The U.S needs to invest $3.3 trillion on new infrastructure to support expected economic growth out to 2030. It's time to get started.
Jan Mischke | McKinsey Global Institute
Sixty years ago, the U.S. embarked on one of the greatest public works projects since the Roman Empire: the Interstate Highway System.
It was a bonanza of productivity for an American economy emerging with brawn from World War II, at one period yielding an annual return of 54 cents for every dollar spent.
But in recent years the federal government has fallen behind on its maintenance budget by almost a third, spending $20 billion a year of a needed $33 billion. Congestion is commonplace and roads and bridges sit in disrepair.
The same story is playing out across the world.
“ The world spends $2.5 trillion a year on big capital projects. As big as that number seems, it’s not keeping pace with a growing world. ”
It’s one of the great under-reported economic crises of our time and is one you can’t see, but its impact is evident in a variety of statistics: poverty, health problems, stunted education gains, global trade waste, job immobility, pollution and inequality.
It’s the infrastructure gap, and it’s widening.
The world spends some $2.5 trillion a year on big capital projects: water, power, energy, transportation and telecom. As big as that number seems, it’s not keeping pace with a growing world.
According to a June report from McKinsey Global Institute, we should be spending $3.3 trillion a year just to support expected economic growth out to 2030.
How do we close an $800 billion annual gap?
McKinsey Global Institute sees big potential in making infrastructure spending more effective by improving project selection, delivery and management of existing assets.
Even the most advanced economies, they say, have room to learn from each other.
As part of a series we’re running on financing breakthrough new infrastructure, Bruce Upbin of Hyperloop One put a few questions to Jan Mischke, senior fellow at McKinsey Global Institute, and an author of the Bridging Gaps report.
Upbin: The report mentions disruptive ideas in the way infrastructure is built (one example being how China’s Broad Group put up a 30-story tower in 15 days). What other examples are there of building infrastructure faster, better, cheaper?
Mischke: Research has found the construction sector to be a technological laggard, with low levels of digitization and R&D spending.
However, McKinsey’s research has shown that emerging technologies could boost productivity by 25 to 30 percent.
A new report just released identified five trends disrupting the construction industry: higher-definition surveying and geo-location, next generation 5-D building information management software (including integration of augmented reality devices), digital collaboration and mobility, the IoT and advanced analytics and “future proof design and construction” – which spans from new building materials, such as self-healing concrete, aerogels and nanomaterials – to innovative construction approaches, such as 3-D printing and pre-assembled modules.
Upbin: Which institutional investors (or which countries) you’ve spoken with have shown the most interest in infrastructure as an asset, as in, which funds are really closing the gap between their current holdings and allocation targets for infrastructure investment?
Mischke: Our report focused on financing sustainable infrastructure found that private institutional investors could fill up to half the financing gap.
In that report, we evaluated eight groups of institutional investors: banks, investment companies, insurance companies and private pensions, public pensions, sovereign wealth funds, infrastructure operators and developers, infrastructure and PE funds and endowments/foundations.
The investors with the greatest value of infrastructure assets under management (AUM) are as follows: banks ($40.2 trillion in AUM), investment companies ($29 trillion in AUM) and insurance companies and private pensions ($26.5 trillion in AUM).
However, this report also found that one of the biggest barriers is not the availability of capital, but rather the lack of a transparent pipeline of bankable projects for investors.
Another report from MGI, “Diminishing Returns,” noted that a continuing environment of low interest rates and low returns could lead life insurers to reexamine their investment strategies, and therefore they could look toward longer-dated and less liquid assets with a higher expected return, such as infrastructure investments or commercial real estate (particularly given recent reductions in Solvency II risk charges for such investments).
More broadly, McKinsey’s asset management practice research shows that investment flows are increasingly moving away from active investment in equities, and toward passive equities, active or passive fixed income or to alternatives and multi-asset products.
This trend could be exacerbated by low returns.
In a low-return era, the proportion of returns given up to management fees in a high-return period becomes less acceptable.
To confront this, asset managers may have to rethink their investment offerings.
“ Congestion is commonplace and roads and bridges sit in disrepair. ”
One option would be for them to include more alternative assets such as infrastructure and hedge funds in the portfolios they manage.
Such alternative assets already account for about 15 percent of assets under management globally today, and flows into such alternative investments have outpaced flows into more traditional assets by three to six times.
Upbin: A new class of financing vehicles to get construction projects off the ground is emerging with names like venture fund structures or early concept development units. Can you tick off some examples?
Mischke: The sustainable infrastructure report referenced above cites the following: The International Finance Corporation’s (IFC) InfraVentures unit helps to develop projects, but also takes equity stakes in them as well, which helps to attract other financing.
Funds like InfraCo, a publicly funded, privately managed early-stage financier of projects in developing countries, have succeeded in such challenging markets as Kenya, Uganda and Zambia.
Upbin: What’s the state of the art in property value capture, in which the project developer is paid from the increased value of surrounding real estate? Is it a growing trend? Spain went so far as to anchor the notion of property value capture in its constitution.
Mischke: One of the best-known examples is MTR in Hong Kong, where land value capture funds much of the rail build-up as well as affordable housing programs.
The CEO of MTR authored an article for our Global Infrastructure Initiative publication that lends additional insights.
Singapore has traditionally bought up private land before redeveloping, thus capturing land value increases. More recently, the cantons of Switzerland are in the process of instituting property value uplift taxes.
Upbin: Changes in government accounting (specifically capitalizing infrastructure investment over time versus expensing it all at once) could unlock more investment by not blowing such a big hole in federal and state budgets. How much do we know about how to account for social returns and depreciation rates for long-term, broadly used investments such as new transportation?
Mischke: There is both wide uncertainty and wide divergence between individual projects. For transportation, depreciation rates of 2.5 percent annually are typical.
From top-down econometric analyses, socio-economic returns of about 20 percent on investment are typical. Bottom-up cost-benefit analyses – which also account for non-GDP impact – are often above 30 percent.
One of the stumbling blocks is that public infrastructure assets often do not have dedicated revenue streams attached to them that could be securitized, and long-term tax uplifts are difficult to measure.
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This article originally appeared on Hyperloop One and was republished with permission.
Animation courtesy of Hyperloop One
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