Challenges to Infrastructure Investment

The large shortfall between the demand for infrastructure projects and those that are successfully implemented shows that there are many challenges facing such projects. So often they fail or at least have limited success in meeting their goals. Many attempts are made to assign reasons for the failure with a view to avoiding future pitfalls, but these exercises are not always successful—so many factors and players are involved that any post-project evaluation findings are generally equivocal if not outright disputed.

Against that background, if the project is also to span more than one country and to have a strong government interest, there are sure to be many new dimensions with a negative potential. The issues noted below are those thought to be more prominent in cross-border infrastructure projects, but they are also encountered to some degree in large national infrastructure development programs.

Funding of infrastructure projects

Governments may be able to finance their national infrastructure projects, but public sector funds are insufficient to finance cross-border projects because of their immense size and high cost. Even for national infrastructure projects, there are limitations to the traditional funding sources because there are many, and sometimes more urgent demands for the use of a government's resources. Multilateral institutions would usually fill in this funding gap, but their funding capacity is also finite because they depend on limited contributions from members, there is a higher cost of funds if raised through the market, and there are competing allocations to other various projects. Efforts to promote private sector participation require measures to provide assurance that the private sector's participation will produce an acceptable rate of return. The private sector often requests government financial guarantees of minimum returns or a subsidy to lower the cost of funds. This situation is harder for cross-border projects because of the difficulty to apportion the burden of guarantees among governments. Without guarantees or soft loans to the private sector, the cost of the projects may be too high and the government may not be able to fully recover the costs from the users of the infrastructure. In such cases, the government may have to absorb part of the costs, which will depend on its fiscal position. The option for cost recovery by divestment of government equity holdings through public offerings also has its limitations. The medium- and long-term nature of projects carries higher risks than usually associated with normal projects and as such may not be too attractive to investors. In view of the points above, the private sector will find it very difficult to lead such projects, but may become involved as a sub-contractor. In that case, a valuable (maybe irreplaceable) management contribution will not be available to the project, thereby reducing its chance of success. Government guarantees from all sides, perhaps in the form of a joint commitment (if two countries are involved) or several commitments (if more than two countries are involved) will be a necessary (but not sufficient) contribution to cross-border infrastructure projects.

Besides financing issues, the low rate of private sector participation is due to a lack of bankable projects, which limits the choice of projects that can be undertaken by the private sector based on the usual business criteria. Therefore, due to their nature as public goods, infrastructure projects cannot charge the public on a full cost recovery, but instead the government or the public sector has to include an element of subsidy for the project to be viable.

Distribution of gains and costs

Countries in East Asia are at different levels of development and have differing infrastructure needs. The costs and benefits to countries participating in cross-border infrastructure projects may differ widely. Countries have varying financial capacities to fund and participate in cross-border infrastructure projects and this situation becomes more complicated when the distribution of the gains does not match their share of the project costs. For example, in a hydroelectric power generation and distribution project, the cost is highest at the point of generating the electricity, namely, building the dam and generation plant. However, because the dam is situated in a location that is determined by geographical features, the dam may be far from the area that is the putative user of the power. That area may lie over the border in another country. The overall project design needs to balance the needs of each participant country. Each has to see an advantage that plays to its existing economic strength. This is important so that the project can be explained in the domestic political forum as providing a local benefit. In short, the project's concept has to be Win–Win. Such projects are not easy to develop, especially if adjacent countries are at very different levels of economic development.

Another aspect of this sharing of costs and benefits has to do with the spillover effects of the construction work for the projects. It is not uncommon for countries that provide funding for infrastructure projects through soft loans to make it a condition of the loan that the construction work be undertaken by companies from their own country. There are concerns that the contract terms, especially the costs, favor the contractors. Often, much of the material for the job is imported from the county funding the project, even if there are comparable materials available locally. Local companies may not get the full benefit because their role in the construction work and in supplying material is supplanted in many cases by imports.

Regulatory and legal risks

Since cross-border projects can involve regulations and legal procedures from different countries, a serious challenge is how to establish a set of rules and protocols that are acceptable to all. When more than one set of regulations and protocols has to be considered, the level of complexity rises. In addition, there is little precedent to follow, so the means of implementing and controlling each project has to be decided on a case-by-case basis. The project organization or institute tasked with drafting the project documentation or arbitrating the competing demands cannot follow an agreed custom and practice if one does not exist. Equally important is the need to agree on a dispute settlement mechanism to deal with implementation matters and issues that may arise after the completion of the project.

In Asia, institutions set up under regional infrastructure cooperation have been ad hoc. Very often, projects fail or are held up, raising costs significantly, because negotiations between governments at the regional and sub-national levels have failed. The harmonization of technical standards is also important to ensure the success of the project. A technical group established for this purpose is critical in reaching an agreement on the common standards acceptable by all countries. Agreement on technical standards is perhaps easier to achieve than that on regulatory and legal matters.

Political risk

Since infrastructure projects span a long period of time, changes in governments or policies may alter the projects' terms and conditions. This is particularly relevant for projects involving sensitive issues such as toll collections and land use by external parties because for these, the government has to win popular support. Hence, a new ruling government may want to alter the terms and conditions agreed by the previous government if they are found to be unsuitable. While the regulatory and legal risks are capable of resolution by rational means, and commercial disagreement referred to an appointed arbitrator, a project may fall victim to a political issue that is quite unrelated to the project itself. For cross-border projects, the risk may be compounded if the project is part of a wider dialogue between the participating countries meaning that the project may no longer be assessed on its own merits. Politicians may employ the project as part of a wider multifaceted accommodation, so that otherwise viable projects become impossible to succeed, or are outright cancelled. As mentioned earlier, most projects are challenging enough that they need the full support of all governments, agencies, and quasi-government agencies if they are to succeed. Since there is no supranational body in East Asia to which politically based issues can be referred for solution, the project may drag on for a long time with the project builder incurring high costs.

Currency and interest rate risk

Most projects will involve borrowing and most will involve borrowing in one currency, erecting the structure or structures using another currency, and possibly, generating funds from the operation of the structures in another currency. By their nature, most infrastructure projects take a long time to complete and during that time the currency exchange rates will change to some degree, as will the interest rates of each of those currencies. The changes cannot be predicted and covered in a project's financial plan, and the magnitude of the changes also cannot be foreseen. Interest rates can be fixed for loans in some cases, but if the amounts are massive, as they generally are, no commercial entity will be willing or able to assume the risk. Therefore, the long gestation period for construction and recovery of investment brings more uncertainty. The private sector accordingly needs a higher rate of return on investments, to compensate for that higher risk.

Environmental and social impact

Cross-border projects are normally on greenfield sites and run the risk of altering in unpredictable ways the physical and social environment of the project area. Environmental degradation has been the common criticism of infrastructure development because forests may be cleared or water flows may be diverted from their natural path. The impact on society can be equally damaging as communities may have to be relocated, which can permanently destroy their traditional way of life and cultural practices. There may be greater pressures and incentives for people to cross borders either to work for the new projects or to escape the adverse effects of construction and development. Objections to infrastructure projects on environmental and social grounds can block or delay matters indefinitely, particularly if the objections come from or are supported by international non-government organizations.

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