PAYNE INSTITUTE COMMENTARY SERIES: COMMENTARY

By Jamal Saghir

November 26, 2024

Introduction

Many years of observations in developing countries make it very clear that no country can achieve sustained increases in GDP without spending on infrastructure, whether for energy services, water treatment plants, roads, railways, ports and airports, telecommunications, digital transformation, urban services, rural facilities, or environmental protection.

In fact, economic development is built on the expansion and modernization of infrastructure systems that supply basic human needs, support the movement of goods and people globally, and power industry and economies. The equitable provision of infrastructure systems and services is a key determinant of development of a country influencing all 17 Sustainable Development Goals (SDGs) and 92% of the 169 SDG targets.[1]

In many countries, the state is still delivering a sizable proportion of infrastructure services. The relative importance of the private sector has increased significantly but the public sector continues to finance and often also deliver many services. Many governments faced with fiscal constraints did try to cut their financing role in the sector during much of the last 20 years, and many succeeded in attracting private capital.

The World Bank has been compiling a database of private participation in infrastructure (PPI) projects in developing and transitional countries. According to the 2023 statistics, PPI amounted to $86.0 billion (322 projects)[2]. The energy sector investments reached $62.4 billion across 187 projects. Transport accounted for $13.8 billion in investment commitments across 46 projects, compared to $58.5 billion across 83 projects in 2022. The water and sewerage sector saw investment commitments of $1.8 billion across 19 projects compared to $5.3 billion across 27 projects in 2022. Municipal solid waste sector investments were recorded at $146 million across 11 projects. Lastly, investments in ICT sector surged $7.8 billion across 52 projects, compared to $2.4 billion across 12 projects in 2022.

While these statistics show large projects could have significant impact when properly implemented, small and medium projects could also have similar impact but also with considerable challenges. The average small infrastructure project size in 2020 was US$183 million as was the median project size—US$78 million in 2020.[3]

In terms of the contribution to investments in physical and social infrastructure, estimates indicate that infrastructure public private partnership projects (PPP), in particular represent approximately 10 percent of the yearly investment in infrastructure by developing countries’ governments and approximately 3 percent of global infrastructure spending. In addition, a number of PPPs attract a significant share of public financing, both directly or indirectly, through guarantees.[4]

This policy paper focuses on small and medium projects in infrastructure projects with an attention on some of the similarities and differences between large infrastructure projects on the one hand and small and medium projects on the other.  It also discusses certain types of small and medium projects and policy implications. It argues that the most important implication is that governments should do what they can to reduce transaction costs.  This may take the form of standardizing contracts, doing the preparatory work on innovative projects or streamlining approvals processes through concession laws. It also argues that sound policy reforms can expand available investment funding, lower investment risks, and attract more funds.

Impact of Infrastructure projects on Development Outcomes

A systematic qualitative overview of the literature undertaking by the World Bank, covering more than 300 studies conducted between 1983 and 2022 [5] focusing on specific infrastructure sectors, considered various dimensions of development impact, including output and productivity, poverty and inequality, labor market outcomes, human capital formation, and trade, concluded that infrastructure improvements are critical in supporting countries’ development process. Studies on digital infrastructure in particular show that firm productivity, employment, and welfare increase with the arrival of broadband internet coverage. In addition, according to the World Bank, the availability of mobile phones improves coordination between producers and traders and hence reduces the price dispersion of agricultural products; and investments in the reliable y of power supply also contribute to firms’ productivity.

What Makes Small and Medium Projects Distinct?

While there are obvious differences in scale and complexity, both small/medium and large infrastructure projects share similarities like the need for proper planning, adherence to regulations, stakeholder management, risk assessment, environmental considerations, and the use of similar project management methodologies, albeit adapted to the project size.

Small and medium infrastructure projects will generally perform better on cost-benefit analysis and appraisal of these projects is easier because the impacts are geographically concentrated.[6] On the other hand, small and medium infrastructure projects don’t offer the transformative potential of big projects. Small projects are not as transformational as big projects. Cost-benefit analysis only accounts for marginal benefits.

Key Similarities of small/medium and large infrastructure projects [7]

• Project Management Fundamentals: Regardless of size, all infrastructure projects require a structured approach with defined phases like initiation, planning, execution, monitoring, and closure, utilizing similar project management tools and techniques.
• Risk Assessment and Mitigation: Identifying potential risks like weather events, design flaws, budget overruns, and managing them proactively is essential for projects of all sizes.
• Stakeholder Engagement: Both small and large projects involve managing various stakeholders including government agencies, local communities, contractors, designers, and landowners, requiring clear communication and collaboration.
• Regulatory Compliance: All infrastructure projects must comply with relevant environmental, safety, and building codes, regardless of their scale.
• Environmental Impact Analysis: Assessing the potential environmental impacts and implementing mitigation strategies is a standard practice across different project scales.
• Procurement Processes: Similar procurement methods like competitive bidding or negotiated contracts can be used to select contractors for both small and large projects.
• Quality Control: Implementing quality assurance measures to ensure the project meets required standards is critical for all infrastructure projects.

What are some possible differences?
Project Scope, complexity and Budget

Large infrastructure projects typically have a much larger scope, higher budget, and longer duration compared to small and medium projects. Large projects often involve more intricate design elements, complex stakeholder dynamics, and greater technical challenges. Compared to small and medium projects, large projects usually require a larger team with specialized expertise and may necessitate more sophisticated equipment and technology.  Large infrastructure projects may face greater political scrutiny and involvement compared to smaller ones.

Transaction Costs

One area where small and medium projects could be special is that transaction costs could be relatively large.  Developing a private infrastructure project is a complex task requiring firms and governments to prepare proposals, market them, conduct bidding or negotiate deals and arrange funding.  The costs incurred in these processes include staff costs, financing costs such as placement fees and advisory fees for investment bankers, lawyers and consultants.  Some of these costs may be just as large for small projects as for large projects.  For example, the complexity of a concession contract for an urban water distribution system may not differ significantly with the size of the system.  It follows, that if at least some transaction costs are of fixed size, transaction costs are likely to be relatively larger for small projects.

One factor which may serve to reduce the relative cost of small and medium projects is that they may be reproduced several times across countries, particularly large countries.  Small projects in, say, India, China, Brazil or Nigeria could potentially be reproduced many times over.  With the development of standard approaches to transactions, preparation costs could be substantially reduced.  One should not be too bullish on the prospects for standardization, however.  Standardization of approach may be more relevant for, say, power off-take agreements than for, say, water distribution concessions which typically vary greatly from city to city.

Governments should do what they can to reduce transaction costs, and this is a lesson which applies equally well to large as to small and medium projects.  The possible advantage of small and medium projects is that they may be more susceptible to standardization of approach since they present greater opportunity for reproduction.  Some governments have tried to clarify their PPI approaches by setting out the responsibilities and rules for government officials in concession or BOT or in general government guidelines.  Such laws and guidelines help to standardize areas such as bidding processes, treatment of international arbitration or responses to unsolicited proposals.

Regulatory Capacity of Governments

Governments of small countries, and municipal or provincial governments are likely to be responsible for small and medium projects.  In small countries, such as the island economies of the Pacific or the Caribbean, there isn’t much choice about the size of projects which can be undertaken.  And in many large countries, decentralization of service provision means that many municipal governments have been given responsibility for a variety of small and medium infrastructure projects.

The difficulty presented by these small governments is that very often their regulatory capacity is fairly limited.  Regulation is a key component of successful private investment in infrastructure.  Infrastructure facilities such as electricity transmission grids or water distribution networks are natural monopolies.  If left completely unregulated, private operators of these facilities would tend to charge inefficiently high prices, so there is a need for some form of regulation, whether it be implemented through contracts or laws.  At the same time, there is a need to protect private investors, who having invested in large sunk costs are vulnerable to regulatory expropriation of their investments.  That is, flexibility in regulatory schemes may be exercised in a way which lowers the firm’s profitability below the level expected at the time of contract closure.  It is a difficult balancing act to strike ensuring that there are ongoing incentives for private investment and ensuring that private firms do not make economically excessive profits.

With less than perfect court systems in developing countries, some specialized regulatory institutions may be required.  The mandate of these institutions may be carefully circumscribed by legislation, and the legislation may specify that the institution has functions which are set out in tightly defined contracts.  To provide flexibility to survive changing circumstances, some discretions may, however, be left with these institutions.

There are a number of cases of small governments which have failed to put in effective regulatory structures before privatization.  These countries may seem like good investments for private firms, because the lack of effective supervision may provide an opportunity for monopoly rents.  This may ultimately prove to be a false economy.  The history of infrastructure has been littered with examples of initial private provision followed by nationalization as private firms have been perceived to make excessive profits.  It may ultimately be in investors’ interests to ensure that an effective regulatory regime is in place, which provides for an equitable sharing of benefits between consumers and investors.

Finding the personnel who can deal with the regulatory balancing act is a challenge for small governments.  One response to the challenge is to outsource as much as possible of the regulatory task, to specialist economic, technical or legal consultants.  However, governments still require skilled personnel to evaluate consultants’ reports and make decisions upon them.  Another complementary strategy being utilized by small governments and state or provincial governments in Australia, Canada and the United States is the creation of multi-sectoral regulatory institutions, which economies on scarce regulatory personnel and which allow lessons to be learned across different sectors.

Where responsibility for regulation rests with municipal governments, central governments may wish to consider establishing technical assistance centers for use by municipal governments, providing a pool of talent and documentation which can be drawn upon by municipal governments.  The services of a central regulatory agency could be offered to be used by municipal governments when they choose.  In municipal projects, much of the regulatory scheme may be set out in tightly defined contracts, so it becomes particularly important that these contracts strike an effective balance between the interests of consumers and regulated firms.  Central governments can help in the process of establishing these contracts by providing model contracts and encouraging pilot projects.

Financing

One area in which small and medium infrastructure projects may differ from large projects is the source of financing.  For example, many small and medium projects are undertaken by municipal or provincial governments, which could be challenging to raise international finance, because of their perceived lack of creditworthiness.

Municipal governments have become important in developing and emerging countries, as governments have shifted responsibility for service delivery closer to the consumers.  Decentralization of service delivery has been partially accompanied by revised fiscal arrangements, with increased decentralization of taxation revenues.

A more common method of raising funds for municipalities has been central-government or donor-supported “municipal development funds” (MDFs) administering a centrally provided pool of funds, acting as financial intermediaries that channel resources in the form of loans or grants and, in some cases, blended financing, providing a bridge to private credit markets, usually backed by a central government guarantee. These funds have been widely used in OECD countries and other emerging economies. They have proven to be instrumental in promoting fiscal discipline and building capacity for project development, repayment and credit history in local governments.

Beyond projects undertaken by municipalities, small and medium infrastructure projects undertaken by the private sector are less likely than large projects to rely on international financing, simply because local capital markets have greater capacity to absorb small and medium projects.  This may be a significant advantage for the political sustainability of small and medium projects, because it lessens the incidence of currency risk.

Policy Implications

Scaling up and sustaining a successful pipeline of small and medium infrastructure projects over time, requires inter alia: i) a robust policy, institutional and regulatory framework, including on assessment and management of fiscal risks and contingent liabilities; ii) an extended pipeline of bankable projects, identified through clear processes prioritize and screen projects for suitability; iii) solid project preparation and structuring capacity (considering commercial viability and risk allocation government support and affordability); and iv) strong transaction support and contract management capacity.

The most important implication of the discussions in this paper is that governments should do what they can to reduce transaction costs.  This may take the form of standardizing contracts, doing the preparatory work on innovative projects or streamlining approvals processes through concession laws.

Regulation is critical but is difficult for small governments.  It is possible to outsource regulatory tasks, limit discretions with contracts and establish multi-sectoral regulatory institutions.  Central governments may consider establishing technical assistance centers for municipal governments.

In financing, there may be opportunities for pooling risk across a range of municipal projects. Increased funding, better projects preparation, and better use of financial and risks instruments all leverage each other, increasing infrastructure services. [8]

[1] https://sdgs.un.org/goals

[2] https://ppi.worldbank.org/content/dam/PPI/documents/PPI-2023-Annual-Report-Final.pdf

[3] https://ppi.worldbank.org/content/dam/PPI/documents/PPI_2020_AnnualReport.pdf

[4] https://www.tse-fr.eu/sites/default/files/TSE/documents/doc/wp/2019/wp_tse_986.pdf

[5]https://documents1.worldbank.org/curated/en/099529203062342252/pdf/IDU0e42ae32f0048304f74086d102b6d7a900223.pdf

[6] https://www.instituteforgovernment.org.uk/explainer/big-vs-small-infrastructure-projects

[7] https://www.instituteforgovernment.org.uk/explainer/big-vs-small-infrastructure-projects

[8] https://www.csis.org/analysis/sustainable-infrastructure-development-sub-saharan-africa

ABOUT THE AUTHOR

Jamal Saghir, Professor of Practice
McGill University, Montreal, Canada

Jamal Saghir is a Professor of Practice at the Institute for the Study of International Development at McGill University, Montreal, Senior Fellow at the Payne Institute, Colorado School of Mines, Distinguished Fellow at the Institute of Financial Economics, American University of Beirut and former Director at the World Bank Group, Washington DC. He is also member of the Board of several companies and organizations.

https://www.linkedin.com/in/jamal-saghir-96453097/

Twitter: @Jamalsaghir3

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