A GOVERNANCE FRAMEWORK FOR INFRASTRUCTURE THAT DELIVERS PROJECTS AT THE RIGHT PRICE, IN THE RIGHT WAY, AT THE RIGHT TIME

36th Annual Meeting of OECD Senior Budget Officials, Rome, Italy, 11-12 June 2015 Ian Hawkesworth,

Head, PPP and Capital Budgeting

Budgeting and Public Expenditures Division

Public Governance and Territorial Development Directorate

OECD

• Public infrastructure investments are: – Expensive – Lumpy – Prone to going over budget – Maintenance deficit leading to accelerated

degradation – Based on standard approaches, perhaps sub-

optimal – Important, Visible, Controversial, – Complicated in governance terms

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What problems are we trying to solve with this initiative?

• Public and private investment is seen as one of the booster rockets needed to make the economy take off (e.g. the Junker plan, G20 IIWG).

• Private investment in particular has suffered post crisis and not rebounded strongly.

• Substantial infrastructure needs in both OECD and emerging economies.

• A neglected focus on governance. • A new and more vibrant modality debate

provides valuable lessons we should take into account.

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Why focus on infrastructure investment now?

The objective of the framework is to : • make the right projects happen, in a cost-efficient and

affordable manner • Provide a user centric, transparent and trusted

process. • Cover the whole infrastructure cycle.

The framework consists of two integrated components: A. A list of governance preconditions - these concern the

overall enabling governance environment for infrastructure. B. A decision tree, which guides countries about what

implementing modalities to choose based on the overall strategies and facts on the ground.

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That is why we need a new approach to infrastructure governance

CONTEXT: WHY WE NEED TO ACT

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Global growth is projected to strengthen, though remaining below long-run averages

Real GDP growth Per cent, seasonally adjusted annualised rate

Source: June 2015 Economic Outlook database.

Reduced fiscal drag—except Japan

Monetary easing—for 50% of global GDP

Currency depreciation—except US

Lower oil prices – adds 0.5% to level of global GDP 0

1

2

3

4

5

6

7

0

1

2

3

4

5

6

7

World OECD Non-OECD

1995-2007 average

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Worryingly, overall investment recovery lags previous cycles

Business investment in different cycles Cyclical peak in OECD real business fixed investment=100

(date of peak indicated)

Source: June 2015 OECD Economic Outlook database.

Sluggish investment means:

● Slower potential output growth

● Labour scarring

● Stagnant incomes, rising inequality

● Slower technology diffusion from innovation frontier 80

90

100

110

120

130

140

150

80

90

100

110

120

130

140

150

t 2 4 6 8 10 12 14 16 18 20 22 24 26 28

t=1973Q4 t=1981Q4

t=2000Q3 t=2008Q1

Quarters since the peak

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… and weak private investment has not really been offset by public investment which has been in long term decline

Note: Percent of GDP, PPP weighted. IMF Fiscal Monitor, September 2014

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Structural policy can help to revive investment, supporting inclusive growth

Estimated impact of shocks on investment Percentage change after 5 years

1. 16% reduction in OECD index of regulation in energy, transport and communications (ETCR) over 5 years, equivalent to the average pace of reduction among 15 OECD countries during the period 1993-2013.

2. Two-standard-deviation reduction in policy uncertainty corresponds to a 26% reduction.

Source: OECD calculations.

Diffusion of innovation Investment

Potential growth

Demand, jobs

0.0

0.2

0.4

0.6

0.8

1.0

1.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

Product marketliberalisation

Two-standard-deviation

reduction inpolicy

uncertainty

1% increase inforeign demand

1% increase indomesticdemand

1

2

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But as the global infrastructure needs are increasing, all pistons must fire …

Source: Standard and Poor’s; Burnett Robin (2014), “Global Infrastructure: How to Fill A $500 Billion Hole”,

• Enhance private finance opportunities • Improve infrastructure governance

(pipeline of good projects etc) • Remove unnecessary regulatory burdens

(some burdens are needed), • Target public interventions to address

specific shortfalls (Junckers plan, etc)

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… and pistons work best with higher octane fuel mix

• Quality of public governance correlates with quality public investment.

• Better managing public investment throughout the life cycle of the asset will realise substantial benefits (new!).

• The governance of infrastructure requires an integrated and systematic approach covering areas such as planning, coordination, regulation, financing and integrity.

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Good governance is a necessary condition for good infrastructure

INFRASTRUCTURE INVESTMENT IS TRICKY

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• Weak capacity for designing a strategic vision for infrastructure.

• Infrastructure impacts communities - without well managed consultation good projects may falter.

• The coordination challenge - a multiplicity of actors across levels of government may derail good projects.

• The skills challenge – lots of things need to go right. • Uncertainty with regards to revenue flows can result

in a lack of confidence in the project.

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Governance challenges 1

• The political jurisdictions and the asset’s functional ones don’t always align.

• Lack of data on performance makes it difficult to use assessment tools well.

• Adverse incentives provided by regulatory frameworks may generate suboptimal investment choices.

• Instability of the regulatory and institutional framework undermines sound decision-making.

• Infrastructure procurement is vulnerable to corruption.

• Political and business cycles can impact infrastructure.

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Governance challenges 2

GOVERNANCE PRECONDITIONS

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1. Put in place a long-term national strategic vision for the use of infrastructure ...

2. … frameworks should encourage sustainable and affordable, management and renewal of infrastructure.

3. The process … should be user-centric - rest on broad based consultations, structured engagement and access to information …

4. Coordination across levels of government and jurisdictions should be frank ... Coordination within levels of government should balance whole of government perspectives and sectoral views.

5. The appropriate skills and procedures to ensure rigorous projects assurance, affordability, value for money and transparency should be in place.

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A. Governance preconditions 1

6. Project assessments should be based on data and a balanced value for money procedure.

7. … focus on the performance of the asset throughout its life.

8. … enhance integrity and anti-corruption mechanisms

9. integrate political, sectoral, and strategic aspects in choosing delivery mode.

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A. Governance preconditions 2

DECIDING ON HOW TO DELIVER THE ASSET

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There are many ways to deliver infrastructure

Direct Provision

OECD Principles for Budgetary Governance

Traditional Procurement

OECD Principles for Integrity in Public Procurement

OECD Principles for Private Sector Participation in Infrastructure

State-Owned Enterprises

OECD Guidelines on Corporate Governance of State-Owned Enterprises

Public-Private Partnerships

OECD Principles for the Public Governance of Public-Private Partnerships

Privatization

OECD Recommendation on the Structural Separation of Regulated Industries

Regulation and regulators

Recommendation on Regulatory Policy and Governance

Co-ordination across levels of Government

Recommendation on Effective Public Investment Across Levels of Government

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OECD Relevant Policy Guidelines

An Integrated Framework

• Designed to identify ways to optimise infrastructure investment decisions – Insufficient attention given to choice of delivery mode – often

driven by expediency and habit. – Decisions relating to mode of delivery should be based on set

criteria and consider the full range of available options.

1. Set a preferred sectoral approach by assessing reform objectives and the characteristics of the sector.

2. Assess how the country circumstances (political economy, government’s capacities, private sector’s capacities, enabling legal environment, etc.) impact the sector.

3. Choose a delivery model based on the project characteristics and overall approach.

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B. The infrastructure Decision Tree

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Set a preferred sectoral approach

What are the prioritized sectoral policy objectives?

What characterizes the market and how politically sensitive is the sector?

Improving quality of services Extent of Market Failures? • Potential for competition • Non-excludability • Network effects

Improving access to infrastructure Improving efficiency Reducing the need for government

subsidies Promoting innovation Political Sensitivity?

• Equity Considerations • Environmental, land Issues • National Security

Speed of delivery Improving quality of services

⇓ Optimal sector approach

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Assess how the country circumstances impact the sector

Dimension Components Political economy • Distribution of the political resources within an

economy?

Government’s capacities • Public sector capacity for implementation, regulation, and monitoring?

Private sector’s capacities • Skills and abilities, the degree to which the market is competitive, whether there is a level playing field between incumbents and new-comers, including those from abroad?

The enabling legal environment • Clear and prudent legislation?

• Dispute resolution mechanisms?

• Legal enforcement?

• The size and financing profile of the investment - e.g. a large initial investment followed by significant operating and maintenance needs could indicate advantages to bundle the construction, operation and maintenance of the assets in a single contract.

• The potential for cost recovery from users or land value capture - e.g. for investments in sectors that have a non-excludable nature, user fees will not be practicable and the project will need to be funded via government spending

• The extent to which quality is contractible – e.g. when quality is difficult to specify and monitor, then contracts are likely to be costly and time consuming to develop, and will be highly vulnerable to renegotiation.

• The level of uncertainty – e.g. many of the most catastrophic infrastructure investments are the result of poor assumptions, often made worse by excessive optimism. In sectors where change is highly unpredictable (e.g. where technology is in flux), preferred modes of delivery should be adaptable, not locked.

• The ability to identify, assess and allocate risk appropriately – e.g. are we sure which parties should carry what risks?

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Choose a delivery model based on the project characteristics

SUMMARY AND NEXT STEPS

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– The new OECD Framework aims to help countries identify ways to optimise their infrastructure decisions.

– It provides an opportunity to assess a country’s infrastructure portfolio in an analytical and timely manner.

– It integrates a sectoral, a country and a project approach to infrastructure delivery, and the governance of such delivery.

– Move towards turning this framework into indicators and collecting comparative data.

– Conduct country reviews. – Looking forward to comments, suggestions and

ideas. 28

Summary