Building the Infrastructure Industry in East Asia Emerging Economies
By Fauziah Zen
The short supply of infrastructure in majority of emerging economies was an alarming issue recently due to its impeding effect on economic growth and quality of life. Sole reliance on public funding is impossible in meeting the increasing need for infrastructure. Estimates reveal that Asian emerging economies should spend eight percent of GDP to maintain a six to seven percent growth. Yet, the actual level of infrastructure spending in majority of these emerging economies is only one-half or about four percent of GDP. The situation leads to the urgency to call for private participation to fill the gap, including privatisation and public-private partnership (PPP).
However, private sector participation requires certain basic conditions: the project should have an acceptable return on investment and a tolerable level of risk. This means that not all types of infrastructure projects can attract private investors, and the condition of associated risks shall be optimally arranged.
Projects under a PPP scheme require strong public leadership. When private investment finances an infrastructure project, whether it is a PPP scheme or contracted out by government, fiscal contribution from public sector is involved. The contribution could be on a cash basis, such as viability gap funding, availability payment, subsidies, etc., or in the form of in-kind support, such as land provision, project development facility, guarantee fund, and others. Some types of risks borne by the public sector can also imply fiscal liabilities. Consequently, the role of the public sector is crucial and should be understood appropriately.
Infrastructure development works under the system that is substantially similar with other industries. The industry can be expected to work efficiently and effectively if the size meets economies of scale, has complete components, and works within an appropriate regulatory framework, as typically shown in Figure 1. The infrastructure industry is far wider than the construction industry; the former consists of the main pillars of industry - the owner, the users, the financiers, and the construction companies - that are regulated under a supportive regulatory framework and backed by intermediaries which serve an effective channelling mechanism and advisory services.
The infrastructure industry in emerging economies either is not large enough or has an incomplete system. The players will come into the market where there is sufficient demand for business. This is a fortunate thing because the government can create the demand, as infrastructure is a basic requirement for growth. Insufficient infrastructure demand in an economy is usually caused by the government either putting less priority on infrastructure development or trying to act as a single player in the market. The latter is typically associated with a misperception of the role of the public sector to provide public goods. There are two common mistakes in understanding this concept; the government (i) misunderstands the concept of public goods - that private goods are often treated as public goods, or (ii) thinks that becoming a provider means becoming a constructor.
Figure 1. Infrastructure Industry Environment
The importance of a sufficient and complete infrastructure industry is obvious. It will reduce transaction costs, improve efficiency, and provide adequate demand through an effective network of market players, an accumulation of knowledge in the domestic market, and better allocation of limited resources. This includes privatising private goods, unbundling non-core tasks of the public sector, and subsidising public goods that can maximise socio-economic welfare. Only the government has authority to do these actions.
One substantial action is to show that the government is highly committed to build its national infrastructure industry. The purpose is to attract private players to establish a long-term market role in the country. The government's task is to convince potential players that the country is putting serious effort to develop a thick market and a perpetually sufficient system for the infrastructure industry.
There are two critical strategies here, namely, (i) offering the market with a good project pipeline under a good regulatory system and in line with the private sector's core competence, and (ii) providing long-term and stable dedicated funds for infrastructure development. The first strategy will improve market efficiency, where the roles of the public and private sectors are made clear. Government can save its limited resources to focus on its core competence and, by doing so, will become more qualified to handle its jobs. The second strategy will convince the market that infrastructure demand will be more predictable and long lasting. Hence, the market will see that it is advantageous to establish a branch in the country or to partner with local companies, and to be more active in the bidding process.
Fauziah Zen is an economist at Economic Research Institute for ASEAN and East Asia (ERIA) and a faculty member of Faculty of Economics and Business, University of Indonesia. She is also a visiting professor in Hitotsubashi University and guest lecturer in University of Tokyo, both in Japan. She has served as Deputy Head of Socio-Humanity Commission in the Indonesia National Research Council and a member of the Advisory Team to Indonesia's Finance Minister on Fiscal Decentralization during 2009 to 2014. She had consulted for the World Bank, ADB, GIZ, AusAID, and USAID, to several government institutions in Indonesia.