Infrastructure summit 2012 summary paper

Speakers and delegates at Economist Conferences’ Infrastructure Summit, held on November 6th 2012, discussed a range of practical and philosophical issues such as the EU’s vision, the r

The scale of infrastructure needs in the UK and across the EU is colossal But what, where, how and when proposed projects for transport, energy, utilities and technology are implemented is subject to continual and protracted debate Speakers and delegates at Economist Conferences’ Infrastructure Summit, held on November 6th 2012, discussed a range of practical and

philosophical issues such as the EU’s vision, the role of the state, what makes a city worth living

in, and how to finance projects

The following themes were among the many concerns of investors, policymakers and citizens:

• EU infrastructure plans and political and budgetary constraints

• Where the role of the state begins and ends, and who bears the costs?

• How to balance local and national interests of major projects, and measure their impact on society?

• How cities develop and connect with other cities, suburbs, regions and the wider world

• The importance of innovation, education and data in creating tomorrow’s infrastructure

• The creative ways to finance huge, long-term projects

THE INFRASTRUCTURE SUMMIT

NEw POlICY, TECHNOlOgY ANd FINANCE

INTROdUCTION

Summit chair:

Patrick lane from

The Economist

THE EU ANd ITS INFRASTRUCTURE STRATEgY

There can be no doubt about the scale of infrastructure needs in the

EU over the next two to four decades, so getting it right is crucial

The EU’s hopes and plans were laid out by Janusz lewandowski, the

EU Commissioner for Financial Programming and Budget who noted

the huge gap between the EU’s infrastructure needs and what were

realistic options given the current financial pressures Europe would

have to invest trillions of euros to achieve the transport, energy and

ICT infrastructure it needs, he said Such networks and cross-border

connections are preconditions not only of an integrated single

market but also the region’s security But the current economic

climate coupled with opposition to budget increases specifically

from the UK, mean that this may not be realised The EU needs to

launch pilot projects to gauge the most cost-efficient financing

approaches This might involve improving long-term finance ratings,

loans and guarantees, generating a strong multiplier effect in the

wider economy, and mobilising public-private partnerships (PPPs)

He re-iterated the pivotal role that the EU plays in developing Central Eastern Europe’s infrastructure: 90% of investment in Hungary, 76% in Slovakia, and 52% in Poland is co-financed by the EU The EU is targeting 12 priority corridors for investment, and high-speed secondary lines to connect hinterlands to the main EU ports It wants to integrate “energy islands” in the EU, such as the Baltic states so they are not dependent on Russian gas giant Gazprom Proposed projects also include linking the power systems

of the UK and France, and strengthening high-voltage connections to Northern Ireland, Norway and Belgium In gas, improving UK-Ireland connections are also important

His view was that the market needed “more of Europe” to solve these problems, but recognised that the EU lacks popular credibility and legitimacy, and so expanding its role is politically not feasible

He felt that the EU’s work was under-appreciated, with the media distorting the true extent of its financial claims on member states The EU budget, he stated, accounted for only 1% of EU member states budgets The much maligned administrative costs accounted for some 6% of the EU budget

He asserted that it was important for member states, especially the UK, “to shape policies, not just belong” This is especially true when it comes to creating a predictable budget to 2020 He noted some benefits that accrue to euro-sceptic nations such as the

UK, with the latter, for example, being the second biggest recipient of grants for research infrastructure in EU, which involves UK universities, such as Oxford and London’s Imperial College leading large research consortia on biological and genetic research Later, Matthias Ruete, director-general of the directorate-general of Mobility and Transport, European Commission elaborated

on the themes and practicalities of the EU’s plans He noted that in transport and logistics six EU member states are ranked in the top 10 globally, and half of the top 30 are EU countries Europe is still producing top-quality trains and cars But the continent stands to lose this important competitive advantage in coming years Given that 13% of EU household costs and 16% of business costs go on transport and logistics, and most of the EU’s oil is imported, it’s vital to ensure that the vision and activity around transport policy is right

Janusz lewandowski

Key benchmarks are set for 2030 and 2050, including the reduction of carbon emissions by 60% There are 40 concrete interrelated initiatives that involve the internal market, infrastructure, innovation and international relations Of the

10 goals, two are specifically related to the transport network, including high speed rail, road to rail and water freight The vision is for a core transport network, equivalent of interstate corridor system, and an energy and digital infrastructure This would be realised by 2030, though some would be complete by

2020 Under a motto “connect to compete”, the commission’s strategy is built around “four Is” integrated, interlinked (i.e crossborder), interoperable (i.e having common standards), and intelligent network (i.e not just roads rail, but intelligent systems, using existing capacity, air traffic management systems) Northern European transport routes might dominate European connections to Asia, but current plans were unlikely to

be affected by the potential impact of the melting ice cap

In the past, Mr Ruete admitted that the Commission got it “horribly wrong” after it attempted to determine future transport networks by simply asking people in Europe what they wanted After heads of states objected to the lack of priorities, Mr Ruete recalled that “we had a dinner” and fixed priority projects “like spaghetti on a map of Europe” There was insufficient regard paid to an effective methodology This time around, he noted, there was more consideration to hubs and ports, and the commission

“refrained from showing any map” in the first instance, but just talked about vision and concept regarding ten core multimodal corridors

Despite a funding squeeze of some 10-20% cuts, there are enough funds to undertake some of the plan, with money managed centrally using innovative financial instruments

THE ROlE OF gOvERNMENT

Mr Lewandowski’s practical thoughts on the need for member states to help shape policy was picked up in a broader sense by

Philippe Aghion, Professor of Economics, Harvard University, about what the role of the state should be in shaping tomorrow’s

infrastructure Professor Aghion re-affirmed that that infrastructure was an important precondition for economic growth, and, explained China’s superior economic performance compared with that of India Along with education, good infrastructure spurs trade and competition, and enables reallocation of resources across geographies or sectors It helps to create knowledge hubs and the connections to them

He referred to Schumpeter’s concept of creative destruction as a way to achieve innovation-driven growth, and as part of this saw

a new role for the state It had a dual responsibility: to promote growth enhancing policies while also reducing the budget deficit The post-war era was largely about “catch-up” growth, based on imitation, so the importance of competition was limited However, there is a residual distrust of anything that seems like industrial policy, or smacks of “picking winners”, which creates lobbies and vested interests A common reaction to an overbearing state of the past was to minimise its activities, by focussing just on law and order, defence etc., and to leave the rest to the private sector

“We are not a welfare state; we are not neoconservative;

we are a smart state.”

Philippe Aghion, Professor of Economics, Harvard University

Matthias Ruete

He felt that today’s modern economy needs something new –a “smart state” that is aware of knowledge externalities and credit constraints A smart state targets investments that are horizontal, (i.e education, skills inputs etc.) vertical (i.e sectoral

industrial policy such as in bio tech, green innovation) and geographical (i.e creating fast trains to knowledge hubs) Governance

is also important to make the best of these investments, so the state has a role in incentivising good governance when allocating funding, to universities or health institutions It’s not just the amount of investment but the quality Economic growth is positively correlated with high scores in international education rankings, rather than linked just to the amount of money spent Similarly, health can be cheaper and more effective, as can be seen in France or Sweden Co-financing can also be a good check on unprofitable projects

Thus, he suggested that EU structural funds’ country allocations are made conditional on being “transformative”, while loans could

be geared towards high-tech investments, focussed on the preservation of competition and with selection being “evidence based”

In short, he noted: “We are not a welfare state; we are not neoconservative; we are a smart state.”

Mariana Mazzucato, Professor of Economics, Sussex University, asked why innovation was coming from the US rather than Europe

Silicon Valley had a mission, vision and a plan, she agreed But it also had plenty of official government support Many firms went to state-backed SBIR for their initial funding She argued that we have over-hyped the role of investors in developing Silicon Valley The much-heralded features of the iPhone, for example, were government funded The NIH had spent $31bn on biotech research, and venture capital rides on that There has been huge amount of free riding on the ecosystem

Neil Rimer, a Partner at Index ventures, argued that it was true that government should fund basic research, but the vital role of

venture capital is to take something from proof of principle and concept to a sustainable business model But Ms Mazzucato added that the state was not just providing basic research Indeed, 80% of radical new drugs were state supported, with VCs mainly doing the product adaptions Therefore, it is wrong to believe that the state’s role is essentially there to provide a structure or business operating environment, within which so-called entrepreneurial revolutionaries launch their business Rather, the state has been instrumental in very direct commercial ways The view that the state should only intervene to counter market failures was wrong; this “bandage” approach is not viable Silicon Valley was not just bottom up; it was top down, with 15 government institutions involved in funding Returns to the state therefore should not just occur through the tax system Google algorithms were funded from the NFS, but the state got nothing from the billions of dollars subsequently made, and is bankrupt The problem is that “we are too fearful of picking winners.” She concluded that government should make things happen that wouldn’t have happened anyway, for example in trying to redirect the economy, stimulate private investment, and create cross-sectoral investment where there is no venture capital

Perhaps the most important role that government can play is in setting out a long term industrial strategy Peter Cochrane, Chairman and CEO, Cochrane Associates felt that insufficient thinking was happening about the UK’s long-term industrial needs

“The UK is engaged in a random walk into the future” Rapidly growing Asian economies do have a long-term vision, but in Europe only Germany has “a vision, a mission and a plan” This, he asserted, should be a major concern of policymakers and citizens as “the future will be wildly different” For example, there will be huge manufacturing capability that is unimaginable today We are already witnessing extraordinary manufacturing capacity today, with over 1bn mobiles being made and distributed annually Apple had sold three million iPads in a single weekend But this astonishing capability will increase exponentially

Neil Rimer

Mariana Mazzucato

Western economies will not be able to grow by constantly looking for efficiency savings, but rather through new, sustainable ways

of doing things, said Mr Cochrane He asserted that long-term infrastructure and technology strategy failed to join the dots, and was too random It doesn’t have to be perfect at the outset, as one always adjusts a mission midway, like any business But the

UK needed to decide what it wants to focus on, and then resource its strategy as necessary A national plan needs to be built on knowhow, on finding an area that is currently less competitive, and excelling there Singapore, for example, invests some $2.5bn in industrial R&D, far larger than similar UK investments “We can’t sit in a room with a wet towel around our heads and think we can come up with the solution, is not going to happen”

An economic model based only on money will destroy the world “The future lies in the intersection of nanotechnology,

biotechnology, ICT and Artificial Intelligence” 3D-printers is one such development that could fundamentally transform our economies One can already print a gear box Boeing is able to print 300 parts for its dream liner The world’s first bicycle and car can

be printed, he noted

Doctors can be overruled by computer algorithms that are more accurate than the judgement of professionals Technology will hit every profession, through social networks and local modifications said Mr Cochrane, adding that we will “move from shipping products to shipping designs”, the system is “going from open software to open hardware, and we are going global.”

It was a perspective that informed some of the thinking of venture capitalist Mr Rimer, a Partner at Index Ventures which seeks passionate entrepreneurs whose products could either replace an incumbent, or even create a new market from scratch He sees the situation in terms of winning a war, and this cannot be won by private enterprise alone But industries that are subsidised (such as green energy) can deter investors who are fearful of subsidies later being removed We need to price in the externalities of those initiatives that we subsidise

Yet attempts to replicate Silicon Valley’s success have failed, as Mr Cochrane pointed out He said that this was because it adopted a

“bottom up” approach, and had been developing for decades longer than the period that European policy makers have been trying

to copy it, so it was important to “forget these complexes [about no European Google or Apple] which is a very European thing”

Mr Cochrane further pointed out that the next version of Silicon Valley would involve key people distributed across many different locations rather than being clustered in the same place

“We can’t sit in a room with a wet towel around our heads

and think we can come up with the solution; it is not going to

happen… The future lies in the intersection of nanotechnology,

biotechnology, ICT and Artificial Intelligence”

Peter Cochrane, Chairman and CEO, Cochrane Associates

POlITICAl CONSIdERATIONS, COMPETINg INTERESTS ANd dIlEMMAS

Having a strategy and agreement about the overall role of the state is one thing But getting strategy implemented is quite another This requires an understanding of the highly-charged dilemmas of everyday political discourse and competing interests This cannot be avoided, given the scale of investment and the social impact that such projects are likely to have

In particular, there is a need for political consensus so that projects can be maintained over several electoral cycles, and because it involves the need to balance multiple interests in society

James Smith, Chairman, Carbon Trust, noted that we take

infrastructure for granted, and don’t want to pay for it, which

is why the state must get involved In the case of adapting to climate change, the problem lies in its incremental nature which makes it hard to identify where, when and for whom the costs

to society arises Yet some £200bn out of £500bn earmarked for infrastructure over the next decade is for energy, and this means getting realistic about what technologies we need, regarding wind power, offshore generation, carbon capture, nuclear and energy efficiency Any serious infrastructure strategy is likely to upset someone, said Mr Smith; if it doesn’t then the strategy is probably not going to be effective

A typical problem here is “planning nimbyism (Not In My Back Yard)” Shell ran into such problems when it tried to install a carbon capture facility near a village close to Amsterdam Sometimes opposition isn’t rational, yet decisions have to accommodate public opposition, and in such a case, it may means taking facilities offshore

It is important not to dismiss local and regional input into plans, and have too many decisions made in Brussels, if there is to be wider support for projects There are many lessons to be learned about winning local success for initiatives For example, main roads may be gritted in winter, but if minor roads are left out, key workers, such as teachers cannot get to work, and schools have to close The details of big projects matter for both technical and political reasons

At the same time, local investments have to consider the wider strategic vision of which they are a part Unfortunately, local organisations

do not have sufficient control over national decisions, especially in energy An example was given of how the Orkney Islands had invested heavily in energy generation for export, but now faces inadequate connections to the grid This was a lesson, applicable across Europe, about not considering complementary investments that may be required It was said that such small islands often make the mistake of presenting a begging bowl rather than a commercial pitch for funding Roy Perry, of the Assembly of European Regions, suggested that

local interest groups adopt a positive attitude of: “this is what we can give, rather than here is what we want”

José viegas, Secretary general, International Transport Forum, OECD emphasised the need to ask what these big projects are

actually intended to achieve Some governments build too much infrastructure without knowing what it was for, says Mr Viegas “If everyone is running after the same ball then you don’t have a good team” Who is doing the other things that are needed to make a plan work?, he asked We need more strategy at a European level But one also needs to capture differences and specialisation in regions localisation but also promoting centres of excellence

A major issue involving resolving competiting interest is the question of who foots the bill The problem is that societies are not ready to pay for externalities, even though some benefit enormously One approach is a “user pays” principle But will road users pay for potholes to be filled, say in the form of a “pothole tax”? (it was suggested that the only tax people willingly pay is for the lottery.) It is in fact possible to identify accurately very specific beneficiaries in some cases For example, the building of a metro station pushes up the rental or sale value of surrounding properties This is a source of revenue that the state seldom sees, and even more rarely taps Yet it would be possible to include the cost of the project in the form of a transaction tax when selling the appreciating property, and this can be calculated precisely based on property values

James Smith

A good illustration of some the political issues arising from a major long-term project is the UK’s proposed High Speed rail program (known as HS2) to connect London and the north According to Alison Munro, CEO of HS2, there is a widespread view that the UK has

fallen behind France, Japan and other industrial nations in terms of transport infrastructure, so a key objective of the planned HS2 rail link is to connect the UK’s south west and the rest

The first phase will not open before 2026 The political problem often boils down to the fact that the beneficiaries are widely dispersed but the losers are concentrated - as with a new airport - and therefore better organised and more coherent The issue then becomes how to compensate the losers

HOw SMARTER CITIES CONNECT ANd dEvElOP

These political considerations are closely related to how government and citizens envisage the future of their cities The HS2 debate is also about the vision of a city as a social and economic entity and its relationship with other cities and regions Ms Munro noted that HS2 is not only about bringing people to London, but connecting regional cities, and to create a more cohesive north as counterbalance to the south east HS2 calculates productivity gains of around £48bn net at present value over 60 years, excluding indirect spin-offs for the economy

The “intra versus inter” city theme about transport infrastructure was developed by Alexandra Jones, CEO Centre for Cities

who believed that the issue centres on a city or region’s access to skills and ideas Both types of connectivity are important But infrastructure investment must also be seen in the broader context of how a city connects with its outskirts, its centre, with surrounding commuter regions, other cities in the country and foreign cities Understanding the context applies not only to transport investment but utilities as well In the case of London, commuters commonly cross administrative boundaries to get to work, 100 miles or more away, from the midlands and the south coast, and it acts as an important gateway to other international hubs in the Europe, the US and worldwide Such interconnectivity is not always apparent in other cities While London may have

a strong impact generating jobs in say Manchester or Leeds, these regional hubs in turn, do not necessarily support their own neighbouring city economies In the case of high-skill jobs, these may concentrate in the inner-cities, so it may be necessary to link different city centres, rather than just cities to their respective outskirts

Connectivity is one vital aspect of good city planning But Elspeth Finch, director, Atkins identified three other criteria:

acknowledging the uniqueness of each city; identifying the objective of a city; and knowing what smart technologies are available and necessary to help achieve this In a similar vein, Jannis van Zanten, Strategy Adviser, City of Amsterdam, judged a city’s

success according to: “why people come to our city; can they afford it and do they want to stay.”

Different cities need to focus on what they are good at Not all cities can, or want to, do the same thing Coastal cities have different concerns to inland, or mountain cities, (e.g flooding, climate change etc.) New cities can be built afresh with smart technologies; older cities may need to be retrofitted, though older cities may be young in population and attitudes Such differences have planning implications London is expanding, and will need to absorb over a million more citizens in the next two decades Birmingham has focussed attention on reducing carbon emissions Singapore has invested in broadband technology

It was also noted that one cannot be too prescriptive as developments can have unexpected consequences The liberalisation of London’s financial sector in the 1980s led to the development of the Canary Wharf financial district a generation later But when Amsterdam sought to develop its commercial standing by increasing the supply of office space, much of this now lies empty Smart cities should be viewed as “loose fit”, where the basics facilities are made available, and then needs

Elspeth Finch

grow organically Cities don’t always need too much investment

to get innovation flowing, and it may be that planners are just making things too complicated People can create their own applications, using the city as a platform, rather than just waiting for the municipality to provide it for them Technology

or data-driven products should be made simple and intuitive, such as London’s Oyster card used to pay for train and bus travel

on London transport Too often, we say: “here’s a problem and here is the technology to solve it” Keep it simple

According to Tom Hoehn, visiting Professor at Imperial College Business School, our ability to collect huge amount of data and

combine, aggregate and analyse it allows us to create new services, such as mobile phone apps for bus timetables or car sharing clubs Data, in some respects, an additional factor of production, can be obtained for free, despite the constraints of privacy and commercial sensitivity which has made some organisations unwilling to share information about themselves or clients Policymakers may consider creating incentives to share for the common good That said, there’s plenty of scope to make better use of data that we already have, and, most crucially to let citizens know what they can do with their data TfL (Transport for London) made a conscious decision to make its data public People are then empowered to make their own smart decisions with this data This includes historic data and real time data used, for example, to monitor traffic jams, underground delays, or the availability of free city bikes Rio de Janeiro, for example, has a data control centre in which various city authorities sit together to facilitate better sharing

Speakers identified other technology and policy trends for the next few years that would impact infrastructure planning

Developments included greater use of “the cloud” and cloud-based apps, to empower the individual as much as the multinational; online social problem solving (for example, local snow clearance initiatives); digital fabrication, 3-D printing; and new materials, such as low carbon cement reinforced with fibre, not steel used to eliminate corrosion and reduce transport costs

Harry verhaar, Head of government Affairs at Philips lighting, reminded delegates that large companies also play an important

role in providing cities with technology Half a city’s energy bill is for lighting, he noted, so anything that can make lighting smarter, cheaper and safer, is important Energy savings can be equivalent to hundreds of power plants And he pointed out that Philips doesn’t need to wait for government support to do this

Sean Griffiths, Founding Director of Fashion Architecture Taste, and Reader in Architecture at University of Westminster,

reminded delegates of the ultimate purpose of technology, and cities generally, and not to discard design and beauty in the quest for efficiency He noted that most of the value of an iPhone lay in its design which was produced in California, not the production cost achieved in China He suggested we need more poets and artists to debate climate change – not simply the scientists He warned that it was too easy to overlook the emotional and cultural values that are essential to our happiness (noting also that internet dating sites and the “blackberry divorce” are important dimensions of our technological age)

EdUCATION ANd SkIllS

The less definable, but essential “softer” aspects of infrastructure development might also include the quality of education and skills A major industry complaint was that firms had to get staff up to the basic education standards that the school system should have delivered Business associations, representing over 100,000 companies, identified serious resentments about having to do remedial work on literacy, numeracy, and basic safety and teamwork skills Of course, business was prepared to spend money on the specialist skills that keep staff in employment and that spread through the supply chain But government had to provide acceptable standards of health and education Even in the US there was deemed to be more cross-party collaboration on educational goals than was apparent in the UK

There was a long and wide ranging list of problems relating to some of the practical skills too Some felt that the UK had deskilled in recent years, for example in nuclear energy, and that skills such as those in the renewable sector, were being exported rather than being kept in the country Others felt that while the UK indeed has the skills, it lacks effective integration of these skills; or that things have gone wrong because of an “infatuation with the process; where we seem to get lost in ticking boxes” Thus, we may be very good at analysing a problem but not at getting things done We also disagree on outcomes such as what the desirable benefits are, the realistic lifespan of a project, how fast our economy will we be growing in five years’ time, or what is affordable, even if it’s not the most cost effective

Tom Hoehn

Other shortcomings identified included a tendency to over-specify a project, thereby stifling innovation There was also seen to be too much “command and control” in an era when command and control management should be on the way out

Some solutions were proposed Apprenticeships should be provided as a valid alternative to our obsession with universities, especially as there are so many other ways to achieve global specialisation No institutions seemed to be feeding the huge demand for technical skills Related to this is an obsession with qualifications, with “outputs rather than outcomes” too often the mark of success Thus more should be invested in technical colleges, and on connecting the worlds of business and education Rising college fees will force students to reconsider if they really want to do a course, and if it is really right for them There was also said to be a need for better teacher training and motivation, which includes keeping teachers up to date, rather suffering from the “half-life

of knowledge” However, the successful Olympic park and massive crossrail project was given as an example of excellent project management and technical skills in the UK

RAISINg lONg-TERM FINANCE

The idea that infrastructure was always the responsibility of government is misplaced; private involvement has always been there over the centuries, simply because government doesn’t have enough money But it was argued that if you want to mobilise private capital, you have to give institutional investors a framework that allows them a long-term return If the regulatory framework is inadequate governments will have a major problem attracting investors

Mathias Burghardt, Head of Infrastructure, AXA Private Equity, noted that there had been a massive drop in project finance since

the financial crisis Over the longer term, Basel 2 and Basel 3 rules would be a disincentive for banks to lend for infrastructure projects He noted that we are in a protracted period of deleveraging But there was still an appetite, not least from Asian investors, for this asset class

This new pool of money may not be sufficient to compensate for the shortfall, but there was arguably already too much liquidity before the crisis hit Money is there, as European pension funds are slowly increasing their allocations, but investors are more cautious than before

What investors want is long-term, inflation-linked cash flows, and infrastructure projects should be a good match, providing pension funds with stable and predictable returns And yet the match often seems hard to make One reason may be that projects are highly leveraged, and it is hard to ensure stable cash flows when borrowing levels are above 50%

Another problem is alignment of interests Typically, private equity investors, with their high annual charges, often have a “buy, hold, flip” mentality But pension funds also have misaligned timescales and fees Often they prefer brownfield assets, and are scared off by greenfield funds There are plenty of institutions that will lend but deals must be carefully structured to satisfy banks, end investor and constructors It is often necessary to take construction risk and sell it on

gerassimos Thomas, director at the dg for Economic and Financial Affairs at the European Commission felt that it was not for

government to pick up the bill, but it had responsibility to attract equity and debt investors The problem, however, according to

gershon Cohen, CEO of Infrastructure Funds, lloyds Bank, was that governments often don’t know what sources of capital even

exist Pension funds, for example, may not be the best source of infrastructure financing More imaginative thinking is needed Could the retail end of the market provide a better return? There is more than enough capital, with new pools of capital opening up all over the world, but governments have to decide what is most appropriate for each project Before the financial crisis there had been too much “dumb” capital, mispricing of risk, leverage, and a tendency to go for the lowest cost of capital, under private finance initiatives (PFI), which today is not necessarily the best choice However, Mr Burghardt warned against being too innovative, to allow risk to be easily transferred The demand for deals is often overestimated and fees are set too high

“ We are reaching a tipping point where decisions have to happen on

airports, roads, railways We don’t have the luxury to continue

the debate.”

Gershon Cohen, CEO Infrastructure Funds, Lloyds Bank