The G-7 Infrastructure Plan Won’t Succeed Unless It Learns from Past Failures

All eyes were on Russia and Ukraine during the recent G-7 summit in Germany. However, the war was far from the only problem on the G-7’s docket. In fact, the summit started with a breakthrough of a plan on an entirely different matter: the need for clean energy infrastructure investments in developing countries.

The initiative, the Partnership for Global Infrastructure and Investment (PGII), aims to deploy $600 billion to counter China’s Belt and Road Initiative (BRI), a global infrastructure agenda that is difficult to measure reliably but which has likely committed $1.9 trillion across 1,590 projects since its inception in 2013. In addition to competing with a sum more than three times what the PGII pledges, the G-7 hopes its initiative will extend an economic lifeline amid a burgeoning emerging-market crisis and accelerate the world’s clean energy transition. These objectives are critical and closely connected, but unless the PGII can muster real policy reforms and lock in firm financial commitments, it will have little chance of success.

Policymakers should be mindful of the likelihood of failure given the poor track record of past U.S. and G-7 efforts. In 2019, the Trump administration established the Blue Dot Network (BDN) to create infrastructure investment standards that would, in theory, expose China’s lack of standards. Yet no such stigma came about, the BDN failed to prevent low- and middle-income countries from working with China, and after two brief years the BDN was phased out.

In 2021, the Biden administration announced Build Back Better World (B3W), nominally the Blue Dot Network’s replacement, which pledged to “catalyze hundreds of billions of dollars of infrastructure investment.” After a yearlong drum roll, however, no public or private sector funds emerged. B3W has since sunk without a trace.

Second, flashy announcements may receive fanfare, but they are not nearly as effective as well-placed reforms. Working within existing institutions allows policymakers to tap into and improve existing operations, resources, and expertise. Given that the work of the BDN and B3W was already being done by the World Bank, it would have been better for the United States and G-7 to focus on improving the World Bank’s existing infrastructure agenda. By starting anew, Washington and the G-7 made their work much harder—and, as quickly became clear, much less likely to succeed.

Third, money talks. In their past efforts, Western policymakers have relied on nonfinancial tools to get capital to flow to low- and middle-income countries: providing advisory services, establishing norms and standards, and serving up virtue-laden rhetoric. Without adequate funding, none of these amount to much. Instead, the U.S. and G-7 efforts came across as paternalistic lecturing that offered no real alternative to the $59.5 billion that China spent on the BRI in 2021 and the $60.5 billion it spent in 2020.

Sadly, these lessons have not been absorbed by the G-7’s new initiative, which is neither a multilateral undertaking nor a detail-oriented reform of the existing development finance system nor a fully funded operation. In the documents that the White House has published, there is in fact no mention of how the United States’ specific pledge of $200 billion will be funded, let alone how the G-7’s total $600 billion figure will be achieved.

Read More

The G-7 Agrees: Russia’s Invasion of Ukraine Is a ‘Zeitenwende’

New survey data shows majorities across the group of major industrial countries see Putin’s aggression as a fundamental turning point for the world.

Analysis |

Tobias Bunde, Sophie Eisentraut

Will Inflation Spark Protests in Africa?

The war in Ukraine has led to rising costs for fuel, food, and fertilizer from Ghana and Nigeria to Egypt—and it could trigger instability.

Africa Brief |

Nosmot Gbadamosi

America’s Nuclear Rules Still Allow Another Hiroshima

U.S. leaders must take responsibility for past nuclear atrocities.

Argument |

Adam Mount

Instead, the White House trumpeted its new initiative with a list of projects that have already been initiated and whose figures are far from firm. As one section of the White House’s announcement unconvincingly reads, “The U.S. Agency for International Development (USAID) will aim to commit up to $50 million over five years to the World Bank’s new global Childcare Incentive Fund.” What this commitment, or the overall financial commitment, will ultimately be is anybody’s guess.

The underwhelming nature of the PGII is understandable. Although the White House may have good intentions, it faces difficult political conditions. The White House lacks an outright majority in the Senate, the filibuster prevents Democrats from passing the ambitious legislation that a $600 billion plan requires, and it has become inconceivable to muster support for a spending bill from Republicans and certain renegade Democrats no matter how critical the cause.

These are tough constraints that are unlikely to loosen anytime soon. As a result, the White House needs a solution that steers clear of toxic U.S. politics while still providing the funding and policy changes that a global infrastructure agenda needs. There are three steps for doing this successfully.

Some might protest that more highly leveraged and lower-rated development banks would be risky. But this does not stand up to serious scrutiny. A AA+ rating is still stratospherically high, and moving in this direction would put the development banks among the ranks of Alphabet, Berkshire Hathaway, and other companies that are considered to have “fortress balance sheets.” What’s more, development banks possess unique semi-sovereign features that make them virtually impervious to financial problems: They enjoy preferred creditor treatment and are largely exempt from debt restructurings that other private sector and bilateral creditors face, they have immense reserves of unpaid callable capital, and their shareholders are themselves sovereign nations. The “downgrade” would be in name only.

However, some may still worry that this will be costly, as lower ratings will inevitably come with higher borrowing costs. But this, too, is overblown. According to econometric research from Italy’s central bank, the major development banks would face only a 0.4 percent to 0.5 percent increase in their funding costs. When the New Development Bank—a World Bank lookalike that was established by the BRICS countries (Brazil, Russia, India, China, and South Africa) in 2014—enacted this policy change, its funding costs were just 0.1 percent to 0.15 percent higher than the costs for AAA-rated peers.

Instead of a collection of unconvincing financial commitments that theoretically added up to $600 billion, there would be a firm figure on which a global infrastructure agenda can rest: $955 billion. Spending this money correctly will bring the figure up further. If development banks are able to use their new funds to “crowd in” patient and productive investment from the private sector, this infrastructure agenda will be better endowed and have a greater chance of success.

Private sector investors need insurance that gives them the security to invest where they otherwise might not—in politically and economically risky places.

Given that the investment landscape in many low- and middle-income countries is not particularly inviting, the second step must be to provide the private sector the security it needs to invest where they otherwise might not—in politically and economically risky places. If investors think the solar farm they have built may be seized by the government, or that they may be unable to get their profits out of the country in which they have invested, the investors will be unlikely to put their money on the line. Offsetting these concerns is no easy task, but as with other risks, insurance can be of great value.

At present, the World Bank’s Multilateral Investment Guarantee Agency (MIGA) offers many helpful insurance policies that protect investors in the event of expropriation, currency inconvertibility, and other problems. However, infrastructure investors note that MIGA’s insurance is expensive and its coverage rather limited. MIGA also does not get into other critical issues, such as foreign exchange risk and the rapid deterioration of local currencies, which can make foreign investors’ profits worthless.

The primary obstacle here appears to be MIGA’s tight budget. In the past five years, MIGA has averaged less than $5 billion in gross issuances per year. That is not enough money to underwrite a global clean energy transition, not enough to facilitate the G-7’s $600 billion target, and probably not even enough to keep up with existing investment interest. Boosting MIGA’s budget by loosening its capital adequacy policies—or those of its parent organization, the World Bank—would allow it to offer more favorable and wider-reaching insurance, which will be essential for crowding in private sector investment for the long haul.

The third step will require development banks to get more actively involved in the financing of clean energy infrastructure. This can come in a few forms: debt, equity, and investment guarantees.

Concessional debt, or lending money to investors for long durations at favorable rates, will inject the patient and cheap capital that infrastructure sorely needs. Given that an infrastructure project, such as a hydroelectric dam, takes many years to build and many more to bear financial fruit, investors will be afraid of facing a maturity mismatch—the quandary of borrowing money from banks for a short horizon but only earning money with which to pay banks back over a longer horizon. More generous debt financing from development banks can mitigate these problems.

Equity financing can also play a valuable role, and development banks should be better endowed to co-invest with private sector partners. If a development bank is an investor, governments are more likely to provide projects the support they need, and other investors are more likely to see the investment as a safe one. These direct investments can also allow development banks to assume “first-loss positions,” as the White House has previously advocated, meaning that development banks will bear the losses that would otherwise cause investors to leave the infrastructure space and never return.

The final form of investment support is revenue guarantees. In many cases, the clean energy infrastructure that is needed will not (or not for a very long time) provide investors the revenue they require. No amount of insurance, debt financing, or equity financing can catalyze private sector engagement if revenue is not forthcoming. Instead, the World Bank and its peers will have to provide minimum revenue guarantees—arrangements in which the development bank ensures some return for the infrastructure investor.

If, for example, a railway is to be built in a location where there has never been a railway, investors will struggle to calculate how much usage it will get and how much cash it will generate. As a result, investors will be unlikely to invest. But if development banks can more generously assist countries in providing minimum revenue guarantees, infrastructure will face no such hurdle.

The G-7’s Partnership for Global Infrastructure and Investment is a noble effort. But so were the Blue Dot Network and Build Back Better World. If the PGII takes the shape of a multilateral, policy-focused, and fully funded initiative, this noble effort might actually be a successful one.