Why infrastructure talk needs to be converted into action

A labourer builds components of wind turbines at a wind power equipment factory in Zouping, Shandong province May 18, 2011. With profitable wind and hydropower businesses included, overall power generation losses narrowed to 6 billion yuan, Xue Jing, director of the statistics and information department under the China Electricity Council, said on the sidelines of a conference in Beijing on Tuesday. Picture taken May 18, 2011. REUTERS/China Daily (CHINA - Tags: ENVIRONMENT ENERGY BUSINESS IMAGES OF THE DAY) CHINA OUT. NO COMMERCIAL OR EDITORIAL SALES IN CHINA - RTR2MLSD

A labourer builds components of wind turbine. Image: REUTERS/China Daily

Dominic Barton
Global Managing Director, McKinsey
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Every day, millions of people across the developed and developing world inch through gridlock or squeeze into packed subway cars to get to and from work. And that is likely to be only one of many frequent – if not daily – confrontations with infrastructure systems that are bursting at the seams. In advanced and emerging economies alike, roads and bridges need repair, water systems are aging or inadequate, and power grids are overburdened, leading to blackouts.

Too many countries have been under-investing in infrastructure for decades, resulting in everyday inconveniences and, worse, creating roadblocks to economic growth. While a major infusion of funding is needed to address infrastructure gaps, finding the money is only part of the solution. Governments also need to reform infrastructure planning and oversight. The public can no longer afford to accept projects with costs that spiral out of control.

Infrastructure projects’ unique ability to create jobs in the short term and boost productivity in the long term is well known to policymakers. Yet talk has rarely translated into action, despite the record-low interest rates of the past eight years.

The world needs to increase investment in transportation, power, water, and telecom systems from $2.5 trillion a year to $3.3 trillion every year through 2030 just to support projected economic growth, according to new estimates from the McKinsey Global Institute. But despite the obvious need for action, infrastructure investment has actually declined in 11 of the G20 economies since the 2008 global financial crisis.

 To keep pace with projected growth, the world needs to invest $3.3 trillion in economic infastructure annually through 2030.
Image: McKinsey & Company

The conventional wisdom is that fiscal concerns make it impossible to marshal enough public funding. In fact, there is substantial scope to increase public infrastructure investment, particularly while borrowing costs remain historically low. In some cases, funding can be found without raising taxes: governments can create revenue streams by instituting user charges, capturing increases in property value, or selling existing assets and recycling the proceeds. Public accounting standards also could allow infrastructure assets to be depreciated over their life cycle, rather than immediately adding their costs to fiscal deficits during construction.

Governments can also do much more to encourage private investment, starting by providing regulatory certainty and the ability to charge prices that produce an acceptable risk-adjusted return. Even more broadly, they can take steps to create a market that more efficiently connects institutional investors seeking stable, long-term returns and projects that need financing.

Given that these investors have some $120 trillion in assets under management, the bottleneck is not a shortage of capital, but rather a dearth of well-prepared, bankable projects. One way to clear it would be to develop the regulatory and institutional groundwork needed to enable funding to flow more smoothly from institutional investors in advanced economies to projects in the emerging world, where huge populations still need access to essential infrastructure services.

Beyond financing, making the infrastructure sector more efficient represents an even bigger opportunity. Delays stretching into years, and cost overruns soaring into the billions of dollars, are a sadly familiar story in public works. And when bridges turn into boondoggles, the public grows more reluctant to invest.

Every dollar allocated to infrastructure needs to stretch much further. Part of that effort involves demanding better performance from the construction industry, where productivity growth has been flat for decades. There are some positive signs of innovation, from accelerated bridge building to pre-fabrication and modular construction techniques. But the sector as a whole needs a major push in terms of modernization, technology adoption, and standardization.

Governments must also transform the institutions and processes under their direct control. Our work with governments around the world has demonstrated that stronger governance and oversight of infrastructure projects can lower infrastructure costs by as much as 40%.

This starts with taking a systematic and data-driven approach to choosing the right projects. Top-performing countries such as Singapore and South Korea do not consider projects in isolation; they consider how each supports their policy objectives, and they weigh it against other projects that might yield better returns.

As projects move down the pipeline toward realization, it is critical to tighten management of the delivery and execution stages. Accelerating environmental reviews, approval processes, and land acquisition can minimize the costs and delays that mount before ground is ever broken. Meeting best practices could unlock huge value: as it stands, the price tags for similar projects can vary by 50-100% from country to country.

“Kicking the can down the road” is not a viable strategy for dealing with the world’s infrastructure needs. It’s up to us to avoid leaving a legacy of deferred costs and deteriorating fundamentals for the next generation. The money is available. Let’s put it to use.

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