Improving Public Sector Infrastructure Investment

Prof. Fernando Fernholz

fernholz@duke.edu

Presentation at the 7th ANNUAL MEETING OF MIDDLE EAST AND NORTH AFRICA

SENIOR BUDGET OFFICIALS. (MENA-SBO). Session 3 Abu-Dhabi, United Arab Emirates. 10-11 December 2014

Outline Importance of Public Investment/Infrastructure Raising productivity [remove bottlenecks] The stimulus effect Challenges Perspectives on Public Investment

Infrastructure spending can be counter cyclical Challenges occur over range of countries and time There tends to be a systematic optimism bias

What can be done? A Systems Approach Project appraisal and overall PIM Improvement Public Private Partnerships Some Reflections for the MENA Region

The Global Context

IS IT TIME FOR AN INFRASTRUCTURE PUSH? THE MACROECONOMIC EFFECTS OF PUBLIC INVESTMENT. Chapter 3. IMF October 2014

According to the IMF and several other sources, increased public infrastructure investment raises output in both the short and long term, particularly during periods of economic slack and when investment efficiency is high. This suggests that in countries with infrastructure needs, the time is right for an infrastructure push: borrowing costs are low and demand is weak in advanced economies, and there are infrastructure bottlenecks in many emerging market and developing economies. To be efficient, public investment must meet two conditions:

allocate to projects with the highest ratio of benefits to costs its aggregate level must align with fiscal sustainability.

Needs vary over space and time

Key characteristics distinguish infrastructure from other capital First, infrastructure investments are often large, capital-

intensive projects “natural monopolies”—it is often more cost-effective for services to be provided by a single entity.

Second, they have significant up-front costs, but the benefits or returns accrue over very long periods of time, often many decades; this longevity (and difficulty of ascertaining adequate returns) are a challenge to private financing and provision.

Third, infrastructure investments have the potential to generate positive externalities, so that the social returns to a project can exceed the private returns it can generate for the operator.

Fourth, because of high level of public resources, there is need

for high level of accountability.

1. Public Investment as Counter Cyclical Policy

Highlights from our Study on Active Public Investment

and Fiscal Stimulus and Growth Impacts

STUDY ON COUNTER CYCLICAL POLICIES:

ROLE OF PUBLIC INVESTMENT TO STIMULATE

DEMAND

Client: World Bank, 2012

Some perspectives

on Public Investment

Region or country

Average

2001-07 2008 2009 2010 2011

Growth

rate

Growth

rate

Growth

rate

Growth

rate

Growth

rate

Change Change Change Change

4.1% 2.8% -0.7% 5.3% 4.0%

-1.3% -3.4% 5.9% -1.3%

2.4% 0.1% -3.7% 3.2% 1.6%

-2.3% -3.8% 6.9% -1.6%

2.4% -0.3% -3.5% 3.0% 1.5%

-2.7% -3.1% 6.5% -1.5%

2.6% -0.1% -4.9% 2.1% 1.1%

-2.6% -4.8% 7.0% -1.0%

4.7% 1.8% -0.7% 8.5% 4.7%

-2.9% -2.5% 9.2% -3.8%

2.4% 0.7% -4.2% 2.0% 1.7%

-1.7% -4.9% 6.2% -0.3%

6.6% 6.0% 2.8% 7.5% 6.4%

-0.6% -3.2% 4.7% -1.1%

8.6% 7.7% 7.2% 9.7% 8.2%

-0.9% -0.6% 2.5% -1.4%

10.8% 9.6% 9.2% 10.4% 9.2%

-1.2% -0.4% 1.2% -1.2%

7.3% 6.2% 6.8% 10.6% 7.2%

-1.1% 0.6% 3.9% -3.4%

3.5% 4.3% -1.7% 6.2% 4.5%

0.7% -6.0% 7.9% -1.6%

5.4% 4.6% 2.6% 4.9% 4.0%

-0.8% -2.0% 2.3% -0.9%

6.3% 5.6% 2.8% 5.3% 5.2%

-0.7% -2.8% 2.5% -0.1%Sub-Saharan Africa

Emerging and developing economies

Developing Asia

China

India

Latin America and the Caribbean

Middle East and North Africa

Table 1. Annual economic growth rates and changes in growth rates by region and selected

countries, 2001-07 and 2008 through 2011

World

Advanced economies

United States

United Kingdom

Source: IMF WEO database

Newly industrialized Asian economies

European Union

-6

-4

-2

0

2

4

6

8

2001-07 2008 2009 2010

An

nu

al g

row

th ra

te (%

)

Figure 1. Average annual economic growth rates in 2001-07, 2008, 2009 & 2010 for the 84 countries with postive and the 90 countries

negative growth rates in 2009

Growth rate in 2009 positive

Growth rate in 2009 negative

Source: IMF World Economic

Outlook database

Result: Fiscal Stimulus has been positive in lifting growth rates.

Public Investment Stimulus was high in the positive 2009 growth rate performance countries

Berlin Mayor to Resign After Criticism Over Delays to New Airport

Klaus Wowereit Blamed After Cost of Building Airport Spiraled, Europe News, Wall Street Journal. By Andrea Thomas. Aug. 26, 2014.

BERLIN—Longtime Mayor Klaus Wowereit said Tuesday he would resign in December, following years of sharp criticism over delays and cost-overruns for a new airport for the German capital. At a news conference, Mr. Wowereit cited the embarrassing delays to opening the new Berlin Brandenburg International airport as a major reason for his resignation, two years ahead of the next election. Mr. Wowereit, who also serves as chairman of the airport's supervisory board, has

been blamed for insufficient controls and the explosion of costs to more than €5 billion ($6.6 billion), from an initial estimate of around €2 billion.

Some perspectives

on Public Investment

2. Challenges Occur in Developed and Developing Countries, and at different periods of time [examples: cost overruns, inaccurate forecasting]

‘Efficiency: Unit costs of major projects’ Final Report, 25 October 2009 RGL Forensics, Frontier Economics, Aecom

Bent Flyvbjerg. Survival of the unfittest: why the worst infrastructure gets built—and what we can do about it. Oxford Review of Economic Policy, Volume 25, Number 3, 2009

Given the data presented above, a key recommendation for decision-makers, investors, and voters who care about ‘honest numbers’ is that they should not trust the budgets, patronage forecasts, and cost–benefit analyses produced by promoters of major infrastructure projects. Independent studies should be carried out and, again, such studies should be strong on empirically based risk assessment.

Public Investment Decisions [infrastructure] and optimism bias:

Investment costs are significantly underestimated => Cost Overruns Operating costs are significantly underestimated => Fiscal Pressure (tighter

budgets) Demand conditions are overestimated => lower than planned revenues or

user streams This leads to inefficient outcomes, negative returns (NPV <<0) Example For PPPs and the Private Sector: The Channel Tunnel Costs of investments exploded and demand below initial predictions. Several studies show that the economies of France and England would have been better off without the Channel Investment, by up to 12 Billion Pounds (the net loss).

3. There is an optimism bias at time of decision making

Some perspectives

on Public Investment

What goes wrong and why? • Lack of systematic approach to demand high quality

project appraisal, selection, implementation and monitoring by decision makers – Lack of government capacity – Lack of transparency and weak oversight by legislature and

public lead to lack of accountability pressures – Lack of capacity or political will by decision makers to use

appraisal results allows poorly appraised “parachuted” projects or “white elephants’ in budget

– Lack of performance budgeting and coordination • Lack of guidelines or conflicting guidelines

– Undermines internal and external ability to conduct and oversee project appraisal.

– Problem becomes more serious the greater the degree of decentralization

• Lack of additional demand data and forecasting models – Technical capacity gap in sector planning & analysis

Source: The Power of Public Investment Management. Rajaram, et al. World Bank 2014.

Public Investment Management (PIM) Study of international experience:

PIM Case study countries The World Bank has been studying PIM experience across countries to

identify how to strengthen performance • Initial core of 6 selected studies:

– Belarus, Chile, China, Ireland, Korea and Vietnam

• Further 13 cases arose from demand: – Angola, Brazil, DRC, Congo, East Timor, Mongolia, Niger, Nigeria, Peru,

Rwanda, Sierra Leone, Uganda and Zambia

• Two separate Bank initiatives: – A 2009 study of PIM in 6 Western Balkan countries: Albania, Bosnia,

Kosovo, Macedonia, Montenegro, and Serbia – A 2008 study of PIM in transport infrastructure in 7 new and older EU

member states: Ireland, Latvia, Poland, Slovakia, Slovenia, Spain and UK.

21

Country summary diagnostics

Institutional

Features

Chile

Ireland Korea

Belarus

China Vietnam Brazil East

Timor

Nigeria

Investment guidance

& preliminary

screening

Formal project

appraisal

Independent review

of appraisal

Project selection and

budgeting

Implementation

Adjustment for

changes in project

circumstances

Facility operation

Evaluation

22 Legend: Green Highest; Yellow: Middle; Red: Lowest Capacity Indexes

The new methodology and reporting has 71 middle and low income developing countries 2010 International Monetary Fund WP/11/37 Investing in Public Investment: An Index of Public Investment Efficiency

PIM functions & stages of project cycle

“Must have” PIM functions

1. Investment Guidance & Preliminary Screening

2. Formal Project Appraisal

3. Independent Review of Appraisal

4. Project Selection and Budgeting

5. Project Implementation

6. Project Adjustment

7. Facility Operation

8. Project Evaluation

Stages of project cycle

1. Identification of projects & programs

2. Design, appraisal, and screening of projects & programs with stages 1. Prefeasibility

2. Feasibility

3. Detailed blue print

3. Independent review of the appraisal

4. Budget authorization of services and appropriation of funding

5. Project implementation: procurement, contracting and monitoring

6. Ex post program or project evaluation

25

Components of project appraisal cycle

• Identification of projects and programs

– current or expected excess demand

– sector demand information and models

– consistency with strategic priorities, plans and budget

• Appraisal of projects and programs

– Components or modules of appraisal of project

1. Demand or market analysis

2. Technical/engineering (including real options)

3. Organization, ownership, human resources and financing

4. Financial analysis including real options, internalized risks and environmental costs

5. Economic analysis including external risks and environmental costs

6. Distributional analysis

26

Appraisal of projects & programs

• Methodologies: – Competing methodologies reconciled: Harberger approach

using weighted average economic prices in domestic currency values (generally accepted worldwide)

• Basic criteria in project appraisal – Net Present Values (NPVs) using Economic Cost of Capital

(EOCK) and internal rates of return (IRRs) from financial and economic perspectives • Self-financing or commercial projects: financially viable? default risks?

• Non-self financing or budget supported projects: budget support needs and availability; economic cost of public revenues

• Targeted poverty alleviation projects: cost of transfer of benefits

• Cost-effectiveness for difficult to measure benefits; also unit pricing in contracts and regulation

– Under NPV rules, VfM can also be calculated.

27

Appraisal of projects & programs

• Stages of appraisal – Prefeasibility – screening and design issues

– Feasibility – detailed design and appraisal

– Detailed blue print – basis of procurement, construction and operation

• Level of effort in appraisal – Appraisal as a project – information and alternatives (real options)

– Repetition and re-use of analysis – demand criteria

– Large projects and large programs of small similar projects

– Special approvals critical to feasibility of project completion

• Land access or allocation

• Environmental approvals (forests, land reclamation, water, etc)

• Major social externalities such as loss of property rights by indigenous people, resettlement costs or job displacement

28

Components of project appraisal cycle

• Review of appraisal – External professional review

• Budget authorization and appropriation of funding – Degrees of transparency of budgeting affects quality of appraisals and

decision making

• Project implementation: procurement/contracting & monitoring – Construction phase

– Operations phase

• Ex post project or program evaluation – Feed back to design, costing and decisions

– Portfolio analysis in addition to case by case analysis

29

Integration of project appraisal and capital budgeting into budgeting systems

• Budget preparation, approvals, length of cycles, and scope & organization – Strategic priorities & plans vs project identification and

evaluation – Filling the project pipeline with “good” projects: two basic

approvals – Mismatch in time frames of budget/political and project

cycles • Time limited authorizations vs automatic or variable length

authorizations

– Organization and management of public sector • Decentralization, dual vs integrated budgets

Strategic priorities & plans

• New projects and programs entering budget from pipeline should be consistent with strategic priorities & plans

• Quality of strategic budget depends critically on quality of – Sector planning – ability to identify and forecast excess

demand for public services

– Project costing and ex post evaluation of projects and programs to inform strategic plans of cost and expected effectiveness of new projects

• Iterative process – good project preparation & implementation enhances budget prioritization and approvals

31

Improving Project Appraisal: Roles of Central Agencies

1. Enhance demand for good project appraisal by decision makers • Transparent process creates accountability

– Opportunity cost of selecting a project should be clear: namely, good projects remaining in pipeline

• Laws required in some countries; administrative regulations or manuals in others

• Strengthen capacity of decision makers to use appraisal results

2. Publish guidelines on the conduct of project appraisal

• General and special sector manuals for all parties involved in public investment including regulated sectors and PPPs

• Formats for spreadsheets to facilitate transfer of completed feasibility studies to government decision makers

3. Strengthen the capacity to conduct project appraisal • Central core unit to maintain methods, economic prices, oversight and

technical assistance to other units

4. Improve service delivery and demand information • Sector demand forecasting models

• Performance budgeting and management

5. Strengthen review, monitoring and evaluation • Establish independent review process for feasibility studies

– Units in universities or research institutions

• Strengthen project implementation and monitoring – Budget performance and cost information feedback

• Strengthen ex post project evaluation

=> MoF provides leadership in budget reform, especially strategic and performance-based budgeting that links with capital budgeting

Improving Project Appraisal: Roles of Central Agencies

Organization & management of public sector • Roles of ministries of finance, economic planning and sectors

– Sector ministries – sector planning and co-ordination; oversight of authorities and regulation

– Economic planning • Macro planning and sector co-ordination • Sector legislation and oversight • Guidelines and methods (including economic prices)

– Finance • Budget system and project approval process • Revenue forecasting and O&M budget support

– Dual or integrated budgets: • Under dual budget, new project and program budget may be delegated to

economic planning

• Outsourcing of project appraisal – Importance of guidelines, oversight and transfer of spreadsheet models

• Donor agencies, international and other financial institutions – Conditions on project – Consistency in appraisal methods

Sample Institutional Chart - Complexity

36

Institutional Arrangements for Capital Budgeting

• A proper institutional design necessary at various levels. • Agency/Department/Line Ministry levels: appraisal/evaluation

units with skilled personnel to appraise and manage projects • Planning/Finance Ministry levels:

– Project formulation and evaluation division (including costing, demand and sector analysis if not in departments or line ministries)

– Project/Program monitoring division – Evaluation division – Statistics division

• With growing decentralization of capital investments to authorities, PPP arrangements and sub-national government, actual conduct of investment appraisal needs to be delegated, but standards and guidelines for selection and incorporation into budgets needs to be set, enforced and monitored by coordinating ministries

• Project and program appraisal capacity is critical for government to control selection of donor funded projects

Public investment modalities Performance management

mechanisms (X)

Organization of investment and service delivery

Debt finance Final revenue source

Government budget and personnel

systems

“Traditional government investment” central or local:

all stages internal to government w/o contracting out

of specific functions

Government debt Primarily public revenue; some user

charges

Legislated functions; performance agreements

“Corporatization” -- publicly owned corporation or authority or special purpose vehicle (SPV)

Government debt and/or guaranteed

corporate debt

Mixed public revenue and user charges

Contractual agreements and

contract management (or regulated)

“PPP” -- privately owned corporation or SPV

Private debt w/o government guarantees

Primarily user charges; also grants, tax incentives, rental

payments

Regulatory arrangements

(especially for price)

Regulated private corporation -- typically utilities

(electricity, telecoms, etc)

Private debt Primarily user charges; also grants,

tax incentives

X: In all cases government investment guidelines , oversight and review should apply

Impacts of investment modalities on net benefit relative to GOO

38

GOO GOO +

user

charges

BOO/T +

guarantees

BOOT +

lease

payment

BOOT

Productivity gain 0 Small pos? Small pos? Pos Pos

Added cost of risk 0 Neg Small neg Small neg Neg

Saving external cost of

public funds 0 Pos Pos 0 Pos

ExamplesPublic road Government

operated toll road

Utility with supply

contract

Facility with lease

payment

PPP toll road

Investment modality

Project parameter

GOO is similar to “public sector cost comparator” in VFM justification of PPP

Some reflections for MENA Region

1. Build or strengthen capacity for the different components of PIMs

2. Consider internal and independent (non-government) systems of appraisal & evaluations

3. Improve access to relevant data for the public and private sectors to share, in relation to public infrastructure investment

4. Explore new modalities of procurement, information and risk sharing and management (including PPPs)

5. Provide clear guidance and guidelines; for different levels of government (when applicable)

THANK YOU