How to get cash into Asian infrastructure the ADBI way
Spillover benefits from roads, railways and other projects can help lure investors. Asian Development Bank Institute's Naoyuki Yoshino explains how
Naoyuki Yoshino, the dean of the Tokyo-based Asian Development Bank Institute, or ADBI, explains a method he’s promoting to try and boost investment in roads, bridges, train systems and other infrastructure projects across Asia. The key is making projects attractive to private investors by offering new means to boost returns.
Q Could you share your views on China’s economic influence in Asia, with particular reference to the Asia Infrastructure Investment Bank launched by Beijing in December 2015?
Infrastructure development is crucial for Asia’s economic growth. This is also true for China and one reason Beijing established the new bank is because it has also need for large infrastructure spending. According to our statistics, the Southeast Asian region requires infrastructure investment of around US$40 billion a year, whereas the actual investment is US$8 billion. This illustrates the huge demand gap against a declining trend in public spending.
Asian countries are desperately in need of new railways, subways and highways to ease the crushing congestion in their growing cities. However, there is a view that attempts at public-private partnerships, or PPP, to finance Asia infrastructure have failed, such as in India. Infrastructure PPP was also tried in Thailand, but after the Lehman shock private investment pulled out because the rate of return fell sharply.
Much of the rate of return is based on so-called infrastructure user charges, such as water fees, highway tolls and train ticket prices. All these user charges are regulated by the governments because if they are too high people are discouraged from using the services. Hence the rates of return are low, especially in the first several years, which adds to the risk involved.
As Asian governments look for alternative means of investment, I am proposing a new approach that provides a higher rate of return to attract PPP investment.
Q Can you explain what that approach is and how it would work?
The focus is on tapping the so-called spillover effects of PPP infrastructure investment and a broader sharing of the revenue benefits derived from such projects. For example, if a highway is built, then companies are attracted to the transport link, they open businesses, which brings jobs, then restaurants open and so on. So these are the spillover effects. And large infrastructure projects create huge spillover effects.
After completion of the STAR highway in the Philippines, sales of offices along the highway increased and business and property taxes rose in tandem. But in the past, all the spillover benefits in the form of increased tax revenue went back to the governments. These benefits were not shared with other investors even though the additional tax revenue was a spillover effect of the highway construction.
The ADBI is establishing methodology that makes it possible to confirm the size of the tax spillover benefit and to share a proportion of that with private investors. In the case of a highway, the toll revenue combined with a share of the tax revenue will raise the rate of return for private investors and consequently make PPP infrastructure projects more attractive.
Q And how is that progressing?
I’m proposing a method known as difference-in-difference estimation. Basically, this compares rate of return from infrastructure projects that share spillover benefits with the private sector to projects in which spillover benefits are not shared.
Initial research shows that in the case of the Uzbekistan railway project, if 20% of the tax revenue benefits had been returned to private investors, then the overall rate of return would have increased 16.7%. If such a spillover benefit system had been in operation in the case of Japan’s bullet train or Shinkansen, the rate of return would have risen 33%. This is clearly a way to attract private investment for cash-strapped governments. I also propose that countries rely on domestic companies for private investment.
Q What has been the response from governments?
I was in Washington DC in December and explained this method at a conference against the backdrop of President Trump’s plans to expand infrastructure investment. The response was this could also be used in the US.
Elsewhere, the initial response is good. What is clear is that there needs to be a clear cut commitment from the start that an increase in income, property and other taxes from an infrastructure project will be shared with private investors and percentages agreed. For example, in my discussions with Vietnam where the government is struggling to build the Circle Line it can be shown that the spillover effect method will offer better returns for private investors.
Our methodology has also shown that highways have better spillover effects than railways. Highways have many exits where local businesses can be started — parking lots and markets for example that can increase local employment. I think there must be a system where local banks and companies invest in these small businesses. This will increase tax revenue and boost returns to private companies.
My method can also be applied to cross-border effects. There is the case of a highway between Pakistan and China. ADB has financed the construction on the Pakistan side and the Chinese AII will complete the China side.
‘Politicians buy land cheap before the infrastructure project starts and make profits later when prices rise. The method I’m proposing can reduce corruption as it will be transparent’
Yet another problem in infrastructure investment is land acquisition as that often faces public opposition resulting in long delays. So I am proposing the implementation of a land trust in which owners receive a rent from the tax revenue and they can retain ownership.
Another merit is achieving income diversity to reduce income inequality which is important for Asia growth. Increased income and property taxes from infrastructure projects can facilitate a progressive tax to better distribute wealth. In turn, government funds can be freed up for investment in public education when more private sector cash flows into infrastructure.
Q Is your methodology in action anywhere at the moment?
I want to start on one project to implement this method, possibly in India, Bangladesh or possibly Vietnam. If one is successful, others will follow. A project that I am pursuing is the construction of a bullet train in Bangalore and I am in talks with the Japanese government that will finance the project.
The big challenge always facing me is the politicians. Politicians buy land cheap before the infrastructure project starts and make profits later when prices rise. The method I’m proposing can reduce corruption as it will be transparent on how much tax has been collected
Q What is the experience of ADBI investment in clean energy?
In Japan we have collected money from individuals for the construction of wind plants in Japan — between US$100 and US$300 each. Each wind power plant costs about 200 million yen (US$1.8 million) and we need 250 investors. We advertise this through the Internet and have seen a good response because the trend is to move away from nuclear power. Local governments and electric companies also provide subsidies for clean energy.
Q It’s the ADB’s 50th anniversary this year. What is there to celebrate?
‘We need to meet middle class needs, which means good education and infrastructure. This is the bedrock’
We are planning a series of conferences in May in Yokohama around the 50th anniversary. We have many goals and many are in progress. We hope to work with Asian countries and I believe that establishing social equality is of crucial importance. Middle-income classes in Asia are growing and they will consume more, which is the reason that countries must move away from export oriented economies to internally oriented growth.
Therefore, we need to meet middle class needs, which means good education and infrastructure. This is the bedrock. So my idea is to bring human capital, government capital, and private capital together to generate proper wealth distribution for the continuation of Asian growth. Widening of income gaps will only bring instability.