Macroeconomics

13 February 2017

Bridging the gap 

At a time when accommodative central bank policies – introduced in the wake of the global financial crisis – appear to have mostly outlived their usefulness, what will provide economies with the boost they need in 2017?

Developed markets, particularly in Europe, are desperate for growth. To that end, it’s likely that governments will turn next to fiscal stimulus. Following potentially prolonged debate about where and how to best allocate resources, they will seek to increase state spending, cut taxes and, in the process, almost surely assume a rising debt burden.  

Politically, focusing on infrastructure investment holds particular appeal. That’s not just because so much of the world’s railways, highways, airports, electrical grids and telecommunications towers are badly in need of an upgrade, wholesale replacement or new construction.

At least as importantly, infrastructure investment stimulates immediate growth through job creation, as well as longer-term growth thanks to increased productivity. Such investment typically has a socioeconomic rate of return of around 20%, according to McKinsey, meaning that $1 of well-spent infrastructure investment can raise GDP by 20 cents in the long run. 

Little surprise, then, that PwC predicts that annual global infrastructure spending will reach $9 trillion by 2025, more than double current levels. 

Between 2000-2015, China led the way – investing over $8 trillion in infrastructure projects, more than North America ($6.9 trillion) or Europe ($5 trillion). Since the start of its recent domestic slowdown, China has stepped up such spending to compensate for a decline in manufacturing investment – a policy that has plenty of critics. 

According to a recent report by the Saïd Business School at Oxford University: “For over half of the infrastructure investments in China made in the last three decades, the costs are larger than the benefits they generate, which means the projects destroy economic value instead of generating it.” 

Meanwhile, in the United States, Donald Trump has promised to inject $1 trillion into domestic infrastructure. It is too early to predict if such a vast package will be passed into law, or how Trump will be able to attract the kind of private-sector investment he claims will largely fund such projects, potentially through tax credits. 

Nevertheless, observers expect a significant ramping up of US infrastructure spending, substantial tax reductions, and an easing of key financial, energy and environmental regulations intended to help accelerate that effort. 

Markets are likely to continue to focus attention on infrastructure-related companies with significant exposure to the United States. Indeed, the US market should become more dynamic in coming years, while a strong US dollar should benefit European infrastructure firms active there. 

The sector is already outperforming in the US, as demonstrated by the MSCI Infrastructure indices, which measure the performance of owners and operators of infrastructure assets. 

In 2016, the MSCI Global Infrastructure Index rose almost 9%, while the US index soared by nearly 22%. Over the same period, the European index declined by more than 9% – at a time when European investors bet heavily on undervalued sectors such as financials and energy, especially in the fourth quarter. 

Over the past decade, European infrastructure investment has closely followed the business cycle, falling in the wake of the global financial crisis and again after the sovereign debt crisis. With the exception of transportation, investment levels have now recovered to at least pre-2008 levels.  

Indeed, European construction is now in the early stages of recovery, supported by rising home prices and high borrowing capacity. With upcoming elections in European states such as France, Germany and the Netherlands, we can expect greater emphasis on infrastructure spending as a vehicle of job creation. 

Meanwhile, the Investment Plan for Europe, launched in 2015 and intended to trigger €315 billion in investment through next year, is helping to finance infrastructure and innovation projects. The European Investment Bank has already approved more than €100 billion in financing, including some 175 infrastructure projects valued at over €22 billion. 

While that figure may represent just a drop in the global bucket, it’s worth noting that European infrastructure is in generally good shape, at least compared to America’s dilapidated bridges, potholed highways and underutilized rail networks. 

Moving forward, the US certainly should and likely will invest heavily. But the greatest infrastructure gap is found in emerging markets – particularly in countries like India, South Africa, Indonesia and Mexico – where some 60% of all such investment will be required over the next 15 years and where the greatest long-term opportunity lies.