Investing in UK infrastructure – some important lessons from China

30 Nov

In George Osborne‘s autumn statement yesterday he promised £30bn for infrastructure building, and a National Infrastructure Plan identifying over 500 projects for the next decade. Tens of thousands of jobs are expected to be created, and a long-term boost to the British economy established. All good news, perhaps, but there are two very important lessons from China that he needs to heed if this plan is to end in success.

British roads: spending holes aplenty

Commentators have been forthcoming in their support for Osborne’s announcement. John Cridland, Confederation of British Industry (CBI) Director General, said that “we particularly welcome the new emphasis on capital spending, and the measures to leverage private sector investment on infrastructure for roads and energy”.

UK institutional investors were reportedly enthusiastic about contributing £20bn to the fund. Joanne Segars, chief executive of the National Association of Pension Funds, said earlier this week that savers’ money would be secure, as big infrastructure projects tend to be long-term, inflation-linked investments that pay out a guaranteed return.

Some saw the benefits of Osborne’s plan being more for the present than the future. ‘Certainly in terms of staving off a recession, the increase in expenditure on infrastructure will probably help,’ said Philip Shaw, economist at Investec.

It is not just Britain that recognises the national benefit of infrastructure investment. China is the current champion of large-scale projects designed to support the growth of its economy well into the current century. (See here a list of some of the more impressive Chinese investments, from huge airports to new megacities and the longest bridges in the world.)

There is no doubt that infrastructure investment is seen as a core element in China’s staggering economic growth over the past decades. “Infrastructure spending is an important way to boost consumption, and it also acts as a spur to economic growth. One need only look at China to see what can be achieved” noted Lou Jiwei, head of China’s $410bn sovereign wealth fund, China Investment Corporation (CIC), in a recent article for the FT. 

Lou continues: “In the wake of the 2008 financial crisis, the government introduced a 4tn yuan economic stimulus package, with a large part of the money directed into infrastructure. As a result China’s annual economic growth rose from 6.8% to more than 10% from late 2008 to the end of 2009.”

The problem though is that not all infrastructure projects are the same.

Simon Pilcher, head of fixed income at M&G fund managers, says: “Infrastructure as a class of assets has a massive variety of risk and return. Some are hugely geared to the economy – for example toll roads. Others, such as water and sewerage, should deliver regardless of the economic downturn, but returns should be low.”

Indeed, China has seen much variation in the returns from its national asset spending. There is in fact plenty of concern about the effectiveness and efficiency of China’s recent infrastructure programme. Many of these projects could turn out to be wealth destroyers rather than creators, white elephants that will never repay their massive debts. The new high-speed rail network – scene of a crash earlier this year that killed 40, and was blamed on the constructors cutting corners – could be one such example, as the BBC’s Damian Grammaticus notes.

Chinese infrastructure projects aren't all perfect

So here is the first Chinese lesson for the Chancellor: be careful about which infrastructure is invested in. The UK needs new assets that will add to the economy, not pet projects for vested interests that turn out to be a burden on Britain for years to come.

The second lesson concerns the issue of how to pay for it.

Despite their warm welcome for the plans, many British pension funds, the planned bedrock of this new investment, are not necessarily set up to invest in infrastructure projects. A specific type of expertise is required to fully understand the risks and to manage the investment of projects like these, and many UK funds simply do not have enough experience to be confident investors.

This means that there may be a funding shortfall for the Chancellor’s plans.

Into this breach may step foreign investors. Some of these, like Canadian and Australian pension funds, would be seen as friendly partners.

Other potential funders would not be seen in the same light, for example the Chinese Investment Corporation. On the face of it, CIC investment would be good news for Britain. China has built up good experience in infrastructure investment, and it has plenty of money to spend.

But there are concerns about China owning key UK infrastructure. Are we as a country really happy about a major foreign power owning assets that touch the lives of so many of our fellow citizens? National self-interest is paramount in Chinese politics, so how would their holding of British water structures, power plants or rail networks be affected if Sino-British relations were to sour? Add to this the fact that British and Western firms have great difficulty getting access to large-scale Chinese projects, and the imbalance and potential risks are plain to see.

Despite these risks, investment in British infrastructure should be seen as a good thing for the economy. A sound power, water and transport network will – if managed and funded correctly – provide new jobs in the short and long-term, and ensure Britain remains competitive for international business. And while we are unlikely to be able to afford some of the huge new Chinese assets, we can at least learn their lessons in how to do things correctly, and avoid the damaging pitfalls.

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5 Responses to “Investing in UK infrastructure – some important lessons from China”

  1. james hodgson November 30, 2011 at 6:32 pm #

    I agree that Infrastructure investment is a positive step forward. As to your point about national interest, it might be worth noting the recent decision by the Icelandic government not to allow the sale of 75,000 hectares of land to a wealthy Chinese businessman. However, there is a careful balance to be reached between national security concerns and the benefits of a global system that allows the free flow of capital and trade.

    • Sam Olsen December 1, 2011 at 10:50 am #

      Agreed, there is a fine line to tread. But there are plenty of funding options

  2. azizonomics December 1, 2011 at 10:56 pm #

    The unfortunate conundrum with infrastructure spending is that its real benefit is the facilitation of economic activity, rather than economic activity in itself. This means that it can take a while for the true effect to be reflected in, say, GDP, and why I see the Keynesian view of stimulus as rather superficial.

    In determining what to invest in, governments need to get a very good grasp on just what kind of facilitation the country needs. While I am a big-time China bull, there is no doubt China has misallocated a lot of capital in the last few years (e.g. Ordos), and ultimately that is something we should seek to avoid.

    This means the UK gov’t needs a good grasp on what it wants to achieve. I’d see this as black swan proofing. For me, this begins and ends with a greater degree of energy independence, and less reliance on high-debt industries like finance.

    I am concerned that a lot of energy will go to “high-impact” headline projects (e.g. bridges) that create significant employment, but don’t really achieve anything in terms of energy independence or black swan proofing.

    • Sam Olsen December 2, 2011 at 12:28 pm #

      Interesting comments. I do agree with you about making sure the Govt chooses the right projects to take forward. But I would say that it is pretty difficult to Black Swan proof at the best of times, let alone when one of most pressing considerations is in reducing unemployment. I would say that the amount of jobs created should be part of the economic case for each project, as well as the natural considerations like revenue etc. There is also the public benefit in stimulating national pride which I always think is overlooked by many: China bases a lot of its self-confidence on its achievements and the huge infrastructure projects are part of this (as they were for Victorian Britons).

      • azizonomics December 2, 2011 at 1:18 pm #

        Well by “proofing” I mean “making more resilient” rather than “preventing”. And reducing unemployment long term is one of the best means for improving resiliency to unexpected events. But yes — a huge aspect of this is restoring self-confidence — something which those riots in August among many other things show we need more of.

        My concern is that Dubai may have created a lot of sensational infrastructure, but this contributed to its financial turmoil, and its acceptance of a bailout from Abu Dhabi. We need infrastructure projects, and world-beating ones, but we can’t lose sight of the fact that projects and development must be sustainable and must leave a real legacy.

        Anyway, i’m very glad you found my blog, and i have really enjoyed reading yours. Keep up the good work!

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