Adapted from an
article first published in the Revue Analyse
Financière (vol. 41) and the Journal of Turkish Weekly , July 30 2011
An era of budgetary hardships and government disengagement
In many ways, the 2008-2009 financial crisis and the ensuing "debt crises" currently afflicting the US and most European economies mark the end of an era soft statism started with the New Deal in 1933 (National Industrial Recovery Act, Public Works Administration") that saw a massive deployment of government resources and the advancement of state ownership across (formerly private) industries and infrastructures throughout the Western world ("Folkhemmet" in Scandinavia, "Welfare State" in the UK"). That model worked relatively well for 75 years as Russia, China and Eastern Europe stagnated under the yoke of total statism and as the primary commodities of Latin America and the Middle East were sold off at suboptimal prices.
The budgetary profligacy of G7 countries on the domestic front (Social Security, Medicare, cheap water and electricity, subsidized housings, "bridges to nowhere'") was only made possible through the continuous flow of cheap commodities from the Arabian Gulf and South America (a continent largely ruled until recently by subservient comprador bureaucracies) and cheap labor from the low-cost manufacturing platforms of Asia ("made in Taiwan" in the 1970s, then "made in China" in the 2000s), and, most importantly, cheap capital from their own central banks or from thrifty countries with current-account surpluses (China, Singapore, South Korea, Germany, Switzerland, Luxembourg, Abu Dhabi"). After decades of criticizing the macroeconomic choices of Asian and Latin American nations (and downgrading their bonds at the first sign of weakness), Western rating agencies are now increasingly chastising European governments themselves as well as the European Central Bank. Tellingly, the hastily drafted, unevenly transposed in national law, and poorly enforced EU rule on rating agencies (Règlement CE n - 1060/2009) has had little effect on the way financial analysts and economists interpret data (in itself not a bad thing) or on the potential for conflicts of interests created by the fuzzy contractual arrangements between credit rating agencies and their clients (a far more troubling issue)"
As predicted by a handful of contrarian economists, the financial balance of power has clearly shifted further away from Western governments and central banks in favor of large private agents such as investment banks and pension funds as well as Asian and Middle-Eastern sovereign wealth funds, a shift marked by the decline of formal inter-national rules, which are being progressively "superseded by more informal norms (broad standards of behavior defined in terms of rights and obligations), in a manner not unlike that of English common law -- unwritten law (lex non scripta) in lieu of written or statute law (lex scripta)". (1) The year 2011 clearly marks the beginning of a new era characterized by the de facto default of formerly "investment grade" countries such as Greece and Portugal (and the forced fire sale of vital infrastructure by those countries) despite the combined efforts of the ECB, the IMF and the EU Commission, the adoption of unprecedented austerity measures in the US (at federal and state levels) and across key European countries including Spain, Italy, Ireland and the UK (2) , and the abrupt winding down of direct public spending on infrastructure across many Western economies- with the notable exceptions of a few cash-rich Canadian and Australian provinces such as Manitoba and Western Australia.
Cash-Rich Investors with Long Liabilities
In that particularly dire economic context, governments cannot resort anymore to the worn-out Keynesian or Rooseveltian recipes based on massive borrowing to fund job-intensive infrastructure projects that allegedly "multiply" aggregate demand and reduce unemployment, with little regard for the long-term monetary and fiscal repercussions of such policies. (3) But, while carefully factoring in and monitoring the monetary and solvency consequences of public spending, Western governments still need to maintain and repair existing infrastructure assets and to build new ones to ensure the economic attractiveness of their territories, while the rapidly growing emerging countries of Asia, Eastern Europe and Latin America need to construct new facilities across the board- which will represent twice as much in GDP terms as OECD countries: "The investment requirement is enormous and the traditional provider of capital for those facilities -- government -- does not have the capital to do that anymore, so they are [increasingly] looking to the private sector to provide [a larger share of] that expenditure" . (4)
It's important to understand the growing role of these private sector investors: chief among them are pension funds, even though, according to OECD researchers, the average allocation to infrastructure only represents 1% of total assets under management by pensions- excluding indirect investment through ownership of stocks of listed utility and infrastructure companies. (5) But there are wide typology differences across regions with many large, sophisticated, pension funds in jurisdictions such as Ontario, Quebec, California, Holland, and Australia already investing more than 5% of their total assets (and typically more than a third of their "alternative" assets) in infrastructure. And, in key areas such as Scandinavia and the US (US pensions had $15.3 trillion in assets at the end of 2010, more than half of the world's total pension investments), we seem to be witnessing a rapid rise of the allocation to infrastructure, even among more traditional pension funds: "The Oregon Investment Council ["] approved its first-ever specific infrastructure allocation, which will reside within a new 5 percent allocation to alternative investments not already represented in its portfolio". (6) In 2Q 2011, 25% of the Global Pensions 100 panel respondents said they planned to implement a new allocation to infrastructure or increase an existing one this year, one of the highest figures on record.
This growing interest for infrastructure investments should come as no surprise to actuarial experts: most pension funds as well as sovereign wealth and reserve funds have long-dated liabilities, be it explicitly (pensions) or implicitly (sovereign and reserve funds, often acting as "future generations" long-term revenue diversifiers in the Arabian Gulf, Norway, Venezuela, Malaysia etc.). These large institutional investors need to protect the long-term value of their investments from inflationary debasement of currency and market fluctuations, and, if required, provide some kind of recurrent cash flow to pay for retiree benefits in the short-medium term (pensions) or to fund the acquisition of other assets (SWFs). From that perspective, infrastructure is an ideal asset class that provides tangible advantages such as long duration (thus facilitating cash flow matching with long-term liabilities), protection against inflation and statistical diversification (low correlation with "traditional' listed assets such as equity and fixed income investments), thus reducing overall portfolio volatility.