Addressing europe’s infrastructure gaps

Addressing Europe’s infrastructure gaps: Fiscal constraints and planning capacity matter

Philipp-Bastian Brutscher, Andreas Kappeler 18 April 2018

Adequate infrastructure is vital for growth. Because the financial meltdown, however, public sector infrastructure investment in the EU has been scaled back. This column uses data from a recently available survey to explore the sources of Europe’s infrastructure gaps. The results claim that more coordination and planning are necessary for infrastructure projects, both at the EU and national levels. Efforts to attract private investors also have to continue.

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The necessity to invest more in Europe’s infrastructure has been heavily discussed in the context of the EU’s post 2020 Multiannual Financial Framework. And rightly so – the longer-term economic performance of the EU and the global economy critically depends upon the option of adequate and state-of-the-art infrastructure (EU 2018). A big body of literature has underscored the need for infrastructure for productivity growth (Berg et al. 2012, Calderon and Serven 2014) and to make economic growth more inclusive and sustainable (Woetzel et al. 2016, UN 2016).

Investment in infrastructure in the EU is today at 1.8% of GDP, based on the EIB Investment Report 2018. That is 20% below pre-crisis levels, although fall in infrastructure investment recently appears to have levelled off. The decline was most-pronounced in the transport sector (EIB 2017).

Figure 1 Infrastructure investment by sector and source, 2005−2016

Sources: EIB estimates predicated on Eurostat, Projectware, EPEC.
Note: Predicated on EIB Infrastructure Database. Data are missing for Belgium, Croatia, Lithuania, Poland, Romania, and the united kingdom. 2016 figures are preliminary. PPP: public-private partnership.

Whether this decline in infrastructure investment is desirable or rather reflects a worrisome gap reaches the core of a heated debate. Infrastructure investment gaps are usually thought as the difference between infrastructure investment needs, or just how much countries should be shelling out for infrastructure and actual infrastructure investment. Some argue that the decline in infrastructure investment reflects a wholesome saturation effect – key transport, communication, and social infrastructures already are set up in the EU. However, this perspective risks overlooking the necessity to replace old infrastructure, complete long overdue connections, and react to technological advances.

Several papers have attemptedto estimate infrastructure investment needs and identify substantial gaps. For the world all together, estimated infrastructure investment needs range between 3.9% to 9.7% of GDP annually (OECD 2017, Bhattacharya et al. 2016, Woetzel et al. 2016, GCEC 2014). Annual infrastructure investment needs in Europe are estimated at 4.7% of GDP for energy, transport, water and sanitation, and telecoms (EIB 2016). The underlying methodologies vary substantially and frequently depend on assumptions about potential GDP growth and elasticities of infrastructure spending to growth (OECD 2017a).

Municipalities in Europe report substantial infrastructure gaps

To donate to the discussion on infrastructure investment needs in Europe and put in a new perspective, the EIB conducted a representative survey of 555 municipalities in 2017. An integral motivation to carry out this survey was that municipalities ought to be in a position to assess infrastructure investment needs, gaps, and impediments within their jurisdiction.

Based on the EIB Municipality Survey, 1 / 3 of municipalities reported underinvestment in infrastructure recently (Figure 2). It is necessary to note that identifies infrastructure investment overall and not simply the area of the infrastructure that municipalities are responsible for themselves. Municipalities particularly often perceive infrastructure gaps in urban transport, ICT, and social housing.

Figure 2 Perceived under-provision of infrastructure

Question: For every of the next, would you say that, overall, past investment in your municipality has ensured the proper amount of infrastructure, or resulted in an under provision or higher provision of infrastructure capacity?

Source: EIB Municipality Survey 2017.

Poor infrastructure investment risks undermining convergence and competitiveness

Poor municipalities over-proportionally report infrastructure gaps. This imbalance in infrastructure investment gaps weighs on the convergence process in Europe. Macro-data support this finding by showing that the decline in infrastructure investment is specially pronounced in countries with the cheapest infrastructure quality to begin with (EIB 2017).

Upgrading Europe’s infrastructure can be key to preserving Europe’s competitiveness. Linking the standard of local infrastructure in the regions of transport and ICT to firms’ investment activities, a clear pattern emerges – poor local infrastructure hampers firms’ capability to react to global growth opportunities and match competition (EIB 2017, Revoltella et al. 2016).

Fiscal constraints restrain government investment in infrastructure…

What’s behind the decline in infrastructure investment in Europe? Figure 1 implies that government investment in infrastructure has declined particularly strongly. At the core of the decline is a shift in public areas outlays from gross fixed capital formation towards current expenditure. While in a few countries, governments have recently presented plans to reverse this trend, in others, budgetary outlooks suggest a continuation of the negative development.

Consistent with this finding, when asked about the primary obstacles for infrastructure investment, 70% of municipalities report fiscal constraints (budget and/or debt ceilings, see Figure 3). Among municipalities that report infrastructure gaps, 75% consider fiscal constraints to become a major obstacle. The distance of regulatory processes to approve a project is mentioned by near 50% of municipalities as a significant obstacle.

Figure 3 Obstacles to infrastructure investments reported by municipalities

Question: From what extent is each one of the following an obstacle to the implementation of your infrastructure investment activities? Is a significant obstacle, a obstacle or no obstacle at all? (1) Balance between revenues and operating expenditure; (2) Limit on amount of debt the municipality can borrow; (3) Usage of external finance (excluding funding from other specialists); (4) Technical capacity to plan and implement infrastructure projects; (5) Co-ordination between regional and national policy priorities (including among municipalities); (6) Amount of regulatory process to approve a project; (7) Political and regulatory stability.

Source: EIB Municipality Survey.

… but effective project planning and execution is paramount to reviving infrastructure investment

Loosening fiscal constraints requires, however, mechanisms that make sure that additional investment switches into the projects with the best social, economic, and environmental impact.

The EIB Municipality Survey shows that there might be room for improvement in this respect – initially, municipalities appear to be alert to the complexities connected with a competent allocation of resources. A lot more than 80% of municipalities declare that they have an urban development strategy. However, not absolutely all municipalities take these strategies under consideration in terms of actual infrastructure planning. Of most municipalities with an urban development strategy, only 72% consult this document along the way of planning infrastructure projects.

Examining the importance that municipalities attribute to ex-ante assessments of infrastructure projects reveals an identical picture. Of the roughly 60% of municipalities that perform some form of ex ante assessment, no more than two-thirds consider it a crucial or essential aspect. Consequently, significantly less than 40% of the surveyed municipalities measure the quality of infrastructure projects ahead of implementation and think about this information important in decision-making.

Figure 4 Need for ex ante assessments of infrastructure projects

Question: And how important would you say will be the results of the independent assessment/s when deciding whether to just do it with a project?

Source: EIB Municipality Survey.

Also, with regards to the coordination of infrastructure investment activities with other bodies, there is room for improvement. Only 45% of municipalities say that they coordinate their infrastructure investment activities with the spot in which they can be found; and only 37% coordinate with neighbouring municipalities.

More efforts are therefore had a need to strengthen coordination and the look and implementation of infrastructure projects at the EU, national, and sub-national levels to make sure effective usage of public funds.

Making infrastructure investment more appealing for institutional investors

The mix of substantial infrastructure gaps and fiscal constraints may necessitate a larger involvement of private investors in infrastructure financing.

Infrastructure investments have many characteristics which should appeal to institutional investors. They have an extended duration, facilitate matching of long-term liabilities with cash flows, and offer opportunities for portfolio diversification as a result of low correlation of returns with other assets (OECD 2011). Yet average infrastructure investment by these investors, by means of unlisted equity and debt, makes up about only one 1.1% of total assets under management (OECD 2016).

The limited involvement of private investors can partly be explained by practical issues. For example, low returns have held back corporate sector investment (Grayburn and Haug 2015). Unlike in america, it appears that regulators in Europe didn’t sufficiently take into account the upsurge in equity risk premia, that ought to have pushed up allowed returns. Moreover, pension funds and insurers are dis-incentivised from buying infrastructure by too little data, some solvency and funding regulations, and limited investment and risk management expertise (Della Croce and Yermo 2013, OECD 2017b).

Additionally it is likely a clear planning and prioritisation system of infrastructure projects also matters for potential private investors’ willingness to activate in infrastructure projects through PPPs or corporate infrastructure projects.

Conclusion

Since there is little doubt that more investment in the EU’s infrastructure is necessary, it really is equally important that the look and implementation of infrastructure projects is strengthened at the EU, national, and sub-national levels. Effective usage of public funds needs to be ensured by strong coordination, planning, and implementation procedures. That is also key to attracting private investors. Exactly like taxpayers, private investors desire to be sure the projects they spend money on are sound and well executed.

In 2017, the EIB provided €18 billion to aid infrastructure projects worth €55.5 billion, drawing in public areas along with private investors. The European Public-Private Partnership Expertise Centre and the European Investment Advisory Hub are two initiatives that helped improve the technical capacity of several of the projects and, as well as EIB financing, made them bankable.

References

Berg, A, E F Buffie and A Cashin (2012), “Public investment, growth, and debt sustainability: Piecing together the pieces”, International Monetary Fund, Working Paper WP/12/144.

Bhattacharya, A, J P Meltzer, J Oppenheim, Z Qureshi and N Stern (2016), “Delivering on sustainable infrastructure for better development and better climate”, Brookings Institution, Washington, DC.

Calderon, C and L Serven (2014), “Infrastructure, growth and inequality: A synopsis”, World Bank, Policy research working paper no 7034.

Della Croce, R and J Yermo (2013), “Institutional investors and infrastructure financing”, OECD, Working Papers on Finance, Insurance and Private Pensions no 36.

EIB (2016), Restoring EU Competitiveness, 2016 updated version, European Investment Bank, Luxembourg.

EIB (2017), EIB Investment Report 2017/2018: From recovery to sustainable growth, European Investment Bank, Luxembourg.

EU (2018), “A fresh, modern Multiannual Financial Framework for a EU that delivers efficiently on its priorities post-2020”, COM(2018) 98 final, Brussels.

GCEC (2014), Better growth, better climate, Global Commission on the Economy and Climate, Washington, DC and London.

Grayburn and Haug (2015), “European regulators’ WACC decisions risk undermining investment decisions” in Insight in Economics 41, NERA Economic Consulting.

OECD (2011), “Pension funds investment in infrastructure: A survey”, International Futures Programme Paris, OECD Publishing.

OECD (2016), Annual survey of large pension funds and public pension reserve funds 2015, OECD Publishing.

OECD (2017a), Buying climate, buying growth, OECD Publishing.

OECD (2017b), Breaking silos: Actions to build up infrastructure as a secured asset class and address the info gap – Plans for G20, OECD Publishing.

Revoltella, D, P-B Brutscher, A Tsiotras and C Weiss (2016), “Linking local businesses with global growth opportunities: The role of infrastructure”, Oxford Overview of Economic Policy 32(3,1): 410-430.

UN (2016), “Industry, innovation and infrastructure: Why it matters? US Sustainable Development Goals: 17 Goals to Transform the world”, US.

Woetzel, J, N Garemo, J Mischke, M Hjerpe and R Palter (2016), Bridging Global Infrastructure Gaps, McKinsey & Company.

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