Infrastructure as economic stimulus: not fast or cheap
17 February 2021: With a strong track record of stimulating post-crisis economies, infrastructure development was always going to feature heavily in government recovery plans – particularly given its central role in achieving carbon neutrality. Infrastructure, however, is not a quick fix.
Richard Abadie, leader of PwC’s global capital projects and infrastructure group, points to the recovery plans that followed previous crises. Following the 1929 stock market crash, stimulus packages announced by USA President Hoover, and then his successor Franklin D Roosevelt, left behind iconic infrastructure such as the Hoover Dam, which was constructed between 1931 and 1936, employing thousands of workers. Then came the US Marshall Plan of 1948 that delivered foreign aid to Western Europe, much of which was spent on rebuilding infrastructure, industries, communities and jobs following World War Two.
Infrastructure investment is a tactic US President Joe Biden, and indeed governments around the world, have on the agenda as we battle existing crises in areas such as health, economics and climate. The world has a lot of recovering to do but we are not anywhere near where we were after WW2 or the 2008 global financial crisis (GFC). “The scale of recovery needed is significant, but the world will recover,” says Abadie. “The key question is: over what period?”
COVID a ‘real economy’ crisis
Abadie reflects on the key difference between the last two global crises we have faced and the ongoing COVID pandemic. “The GFC was predominantly a crisis in our financial systems and the policy tools deployed such as quantitative easing and taxpayer support for financial institutions were very much a feature of the GFC recovery landscape,” he says. COVID, on the other hand, has become a “real economy” crisis, spreading to all corners of the global economy, requiring support for health systems, jobs, companies, transport operators, airlines and so on. “Quantitative easing will help but is nowhere near enough,” he adds.
In the UK, and indeed in most parts of the developed world, the period post-GFC was marked by low economic growth, low interest rates, low wage inflation and limited advances in productivity. The increasing borrowings to finance the COVID stabilisation programmes come against a backdrop where real interest rates were already heading into negative territory and will likely lead to more borrowings to finance debt-fuelled recovery programmes. This, says Abadie, is a risky but necessary strategy to drive economic growth, as we begin to recover from the pandemic.
In the UK, Office for National Statistics data for December 2020 show that public sector net debt at the end of December 2020 was around 99.4% of GDP. This was the highest debt-to-GDP ratio since the financial year ending 1962. In Brazil, public debt is rising from 75% GDP in 2019 to a level that could top 100% in 2020. South African public debt has risen from just over 60% to something close to 80% GDP in the same period.
The recovery hasn’t started yet
“There’s a lot of talk of recovery – and clean recovery – but we’re still in a stabilisation period,” says Abadie. “The recovery hasn’t started yet. We have a long-term, net-zero vision on the one hand, but short-term budgeting on the other, and we haven't worked out how we're going to pay for the vision yet. There’s nothing wrong with that because, until the economy gets back to something resembling normality, we're in that stabilisation period, just trying to keep people safe, in jobs and companies going.”
Abadie points out that if we think this lack of clarity is a problem in, say, the US and Europe, the challenge is exponentially higher in emerging markets like, say, Nigeria or South Africa. “In some of these emerging markets recovery is a real problem because they just don't have the capacity to borrow at the levels needed to stimulate their economies, and the reduced tax revenues make debt repayments more difficult,” he says.
“We don’t want any old recovery. We want one that focuses on sustainability, resilience and inclusivity. This trifecta is needed to ensure a balanced recovery that focuses on people, jobs, rebalancing economies, protecting our environment all while making us more resilient to future shocks.”
A decarbonised economy
Around 70 to 80% of carbon emissions come from infrastructure and infrastructure-related sectors. “If we want to decarbonise the UK by 2050 and hopefully the planet shortly thereafter, we have to focus on infrastructure. Most of the infrastructure we've built will be around for many years so how do you reduce carbon footprint? It’s very difficult. We have to tackle decarbonisation on multiple fronts” says Abadie.
As for who will provide the money to build and adapt the infrastructure of tomorrow, Abadie believes the financial services sector is taking a strong lead. “So much of the capital that's going to be required for recovery, transition and adaptation is going to come from our financial institutions: banks, private equity, pension funds, and so on. They are increasingly united and are almost becoming a quasi-regulator on carbon. That evolution is well underway.”
But it is not just about finance; it is also about building a supply chain that can get us to net zero. “The greening of finance is moving in the right direction, but the supply market is not there yet at scale for all of net zero,” he says. “We saw the boom in the solar industry which drove down solar panel prices by up to 80% in a little over 10 years. The government push in offshore wind changed the sector from unbankable to project financeable in a similar period. Now we have over 40% of total power generation coming from renewable sources in the UK. We will need the same ramp-up in production, lowering of cost and ongoing technological improvement to deliver decarbonisation in transport, industry, and heat and buildings and further decarbonisation in electricity.”
The actions of the UK government, whether directly or through the regulators, will determine whether we meet our net zero targets by 2050. Abadie says: “The UK Government set the net zero by 2050 ambition and codified it into law. It now faces the daunting task of creating an enabling environment for the economy to meet the challenge. It is off to a good start with the National Infrastructure Strategy, the Energy White Paper and myriad guidance documents around areas like carbon capture and storage, and Regulated Asset Base in nuclear. It is clear the government understands the need to provide a pathway for net-zero investable business models and the market will engage enthusiastically”.
National Infrastructure Bank a ‘focal point’ for UK recovery
It is worth noting that investment is not only required to achieve net zero but also to deliver digital, environmental, transport and social infrastructure. Crowding in private capital will therefore be a key requirement for delivering the UK national infrastructure strategy. “The National Infrastructure Bank (NIB) will be a focal point for government support into the capital structures of net-zero projects,” says Abadie. “Providing support around construction completion on time and budget, giving confidence about the revenue streams of emerging sectors, and generally de-risking first-of-a-kind projects or programmes, is likely to be a key focus of the NIB and government. Grants from government and partial equity, debt and guarantees from NIB, should enable the crowding in of private capital. Hopefully, the government and the NIB will be able to sell down or exit its early interventions to reduce the impact on taxpayers who ultimately carry the burden of government interventions”.
Abadie points out that we have seen a massive evolution of infrastructure delivery and financing that will continue. “The blending of public capital, private capital and grants will help to balance risk transfer, crowd in private money and bring down the cost of capital, making the cost to consumers and taxpayers more affordable and better value for money,” he says.
While Abadie notes that the ambitions of an infrastructure-driven recovery will be challenging to achieve affordably, we can’t afford to fail. “It will need the best of the public and private sector in collaboration to successfully deliver the ambition,” he says.
Infrastructure investment can be as powerful an economic stimulant now as it was in the days of Hoover and Marshall, but over the medium to long term. These historical references faced their own urgency and complexity. Ours today blends economic and social imperatives with an environmental one. By blending the best of the public and private sectors, we can rise to the affordability and delivery challenges and build forward in a more sustainable, inclusive and resilient way.
