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Redefining infrastructure to boost growth

After several months of disappointing economic indicators, China’s State Council has unveiled a mini stimulus package, focused on social-housing construction and railway expansion.

While consumption-driven growth remains a long-term goal for China, infrastructure will continue — at least in the short term — to serve as a key driver of China’s economy. PHOTO: BLOOMBERG

While consumption-driven growth remains a long-term goal for China, infrastructure will continue — at least in the short term — to serve as a key driver of China’s economy. PHOTO: BLOOMBERG

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After several months of disappointing economic indicators, China’s State Council has unveiled a mini stimulus package, focused on social-housing construction and railway expansion.

The decision came a month after Premier Li Keqiang’s declaration that China had set its annual growth target at around 7.5 per cent — the same as last year’s goal.

The implication is clear: While consumption-driven growth remains a long-term goal for China, infrastructure will continue — at least in the short term — to serve as a key driver of China’s economy.

Of course, China is not the only economy that depends on infrastructure investment to buttress economic growth. The World Bank estimates that infrastructure investments accounted for nearly half of the acceleration in Sub-Saharan Africa’s economic growth from 2001 to 2005.

The bank said a 10 per cent increase in infrastructure investment is associated with gross domestic product growth of 1 per cent. Such investment also creates jobs, both in the short term, by creating demand for materials and labour, and in the long term, for related services.

For example, every US$100 million (S$125 million) invested in rural road maintenance translates into an estimated 25,000 to 50,000 job opportunities.

But these benefits are diluted in China, owing to its excessive reliance on public funding. Indeed, in recent years, less than 0.03 per cent of Chinese infrastructure investment — which amounted to roughly 9 per cent of GDP — was derived from private capital.

FINANCING INFRASTRUCTURE INVESTMENT

This problem is not limited to China; of the 7.2 per cent of GDP that Asian countries spend, on average, on infrastructure development, only about 0.2 per cent is privately funded. By contrast, in Latin America and the Caribbean, private capital finances, respectively, 1.9 per cent and 1.6 per cent of infrastructure investment.

Discussions within the Group of Twenty have produced two possible explanations for Asian countries’ inability to attract more private capital to infrastructure projects.

Most developing countries argue that the problem is rooted in the provision of capital, with investors preferring to fill their infrastructure portfolios with low-risk projects, and insurance companies and banks facing overly restrictive regulations. Organisation for Economic Co-operation and Development countries such as Germany counter that the problem is the lack of investment-worthy assets; there are simply not enough bankable projects available.

In fact, both explanations are correct — but neither is complete. It is time for Asia’s leaders to recognise that the lack of private funding for infrastructure projects cannot be reduced to one or even two problems, and to develop comprehensive solutions that account for the full scope of the challenge.

NEW ASSET CLASS

This requires, first and foremost, abandoning the view that infrastructure assets fit into the paradigm of traditional asset classes such as equity, debt or real estate. Infrastructure must be redefined as a new asset class, based on several considerations.

For starters, there is the public-good element of many infrastructure projects, which demands contingent government obligations such as universal coverage levels for basic services. In order to make such projects more appealing to private investors, economic externalities should be internalised and a link should be established between the internal rate of return, which matters to a commercial investor, and the economic rate of return, which matters to society.

Moreover, innovative mechanisms to supply new assets to investors would be needed — and that requires the creativity found and priced by markets. To this end, private-sector sponsors must be given space to initiate valuable projects.

The new asset class would need its own standardised risk/return profile, accounting, for example, for the political risks that public-sector involvement may imply and for the lower returns from infrastructure relative to traditional private equity.

Moreover, the risks associated with the new asset class would change as projects progress from feasibility study to construction to operation, implying that each phase would attract different sources of funding. A clear understanding of this process would enable potential investors to assess projects more effectively, which is critical to encouraging them to put up financing.

Another important consideration is the considerable technical expertise that infrastructure investments demand, which makes them more complex than most assets. Similarly, a specialised network of actors would be needed to ensure that intermediation of infrastructure transactions is efficient and cost-effective, instead of fragmented and slow, as it is now.

For countries that lack China’s strong fiscal position, the need to attract private capital to infrastructure investment is obvious. With nearly 70 per cent of Sub-Saharan Africa’s population lacking access to electricity and 65 per cent of South Asians lacking access to basic sanitation, there is no greater imperative than to plan, fund, build and maintain infrastructure assets.

But private investment in infrastructure remains vital even in countries such as China, because it brings the power and dynamism of the market, which improves the allocation of capital and promotes transparency. Indeed, more private-sector involvement would make the kind of scandals that have occurred in China’s railway sector far less likely.

In short, redefining infrastructure as a new asset class is the only credible way to attract funding for infrastructure construction, and thus to boost long-term economic growth and the employment rate. It is time for Asia’s leaders to step up. PROJECT SYNDICATE

ABOUT THE AUTHORS:

Justin Yifu Lin, a former chief economist and senior vice president at the World Bank, is Professor and Honorary Dean of the National School of Development, Peking University, and the founding director of the China Center for Economic Research. Kevin Lu is a distinguished fellow at INSEAD Global Private Equity Initiative and a managing director at Partners Group, a global private equity firm.

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