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What the G20 can do about infrastructure

What the G20 can do about infrastructure

Infrastructure is now a standard item on the G20 agenda. Serious infrastructure shortages are ubiquitous. With global economic growth slow, ample construction capacity and interest rates at historic lows, there seems to be an opportunity to address the infrastructure gap. But many governments see themselves as constrained by high debt levels.

Is the answer to get the private sector to fund infrastructure through public-private partnerships (PPPs)?

Turkey, as the current G20 president, supports this idea. Turkish Deputy Prime Minister Ali Babacan has said:

Some countries do not have the budgetary room to raise investment spending: they have high debt rates, are undergoing fiscal consolidation, and are hardly able to cut down budget deficits and debt rates. When we ask them to raise investments, they talk about budget constraints. Consequently, public-private partnerships need to gain more prevalence all around the world.

But are PPPs the answer? An article in the latest Lowy Institute G20 Monitor makes the case that this emphasis on funding misunderstands the role of PPPs.

Infrastructure projects present mighty challenges. They are often big, long-lasting, technically challenging and can be controversial as they sometimes involve social disruption. Even when the project is highly desirable and socially useful, it is hard to make it commercially viable because the outputs are often public goods (that is, they are 'non-excludable'; everyone can use the street-lights, so no-one pays), natural monopolies (no point in having two pipes supplying your house with water), or they have historically been provided free or been heavily subsidised.

These challenges are, almost always, much more serious than the issue of funding. [fold]

Certainly, there are financial constraints on governments. But these are usually self-imposed. The political process has imposed spending caps and debt limits for good reason: as a response to pork-barrel spending, white elephant projects, inefficient implementation or over-manned operations. Very few governments, however, have actually reached the limit of their ability to sell debt and use the proceeds to fund infrastructure expenditure. Paradoxically, these self-imposed constraints have been put in place specifically because it is so easy for governments to borrow. 

What's the case for involving the private sector?

In recent decades there have been many successful full privatisations (as opposed to partnerships). In Australia, Telstra and Qantas provide just two instances among the many global examples. If a project is suitable to be handed over entirely to the private sector, this will usually be better than a PPP. Implemented privately, the project benefits from the profit motive – a powerful driver of efficiency. This approach does not entirely eliminate white elephants (big, technically difficult projects can fail, whether in the public or the private sector), but it would stop pork-barreling ('bridges to nowhere'). As well, the private sector may be better at operational issues, including imposing user charges (tolls on roads and full cost recovery for utilities).

Full privatisation is suitable where the industry is not a natural monopoly. Technological change has helped put more projects into this category, turning natural monopolies such as telecommunications into multi-firm industries with vigorous competition.

But in many sectors, the public good characteristics of the industry are central to the provision of the service. If the function is fully privatised, it would have to be comprehensively and intrusively regulated to prevent the private owners from exploiting the monopoly position, in terms of price or service quality. The closer the industry is to a monopolistic utility, the harder it is to offset these issues with regulation.

PPPs fall into an ambiguous middle ground. In early uses of PPPs, the private sector partner often showed itself to be more skillful at shifting risk to the public partner, with the cost of failure borne by the taxpayer. As the public sector became more experienced at avoiding this deficiency, the private sector became less enthusiastic about the PPP model. In Australia, the private sector prefers to finance risk-free projects, with construction already complete and 'take-or-pay' contracts. But getting the private sector to fund risk-free projects makes little sense: governments can borrow more cheaply than any private investor.

Rather than funding shortages, the greater obstacle to faster expansion of infrastructure investment is the dearth of projects whose commercial viability has been firmly established by detailed assessment. Projects fail because of misforecasting of demand and construction costs, through legal difficulties with land acquisition or the myriad risks which surround large technically complex construction. Better project assessment is the key to deciding which projects are viable and to reducing the intrinsic risks. 

The G20 is in a position to encourage the international development banks (the World Bank and the regional banks) to resume a more active role in this sort of project assessment. Infrastructure was once the bread-and-butter of these institutions, but limited funds and governance issues (including pressure from NGOs on environmental issues) have restrained their contribution. 

G20 finance ministers and leaders could usefully debate how to return these development banks to a key infrastructure role: as expert assessors, able to evaluate cost/benefit, technical and environmental issues. At the same time, their assessment will make it clearer which projects should be fully privatised, which ones are best left in public hands and which (if any) fall into the ambiguous category of public-private partnerships.

Photo courtesy of Flickr user Daniel Parks.

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