More austerity won't save the global economy. Building infrastructure just might.
- By Justin Yifu LinJustin Yifu Lin is senior vice president and chief economist of the World Bank.
Today’s mounting anxiety over weak growth prospects is more than just a bad hangover from the financial tumult of 2008. In the United States and several European countries, new jobs remain scarce. National incomes in some advanced countries still linger below pre-crisis levels. The medium-term outlook for the United States and Europe is dim. Not only will this make it more difficult for advanced economies to tackle fiscal and employment problems at home, but it will also reduce growth prospects for developing countries, many of which — particularly in the Middle East and sub-Saharan Africa — suffer from a lack of employment opportunities. The result? Millions trapped in poverty, creating fertile ground for social instability. While governments on both sides of the Atlantic are considering cutting budgets, what the world needs most right now is growth.
Without growth, it will be very painful and difficult for advanced economies to increase employment and significantly reduce their debt burden. But how to do it? The solution could take the form of a global infrastructure investment initiative, which would rest on two key pillars. First, advanced economies would need to spend billions of dollars on infrastructure projects, whether by upgrading old facilities or building new ones that release bottlenecks to growth. But even this might not be enough to generate sufficient growth and jobs. Thus, policymakers, entrepreneurs, and investors should also promote and facilitate infrastructure investments in developing countries where opportunities for such investments abound. This should not be seen as charity: Infrastructure investments in developing countries increase demand for capital goods, such as the turbines or excavators that are often produced in the United States and Europe.
Promoting infrastructure investments in developing countries, an idea that is also being advanced by the G-20, would boost exports, manufacturing employment, and growth in high-income countries, while reducing poverty and enhancing growth in the developing world. It’s a win-win solution.
It is important, now more than ever, for advanced economies to continue investing in infrastructure to create jobs and support growth. Good private investment opportunities are hard to find amid the current turmoil. Factories continue to carry spare capacity, and homes and office buildings remain vacant. Infrastructure investments can fill the void, creating much-needed jobs in the construction sector, which has been particularly hard hit, and generating demand for industrial products. Upgrading existing infrastructure and building new transit nodes, if well chosen, can enhance future productivity, raising competitiveness and growth and boosting countries’ ability to repay the investments in the future. U.S. 10-year Treasury bonds have been trading at historically low levels since the financial crisis hit. I could therefore not agree more with my colleague Joseph Stiglitz of Columbia University, who recently wrote, "[T]he real answer, at least for countries such as the US that can borrow at low rates, is simple: use the money to make high-return investments."
But what about the fear of unsustainable debt burdens, which have Western governments searching for budget cuts? Lack of growth is one of the biggest threats to debt sustainability right now, and cutting growth-enhancing expenditure is misguided. And many infrastructure projects can actually be self-financing: Take, for example, toll bridges or highways. What’s more, it is often cheaper to keep roads and other infrastructure in good shape through regular maintenance than to repair them once they are badly damaged.
With public coffers empty or at best strained, innovative mechanisms are required to attract private-sector financing for infrastructure projects, including the use of public-private partnerships, or PPPs. Well-designed infrastructure investments can generate secure and attractive returns for private investors in the current low-growth, high-risk environment. Government officials on both sides of the Atlantic have drawn up interesting proposals to encourage PPPs for infrastructure investment. U.S. President Barack Obama’s administration, for example, has backed the creation of the National Infrastructure Reinvestment Bank, which could issue infrastructure bonds, provide subsidies to qualified infrastructure projects, and provide loan guarantees to state and local governments. Europe is considering the implementation of a new Europe 2020 Project Bond Initiative, which would use public guarantees to leverage private-sector financing from nontraditional investors, such as pension funds.
But creative investment at home might not be enough to help high-income countries get out of the crisis. A global infrastructure initiative should also look to the developing world, where infrastructure investments can be truly transformative. America’s history reminds us why: In 1919, when a young lieutenant colonel, Dwight D. Eisenhower, drove from Washington, D.C., to Oakland, California, with the Motor Transport Corps convoy, it took him 56 days to cover the 3,250 miles, covering an average of 58 miles during daily 10-hour rides. Upon his return, he reported that bridges were destroyed by the convoy, trucks became stuck during rain, and some roads simply could not accommodate quick, easy travel. Later, as president, when Eisenhower promoted the 1956 Federal Aid Highway Act, he envisioned that its "impact on the American economy — the jobs it would produce in manufacturing and construction, the rural areas it would open up — was beyond calculation." Similar opportunities to transform economies still abound in developing countries today.
The infrastructure shortfalls in the developing world are staggering. Roughly 1.4 billion people have no access to electricity, about 880 million people still live without safe drinking water, and 2.6 billion are without access to basic sanitation. About 1 billion rural dwellers worldwide are estimated to have no access to all-weather roads within two kilometers (about the length of a 25- to 30-minute walk). Per capita electricity consumption in sub-Saharan Africa (excluding South Africa) averages only 124 kilowatt-hours a year, hardly enough to power one light bulb per person for six hours a day. Lack of infrastructure not only impinges on the daily lives of millions, but it also renders firms less competitive. Power outages and water suspensions occur frequently, hampering productive activities. Enterprises in Tanzania, for example, face power outages 63 days a year. Enterprise surveys by the World Bank show that between 3 to 10 percent of total sales were lost to electricity outages in developing countries in recent years. And many businesses are never started because the required infrastructure services are not available. Developing countries’ lack of infrastructure, particularly at the regional level, for example, is often a major impediment to attracting foreign investment. It’s therefore unsurprising that the G-20 wants to "make a tangible and significant difference in people’s lives, including in particular through the development of infrastructure in developing countries."
Investing in infrastructure would give developing countries a powerful boost. According to World Bank research, on average, annual growth in developing countries increased by 1.6 percentage points in 2001-2005 relative to 1991-1995, due to infrastructure development. The largest contribution of infrastructure development to growth was achieved in South Asia, where it reached 2.7 percentage points per year. If low-income countries in sub-Saharan Africa would develop infrastructure at the same rate as Indonesia, growth of West African low-income countries would rise by 1.7 percentage points per year. If African economies would reduce in half the gap between their level of infrastructure and the average level of infrastructure in Pakistan or India, Central African low-income countries would gain on average 2.2 percentage points of growth and East and West African countries 1.6 percentage points. Similarly, if each Latin American country would match the average level of infrastructure observed among middle-income countries elsewhere (such as Turkey or Bulgaria), growth in Latin America would rise approximately 2 percentage points per year. The Andean countries would gain most — 3.1 percentage points of growth on average.
A recent World Bank paper also looks at the impact of large-scale infrastructure investments in China. Between 1990 and 2005, China invested approximately $600 billion to upgrade its road system. This investment’s centerpiece was the National Expressway Network, which, spanning across 41,000 kilometers, was designed to eventually connect all cities with populations over 200,000 (only the U.S. interstate highway network is longer). Recent World Bank research shows that aggregate Chinese real income was approximately 6 percent higher than it would have been in 2007 if the expressway network had not been built.
Again, investing in infrastructure in developing countries, while it can do much good in these countries, is not charity. It will also create jobs and generate growth in advanced economies. Most of the capital goods required to build electricity, sewage plants, and roads are produced in the United States and Europe. Infrastructure investments in developing countries would therefore increase demand for manufactured goods in advanced economies. A rough rule of thumb is that for every dollar invested in developing countries, imports of capital goods increase by 50 cents. About 70 percent of traded capital goods from developing countries are sourced from high-income countries. This implies that a $1 increase in investment in developing countries tends to result in a 35-cent increase in exports from high-income countries.
The World Bank estimates that annual investments of more than $1 trillion — about 7 percent of developing-country GDP — are required to meet basic infrastructure needs in developing countries between 2010 and 2020. Countries that have grown rapidly — such as China, Japan, and South Korea — invested upwards of 9 percent of GDP every year for decades. Assuming that infrastructure financing in developing countries continues at historical trend levels, there remains an infrastructure-financing gap of more than $500 billion per year over the medium term.
A global infrastructure investment initiative could aim to close this gap. If it were closed, the associated annual demand for capital-goods imports worldwide — for infrastructure investment alone — would increase by $250 billion, more than $175 billion of which would come from high-income countries. Total capital-goods exports from all high-income countries in 2010 amounted to approximately $2.4 trillion. Capital-goods exports from high-income countries would therefore increase by over 7 percent, creating much-needed jobs in the manufacturing sector of advanced economies, reducing unemployment and increasing consumption. The reduction in excess capacity in turn would lead to a pickup in investment. In addition, the threat of global climate change increases the demand for infrastructure that is resilient to natural disasters, less damaging to the environment, and supportive of sustainable development. This provides new opportunities for advanced economies to invest in innovative solutions. Growth would recover and fiscal revenues increase, ultimately leading to a decline in public debt burden.
But the benefits from scaling up infrastructure investment in developing countries do not stop there. As developing countries prosper, their demand for imports from around the globe will rise. As production networks become more and more sophisticated, fast and reliable infrastructure connections become more and more important. Improving regional connections would not only increase intraregional trade, but it would also open previously untapped markets. Boosting exports in advanced economies would also reduce their external borrowing needs, potentially unleashing more surplus global savings in support of investment and growth in developing countries. This in turn would lead to additional investment opportunities and the opening-up of new markets. Ultimately, this could create a virtuous cycle, with surplus global savings supporting investment and growth in developing countries.
But how could the infrastructure funding gap be closed without putting an additional fiscal burden on already cash-strapped governments? There is no single solution. It will require greater efficiency in spending and increased cost recovery for those sectors with such potential. It will also require tapping a combination of financing from both traditional and new sources: the private sector via PPPs, notably by deepening local capital markets to tap domestic investors. Making the most of new financiers from emerging economies such as China, Brazil, and India, will be essential.
Infrastructure can ultimately be paid for by either taxpayers or its users. But it can also be financed in a variety of ways: government spending, loans or grants from multilateral institutions and bilateral creditors, and private-sector lending. Domestic public financing has been a dominant source of infrastructure financing in many developing countries. Official development assistance from traditional donor countries targeted toward infrastructure reached around $90 billion in 2009 as aid agencies made substantial efforts to help developing countries cope with the consequences of the global financial crisis. But going forward, such assistance will likely decline and return to pre-crisis trend levels.
But traditional donors aren’t the only option. Other donors, such as Brazil, China, India, and various Arab countries, have recently emerged as major financiers of infrastructure projects in Africa. Overall, infrastructure resources committed to Africa by these countries jumped from $1 billion per year in the early 2000s to close to $10 billion in 2010. Chinese financing for African infrastructure structure projects alone is estimated to have reached a record level of roughly $9 billion in 2010.
Private participation in infrastructure could also play a role in helping to close the investment gap in many developing countries. Here’s how it works: Public-private partnerships, or PPPs, are established through a long-term contract between a government and a private investor. The investor finances at least part of the investment in return for future service fees that are collected from the users, and it sometimes also receives government subsidies. Private participation in infrastructure investments has played an increasingly important role in developing countries, reaching close to $160 billion in 2009, but is concentrated in a handful of large emerging economies, such as Brazil, China, India, Russia, and Turkey. It is also limited to a few sectors, especially telecommunications.
Significantly expanding private-sector involvement will require addressing a number of issues. First, the company implementing the project and its private shareholders are often exposed to considerable risks, such as shortfalls in projected revenues, exchange-rate risks, and political risks. Infrastructure projects need high upfront financing, which can take decades to amortize; pre-construction and construction periods often stretch over several years, during which the companies involved obtain no revenues. Second, identifying the right infrastructure projects and marketing them to the private sector requires very specific know-how and upfront financing, which is often unavailable in many developing countries.
Reducing these risks for the private sector is crucial to success. One way to do so is combining private-sector financing with public-sector or donor funding. Initiatives in advanced economies, such as the National Infrastructure Reinvestment Bank in the United States and the new Europe 2020 Project Bond Initiative, are good examples. Both initiatives contemplate the use of public guarantees for private-sector financing. But though government guarantees can insure against project-related risks, they are unlikely to mitigate investors’ perception of risks associated with the government itself. The World Bank Group therefore provides political risk insurance against risks such as currency inconvertibility, expropriation, war, terrorism, civil disturbance, and breach of contract. It has increasingly used guarantees to catalyze private finance. But more remains to be done.
As for the know-how problem, innovative knowledge hubs that build the required financial and technical capacity of government officials in developing countries and provide relevant expertise could be scaled up. In November 2010, the World Bank Group launched, in partnership with the Singaporean government, the Infrastructure Finance Center of Excellence, which aims to build capacity in the public sector to better manage private-public partnerships. Similarly, the World Bank’s Arab Financing Facility for Infrastructure, carried out in partnership with the Islamic Development Bank, aims to raise up to $1 billion in new infrastructure investments in Arab countries.
The potential for mobilizing funding from investors, such as sovereign wealth funds (SWFs) — funds that invest state-owned profits — seems promising. The IMF estimated that SWFs held more than $3.2 trillion in financial assets at the end of 2008, and these assets are expected to grow rapidly in coming years. Some SWFs are already investing in infrastructure in developing countries. The China-Africa Development Fund, an equity fund that invests in Chinese enterprises with operations in Africa, reportedly invested nearly $540 million in 27 projects in Africa that were expected to lead to total investments of $3.6 billion in 2010. And the Qatar Investment Authority plans to invest $400 million in infrastructure in South Africa.
Still, funds targeted toward developing countries are only a fraction of available resources. Since 2007, about 166 infrastructure funds with approximately $110 billion in commitments were raised globally. Only 15 percent of the funds raised were targeted toward developing countries. To overcome these shortcomings, the private-sector arm of the World Bank Group, the International Finance Corporation, is launching an infrastructure fund with a target size of $1 billion that will raise funds from sovereign and pensions funds and other institutional investors.
Investing in infrastructure is critical for generating growth and creating jobs — perhaps now more than ever. For advanced economies, it may be the fastest way out of their slump. For developing countries, it is a powerful vehicle for transforming their economies, enabling their businesses to work unimpeded without electricity shortages, communicate freely, expand their markets, and, ultimately, climb up the technological ladder. The need is clear. The money is available. Now is the time to help steer it to finance the roads, ports, railways, and power plants needed to support jobs and prosperity in high-income and developing countries alike — for the benefit of all.