Can P3 Help Tackle Asia’s Corruption Problems?

By Henry Teitelbaum, P3 Planet

(A version of this story previously appeared on Aon One Brief)

The Big Picture

Economic growth, supported by huge flows of foreign capital, has expanded prosperity in many countries across the South and East Asian region, leading to declines both in poverty and political risk.

But now, as China’s growth engine for the region subsides, regional competition for capital is likely to increase. While economic challenges in the short term create uncertainty, a renewed focus on anti-corruption efforts in the region could help states remain preferred destinations for foreign investment over the long-term.

The impact of anti-corruption campaigns in China, India, Indonesia and Malaysia are already being felt, according to the 2016 findings of Aon’s annual Political Risk Map. Across the Asia-Pacific region, tackling corrupt practices in both public and private sectors could not only reduce political risk, but also economic inefficiency. This in turn should support resilience in individual Asian economies at a time when emerging economies remain under intense pressure, helping them to more effectively address their growing infrastructure needs.

The challenge is very real. Urbanization and population growth is driving huge demand for basic essentials such as water, sanitation, transportation and electricity. This will place a clear focus on inclusive, sustainable development, that will reduce the already significant impact of development projects on the environment. At the same time, public financial resources are stretched and existing multilateral bank funding is insufficient.

New multi-lateral lenders, including the Asia Infrastructure Investment Bank (AIIB) may help to attract private investment to meet the region’s infrastructure needs. But ensuring this foreign capital remains for the long-term may also depend on progress in anti-corruption efforts. Clearer legal and regulatory frameworks and more transparent procurement structures could become important ways to accomplish both goals.

Deep Dive

Developing countries in Asia – including India, China, Indonesia, Malaysia, South Korea, Taiwan, Thailand and the Philippines – have achieved great success in generating prosperity, alleviating poverty, and encouraging political stability over the past 20 years. Much of this has been due to their ability to attract foreign investment through skilled labor, low wages, pro-market policies and political stability.

Political and economic risks in many Asian countries have also declined as stable currencies, and in some countries the adoption of pro-market policies the spread of democracy have expanded prosperity and created middle classes. But now, the physical infrastructure that is needed to keep apace with the demands of growing and increasingly urbanized populations is proving inadequate to the task. Asia’s infrastructure market is set to grow to 60% of global demand by 2025, according to PwC’s Capital project and infrastructure spending: Outlook to 2025.

Balancing Reform, Growth and Uncertainty

Nevertheless, as the Political Risk Map reported, countries such as China may face uncertainties in economic policy as their governments try to strike a balance between implementing reform and managing growth. In China, President Xi Jinping continues to consolidate power through his anti-corruption campaign – the economic outcomes of which are likely to be positive – while in India, Indonesia and Malaysia measures to counter corruption are expected to improve political and economic resilience.

“Anti-corruption campaigns may rebalance concerns regarding a stalling Chinese economy, but improvements in political risk do not necessarily translate into economic gains,” says Karl Hennessy, President of Aon Broking and CEO of the Global Broking Centre in London.

“Macroeconomic drivers are behind the current slowdown in China,” Hennessy continues. “While a war on graft is likely to have a positive, long-term impact on China, it may also reflect efforts to stabilize an economy going through an unprecedented deceleration. Following stock market uncertainties earlier in the year and a slide in GDP, Beijing may be turning to additional levers to instill greater confidence in its future economic program.”

The Rise Of Institutional And Private Funding

Outside of China, public funding resources for investing in this infrastructure are largely not up to the task. This is especially the case in poorer countries, where scarce government funding is needed to care for poor, largely rural populations. In countries such as India, this leaves little discretionary public funding available to support investments that would allow public infrastructure to keep pace with growing demands for better schools, healthcare facilities, care for the elderly, water, waste, electricity, broadband and other basic requirements.

As long-term investors in developed countries seek ways to diversify globally, opportunities to attract private investment from abroad to help meet this demand are increasing. However, competition for capital from other countries in the region also means that foreign investors will be weighing the relative risks more carefully than ever.
Existing multi-lateral lenders such as the Asia Development Bank (ADB) are inadequately funded to meet expanding demand for infrastructure, bureaucratic and slow. New multi-lateral lenders, such as the Asia Infrastructure Investment Bank (AIIB) and possible increased in capital flows from regional trade agreements like the Trans-Pacific Partnership (TPP) may help to attract private investment to meet infrastructure needs.

The robustness of legal, regulatory and market structures are important factors for determining where this private capital will gravitate. But corruption, in addition being a drain on public finances, is a major risk factor for both public and private investors and is a key determinant in their choice of where to invest.

In China, where state-controlled enterprises, including infrastructure developers, absorb a huge proportion of the country’s financial resources, the government’s current anti-corruption drive is a central part of its goals to make the state more efficient, thereby freeing up capital in the more efficient private sector.

Some Asian countries, notably India, have significant Public-Private Partnership (P3) programs underway to help tackle their infrastructure needs. When they work well, the competitive bidding and need for transparency involved in P3 tendering can itself help to reduce or eliminate corrupt influences. At the same time, the contract forces greater accountability on to the private sector by specifying penalties for inadequate delivery or maintenance of the asset.

Partnership structures such as these can also bring stability to foreign investment flows into the country, create local jobs, encourage the development of a domestic investor base and even respect for the rule of law. At the same time, foreign institutional investors gain investment and currency diversification and the potential to earn strong returns on investment.

For Asian economies to overcome the potential ripple effect of China’s current economic slowdown and secure sustainable long-term growth, increasing political stability can play a key part. While much progress has been made in recent years, as seen in the findings of Aon’s Political Risk Map, there is still work to be done – and political stability is only part of the story.

How Can We Tackle The Infrastructure Crisis?

By Henry Teitelbaum

(Originally Published in Aon One Brief, March 3, 2016)

We often don’t think about it until it breaks down, but the reality is that much of modern society in the developed world is dependent on public infrastructure investments in roads, airports, schools, water, sewage and electricity utilities that were made half a century or more ago. Without these, developed economies and societies simply wouldn’t be able to function.

But in recent years, a lack of public investment has forced many of these basic building blocks of prosperity to serve beyond their intended lifespans. In the U.K., the lack of upgrades or replacements for ageing power plants have begun to threaten electricity blackouts, while the recent toxic tap water in Flint, Michigan, has highlighted that ageing infrastructure may not just lead to an economic impact, but also create serious health issues. As many as half a million children may have been affected by lead poisoning from ageing pipes in the U.S. alone.

Why has the condition of our public physical infrastructure been allowed to deteriorate so sharply – and in our current age of over-stretched public purses, and with ageing populations putting increasing pressure on tax revenues, what are the options for addressing this worsening challenge?

In Depth

Globally, the World Economic Forum estimates that the planet is under-investing in infrastructure by as much as $1 trillion a year – since 1990, the global road network has expanded by 88 percent, but demand has increased by 218 percent in the same period.

With the global population continuing to grow – and urban populations in particular – the pressure on existing infrastructure is only set to worsen. And in the developed world that infrastructure is creaking: in the U.K., 11 coal-fired power stations are nearing 50, the end of their operational lives, and replacements have yet to be built; in the U.S., the average age of the country’s 84,000 dams is 52; in Germany, a third of all rail bridges are over 100 years old; parts of London’s Underground rail system, still in daily use by hundreds of thousands of commuters, run through tunnels that are over 150 years old.

According to the Report Card on America’s Infrastructure by the American Society of Civil Engineers (ASCE), the U.S. alone will need $3.6 trillion of infrastructure investment by 2020, assigning near-failing grades to inland waterways and levees, and poor marks for the state of drinking water, dams, schools, road and hazardous waste infrastructure.

Europe’s infrastructure is in worse shape – The Royal Institute of International Affairs has suggested that the continent needs $16 trillion of infrastructure investment by 2030, more than any other region in a world.

Taxing Issues, Tragic Consequences

While taxes once covered the cost of building and maintaining public infrastructure, entitlement programs such as social security and healthcare have started to claim a larger share of these funds as a percentage of government tax revenue, particularly as the number of people in retirement expanded.

In addition, as the cost of social programs grew, governments came under pressure to cut taxes, leaving even less money available to maintain existing infrastructure, let alone invest in the requirements of growing populations. “Too often infrastructure is seen only through the lens of cost, expenditure and not core to society prosperity”, says Geoffrey Heekin, Executive Vice President and Managing Director, Global Construction & Infrastructure, Aon Risk Solutions.

“Since the 1950s, investment in infrastructure in developed countries has been declining,” he says. “In the U.S., for example, investment as a percentage of GDP has fallen from around 5-6 percent in the 1950s to around 2 percent today.”

Tragically, train derailments, road closures, water mains breaks, and even bridge collapses to become commonplace. “Until situations like the water crisis in Flint or a bridge collapse happen, infrastructure does not hold proper weighting in the psyche of leaders in government,” says Heekin.

This lack of attention to infrastructure is costing developed economies billions of dollars in lost productivity, jobs, and declining competitiveness. Without addressing the infrastructure investment gap, the U.S. economy alone could lose $3.1 trillion in GDP by 2020, according to the ASCE, while one estimate attributes 14,000 U.S. highway deaths a year to poorly-maintained road infrastructure.

A Private Sector Solution To Public Sector Under-Investment?

To begin reversing the infrastructure gap, it is likely that governments will need to find ways to encourage private sector investment towards replacing, renewing and upgrading physical infrastructure.

Governments of all political stripes are increasingly supportive of private investment in infrastructure. One model that is now gaining attention is the Public Private Partnership (P3) model.

P3s in one form or another have been used successfully in developed countries for several decades. They are being used to procure everything from public health care facilities, schools and courthouses to highways, port facilities and energy infrastructure. While the volume and type of P3 deal can vary widely by country, there continues to be an upward trend for the model’s usage by the public sector.

In 2015, for example, Canada procured 36% of its infrastructure with the P3 model. Aon Infrastructure Solutions anticipates that 21 P3 projects will close in Canada in 2016, with a total capital value of USD$12.8 billon – the highest value of P3 projects in Canadian history. In the US, where adoption of the P3 model is less widespread, 11 projects are expected to close in 2016, with a capital value of USD $8.7 billion dollars.

Like traditional design-bid-build procurement, P3 projects involve public authorities putting out tenders for public projects or programs for competitive tender, and selecting a preferred bidder from multiple bidding consortia. The key difference is that the contractual structure in P3 allows the public authority to transfer a different set of risks to the private party – including (but not always) the financing for the project. The arrangement can allow the private partner that designs, builds, and finances construction of the asset to operate and maintain it in return for either, 1) a share of the revenue generated by the use of the asset, or 2) a stream of constant payments from the public authority (also called availability payments).

Keeping Focused on the Big Picture

“The public sector benefits from P3 delivery when the model is applied to a project that meets a community need and is procured through a transparent, accountable process,” says Gord Paul, Senior Vice President & National Director of Public Private Partnerships, Aon Risk Services, Canada.

“Public authorities seek ‘value for money’ in a P3 project by looking to the long-term value,” Paul says. This means identifying whether the private sector party is able to design, build, finance, operate and maintain an infrastructure project for a price lower than if the public authority did it on its own over the same period. It’s about the full lifecycle of the project – not just the build costs.

Taking a big picture view is equally important for the private sector party, says Alister Burley, Head of Construction for Aon Risk Services Australia. He points to the importance of taking a holistic view to P3 projects and investments to enable efficiencies to be built that will carry forward over time.

If done right, P3 arrangements can be a significant benefit to both the public and private sectors. Public bodies gain a much-needed boost to their infrastructure, often with long-term maintenance included in the deal, reducing the potential negative economic and health consequences of infrastructure failure. And private investors can secure a stable, long-term return through a stake in some of the underlying essentials of our economies.

Whatever route governments take to secure the integrity of our underlying infrastructure, one thing is clear – without a significant increase in infrastructure investment over the coming years, the world’s economy and health could well be put at further risk.