Grigory Milov, Margarita Lyutova
Vedomosti | January 18, 2013
3.8% of global GDP is spent on investing in infrastructure, according to specialists from McKinsey Global Institute (MGI) and McKinsey Infrastructure Practice. They analyzed these expenses in 84 countries (which account for over 90% of global GDP) over 18 years.
China is the undisputed infrastructure investment leader: in 1992 through 2010, the figure was 8.5% of GDP on average (USD 503 billion per year in 2010 rates of exchange, please refer to the iconographic model). Russia's figure, on the other hand, is below even the global average –3.21%, however, this is above the amount spent, for instance, by the USA or the EU.
By 2030, the global infrastructure spend will have to be at least USD 57 trillion, should the global economy grow, on average, by 3.3% per annum. At that, the required investment will increase from USD 2.6 trillion in 2013 to USD 4.1‒4.8 trillion (in 2010 prices). For reference, global defence bill in 2011 was USD 1.7 trillion.
Yet, the return on infrastructure investments has been low for decades, minor positive dynamics are few and far between, conclude the MGI researchers. The key issues, in their opinion, are linked to very substandard planning, project implementation, and management systems. The experts reviewed over 400 projects and came to the conclusion that there was potential to boost productivity by 60%, whilst reducing the cost by 40%. In the next 18 years, the global economy could be saving at least USD 1 trillion a year on infrastructure projects.
Russia's savings potential is just as great, claims Jan Mischke, senior fellow at MGI and one of the authors of McKinsey's report. For example, labour productivity in Russia's residential construction sector in 2009 was estimated by McKinsey merely at 20% of the USA's figure. However, in other countries, including the leading economies, this figure isn't improving, either. As for the USA itself, in 1989 through 2009 this metric dropped by 20% despite an almost 50% productivity increase across other sectors.
Of the USD 1.5 trillion that Russia will spend on infrastructure in 2013 through 2030, savings potential estimated by MGI amounts to USD 600 billion, over USD 30 billion per year. At that, the researches place an emphasis on the fact that these savings won't require any groundbreaking new methods: the existing best practice methods have been tried and tested. For example, simply by making the project selection procedure more rigorous, Chile and South Korea were able to achieve 15‒20% savings in capital investments.
Yet, in most countries, planning of infrastructure projects is in no way linked to broader social and economic objectives, the required sum of investment is initially underestimated while the benefits from implementing the projects are overrated, resources are allocated depending on narrow-minded political interests, and corruption is possible at the project selection stage, the researchers claim.
For example, it happens that a decision to expand the network of high-speed motorways is made without any consideration for the development plans for railways, ports and airports, and without taking into account the development of road infrastructure nearby. The Olympic budget of Sochi 2014 has jumped from RUB 320 billion to RUB 1.4 trillion, while the cost of hosting the APEC summit increased from RUB 149 billion to RUB 680 billion. In South Korea, Private Infrastructure Investment Management Centre (PIMAC) turns down 46% of project proposals. Before PIMAC was established, 97% of projects were approved. In South Africa, a similar process enables to cut costs by a third. The Chilean Ministry of Planning has prepared a master plan of infrastructure development, then projects are assessed by a special agency ‒ the national system of government investment, and final decisions are made by the Ministry of Finance. Information on selection criteria, results of analysis and assessment, and the reasoning behind the decisions made is available to the general public. As a result, 25‒35% of projects are turned down in Chile.
Russian public servants agree with the researchers' findings. In the public road sector, claims a federal government official in charge of infrastructure, there is untapped potential to increase return on investment: before moaning about insufficient funding, one needs to show that bigger and better things can be built even with the existing budgets. System failures are to blame, believes a representative of a large construction company: due to the lack of long-term strategic planning and high risks, companies are keen to make as much money as possible here and now. At every next stage, new companies are put in charge of infrastructure projects, and the costs get inflated, he continues. In addition, cost estimates are based on statutory rather than market price of the work, adds Vedomosti's source, "A contractor can only realise if the cost was over- or underestimated once he has started the work." In road construction, up to 60% of funds can be stolen ‒ this was an earlier claim by Sergey Pavlenko, former head of Federal Service of Financial and Budgetary Oversight, "This is because of the Soviet construction standards, according to which roads are planned with a strength ratio of 'two'. In other words, one can steal half the money or even slightly more and bring the ratio down to 'one'. The crucial thing is to calculate the geological parameters so that the road surface doesn't break."
The situation has been stagnant for at least the last 70 years, concludes Bent Flyvbjerg of Saïd Business School at the University of Oxford in his article Survival of the unfittest: why the worst infrastructure gets built—and what we can do about it: 9 out of 10 projects overrun their budgets, in railway building the cost estimate is inflated by 44.7% on average, in bridge and tunnel building ‒ by 33.8%, in road construction ‒ by 20.4%. Over the last 20 years, progress was slow, but that doesn't mean that we can't ever succeed, insists Jan Mischke.