Europe] uses the EU budget in a risk-absorbing capacity to leverage €315 billion of private funding,” says Maarten Leen, head of macroeconomics at ING. “But so far, private sector take-up has been limited. As a result, there has been no real economic benefit.”

All too frequently, countries that would most benefit from infrastructure spending and gain the greatest multiplier effect have the least ability to fund it. “Periphery countries, such as Italy and Spain, are constrained by the Maastricht criteria [which limit eurozone members’ budget deficits to not more than 3% of GDP]; while those countries with the most fiscal space, such as Germany, have the least need for stimulus,” says Charles St-Arnaud, senior international economist at Nomura Securities International.

Brazil faces similar constitutional constraints. It ranks 123th out of 144 countries for the overall quality of its infrastructure, according to the World Economic Forum report for 2015-2016. Its economy is estimated to have shrunk by around 4% in 2016. But in December it enacted a constitutional amendment that imposes a ceiling on public spending for the next 20 years, because of its enormous budget deficit. Countries without constitutional restrictions may face budgetary or market constraints: the cost of debt may be prohibitive because of investors’ concerns about solvency, for example.

In such situations—and even where countries can access low-cost funding—governments turn to the private sector, which brings both advantages and disadvantages. “No one can borrow as cheaply as the government, [and] the private sector inevitably wants a return. Therefore, a privately funded project will always be more expensive,” explains Leen. “However, privately developed and managed projects can be more efficient.”


Despite plenty of private sector money looking for stable, long-term returns, attracting money to infrastructure can be tough. “Countries that are perceived to have a quality framework attract greater private sector investment, are able to build high-quality infrastructure and therefore achieve more economic benefit,” says Deutsche Asset Management’s Minella.

The best-known model is the public-private partnership (PPP). “It engages the government but delivers the efficiency of the private sector,” says Renaissance Capital’s Kazbegi. In emerging markets, multilateral institutions play an important role, either by investing directly and jointly with other parties or by derisking projects to encourage private investors to come in, he adds. But in developed markets, despite plenty of debate, no alternative to PPP has yet emerged.

Unfortunately it takes many years for a country to establish and test a PPP framework, and few countries have done the necessary groundwork. “One of challenges facing President-elect Trump is that such a framework is not yet fully in place in the US, making it more difficult to swiftly mobilize private investment in the way he seeks,” explains Minella.

Governments and investors need to think more creatively if they are to increase private sector involvement in infrastructure. The Solvency II regime, for example, is increasing insurance companies’ investment in infrastructure projects because such assets have a relatively low capital charge, according to Minella. Similar reforms could encourage increased investment by other types of investors.

At the same time, the private sector needs to change its mind-set. “Some pension funds are too passive, often by mandate, in their pursuit of infrastructure opportunities: they are content to buy bonds that support projects rather than taking a more involved role,” says Nomura’s St-Arnaud, who suggests that a more active approach—such as that taken by Canadian pension plans, for example—may be advantageous to all.


Leen: A privately funded project will always be more expensive, but it might be more efficient.

Ultimately, it is the infrastructure itself which determines the benefits generated. Picking the highest-return projects and executing them without political interference is essential, according to Ashmore’s Dehn. Unfortunately, this rarely occurs. “Japan had a long period of low growth and invested heavily in infrastructure,” notes Leen at ING. “However, this did little to impact the long-term economy, because much of the spending was wasted on projects such as building bridges to islands where almost no one lived.”

Politicians are often attracted to headline-grabbing projects when they should be focused on the micro-level improvements designed to enhance economic efficiency rather than to generate demand, according to Capital Economics’ Kenningham. “Maintenance and incremental improvements to existing infrastructure can have a higher benefit-to-cost ratio,” he says. “For example, improvements to signaling systems on the London Underground and the introduction of the congestion charge for traffic in central London have delivered high returns relative to their costs, but it’s unclear that something as expensive as [the London-to-Northern England high-speed railway] HS2 will be worth the money.”

Such improvements avoid the obvious pitfalls of large-scale projects, such as overspending and delays (in an extreme example, London’s Heathrow expansion took decades to gain approval). Micro-level projects are also less likely to be inflationary in countries with capacity constraints. “The argument [for micro-level improvements] is easier to make in the US than the case for a boost to overall demand,” Kenningham notes.

With so many potential roadblocks to success, is infrastructure investment really worthwhile? To be sure, many Western countries (and certainly most emerging markets) need new infrastructure. But effective infrastructure investment is a tricky tool to wield and therefore unlikely to be an effective short-term remedy for economies suffering from weak demand—assuming there is even the political will or market willingness to fund debt-driven investment. Certainly, the way many politicians are latching onto infrastructure as a replacement for faltering monetary policy could be a recipe for disaster.


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