Article / 24 February 2017 at 16:00 GMT

Is infrastructure spending an enabler or boondoggle?

Managing Partner / Spotlight Group
United Kingdom
  • Infrastructure spending is needed across the developed world
  • The market only appears to have responded as Trump’s message grew louder
  • The way ahead cannot be based on more wasteful state spending
  • Private debt or equity financing is more accountable and effective
California highway interchange
 US president Donald Trump has raised the prospect of a big wave of 
spending on infrastructure. Photo: Shutterstock

By Stephen Pope

What are the major impairments to economic growth in the developed and developing world?

I would identify five key areas:

1. Labour force size
2. Labour productivity
3. Labour value added
4. Financial flow
5. Viable infrastructure

One could suggest that the birth rate or net migration are critical factors, but they are subsets of the labour force size just as education is a subset of both productivity and value added.

It has been argued that a wave of regulation since the 2008/9 financial crisis has stifled the willingness of banks to lend capital to all but the very best of borrowers. But large companies' habit of abusing smaller subcontractors by not paying their bills on time is, I would argue, a more pressing problem.

Infrastructure ignition

There has long been a body of opinion that says improving the infrastructure to support the efficient transport of people, goods, information, communication, entertainment, energy and water is critical to the growth rate and standard of living of any nation.

A reason to put off such spending has been — as well-intentioned as it may be — that prevailing levels of national debt relative to GDP across the world are too high and that such spending is often riddled with inefficiency.

Surely there is a better way to make much-needed infrastructure expenditure work by holding those who win contracts or authorise the release of funds more accountable.

So the key question to ask when a key project carries a high price is: What value will we derive from this spending and over how many years?

The world has sat up and taken notice of US president Donald Trump's call for more infrastructure spending.

Below we look at key sectors in the Standard & Poor’s 500 Index for a one-year and three-month period out to four-weeks after Trump's November 8, 2016 victory. The chart shows that the energy and materials sectors were among the best performers as both are in the “leading and gaining” quadrant.
SP returns Source: Deutsche Bank, Thomson Reuters, US Global Investors

Similar results are found in the small-cap Russell 2000 Index where materials and processing was the best performer for the one-year period, while energy led over the past three months.
It may be argued that the energy sector got a boost from Opec’s announcement at the end of 2016 that it would seek to scale back production for the first time since 2008, leading to a strong rally in crude oil. But energy and materials also appear to have been boosted by hopes that then president-elect Trump would deliver on his commitment to infrastructure repair and renewal.

Whether Trump succeeds in convincing Congress will depend on how he intends to finance such a scheme. Its scale would also be crucial in colouring the thinking of the US Federal Reserve as to the next timing of a tweak in the Fed funds rate.

With the Republicans controlling the House and Senate, Trump will hope that he will have an easier ride than his predecessor. Even though most of the $1 trillion that Trump thinks needs to be spent will allegedly come from private investment, fiscal conservatives who blocked Obama’s 2009 smaller stimulus package, of just $800 billion, might question the wisdom of Trump’s request. 

So he needs to be smart and ensure he has identified shovel-ready projects in the areas of greatest need in Republican-held marginal areas to create jobs and hence voter approval ahead of the 2018 mid-term elections.

Eye-watering debt levels

Just stop for a moment and consider the level of debt to GDP plus the two- and 10-year government yields in key areas of the developed world: 
Source: National agencies and treasuries

Given that the cost of capital is so low, isn't this really the greatest ever opportunity to rebuild instead of just renovating everything? Or with debt levels so high, can more borrowing really be justified at the current time?

A report from the World Economic Forum estimates that every dollar spent on a capital project in utilities, energy, transport, waste management, flood defence or telecommunications generates an economic return between 5% and 25%. This provides a strong argument for an additional $70 trillion to be spent on global infrastructure by 2030.

I do not doubt for a moment that there are many cases to be made for improving roads, rail links, air and sea ports as well as protections against rapid changes in the climate. I accept that such expenditure will eventually deliver a positive multiplier effect.

But across the world one can find countless examples of contracts being awarded to family members or friends. Deals being dished out in return for kickbacks. Apart from the scourge of corruption or graft, what about the waste that occurs in project administration? 

In the UK in 2011, an abandoned NHS patient record system cost the taxpayer nearly £10 billion with a final bill for what would have been the world's largest civilian computer system seen as running into several hundreds of millions of pounds.

UK members of parliament on the public accounts committee said final costs were expected to increase beyond the existing £9.8 billion because new regional IT systems for the NHS, introduced to replace the National Programme for IT, were poorly managed and riven with their own contractual wrangles.

One might expect that the Germans would be fiscally responsible. Well, what can one say about a saltwater fish farm 600 kilometres from the sea or seven bridges over a 1.5 km long river?These are controversial German local government projects, costing millions to the taxpayers.

Last year, France's top auditors, the Cour des Comptes, said there are numerous ways France can save money. They noted France wasn't adjusting to the decreasing dependence on posted mail. Postal workers could be regarded as underoccupied as a result, and they're allowed to clock off when they've finished their rounds. This means it is impossible to know how much potential working time is lost.

The US has its own examples of wasteful state spending.

A proposed $223 million Alaskan overpass known as the “Bridge to Nowhere” to serve barely more than 50 people on Gravina Island became a symbol of the foolish legislative procedure, and was later scrapped.

The Obama administration in 2014 requested just over $90 million in funding for the restoration and upkeep of buildings in Washington, DC. Work has been done, with the most visible action on the rotunda of the capitol, but an additional appropriation in 2016 raised the fund total to 93.8% above what was required. Why is this money just sitting idle?

Washington DC in winter
 Trump will need to secure Congressional support 
for his infrastructure plans. Photo: iStock

Need for better infrastructure

The pressing need to invest in infrastructure is apparent, and in developed countries there is an urgent demand for renewal of existing infrastructure, much of which was built more than 50 years ago, if not longer.

I want to see better infrastructure in my own country and across the world. But I am not willing to accept the left-leaning mantra of more state spending because the central government knows best. As government debt burdens in the advanced world have risen above acceptable levels, we must increasingly look to private investors to help fund infrastructure projects.

This can be done through debt or equity funds that sit at the crossroads of fundamental economic drivers, moderate political will, growth in aggregate demand, and diverse, local, regional and national issues.

The future is most encouraging if we have the sense to shift away from reliance on government financing to more private funding. The government and the market can hold such projects to account, thereby widening infrastructure investment opportunity in a sensible long-term, fiscally responsible, strong-growth strategy.

Road through US Southwest
 Time for an upgrade? Road through the scenic US Southwest. 
Photo: Shutterstock

— Edited by John Acher

Stephen Pope is managing partner at Spotlight Ideas


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