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  From the report
Executive Summary
The Global Risks Landscape 2010
Fiscal Crises and Unemployment
Underinvestment in Infrastructure
Chronic Diseases
Risks to Keep on the Radar
Managing Global Risks
Processes and Definitions
Global Risks Barometer 2010
Contributors and Acknowledgements
  Global Risks 2010
    In collaboration with Citi, Marsh & McLennan Companies (MMC)
    Swiss Re, Wharton School Risk Center, Zurich Financial Services
Global Risks 2010 Home

Underinvestment in Infrastructure Printer friendly version  Send to a friend

Global Risks 2009 noted the importance of spending decisions as governments launched fiscal stimulus packages to boost growth and create jobs. Infrastructure investment choices are key at any time but they are particularly critical, if the dual challenge of population growth and climate change is to be met, in five areas: agriculture, energy, water, transportation and climate change adaptation.

Click here for the full Risks Interconnection Map (RIM) 2010.

The Global Risks Expert Perception Survey 2010 data shows underinvestment in infrastructure as one of the most highly interconnected risks on the RIM (Figure 14). The strongest links are to fiscal crises, oil prices and natural catastrophes, but it also links to health issues, including infectious diseases as well as chronic diseases, and to food price volatility. The World Bank has put global infrastructure investment needs at US$ 35 trillion over the next 20 years. In the US alone, the American Society of Civil Engineers rated US critical infrastructure as a "D" (where "A" is the highest grade) in 2009 and estimated that US$ 2.2 trillion was necessary over the next five years. The US spends approximately 2.4% of GDP per annum on infrastructure, compared with approximately 15% of GDP on health. Underinvestment infrastructure is not just a risk to existing structures in the developed world, if it is not addressed it is also a barrier to growth and development in the developing world as well.

New and existing infrastructure is critical to resilience
The last decade has seen the rise of the public-private partnership model for large infrastructure projects, many of which are needed in countries where the political and governance environment are far from ideal or even stable. Traditionally, the state is seen as the driver of major infrastructure projects, such as road, rail, energy and water grids. The initial investment is made by governments, with private enterprise running the delivery and service aspects through licensing or other long-term agreements. However, as discussed earlier in this report, many governments must manage the critical maintenance and renewal of existing infrastructure, as well as new, large-scale projects in energy, transportation and urbanization, in the face of widening fiscal deficits and growing debt.

For other countries, including many emerging markets, the barriers may not be weak fiscal positions but rather concerns about political stability and governance structures to protect investments. Many countries richly endowed with natural resources, such as energy, metals, or agricultural crops, have become targeted by other countries for inward infrastructure investments in return for access to resources. The problem is that these infrastructure investments can be blinkered and "resource-centric", and might not serve the country as a whole. But this problem must rest largely with the producer nation's government, which is ultimately responsible for creating linkages to a wider plan for development. Examples of a narrower view of infrastructure development can be found from South America to Africa, where villages without running water and electricity sit next to busy highways ferrying goods to and from state-of-the-art port facilities. The risk of local unrest is high, but the greater risk is the depleted potential for long-term development and greater economic well-being for the wider population.

To address infrastructure needs with a vision for a sustainable, resource efficient approach to projects is one of the challenges of both emerging market and developed world countries. Given the financial, political, environmental and even societal risks involved in infrastructure projects, there is a need to establish best practices, to share know-how and enabling technologies, and to find innovative ways to finance development while managing risks. International finance and development institutions have long been working on multistakeholder approaches, but these efforts will have to be stepped up. One area under discussion as part of the proposals coming from the Forum's Global Agenda Councils is that new models might be found to encourage large institutional investors, who have a longer term investment horizon, such as pension funds or sovereign wealth funds, to invest in infrastructure projects. As an area linked to so many risks and one that can ultimately amplify or dampen the impact of a range of other global risks, the time has come to step up the dialogue and thinking to achieve the necessary level of infrastructure investment in an economically and environmentally sustainable manner.

Agriculture: the infrastructure necessary for food security and sustainable growth
Despite an increasingly urban global population, 75% of the world's poor continue to live in rural areas. As this report discussed in 2007, food security is driven by a number of factors but all are highly interlinked and infrastructure is at the nexus of many of these factors. A still growing global population that is moving to a more protein intensive diet engenders not only greater overall demand for food but also greater demand for the water and energy needed to produce and transport that food. Few countries have the mechanisms in place to manage their future needs in terms of infrastructure and health planning based on available water for the population. For example, a 2009 report on water by the Forum6, estimated that by 2030 there will be a 40% shortfall between the amount of water India requires to meet its own energy and food production needs and the water available to do so.

(6 "The Bubble Is Close to Bursting", World Economic Forum 2009 www.weforum.org/en/initiatives/water/).

If agricultural productivity is to have any chance of increasing to meet the demands of 9 billion people by 2050, a second Green Revolution will have to happen. Indeed, in Africa the first green revolution is still to take place. But there are also huge gains to be made from investment in better storage and transportation systems, thus minimizing waste and maximizing the amount of food reaching consumers. The impact of investment in these facilities could make a significant contribution to reducing some of the volatility in food prices. In addition to storage and transport, two other areas of infrastructure related to agriculture are key: water and energy. Agriculture accounts for 70% of the draws on water and as the effects of climate change mean that many areas become drier or more prone to extreme weather, improved water efficiency becomes vital. Improving water capture and irrigation would be an investment not only in productivity but in sustainable resource management. Investment in energy infrastructure is also a priority in rural areas in developing countries and must be part of a broader energy strategy. Farmers can be doubly hit by rising or volatile energy prices through input and transportation costs, but energy prices also link to the input side, with gas prices in particular affecting nitrate-based fertilizers.

Infrastructure investment alone will not be sufficient, but it will be a necessary accompaniment to investment in other areas and to improved market structures at the national and international level. Challenges in this area are manifold. Some of the most productive land in the world is in areas of high instability and where major infrastructure projects require governments, international institutions and aid agencies to be innovative in the way risk is shared if they are to attract the substantial private investment necessary. Farms in much of the world are small, insufficiently productive and very labour intensive. As populations become more urban, there is a risk that labour and know-how are lost. As discussed in Global Risks 2009, and mentioned earlier in this chapter, there is a risk of "land grabbing", as nations try to secure their food supply by investing directly into agricultural land in other countries.

The infrastructure necessary to support sustainable agricultural production will not just pay off in terms of providing food to the more than 1 billion people who went hungry in 2009, but it will also help drive development in rural areas. The UN Food and Agriculture Organization (FAO) and World Food Programme predict that the food crisis of 2008, which led to riots and political turmoil in several countries, will be repeated over the coming decades. What is clear is that current levels of investment in agriculture are not enough to drive the 70% increase in food production necessary to feed an expected population of 9.1 billion by 2050. During the last period of fiscal crises in the 1980s and 1990s, agriculture suffered from reduced investment that was never restored. Poor returns, uncertainty and distorting subsidies made investment less profitable. In the face of rising unemployment and reduced consumer spending in the advanced economies and a record number of people suffering from hunger globally, governments and international institutions now need to think long term, and create the mechanisms and environment to encourage investment in infrastructure and leverage that investment for growth and stability.

Infrastructure and energy security
While the recession caused global energy use to fall in 2009 for the first time since 1981, the long-term trend for energy consumption is still upwards. The main demand will continue to be for fossil fuels. The demand for oil will be primarily driven by the transport sector. Coal and gas will be the main fuels needed to meet the growing demand for electricity, and most of that demand will be in China, developing Asian countries and the Middle East.

As energy demand fell over 2009, so did energy investment because of the tighter credit environment. The International Energy Agency (IEA) estimates that investments in oil and gas projects were cut by 19% from 2008 to 2009. Investment in renewables fell even more. Without government fiscal packages, investment in renewables would have fallen by 30% but even with them, they fell 20%. Underinvestment in energy infrastructure touches on a number of key themes of this report (see the box on energy security page 21). The demand for energy will rise as the global population grows and with it consumption. Current energy policies, based on fossil fuels, look increasingly untenable given what they would produce in terms of CO2 and greenhouse gas concentrations. Energy security has long been used to describe the need for a stable and guaranteed supply: in the 21st century it may need to be redefined as meaning stable, guaranteed and carbon neutral.

The links to the financial crisis and to fiscal crises also have a direct impact on underinvestment in energy infrastructure. First, a lag in investment may mean that as demand returns there will be a shortfall in capacity that could lead to supply constraints in the medium term, thus oil price spikes and higher price volatility. Any major disruption to supply or rise in prices over the next years could slow the recovery and set back growth. Second, a huge amount of energy infrastructure investment, estimated at almost half of the total US$ 1.1 trillion per annum by the IEA, is needed to meet the rapidly rising demand from developing countries. Rural areas in Africa, India and other parts of Asia are in particular need of reliable energy production and supply to support their development.
Third, aside from the enormous and pressing need for public and private finance for energy infrastructure, the over-arching need is for this money to be spent strategically. The stimulus packages proposed by several governments targeted investment into renewable energy to reduce long-term dependency on fossil fuels but equally to reduce CO2 emissions. Low-carbon investments, investments in more energy efficient infrastructure and in carbon capture and storage will all be part of the arsenal needed to mitigate climate change.

Energy security and investment: walking the tightrope between national policy imperatives and economics

Energy companies faced significant challenges as a result of the global economic slowdown in 2009, many of which will play out in 2010 and beyond. With demand growth uncertain, credit constrained and balance sheets stretched, there was a tendency for companies to prioritize short-term consolidation over longer term investment needs. In other words, the overall shortage of capital and decisions to pay off debt resulted in the postponement of major infrastructure outlays. It also meant a reluctance to exploit reserves that were economically non-viable at current oil prices, and a withdrawal from renewables portfolios with weaker or less reliable economics.

Impact on energy security 2010-2015
Long lead times in the sector mean that decisions made now could have a number of negative consequences across the different dimensions of global energy security. These include:

• Slower expansion of upstream activities and supply side constraints. An increasing percentage of oil concessions will be won by well-capitalized national oil companies. In addition, should there be a swift rebound in demand pressure on existing transportation infrastructure could lead to a tightening gas supply market.
• Sudden leaps in energy prices. Inevitably a high proportion of the likely rises will be passed on to consumers, domestic and business alike.
• The failure of energy infrastructure to meet demand. Investment delays will increase the likelihood of reliability issues with ageing plants, grids and networks in developed countries. Much-needed projects in developing countries, which will bring about greater access to energy resources, will not be initiated.
• Weaker performance in emissions reduction programmes. Delays in upgrading generation assets in developed countries will also result in an inability to achieve CO2 efficiencies. Any slowdown on renewables investments will mean that certain countries/regions will fail to meet ambitious uptake targets and goals for increasing supply diversity.
• Resource nationalization. International access to new energy sources might be restricted.

What governments can do
The energy sector stimulus packages announced in 2009 (see Figure 8 below) are an important contribution to the situation, despite the relatively low levels of funds distributed, only 15% to date, and concern in some quarters that the sums involved are not sufficient to bring about a sustainable and reliable energy future. Given the long-term nature of the industry, companies considering major strategic commitments need an enduring policy framework with appropriate parameters and incentives that can bring some predictability to their planning. This means clear direction at the international level on climate policy and trade issues, and robust long-term strategies from national governments regarding infrastructure renewal to enhance security of supply, reliability and the reduction of carbon emissions.

Figure 7: Key stimulus packages for the energy sector, 2009-2011
Country/region Amount Key foci
South Korea
US$ 66.6 billion
US$ 46.8 billion
US$ 8.0 billion
US$ 7.7 billion
US$ 7.6 billion
US$ 3.7 billion
US$ 3.4 billion
US$ 2.7 billion
US$ 2.4 billion
Clean energy generation
Energy efficiency
Grid development
Source: New Energy Finance (2009)

What energy companies can do
To position themselves competitively for the next few years, energy companies need to address a number of issues in their planning. They should consider how best to adjust the mix of assets, businesses or sources of supply in ways that both reduce exposure to price volatility and political instability, and enhance their capacity to respond to toughening policy requirements. In doing so, they should establish how to optimize their strategic investment capacity on a risk-return basis and ensure that their approach to debt/ leverage reduction does not significantly impair their ability to achieve strategic growth.

Infrastructure and climate change adaptation
Despite declining budget resources, and in addition to the investment needed in the area of energy, governments must urgently take steps to address the unavoidable consequences of climate change. Denser urban development in coastal areas (15 of the world's 20 megacities are coastal), lax planning that allowed property development on natural flood plains or higher dependency on crops in increasingly drought-exposed areas are just some examples of the type of risks that cannot be avoided but where adaptation strategies can be adopted. But which strategies? The Economics of Climate Adaptation (ECA) Working Group7 has created a framework for evaluating the alternatives that governments might consider. The ECA Working Group was formed to explore how countries can become economically more resilient in the face of climate change. By estimating a location's total climate risk - calculated by combining existing climate risks, climate change and the value of future economic development - and using a cost-benefit analysis to create a list of location-specific measures to adapt to the identified risk, the working group was able to evaluate current and potential costs of climate change and how to respond to them. A scenariobased approach was used to manage the level of uncertainty inherent in judging future climate patterns and assessing different conditions in which a community would need to respond.

(7 The Economics of Climate Change Working Group is a partnership between the Global Environmental Facility, McKinsey & Company, SwissRe, the Rockefeller Foundation, ClimateWorks Foundation and the European Commission, and Standard Chartered Bank. www.swissre.com/climatechange)

This approach was applied to eight regions in both developed and developing countries (China, India, Samoa, Guyana, United States, Mali, United Kingdom and Tanzania) representing a wide range of climate hazards, economic implications and development stages. The overall findings, in the ECA report Shaping Climate-Resilient Development, showed that easily identifiable and cost-effective measures - such as improved drainage, sea barriers and improved building regulations, among many others - could reduce potential economic losses from climate change. Indeed, most could deliver economic benefits that far outweigh their costs, as adaptation measures on average cost less than 50% of the economic loss avoided. This confirmed the link between using a risk management approach to adapting to climate change and the broader goal of supporting long-term regional economic development.

Addressing systemic risk in critical infrastructure
As services provided by critical infrastructure become ever more embedded in wider systems, it becomes increasingly important to maintain their integrity and resilience. For example, financial systems and emergency services are highly dependent on telecommunication operations, which are highly reliant on electricity. And, even within a given industry, a critical network is made of multiple interdependent pieces which often rely on the robustness of the weakest link in the network. Companies and governments need to be aware of these interconnections when they build and manage these systems.
Some recent examples and possible scenarios
The large-scale August 2003 power failures in the north-east of the US and in Canada, which deprived more than 50 million North Americans of electricity, was triggered by the failure of a utility in Ohio. A disease originating in one region of the globe can readily spread to other areas through transportation networks, as was the case with the rapid spread of SARS in 2003 or with swine flu in 2009. The meltdown of a nuclear reactor in one country can lead to massive radioactive contamination hundreds of miles away, as illustrated by the Chernobyl nuclear plant disaster in 1986. Looking ahead, a major terrorist attack that closed a port such as Rotterdam, Hong Kong or Los Angeles for weeks would have severe economic consequences on world trade because it would inflict major disruptions in complex just-in-time supply chains that comprise the global economy.
Private efficiency, public vulnerability
These examples illustrate the existence of important interdependencies between people and organizations, hundreds if not thousands of miles apart, through the malfunctioning of technical infrastructure that we use and depend upon today. If the organization is a firm, there is a need to balance the additional private costs to operate more safely that might negatively affect the firm's bottom line with the benefits of reduced global risks; that is the trade-off between private efficiency and public vulnerability. The reluctance of private firms to undertake these measures unless they know others have followed suit is a source of market failure.
Looking for solutions
A challenge for policy-makers and business leaders is to provide the right regulations or incentives to invest adequately in security.
• Third party inspections and well-enforced regulations might be necessary to ensure that infrastructure is well designed and maintained over time. In countries where the large majority of infrastructure is operated by the private sector, regulations might be inspired by industry best practices since most of the knowledge and resources will be found there.
• Building global coordination and reaction capacity. Since these risks arise within interdependent networks, effective solutions usually demand looking beyond an individual firm to its operating units. These solutions might involve well-enforced regulations or coordinating efforts across divisions in a firm, across a supply chain, across operators of a given type of infrastructure, and across countries in the form of treaties or global compacts. Sometimes top decision-makers in the public and private sectors can join forces to decrease collective risk: this was done successfully under the leadership of research institutions serving as a neutral party in the aftermath of the anthrax crisis in 2001 through the development of a global reaction capacity platform between postal operators of over 20 countries. The same framework could now be applied to many other critical services.
• Thinking long-term return on investment. A major challenge with security of critical services is the tendency to be myopic and to seek short-term reward. Energy companies are now considering proposals to encourage consumers and businesses to invest in more efficient energy efficient measures by incurring the upfront costs, which will be paid back over time by the user of the appliance through the savings they achieve in lower electricity bills. The market for building brand new infrastructure and replacing ageing ones is huge in Asia, Africa, Europe and the Americas. Investment decisions made today will thus have a determinant impact for years to come. There is an opportunity here to make critical infrastructure not only more secure, but also greener.