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The Infrastructure Finance Challenge

Ingo Walter

1. Infrastructure, Performance and Economic Growth

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1To begin, we explore how infrastructure investments are, or should be, defined in a way that makes sense in the context of the world’s complex and dynamic capital markets. They must be clearly-defined and operationally viable in order to be financeable in the real world of performance-driven asset portfolios.

  • 1 For example, the recent agreement by world leaders on transitioning to a low-carbon economy, toget (...)

2Legal issues are always an important consideration in infrastructure finance, including ownership and governance of projects, questions of eminent domain, and regulation of infrastructure projects in private (or joint public/private) control. Labor relations, health and safety, and other social concerns are also critical. So are environmental impacts and sustainable development.1 Here the public-goods characteristics of infrastructure often complicate the assessment of their benefits and costs in the real world of political economy. This raises the need for market discipline in the execution of infrastructure projects.

3It is impossible to escape the drumbeat of commentary by media pundits, business experts, and government officials about the world’s enormous infrastructure “needs” in the years ahead.

4In the US, for example, the American Society of Civil Engineers (ASCE) in 2015 awarded the country a minimally passing grade of D+ for its “crumbling” infrastructure. Attempting to estimate the opportunity cost of the most glaring deficiencies in terms of lost income, output, and growth, the ASCE identified some $3.6 trillion of unfunded infrastructure investment needed to remediate them. Other countries are said to be in better or worse shape than the US. Combined with the infrastructure needs of the developing world, such estimates highlight the enormous potential for infrastructure development — and the accompanying financial challenges.

  • 2 [n.a.], “Building Works”. The Economist. 29 August, 2015.

5The consulting firm McKinsey & Co. has estimated that the world will need to spend an aggregate $57 trillion (at 2010 prices) between 2013 and 2030 to keep up with infrastructure needs, or roughly $3.2 trillion per year in real terms. This estimate suggests a GDP spending shortfall of 1% for the OECD countries from 2007 through 2012 (from 3.5% to 2.5%) resulting from infrastructure under-spending, further retarding already sluggish economic growth around the world.2

6More positively, OECD estimates suggest that annual worldwide spending on infrastructure will remain robust, averaging $1.8 trillion to $1.9 trillion annually through 2030, an increase from an average of $1.6 trillion per year from 2000 through 2010.

7The Brookings Institution issued a report assessing the global infrastructure investment need between 2015 and 2030 at around $90 trillion, or $5 trillion to $6 trillion per year [Brookings, 2015]. The reality of fiscal constraints — in Europe, the US, and many other countries — could translate into a materially larger private-sector role in overall infrastructure finance.

8Some observers have highlighted the missed opportunity for infrastructure spending during a time of low growth, low construction costs, low inflation, and historically low interest rates in many countries. Others point to indecisiveness and inordinate delay (sometimes far exceeding the duration of World War II) of projects designed to plug fairly ordinary but nevertheless significant infrastructure gaps.

9Whatever the numbers, people seem to broadly agree that infrastructure is a key dimension of economic and social development worldwide. They also concur that its impact reaches deep into the global economy, with important and complex implications for economic and social progress. As well, there is consensus that infrastructure dynamics can be difficult to gauge, with external costs and benefits sometimes differing materially from the internal costs and benefits.

10Countries have a broad range of growth experiences. Some grow very slowly or not at all. Others experience growth spurts and then either slow down or experience a crisis and subsequently regress. A few developing countries have experienced sustained periods (25 years or more) of high growth, 6% or 7% annually on average, sometimes more.

11Poor or inconsistent economic performance has many causes. Among them are flawed governance and faulty choices of growth model — that is, models that either do not work or have some “self-limiting” characteristics in terms of duration. Interestingly, the successful cases have common features. They are predominantly open-economy models. For developing economies, such interaction with the global economy offers two advantages.

12One is access to advanced-country technology and know-how, which can accelerate a shift in potential productivity when imported and adapted. An economy’s knowledge and technology base, embedded in its people and institutions, primarily determines that economy’s productivity. The principal means of enabling long-term growth comes from augmenting that base through investment and innovation.

13Second, the global economy provides a large market for tradable goods and services. The global market’s size permits specialization in a way that a domestic economy, particularly a developing one, does not because of its relatively lower incomes and limited demand. Specialization via comparative advantage allows rapid economic expansion even with limited human and physical capital.

14What do successful developing countries do, or need to do, to take advantage of this accelerated growth potential? The short answer is that they need to invest in infrastructure to deepen their economy’s capital. Based on the known cases of sustained high growth, overall investment rates of 25% to 30% of GDP are required to sustain GDP growth above 6% to 7%.

15Investment in all cases is a mix of public- and private-sector capital formation. The data on public-sector capex are surprisingly weak and inconsistent, especially in light of its central role in sustaining growth and competitiveness. Based on experience in an array of countries, public investment specifically in infrastructure projects in the range of 5% to 7% of GDP seems necessary. Private-sector investment would then need to be about 20% to 25% of GDP for overall investment to reach a 6–7% sustainable growth range. Most developing countries and many advanced countries fall short of this target.

16For developing countries specifically, the shortfall reflects several factors. Investment rates at these levels, to the extent they are financed domestically, are “expensive” in terms of forgone short-term consumption. In relatively poor countries, this tradeoff often tips in favor of present consumption at the expense of investment that would allow higher levels of future consumption. For understandable reasons, developing countries have a very high social discount rate that, in the reality of political economy, can overshadow the requisites of investment-generated growth.

17In particular, private-sector domestic and cross-border investment can fall short for several reasons. It requires a secure investment environment, which means that property rights are reasonably respected and that factors affecting return on investment (e.g., taxation and regulation) are predictable and not subject to arbitrary change. This is a matter of commitment, confidence, and establishing a track record. Without a relatively secure investment environment, extraneous risk undermines investment and/or redirects it to more attractive venues in the global economy.

18The tradable part of the world economy is very competitive, a fact that was underappreciated for many years. China’s rise as a manufacturing source, with its very large scale and absorptive capacity, made policymakers much more aware of growth policy’s competitive dynamics.

19As noted, the core of attracting both domestic and international private capital lies with investment in complementary public tangible and intangible assets, primarily human capital and infrastructure. Augmenting these assets increases the return to private investment and leverages it on both the tradable and non-tradable sides of a national economy. The tradable side drives growth because of its enhanced capacity to expand rapidly. Rising incomes then generate increased demand on the non-tradable side.

20Public-sector investment reflects how a developing country exploits its comparative advantage. Attractively priced and mobile human capital is key. The next important component comes from infrastructure that delivers power and telecommunications reliably, as well as ports, roads, rail links, and airports that, properly regulated, lower the cost of logistics and raise the return on investment in plant and equipment. In today’s world of climate change and water scarcity, environmental infrastructure also has increasing importance.

21Fifty years ago, this growth model’s elements were not as well understood as they are today. Growth in the developing world was quite limited prior to World War II, so economists had very few examples for modeling the growth process. Because it is easily replicated, useful knowledge has a powerful capacity to spread growth making knowledge the basis of “catch-up” growth. But that fact was not well appreciated at the time. The complementarity of public and private investment was likewise underappreciated. People thought that a country could make the tradable part of the economy grow by excluding external competition (the import-substitution model) rather than by taking direct steps to drive up productivity.

22Based on historical experience in developing countries, the role of investment (private and complementary public) is now reasonably well understood. And yet, patterns of underinvestment persist, particularly in infrastructure. High-investment cases are the exception rather than the rule. The question is, why?

23To begin answering this question, we focus on how needed investment, particularly public-sector investment, is financed and by whom. In the exceptional cases of sustained high growth cited earlier, public-sector investment has been financed largely domestically. In contrast, numerous cases of substantial external financing of public investment (or external financing of the government in general) did not result in sustained high growth. Indeed, they often ended badly in economic slowdowns, crises, and defaults. So the history of using the global economy’s capacity to invest in order to overcome the challenge of generating sufficient funding from domestic sources — including the government’s capital budget — suggests that there are serious obstacles to doing so. In a nutshell, public-sector investment is the crucial ingredient in all known recipes for a country to achieve sustained patterns of inclusive growth. For the most part, however, external funding has not so far succeeded in this arena.

24As noted earlier, domestic infrastructure funding requires a tradeoff between present and future consumption — a tradeoff that most lower-income countries have trouble making. Yet large pools of investable funds are eager to underwrite infrastructure if the risk and return parameters are suitable. And the social benefits, to the extent that they exceed the private returns to investors, are viewed as a plus by many institutional investors.

25The propensity to underinvest in infrastructure is not confined to developing countries, where arguably the affordability and time-value of consumption issues are more dramatic. Why is that?

26First, the importance to long-term growth of public investment in general, and infrastructure in particular, is not well understood.

27Second, as with all issues involving tradeoffs of present consumption for future benefits and growth, the question of “who pays” invariably comes up. It is often referred to as the “burden-sharing” issue. In many economies, an inability to resolve this issue in what is generally agreed as a “fair” way causes inaction even when the problem is well diagnosed. “Fairness”, after all, tends to be subjective.

28Third, deficiencies in infrastructure investment produce no immediate negative effects, other than distorting the composition of aggregate demand. It takes a while before a bridge collapses, for instance. Deferred maintenance is a ubiquitous problem and not confined to the public sector. More generally, under financial pressure or with competing claims, all economic sectors defer expenditures that lack immediate negative consequences — including businesses, households, governments, and non-profits.

29Fourth, there are good arguments for financing the investment component of public-sector expenditure with debt. Essentially, using debt rather than current tax revenues produces less tax distortion in resource allocation over the life of the assets and their social/economic benefits. In the present context, however, real and perceived constraints on public debt levels and ratios lead to underinvestment.

30Finally, in this distinctly “second-best” set of conditions (unusually constrained at present), are there new funding models in which private, quasi-private, and external pools of capital can help fund investment in infrastructure? If so, what are they, and in what areas of infrastructure do they apply? Moreover, what obstacles must be removed to make them part of the solution? These questions provide our focus for this study.

31A final word of caution: Underinvestment on the public-sector side of infrastructure development creates an important growth constraint. But it is not the only one. The absence of structural flexibility and mobility of resources is another, and major failures of inclusiveness in the labor force are a key factor. In addition, the return on public-sector investment in terms of elevated growth and future incomes depends on the presence or absence of complementary conditions and, if necessary, meaningful reforms.


1 For example, the recent agreement by world leaders on transitioning to a low-carbon economy, together with the consensus on the UN Sustainable Development Goals (several of which relate directly to infrastructure needs), focuses attention on building green infrastructure and reducing the environmental footprint of existing infrastructure. In addition, infrastructure will need to be made climate resilient — that is, able to adapt to changing weather patterns.

2 [n.a.], “Building Works”. The Economist. 29 August, 2015.


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