The role of private finance in infrastructure development: PPP and new investors

Not only is the COVID-19 pandemic presenting massive challenges to the financing and the delivery of the world’s health systems, but it is also fostering a debate on the strategic direction that many critical global priorities should take.

The revolution we are preparing for requires a huge amount of financial resources: the actual cost of the digital and environmental transition is estimated around 3.5 trillion euros globally by 2050, five times greater than the European Recovery Plan.

This transition needs significant investments in good and innovative infrastructures, which ought to be able to support growth in order to tackle the asymmetric consequences of the pandemic and to address the social challenge and the distributional effects of the transition. Modern policies have to be designed to ensure a fair transition that may place citizens, not infrastructural projects, at the centre-stage: “to leave no individual or region behind in the great transformation ahead”, as stated by the European Green Deal.

Literature in Economics and past experience show that, when economic growth declines, investments have the potential to be a key contributor to the recovery: infrastructure is a powerful vector for social and economic development, and its industry accounts for 6 percent of the global GDP and workforce. Investment in infrastructure has an annual multiplier effect of 0.4 to 2.2 times GDP, and it can help to create at least 10.000 total jobs for every $1 billion spent.

However, investment in infrastructure also plays a short-term important role, since it has a direct impact both directly and indirectly: directly, because infrastructure investment is an integral part of aggregate demand; indirectly, because it produces an amplified effect on both GDP and employment.

Given the current significant infrastructure needs, it is of paramount importance that infrastructure solutions are designed in the most sustainable way, including environmental considerations and climate resilience, economic and financial aspects, governance issues and social implications. According to the F20 Platform, approximately 70 percent of global greenhouse gas (GHG) emissions are caused by the construction and operation of infrastructure. We know that the relaunch of investments will exert strong pressure on ecological systems and social stability. The intensity of these effects could generate a disequilibrium between different areas of the world: over the next ten years, the world’s population will grow from today’s 7.5 billion to around 8.7 billion, three quarters of which will be living in cities and developing countries. When the coronavirus pandemic crisis will be definitely over, the recovery will come with enormous challenges for those countries, which will have to provide jobs, resources and infrastructure to guarantee at least current (or, hopefully, better) levels of well-being to their citizens.

If the transition needs a lot of resources (infrastructure gap is globally estimated around 750 billion dollars per year by 2040), finance is ready to become a pivotal player in the new scenario: public finance has to build conditions to implement infrastructures available for all (the market alone tends to create social inequalities, because of return expectations), and sustainable for all (investors and final users), reducing risks and allowing private finance to operate. To boost the infrastructure sector, many governments have introduced policies and specific financial instruments (grants, availability-based payments, direct provision of debt and equity capital) for solving market failures and making the investment sustainable or profitable.

Some numbers about the current situation: investment commitments in the first half of 2021 stood at 35.6 billion dollars, marking an increase of 68 percent from the first half of 2020, yet still a 12 percent decrease from the previous five-year (2016-2020) average. According to a recent survey by the European Investment Bank (EIB), about half of these infrastructure investments are currently made by local governments. COVID-19 has had an impact on 40 percent of these investments, interrupting or slowing down projects for the construction and the modernisation of public transport networks, wastewater treatment plants, as well as energy efficiency interventions in public buildings (schools, hospitals and social housing projects).

Nevertheless, the involvement of public and local stakeholders raises at least three kinds of problems. First, regulatory uncertainty and an excessive level of bureaucracy hinder the mobilisation of private capital. Adopting an adequate governance model, in terms of clear rules and simplification of procedures, is essential to ensure the effectiveness of investments.

Second, municipalities lack skills and managerial/technical competences. In the coming years, developing an “operational culture” in local governments to manage resources and projects that will involve a high degree of complexity is required.

Third and last, municipalities struggle to finance current expenditure, due to public budget constraints and privatization policies. This is why private finance plays a crucial function in compensating this structural frailty, because it provides both necessary resources and competences in a public-private partnership (PPP) perspective.

Many studies demonstrate that PPPs have a number of advantages that cannot easily be replicated with other models.  First of all, PPP projects tend to be delivered on time and on budget if compared to other procurement facilities: this is largely due to the risks associated with delays and cost overruns being placed on the private sector. PPP can also ensure better risk management (the principle that risks are allocated to the party that is best placed to manage them), better value-for-money efficiencies (defined and predictable cost-capability trade-off enable the realisation of infrastructure that can offer a better value asset overall), and good balance of interests (the presence of the public partner is focused on the objectives to be achieved in terms of public interest and quality of services offered).

Last but not least, innovation has to be considered as a priority: governments operating on an output basis and contracting a full-life service enable the private sector to achieve efficiencies not only during the construction phase, while also ensuring that assets are well preserved and allocated to meet life requirements.

High-quality infrastructure is a long-term process that feeds on finance but whose needs go beyond financial means. Procuring, building, and maintaining this type of infrastructure require a cooperative approach among a large number of stakeholders such as local governments, development agencies and banks, financial institutions, and private companies, especially in developing countries.

In this context, infrastructures are attracting interest from a new range of investors: institutional actors such as foundations, philanthropic bodies, pension funds, insurance companies and sovereign wealth funds can provide a long-term approach to infrastructure investments, and they are equipped to become a key player in developing infrastructure as a new asset class, ensuring sustainable growth, job creation and socio-economic stability.

There are early signs that the pandemic might have accelerated an already changing paradigm: infrastructure spending will be a central pillar in governmental efforts around the world to support a new economic cycle. This creates a unique opportunity for private finance to build green and social infrastructure that can support a needed transition, reduce emissions and ensure public health and wellbeing.

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About Fulvio Bersanetti

Fulvio Bersanetti

Fulvio Bersanetti is Program Officer at Fondazione Compagnia di San Paolo, Impact Innovation Dept. Graduated in Economics at University of Turin, he worked as senior economist at REF Ricerche (Milan) and as senior program manager at FCA-Stellantis, Data science Dept. (Turin). His main interest lies the intersection between finance, tech and innovation.

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About Paolo Mulassano

Paolo Mulassano

Paolo Mulassano is Head of the Impact Innovation Department at Compagnia di San Paolo Foundation. In addition, he is Adjunct Professor of Innovation Management at the University of Turin and he is an Innovation Manager of Equiter spa. Mulassano has more than 12 years of experience in international innovation management.

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