Getting more out of infrastructure to drive economic development Robert Palter, Global Head Infrastructure Practice McKinsey & Company

Economic Development 411 December 4, 2015

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Key messages

▪  Infrastructure has an important role to play in economic development

▪  The US (and the rest of the world) has as significant infrastructure gap to close and many people argue PPPs, creative financing and other capital sources are required

▪  However, there are opportunities to get more out of existing infrastructure to offset the capital shortfalls plus drive continued economic benefit

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Investments in infrastructure are amongst the highest stimulus multipliers and create more than 30,000 jobs for every $1 billion spent

SOURCE: Moodys.com; Federal Highway Administration’s (FHWA) Office of Transportation Policy Studies

1 year $ change in GDP for a given $ increase in spending

0.27

0.29

0.30

0.37

0.48

1.02

1.03

1.26

1.29

1.36

1.59

1.64

1.73

Unemployment benefits

Food stamps

Infrastructure spending

Across-the-board tax cut

Make expiring dividend and capital gains tax cuts permanent

Make income tax cuts permanent

Non-refundable tax rebate

Payroll tax holiday

Reduce corporate tax rates

Accelerated depreciation

Extend alternative minimumtax patch

Refundable tax rebate

Transfers to state governments

Moody’s estimates

For every $1 billion spent on ▪  New roads and bridges,

27,000 jobs are created ▪  Maintenance and repair of old

roads and bridges, 30,000 jobs are created ▪  Public transportation systems,

32,000 jobs are created

Other studies cite similar multipliers (e.g., White House’s report puts the spending multiplier at 1.57 versus tax cuts at 0.99)

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2.6

3.32.9

3.4

2.8

3.63.3

5.0

2.62.3

2.72.2

2.6 2.4

Germany Canada United Kingdom

France United States

Japan Sweden

Most advanced economies must raise infrastructure spending by nearly 1 percentage point of GDP to support economic development and maintain competitiveness

Gap between historical spend and estimated future spending need Percent of GDP

Estimated need

Actual spend

-1.0 -0.9

-0.6 -0.7

-0.6 -0.7

Ohio is at 3.2%

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17

15

7

48

72

28

Rail

1

Aviation

4

Transit Roads, highways,

bridges

Total

100

Parks, recreation,

schools

Energy

3

Waste

4

Water, waste water

Water transport

2

SOURCE: American Society of Civil Engineers; US Department of Transportation; McKinsey Global Institute

Transportation infrastructure

Other infrastructure Estimated infrastructure investment shortfall for the United States Percent; 100% = $1.1 trillion over 5 years

The shortfall in US infrastructure investment is felt most acutely in transportation

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Electricity

Roads

Telecom

Rail

Water

Ports

Airports

When aggressively deployed, PPPs range from 5% to 25% of infrastructure spend…not enough to close the gap

10010

100

58

901176

35

13

7 89 118

21

20 4

56

84

18

96

100

20

36

16

28

64

52

82

9

10

66

81

156

47

0

4

26

SOURCE: HM Treasury, United Kingdom; Planning Commission, India; McKinsey Global Institute analysis

Planned public, PPP, and private investment in core infrastructure Ratio per sector

United Kingdom 2011-15 100% = $257 billion

India 2007-11 100% = $485 billion

Private

Public-private partnership (PPP)

Public

64% (164)

23% (59)

13% (33)

31% (150)

64% (310)

5% (24)

Transport Energy Telecom Waste Water

Percent; $ Billions

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Cost of capital argument for economic development

§  Many observers argue that the government has the lowest cost of capital and thus should develop, own and operate all infrastructure not private enterprise

§  However, research is clear that private sector efficiency in construction and operations relative to public sector offsets the higher cost of private capital

§  Moreover, government cost of capital is likely higher than observers think and governments’ ability to raise financing is limited –  Cost of debt does not equal cost of capital –  Cost of equity in a public sector context is the tax base’s willingness to have its

taxes raised

§  Therefore, private sector should probably take on infrastructure projects where the economics support the project and governments should use their limited financing ability to undertake state/nation building projects that do not make sense for the private sector but do have long-term social and economic benefits –  Eglinton Crosstown project done as a PPP –  Ring of Fire road done through public sector financing

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Project delivery ▪  Delays in land acquisition and approvals ▪  Insufficient planning resulting in risky projects with costly claims ▪  Lack of collaboration and inappropriate tendering stifling innovation and design to

value ▪  Lean techniques and modularization in their infancy ▪  Insufficient oversight and coordination during construction resulting in delays and

claims ▪  Construction sector held back by lack of education, fragmentation, overregulation,

lack of innovation, informality

Making the most of existing infrastructure ▪  Inefficient operations as capacity bottleneck, particularly in ports, airports, and rail

stations ▪  Maintenance backlog increasing total cost of ownership ▪  High transmission and distribution losses in water and power ▪  Insufficient pricing and demand management

Project selection ▪  Blurred lines between political and technocratic aspects ▪  Unclear methods to assess and prioritize alternatives ▪  Lack of coordination between assets

Typical issues along the infrastructure value chain

SOURCE: McKinsey Global Institute

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2.7

0.4

1.70.10.2

Optimized need

0.2

Making the most of existing infrastructure

0.1

Streamlining delivery

Improving project selection/optimizing infrastructure portfolios

Infrastructure need

0.61

Global infrastructure investment need and how it could be reduced Yearly average, 2013-30 $ trillion

The $1 trillion-a-year infrastructure productivity opportunity

SOURCE: McKinsey Global Institute analysis

1 Telecom investment need beyond the scope of this paper.

Demand management

Operations and reduction of transmission and distribution losses

Optimized maintenance

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Value engineering yields significant savings – example road surface

Impact – reduced amount of hot mix base by differentiating between light and heavy traffic lanes

RW2 RW1

Reinforcement layer

Surface

Thickness of hot mix base

Heavy traffic only in left lane

Heavy traffic lane Light traffic lane

Incentives introduced to apply active

design (profit sharing)

Same thickness of hot mix base in all lanes independently from traffic expected per lane

Source of waste

SOURCE: McKinsey

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Construction productivity has been flat or falling in many advanced economies

SOURCE: OECD Labour Productivity by Industry (ISIC Rev. 3); McKinsey Global Institute analysis

120

100

140

90

130

80

110

150

0 1989 95 05 2000 2009

Labor productivity Index: 100 = 1989 for the United States, 1991 for Germany

Rest of economy

Construction

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But, rather than always looking for new money for infrastructure, technology can be used to get more out of existing infrastructure

9.7

25.0

2.7

17.0

14.0

62.0 Optimized traffic signals

39.0

National real-time traffic information system

Integrated corridor management

7.5

8.7

3.6 2.8

Commercial vehicle information systems and networks

Electronic freight management system

Maintenance decision support system

2.0

1.3

"Traditional" road capacity

Intelligent traffic management

Upper range

Lower range

Average benefit-to-cost ratios

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Emerging technologies could improve productivity in airports Beacon, thermal imaging Robotic technology

Connectivity based apparel Cashless payment

WAZE ▪  Community based traffic and navigation to enable getting more out of existing road infrastructure

iBeacon by apple

▪  Personalized Bluetooth – based location – push notifications

Thermal imaging

▪  Infrared thermal imaging camera and strategically located optical sensors to provide an estimate of how long the queue will take to pass (Vaernes)

▪  Shoe insoles placed in shoe communicate with smartphones SAT NAV and vibrate when change of direction needed, enabling faster move from A to B (airports, train stations, urban areas)

‘Super- shoes’ by D Dand

‘Ray’ by Boomerang Systems

▪  Automated parking system can be controlled and booked via an app. “Ray” parks vehicles dropped off at the designated area (Dusseldorf airport)

▪  Increase parking area by 60%

HENN – NA

▪  Hotel 90% operated by robots from check-in to in-room butler (Nagasaki, Japan)

▪  Facebook- and twitter- based, cash-less payment offered to customer via private message with link to preferred payment method

Social media- based payment by KLM

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But, do these technologies create value for infrastructure asset owners and operators? US airport case example

16.814.514.4

Piloting and refining Maturity

+16%

Pre-launch baseline

Average retail, food, and beverage spend per passenger

USD

Oct 13-Apr 14 May 14-Dec 14 Jan 15-May 15

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What does this all mean for a community like Columbus and greater Ohio?

•  There are many technology solutions that apply to urban and rural infrastructure assets which could unlock more potential from those assets, delay the need for more capital and improve economic development and competitiveness in Ohio

•  While infrastructure is – by definition – very local, successfully building and maintaining competitive infrastructure (and thus a competitive economy) requires municipal, state and local governments to work together

•  PPPs are likely more attractive to larger urban projects vs rural community building type projects that will have long-term economic benefit but need short-term economic support. However, Ohio will need both types of financing to ensure competitive infrastructure and economic development

•  We are now at a time when all stakeholders in infrastructure need to innovate their approaches to project selection, planning, financing, construction and operations. Governments can lead the charge on this front

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THANK YOU