Looking beyond finance

By Jan Mischke and Diaan-Yi Lin

Global leaders in infrastructure development confront a multi-trillion dollar gap in investment. New analysis from MGI estimates US$69 trillion of investment will be needed between now and 2035, write Jan Mischke and Diaan-Yi Lin in The Business Times of Singapore.

Across the globe – in developed and developing countries alike – insufficient and outdated infrastructure is eroding the quality of life for individuals and slowing national economic development. Adding to the challenge, trillions of dollars in infrastructure investment are needed annually just to keep pace with expected population growth.

Almost 200 world leaders in infrastructure development and investment are meeting in Singapore this week for the fourth annual Global Infrastructure Initiative (GII), a summit convened by global management consultancy, McKinsey & Company. Among the crucial topics on the table is how to narrow the gap between current spending trends for road, bridges, water and power systems, and other essentials of public infrastructure and the projected needs.

A new analysis from the McKinsey Global Institute (MGI), to be released this week in tandem with the summit, estimates that the world must invest US$3.7 trillion a year on infrastructure over the next two decades, primarily for roads and power systems to keep up with population trends. In total, US$69 trillion of investment will be needed between now and 2035. The majority of the need is in emerging markets, and more than half is in Asia.

However, investment to date is not keeping pace. MGI found that from 2000 to 2015, average investment rates lagged what will be needed going forward in many large economies. Notably, gaps appear most pronounced in Brazil, Indonesia, and Mexico, but also the developed world (e.g. United States, United Kingdom and Germany) is falling short. The gap to 2035 amounts to $5.5 trillion even before additional costs to meet the Sustainable Development Goals.

Fortunately many countries understand the challenge and increased their infrastructure spending, in terms of share of GDP, between 2013 and 2015, notably India, Indonesia, and South Africa, as well as some European countries. At the same time, however, spending has stagnated in the United States. And it has dropped, arguably rightfully so, in China and Australia.

Outdated and insufficient infrastructure can be dangerous, as well as simply inconvenient. But beyond these considerations, inadequate infrastructure can be a significant drag on economic growth. Among other benefits, appropriate infrastructure provides safe and reliable energy, promotes inclusive industrial growth, and eases movement of goods and labor. Every dollar invested in infrastructure can return an additional 20 cents to GDP in the long run, a 20 percent rate of return.

Without doubt, governments must continue to increase their investment in infrastructure, but spending increases alone will not bridge the projected gap with real needs. Beyond finance, government must take the lead to ensure that infrastructure spending and assets deliver the greatest benefit.

McKinsey has identified three specific areas in which improved infrastructure efficiency and effectiveness can save more than $1 trillion a year globally. Singapore is already exploring or leading in some of these opportunities and can offer first-hand insights to leaders gathered for the infrastructure summit.

First, governments must strive to squeeze the most use out of existing infrastructure. While new projects often attract attention, improving and prolonging the life of current infrastructure could capture about two-fifths of the estimated savings. Governments and asset owners can use modern data analytics to prioritize maintenance and repairs, deploy smart systems that augment capacity, and reduce demand with targeted pricing mechanisms.

Singapore, for example, implemented an electronic road pricing system in 1998 for traffic in the country’s central business district. The system, the first of its kind, is credited with lowering traffic volume and providing a more efficient transportation network. The system is also expected to be expanded to include features like parking payments and real-time traffic information.

Next, public and private sectors must work together to deliver projects more efficiently, beginning with construction. Streamlined delivery accounts for another two-fifths of the estimated savings. MGI found that, globally, annual labor-productivity growth in construction averaged just 1 percent over the past two decades, compared with an average of 2.8 percent for all sectors and 3.6 percent for manufacturing.

Despite improvements in recent years, construction productivity across Asia continues to lag that in other industries. In Malaysia and Singapore, for example, labor-productivity in construction is about a third the average seen across other industries, which costs Singapore about $15 billion a year in lost value and Malaysia about $11 billion. The situation is more pressing in Indonesia, where construction productivity is just more than a tenth the overall average, costing the economy about $190 billion a year in lost value.

By addressing a full menu of initiatives – regulation, design processes, contract structures, procurement and supply-chain management, on-site execution, new technology, materials, and automation, and workforce development – construction productivity could be boosted by up to 60 percent, MGI concludes.

The final fifth in estimated savings comes from improved project selection. Too often, for instance, projects are still approved based on a “wow” factor, political tradeoffs, or wildly optimistic use projections. Instead, governments should use fact-based analysis to identify projects that present the strongest objective business cases and to evaluate the realistic costs and benefits of each idea.

As the world struggles to meet the infrastructure needs of a growing population, increased finance is just a part of the solution. Governments and private companies can work harder to extract greater good from current assets and new funding, delivering greater benefits to individuals and companies and creating a smoother path for economic growth.

This article first appeared in The Business Times of Singapore.

About the author(s)

Dr Jan Mischke is a Senior Fellow at the McKinsey Global Institute, based in Zurich, and Diaan-Yi Lin is a Senior Partner and Managing Partner, Singapore at McKinsey & Company.