Bringing existing global infrastructure up to safety and efficiency standards and accommodating the needs of economic and population growth with new infrastructure will require US$30 trillion to be spent by 2030, the World Bank estimates.

That means governments will have to spend 6%-7% of their gross domestic product on infrastructure annually, vs the 1%-2% the industrialized world is currently spending, says Gregory Smith, president and CEO of Macquarie Power & Infrastructure Income Fund in Toronto.

Yet governments are not yet seriously tackling the issue of where the money for infrastructure repair and growth will come from. Interest is growing among pension funds and insurance companies as well as retail investors, and privatization and public/private partnerships (PPPs) may provide some solutions. But the bulk of the funding will have to come from government coffers, which could mean higher taxes and user fees.

Much of infrastructure is transportation-related — roads, bridges, rail lines, ports and airports — but it also includes water and waste management, as well as power and telecommunications structures. In addition, there is the social infrastructure of hospitals, schools, parks and community/recreation centres. Finally, there is the interdependent national networks required in the war against terrorism.

In the industrialized world, Smith says, putting enough infrastructure in place to keep pace with the growth in population and real GDP will require 3%-4% of GDP; another 3% will be needed to repair and replenish existing infrastructure. In dollar terms, in the U.S. in 2006, 6%-7% of GDP would have translated into $800 billion-$900 billion. (All figures are in U.S. dollars.) Over the next five years, the U.S. will need to spend $1.6 trillion; Europe, $1 trillion; and Asia, more than $1 trillion. Canada’s bill will be $300 billion-$400 billion.

In emerging countries, it is a somewhat different scenario. Because they don’t have a lot of existing infrastructure, most of their spending will be on new facilities needed to fuel their growth. The urban population in China and India, for example, is expected to grow by one million a week for the next 35 years, says Patricia Fee, money manager at IG International Management Ltd. in Dublin. Together, China and India are projected to spend about $180 billion a year for the foreseeable future on water infrastructure alone, vs around $90 billion currently.

Overall, China is spending about 9% of GDP, says Ani Markova, infrastructure specialist and associate manager of AGF Canadian Balanced Fund at AGF Funds Inc. in Toronto; India plans to increase its spending to 8% from 4%.

A recent CIBC World Markets Inc. report notes that China, with nine of the world’s top 50 ports, plans to spend $50 billion on additional port infrastructure over the next five years and is building 22 new intermodal terminals. Markova points out that China discharged 52 billion tons of waste water in 2005, up 26% from 2000, and notes that only about half of China’s water is treated.

In India, highways move about 70% of goods transported but still account for only 2% of the country’s road system, while India’s ports have a vessel turnaround time of three to five days vs only four to six hours in Singapore and Hong Kong, says the CIBC World Markets report.

“Everyone can see the need for infrastructure in emerging markets, but the need is equally strong in the developed world,” says Ben Heap, senior manager with the global infrastructure group at UBS Global Asset Management in New York.

It was about 10 years ago that governments and the public woke up to the issue of spending on infrastructure. Politicians have started talking about it — but it is still not a priority.

“At elections, voters are making their priorities clear — more education, better health services, more age care, stronger security,” explained Lord Macdonald of Tradeston, Macquarie’s chairman for investment banking in Europe, in a speech to an Organization for Economic Co-operation and Development forum in May. “The growing need for infrastructure investment will run far beyond the capacity of governments alone.”

Social programs are getting the bulk of government funds. Government spending on social programs in OECD countries rose to 21% of GDP in 2003 from 16% in 1980. By 2050, spending on public health and long-term care is expected to increase to 10.1%-12.8% from 6.7% in 2005, while pension payments could rise by three to four percentage points.

@page_break@Most industrialized countries have underspent on infrastructure since the 1970s. The recent collapse of bridges in the U.S. and Canada underlines the safety issue. The U.S. Federal Highway Administration estimates that 31% of U.S. bridges are either structurally deficient or functionally obsolete, says Fee, and that it will cost $19.4 billion a year to fix them.

Markova notes that the U.S. built 144,000 miles of new highways in 1960-65 but only 59,000 miles in 2000-05. The American Society of Civil Engineers has assigned an average grade of “D” to the U.S.’s infrastructure.

Smith points to estimates that 25% of Canadian treated water disappears through leakage.

Many of North America’s ports are already operating at slightly less than a 90% utilization rate and demand is rising by the equivalent of one Vancouver-sized port a year, according to CIBC World Markets.

Because decaying infrastructure is “out of sight, out of mind,” says Smith, it is easy to put off spending.

But globalization and safety issues are forcing countries to pay attention. If infrastructure is failing, their companies lose competitiveness and market share. Cities become congested, bridges collapse and natural disasters such as hurricanes leave a trail of destruction.

The longer governments put off repairing and updating infrastructure, the more it will cost. It’s like a roof, says Smith: if you don’t fix individual shingles that need repairing, you have to replace the whole roof in 10 years.

Privatization is one option for governments, and they have been vigorously pursuing it. Since the 1980s, $1 trillion in government-owned assets in OECD countries have been privatized, much of it infrastructure. Two-thirds of the privatizations in 1990-2006 have been related to utilities, transportation, telecommunications and oil facilities. In non-OECD countries, there has been about $400 billion in privatizations since 1980.

But countries vary in how much they are prepared to privatize. Railways, for example, are private in North America but public in Australia. Britain and France have privatized water treatment.

Although there is room for more privatization, there are limits to how much can be done. Privatization is only possible when an activity or service is no longer considered a public-sector priority and there is sufficient competition in the sector. Railways in Canada are a case in point: Canadian National Railway was sold to the public in 1995.

Fortunately, inves-tors are becoming increasingly aware of the benefits of investing in infrastructure. The big pension funds first saw the possibilities, recognizing that long-term infrastructure investments provide the steady cash flow that match their pension-benefit liabilities. Such investments are also a hedge against inflation. Not only does the value of real assets rise with inflation, reflecting increasing replacement costs, but most contracts to run infrastructure contain inflation indexing for fees charged.

Infrastructure is also an ideal investment for insurance companies, which have the same kind of long-term liabilities. But insurers have been slower off the mark, says James Leech, senior vice president of private capital for Ontario Teachers’ Pension Plan Board. (Leech becomes president and CEO Dec. 1.)

Retail investors are also waking up to the benefits. Retail infrastructure funds have been available in Australia and Spain for many years. Australia’s Macquarie Bank Ltd. , which had $108 billion in global infrastructure assets under management as of June 30, started Macquarie Infrastructure Group, listed on the Australian Stock Exchange, in 1996. MIG now has 31 funds worldwide — including Macquarie Power & Infrastructure Income Fund in Canada.

But it’s only recently that other large financial institutions have launched infrastructure funds.

There is no lack of private-sector assets to be tapped. The OECD has identified $18 trillion of investible assets in pension funds in OECD countries. Yet, the private sector is expected to fund only a portion of infrastructure spending, and the amount will vary by country. Fee says PPPs are expected to increase by 50% in France, Italy, Spain and Portugal and to account for 30% of their infrastructure financing by 2009; the British government expects to use them for 10%-15% of its financings.

Smith thinks the financing figure will be 10%-20% in Canada.

In some cases, the private-sector partner provides just capital; in others, it designs, maintains and operates the infrastructure over a long period, and contracts can be as long as 99 years. But ownership always remains with government.

The private sector is good at finishing projects on time and on budget, which keeps costs down. According to Smith, studies suggest that more than 90% of PPPs in Britain — which has been the leader in using PPPs, with almost 900 projects totalling $50 billion in the past 10 years — were on time and on budget, vs 75% of projects by governments done in the traditional way.

PPPs are also innovative in terms of project design, putting up sufficient capacity to meet current needs but building in the ability to expand as usage grows. Smith adds that PPPs are also good at maintenance, pointing to how quickly accidents are cleaned up and snow is removed on the Highway 407 toll road around Toronto, which he considers a model for PPPs globally.

Some private investors prefer to build new infrastructure projects, then sell the operating contract to investors that are more comfortable running infrastructure projects.

Most private investors don’t have the expertise to run PPPs, so they usually establish a corporation with a management team, appoint a chairman and elect a board of directors. They have seats on the board but not necessarily a majority of the seats. In the OTPPB’s case, the majority of directors are independent directors. “We believe in the corporate model that says the board oversees,” says Leech.

PPPs are appropriate only for projects of a certain size — $25 million is probably the threshold, says Smith. So, there is a limit on how much funding can come from PPPs. Many projects — especially at the local government level, at whose jurisdiction about half of public infrastructure falls — would cost less than that, as would as the repair of existing infrastructure.

At the other end of the scale, really massive projects would be beyond the means of private-sector investors, says Tony Roper, director of London-based HSBC Specialist Fund Management Ltd. and manager of HSBC Global Infrastructure Fund, launched last year.

Furthermore, projects are only suitable for private financing if the risks, both political and environmental, can be estimated and returns are reasonable. Returns depend on revenue. Private investors want to be confident that the user fees they need to charge to generate a good profit are affordable to the population that will use the facility and that usage will be high enough to provide the revenue.

Political risk is an obvious problem in many emerging countries, but can also rear its ugly head in areas considered politically safe. Leech points to Toronto’s Highway 407 as an example. The private partners had to take the government to court in order to change the toll-setting mechanism. The partners won, but it underlines the risk that’s inherent in any political situation.

Environmental risks include not only those that are known, such as the cleanup of sites already required by legislation or regulation, but also those that may come. Governments — at least, in the industrialized world — are trying to grapple with the potential effects of climate change and are likely to bring in new laws and regulations. Private investors will be unlikely to invest in anything in which new environment rules could produce large liabilities.

Markova thinks revenue requirements will mean that only 10% of new roads will be attractive investments for private-sector investors. The rest of the funding will fall to governments, which have yet to wrap their heads around the infrastructure funding issue. IE