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Partnerships Help Bridge the Infrastructure Gap

May 24, 2013

The difference between demand and investment in infrastructure around the world is $1 trillion to $1.5 trillion annually, according to analysis by The Boston Consulting Group. This infrastructure gap has implications for the standard of living in many nations, as well as for global economic growth. Public-private partnerships (PPPs) will play a key role in bridging the gap. But while PPPs have great potential, they also pose great challenges for governments and private-sector companies alike.

Philipp Gerbert, a senior partner and managing director in BCG’s Munich office, recently shared his thoughts about the current state of global infrastructure investment, the potential of PPPs to drive infrastructure improvements, and the steps that government and private-sector leaders must take to make those partnerships successful.

BCG analysis has found a significant gap between what is being spent on infrastructure investment and what is needed. What accounts for this shortfall?

There are both supply- and demand-side drivers behind this shortfall, and each is a powerful force. However, the challenge varies significantly depending on the country context. In developed countries, where most infrastructure investments have occurred in the post–World War II era, many assets are approaching the end of their useful lives and need replacement. At the same time, government budgets—and, consequently, infrastructure supply—are increasingly constrained as a result of the global financial crisis.

In contrast, tremendous demand for infrastructure in emerging and developing countries is caused by growing populations, rapidly progressing urbanization, industrialization, and increasing integration into global supply chains. In addition to limited public budgets, supply there is often constrained by the public sector’s lack of expertise in planning and preparing bankable projects. Insufficient project preparation on the government side, in turn, leads to wariness on the part of the private sector. That caution stems from concern over risks posed by issues such as immature regulatory frameworks, politicized decision making, and difficulties with land acquisition.

What are the repercussions of a gap in infrastructure investment?

On the one hand, there are immediate, highly visible effects, such as congestion at ports, airports, and roads, as well as power shortages, which are a chronic feature of daily life in developing countries, including India, Brazil, and most parts of Africa. These events can have severe implications on the functioning of a country’s overall economy. In Africa, for example, some 40% of the food produced perishes on the way to market. And in Russia, the percentage of a product’s overall price that is attributable to transportation costs is twice as high as it is in other countries.

These infrastructure deficits also have both tremendous long-term implications for economic growth—because the affected countries are less competitive in attracting investment and conducting business is more difficult—and strong social and environmental ramifications. For example, more robust infrastructure can improve education, health, and social equity.

How can public-private partnerships help address this challenge?

PPPs address the infrastructure investment gap in three ways. First, PPPs can help to screen out the least needed projects because both the public sector and the private sector are forced to conduct early and thorough due diligence. In addition, PPPs bundle various life-cycle aspects of a project, including design, construction, operations, and maintenance, into one contract. As a result, the contractor weighs the trade-offs of various decisions across the entire life cycle of a project. This, in turn, leads to a more efficient project overall and saves scarce public funds. Finally, PPPs also mobilize new sources of private finance, for example from long-term institutional investors, such as pension funds and insurance companies. Channeling those financial resources into infrastructure can accelerate projects that have stalled in the pipeline due to insufficient or slow public-sector financing. In the end this means that the public reaps the economic and social benefits of those projects earlier than they otherwise would have.

Of course, there are many valid alternatives to PPPs. Equally important to closing the gap are other government policies, such as those that improve project prioritization, enhance the efficiency of asset delivery through traditional government procurement, and make existing assets more productive. But for many countries, PPPs are a viable solution, and—if done right—they can significantly contribute to this effort.

What are the common elements that governments have embraced across successful PPP markets?

First of all, successful countries have built long-term and continuous pipelines of projects to attract companies to the market and signal government commitment to the PPP program. Ideally, such project portfolios should be derived from comprehensive infrastructure plans, and each project should be selected according to the results of a rigorous value-for-money analysis that confirms that a PPP is a better deal for taxpayers than traditional government procurement.

Another success factor is a certain degree of standardization in the project preparation and procurement process. The aim is to reduce transaction costs and make transactions more predictable for the private sector. This may include various components, such as establishing a clear approval process, a standardized process for land acquisition, institutionalized funding mechanisms to cover the cost of project preparation, and model documents for the tendering process.

Successful countries also have taken a methodical and staged approach to their PPP programs, starting with bankable, less controversial projects in one sector and then gradually expanding the scope and the transaction complexity.

This helps to nurture the various components that make a successful PPP effort possible—what we call the enabling environment. Though this is a long-term process, it should be a key priority. So the public sector needs to build a robust legal and institutional framework, with an independent regulatory function and a trusted dispute-resolution process. Governments must also ensure that they have the necessary skills and talent to manage PPPs, in some cases by establishing PPP units. They should take steps to make PPPs an attractive proposition for the private sector as well, for example by creating innovative risk-guarantee schemes to channel the funds of long-term investors, such as pension funds and insurance funds, into infrastructure assets. Last but not least, policies to increase transparency around the PPP program and to avoid corrupt practices are essential to get broad buy-in from the private sector and the general public.

For the private sector, how do the challenges of a PPP differ from the typical challenges of public-infrastructure contracts?

Indeed, PPPs are challenging for both the public sector and the private sector. In a PPP, a company engages in a partnership with a government for multiple decades, with numerous unknowns. In addition to the risks associated with traditional infrastructure contracts, such as the possibility of major cost overruns or construction delays, companies in some countries are exposed to potential financial hits if demand for the asset does not match forecasts. There are significant political and regulatory risks as well. After all, companies may sign the original contract with one government and, after the passage of an election cycle, find themselves dealing with a very different group of government leaders several years later. As a result, the ability to assess future scenarios and work with regulators is paramount. And companies need to be prepared for a more public role, where they may find themselves center stage in a debate over the quality of the service they are delivering.

Private companies also need to build a broad set of skills in-house. They may need to orchestrate a consortium that delivers everything from design to operations. And given the critical importance of risk management and financing, construction companies often have to excel in skills that are usually more closely associated with asset managers and banks.

Partnerships Help Bridge the Infrastructure Gap