McKinsey: Costs for Needed Infrastructure Can Be Reduced

by Gavin Kakol, GEI Associate

According to a recent report from the McKinsey Global Institute (MGI), worldwide infrastructure, including transportation networks, power, water, and telecommunication systems necessitate updating.  In order to maximize production, or at least maintain our current trajectory, projections call for a $57 trillion dollar infrastructure investment over the next 18 years.

That’s a 60 percent increase from the previous 18 year cycle!  The big question is: how can we dispense colossal quantities of capital when commercial debt haunts national balance sheets, resources have become ever scarcer, and the climate becomes increasingly capricious?

From an extensive analysis of over 400 case studies, MGI predicts the proper allocation of resources could result in an $18 trillion dollar reduction (40 percent)  from previous estimates. The following statement from MGI sums up the current situation appropriately:

The potential to boost productivity is s large because of failings in addressing inefficiencies and stagnant productivity in a systematic way.  On the whole, countries continue to invest in poorly conceived projects, take a long time to approve them, miss opportunities to innovate in how to deliver them, and then don’t make the most of existing assets

Some of the factors involved:

• Insufficient roadways are to blame for $101 billion of wasted time and fuel annually.

• During the previous two decades, the construction sector has seen zero productivity growth.

All else said, the task ahead won’t be easy.

(See above image larger)

The above graphic illustrates three methods used to project allocated costs necessary to maintain current productivity.  Below are their interpretations:

• Historical Spending: With 84 nations in mind, MGI used insight from the International Transportation Forum and IHS Global to determine infrastructure needs investment equivalent to 3.8 percent of total national expenditure.  Current global GDP growth estimates of 3.3 percent annually facilitate a future investment of $62 trillion dollars by 2030.

• Infrastructure Stock: GMI  identified 12 countries with tangible spending data over all assets; on average, economies invested 70 percent of their GDP into infrastructure.   Using a 70 percent model, $67 trillion of global investment will be necessary to continue course to 2030.

• External Estimates: Using independent estimates from sources including the Organization of Economic Cooperation and Development, GWI found $57 trillion dollars were needed to meet 2030’s infrastructure requirements; approximately half would be allocated to road and power projects.

However, citizens don’t necessarily have to prepare for a 60 percent net increase in taxes, and governments shouldn’t expect to borrow excessive funds either!

According to MGI, project coordinators’ proper allocation of resources could cut infrastructure costs by 40 percent. By this figure, costs would recede from $57 to $39 trillion over the next 18 years; that’s just 3 trillion more than the previous 18 years’ $36 trillion investment.

The basic framework to cut costs, “levers” as MGI puts it, are as follows:

1.  Optimize infrastructure portfolios:  Project planners need to address the source bottlenecks before increasing the project’s scope.  The planning stage of a project needs a cost-benefit analysis to decide the most effective implementation of resources.

2.  Streamline delivery: To increase overall profitability, governing agencies need to provide fast project approval.  On the other hand, project managers need to invest in early stages of planning to avoid later mistakes, saving precious time and capital. Additional lean manufacturing measures, such as advanced construction technique also warrant consideration to save costs.

3.  Make the most of existing infrastructure: Another cost saving measure would be the reworking of current infrastructure constraints.  MGI suggests a Total Cost of Ownership Approach (TCO), whereby the long-run net-profitability of restructuring is assumed.  They source road refurbishment may for example cost $12 billion, but over twenty years assume a benefit of $45 billion.

In total, these mechanisms could save $1 billion annually.  Investment spending is the prime means of maintaining and extending our production possibilities.  Investment puts people to work; MGI’s analysis shows that for a one percent increase in infrastructure investment, on average 1.5 million new jobs are created in the United States!  This phenomenon exists worldwide.

Aside from just numbers, infrastructure investment increases our standard of living; they translate into better sanitation, safe driving, and reduced incidents of power blackouts.  Part of infrastructure investment falls onto telecommunications, without which we’d lose capability to connect worldwide.

Maintaining our standard of living doesn’t have to be a tax burden or a treasury crux.  With the proper implantation of scarce resources, we can facilitate a bright future filled with growth and productivity.

References:

• Infrastructure Productivity: How to Save $1 Trillion a Year (Richard Dobbs, Herbert Pohl, Diaan-Yi Lin, Jan Mischke, Nicklas Garemo, Jimmy Hexter, Stefan Matzinger, Robert Palter, Rushad Nanavatty, McKinsey Global Institute, January 2013)

• Executive Summary

• Full Report