The world is in urgent need of more and better infrastructure, and the sums that must be spent to narrow the infrastructure gap – an estimated $4 trillion a year – are far beyond what it is realistic to expect governments to raise in taxes. This means we need private investment, but private investors are wary of the risks involved in committing money to projects that will bring returns over a very long period of time. How can we increase investor confidence, to end the capital stand-off and unlock the necessary funds?
Caution is understandable, because a wide range of political and regulatory risks can hit projects whose life cycle is longer than the political cycle. For example, a future government could decide to impose new regulations or taxes, renege on commitments to pay, cut short a concession to operate an infrastructure asset or even nationalize it outright. Private investors weighing these risks also have to consider the fact that judicial processes will not be efficient or effective in enforcing the original agreement.
These are not new challenges. They were discussed, for example, at the High-Level Panel on Infrastructure during the B20 and G20 in Cannes in 2011. But we have so far lacked a systematic framework for thinking about them, and about what both the public and private sector can do to tackle them. A new World Economic Forum report, Strategic Infrastructure: Mitigation of Political and Regulatory Risk in Infrastructure Projects, aims to fill that gap.
First we need to identify the root causes of political and regulatory risk. These include the way that perceptions of the public interest can change over time, as attitudes evolve on matters such as environmental responsibility; the nature of political systems, which make it difficult for a present parliament to circumscribe the sovereignty of a future parliament; and misperception by investors about the likelihood of public pressure mounting over an issue, and governments responding.
There is no silver bullet in balancing investors’ need for predictability with electorates’ need for flexibility. But sometimes rules can be defined that allow for flexibility in a predictable way – an example being Germany’s feed-in tariff for newly built photovoltaic plants, which automatically adapts according to the amount of photovoltaic capacity connected to the grid.
Passing investment stability legislation and offering constitutional guarantees are part of what governments can do. But these are not enough on their own – they need to be backed by credible agencies and a strong commitment to anti-corruption. There is also scope for bilateral investment treaties to play a greater role. Although many such treaties already exist, they are often under-used, in part because protection clauses can be vaguely written and arbitration procedures controversial.
Alongside government actions, the private sector could also develop a wider range of risk-mitigation measures. Many of the harder risks, such as assets being expropriated or local currencies becoming inconvertible, can be addressed though financial instruments. Carefully considered ownership structures, such as joint ventures with local partners and multilateral development banks, can help to deter political interference. And the greater the degree of professionalism, sustainability and openness with which a company operates, the less likely public pressure for political interference is to materialize in the first place.
Addressing the infrastructure gap is vital if the world is to urbanize, continue to deliver economic growth, spread prosperity and meet the challenge of climate change. Mitigating the risks of private investment in infrastructure will be possible only with the public and private sector working together in genuine and transparent partnership.
Our report on political and regulatory risk in infrastructure projects, published today, is available here.
Watch a session from Davos 2015 on Closing the Infrastructure Gap.
Author: Pedro Rodrigues De Almeida, Director, Head of Infrastructure and Urban Development Industry
Image: The 405 freeway looking southbound running underneath the 10 freeway is shown in this aerial photo in Los Angeles, California September 29, 2012. REUTERS/Gina Ferazzi