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The lure of infrastructure investment

Like motherhood and apple pie, it is hard to be against improving a country’s infrastructure. No wonder then, that politicians are tempted to promise voters massive upgrades of road and rail networks, more airports, fancy high-speed trains, even fundamental overhauls of health and education systems.

But do these grand projects ever pay off? The question is worth asking given that governments across the world, but especially in Asia, are announcing ever more ambitious plans to boost economic growth, eradicate poverty and go greeen -- preferably all at the same time. I am thinking here particularly of “Jokograd” – the derisory label many Indonesians are giving to the $37 billion scheme their president “Joko” Widodo has hatched to move the nation’s capital from Jakarta. But it applies also to the giant infrastructure plans of the Philippines, Malaysia and many others.

From a macroeconomic point of view, such investments are generally sound policy. As long as the returns – even if rather long-term and “social” – exceed the government’s borrowing costs, they will create value. Given today’s record low (or negative) bond yields, that should mostly be the case. Moreover, all new activity, such as construction, immediately adds to short-term GDP. At a time when households are overly indebted and companies reluctant to invest, such government spending is often needed to keep the economy going.

China is the past master here. Over the past 20-plus years, it has relentlessly driven its economy forward through investment projects, the bulk of which have been related to infrastructure (including real estate) and financed by the state. Turning on and off the investment tap has been Beijing’s main policy lever to keep growth at acceptable levels – as demonstrated particularly in its response to the financial crisis.

Japan too is a dab hand at this, with a reputation for building bridges to nowhere and paving much of its wonderful countryside in cement. Critics argue that a large proportion of this supposed “investment” has been wasted and has raised the national debt to an unsustainable level of well over 200% of GDP. However, Richard Koo, the head of the Nomura Research Institute, argues in this recent piece in the FT, that Japan’s two lost decades would have been much, much worse (akin to America’s Great Depression) but for the stabilising spending undertaken by the government. So in his view, that spending, and the associated borrowing, has been worth it.

In China too, while there are ghost towns of unoccupied apartments and rather too many small cities with large, empty airports, there is no doubt that the country has modernised at an astonishing rate, lifting hundreds of millions out of poverty. Again, the growing debt load, even taking into account all the off-balance sheet liabilities, may well be justifiable.

Importantly, both countries have largely closed financial systems in the sense that domestic savings can and will absorb rising levels of government debt. That is not the case for Asean’s smaller and more open economies that rely on foreign investment and are thus vulnerable to capital flight.

Probably even more critical is that Japan – and even China, mostly – are countries with a well-educated and efficient bureaucracy, stable political leadership and clear chains of command. These appear to me to be essential preconditions to executing giant, centrally mandated infrastructure projects. Can we assume the same to be true in south-east Asia?

As an answer, please take a look at our latest piece from scoutAsia Research which documents that contractors in the Philippines spend an extra 15-35% on top of their initial budget in bribes and fees...including "revolutionary taxes" to stop communist rebels blowing up what they are building. This is one reason, though not the only one, that President Rodrigo Duterte's $158 billion "golden age of infrastructure" is failing to amount to much: so far, only 2 of 75 projects promised three years ago have been completed and most have yet to start.

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