Presentation by Fernando Fernholz at the 7th annual meeting of the MENA Senior Budget Officials held on 10-11 December 2014. Find more information at http://www.oecd.org/gov/budgeting

1. Improving Public Sector Infrastructure Investment
Prof. Fernando Fernholz
fernholz@duke.edu
Presentation at the
7th ANNUAL MEETING OF MIDDLE EAST AND NORTH AFRICA SENIOR BUDGET OFFICIALS. (MENA-SBO). Session 3
Abu-Dhabi, United Arab Emirates. 10-11 December 2014

2. Outline
Importance of Public Investment/Infrastructure
Raising productivity [remove bottlenecks]
The stimulus effect
Challenges
Perspectives on Public Investment
Infrastructure spending can be counter cyclical
Challenges occur over range of countries and time
There tends to be a systematic optimism bias
What can be done? A Systems Approach
Project appraisal and overall PIM Improvement
Public Private Partnerships
Some Reflections for the MENA Region

3. The Global Context

4. IS IT TIME FOR AN INFRASTRUCTURE PUSH? THE MACROECONOMIC EFFECTS OF PUBLIC INVESTMENT. Chapter 3. IMF October 2014 According to the IMF and several other sources, increased public infrastructure investment raises output in both the short and long term, particularly during periods of economic slack and when investment efficiency is high. This suggests that in countries with infrastructure needs, the time is right for an infrastructure push: borrowing costs are low and demand is weak in advanced economies, and there are infrastructure bottlenecks in many emerging market and developing economies. To be efficient, public investment must meet two conditions:
allocate to projects with the highest ratio of benefits to costs
its aggregate level must align with fiscal sustainability.

5. Needs vary over space and time

9. Key characteristics distinguish infrastructure from other capital
First, infrastructure investments are often large, capital- intensive projects “natural monopolies”—it is often more cost- effective for services to be provided by a single entity.
Second, they have significant up-front costs, but the benefits or returns accrue over very long periods of time, often many decades; this longevity (and difficulty of ascertaining adequate returns) are a challenge to private financing and provision.
Third, infrastructure investments have the potential to generate positive externalities, so that the social returns to a project can exceed the private returns it can generate for the operator.
Fourth, because of high level of public resources, there is need for high level of accountability.

10. 1. Public Investment as Counter Cyclical Policy Highlights from our Study on Active Public Investment and Fiscal Stimulus and Growth Impacts
STUDY ON COUNTER CYCLICAL POLICIES:
ROLE OF PUBLIC INVESTMENT TO STIMULATE DEMAND
Client: World Bank, 2012
Some perspectives on Public Investment

11. Region or countryAverage 2001-072008200920102011Growth rateGrowth rateGrowth rateGrowth rateGrowth rateChangeChangeChangeChange4.1%2.8%-0.7%5.3%4.0% -1.3%-3.4%5.9%-1.3% 2.4%0.1%-3.7%3.2%1.6% -2.3%-3.8%6.9%-1.6% 2.4%-0.3%-3.5%3.0%1.5% -2.7%-3.1%6.5%-1.5% 2.6%-0.1%-4.9%2.1%1.1% -2.6%-4.8%7.0%-1.0% 4.7%1.8%-0.7%8.5%4.7% -2.9%-2.5%9.2%-3.8% 2.4%0.7%-4.2%2.0%1.7% -1.7%-4.9%6.2%-0.3% 6.6%6.0%2.8%7.5%6.4% -0.6%-3.2%4.7%-1.1% 8.6%7.7%7.2%9.7%8.2% -0.9%-0.6%2.5%-1.4% 10.8%9.6%9.2%10.4%9.2% -1.2%-0.4%1.2%-1.2% 7.3%6.2%6.8%10.6%7.2% -1.1%0.6%3.9%-3.4% 3.5%4.3%-1.7%6.2%4.5% 0.7%-6.0%7.9%-1.6% 5.4%4.6%2.6%4.9%4.0% -0.8%-2.0%2.3%-0.9% 6.3%5.6%2.8%5.3%5.2% -0.7%-2.8%2.5%-0.1% Sub-Saharan AfricaEmerging and developing economiesDeveloping AsiaChinaIndiaLatin America and the CaribbeanMiddle East and North AfricaTable 1. Annual economic growth rates and changes in growth rates by region and selected countries, 2001-07 and 2008 through 2011WorldAdvanced economiesUnited StatesUnited KingdomSource: IMF WEO databaseNewly industrialized Asian economiesEuropean Union

12. -6-4-2024682001-07200820092010 Annual growth rate (%) Figure 1. Average annual economic growth rates in 2001-07, 2008, 2009 & 2010 for the 84 countries with postive and the 90 countries negative growth rates in 2009Growth rate in 2009 positiveGrowth rate in 2009 negativeSource:IMF World Economic Outlook database

13. Result: Fiscal Stimulus has been positive in lifting growth rates.
Public Investment Stimulus was high in the positive 2009 growth rate performance countries

14. Berlin Mayor to Resign After Criticism Over Delays to New Airport Klaus Wowereit Blamed After Cost of Building Airport Spiraled, Europe News, Wall Street Journal. By Andrea Thomas. Aug. 26, 2014. BERLIN—Longtime Mayor Klaus Wowereit said Tuesday he would resign in December, following years of sharp criticism over delays and cost-overruns for a new airport for the German capital. At a news conference, Mr. Wowereit cited the embarrassing delays to opening the new Berlin Brandenburg International airport as a major reason for his resignation, two years ahead of the next election. Mr. Wowereit, who also serves as chairman of the airport's supervisory board, has been blamed for insufficient controls and the explosion of costs to more than €5 billion ($6.6 billion), from an initial estimate of around €2 billion.
Some perspectives on Public Investment
2. Challenges Occur in Developed and Developing Countries, and at different periods of time [examples: cost overruns, inaccurate forecasting]

15. ‘Efficiency: Unit costs of major projects’ Final Report, 25 October 2009 RGL Forensics, Frontier Economics, Aecom

17. Bent Flyvbjerg. Survival of the unfittest: why the worst infrastructure gets built—and what we can do about it. Oxford Review of Economic Policy, Volume 25, Number 3, 2009
Given the data presented above, a key recommendation for decision- makers, investors,
and voters who care about ‘honest numbers’ is that they should not trust the budgets, patronage forecasts, and cost–benefit analyses produced by promoters of major infrastructure projects. Independent studies should be carried out and, again, such studies should be strong on empirically based risk assessment.

18. Public Investment Decisions [infrastructure] and optimism bias:
Investment costs are significantly underestimated => Cost Overruns
Operating costs are significantly underestimated => Fiscal Pressure (tighter budgets)
Demand conditions are overestimated => lower than planned revenues or user streams This leads to inefficient outcomes, negative returns (NPV <<0) Example For PPPs and the Private Sector: The Channel Tunnel Costs of investments exploded and demand below initial predictions. Several studies show that the economies of France and England would have been better off without the Channel Investment, by up to 12 Billion Pounds (the net loss).
3. There is an optimism bias at time of decision making
Some perspectives on Public Investment

19. What goes wrong and why?
•Lack of systematic approach to demand high quality project appraisal, selection, implementation and monitoring by decision makers
–Lack of government capacity
–Lack of transparency and weak oversight by legislature and public lead to lack of accountability pressures
–Lack of capacity or political will by decision makers to use appraisal results allows poorly appraised “parachuted” projects or “white elephants’ in budget
–Lack of performance budgeting and coordination
•Lack of guidelines or conflicting guidelines
–Undermines internal and external ability to conduct and oversee project appraisal.
–Problem becomes more serious the greater the degree of decentralization
•Lack of additional demand data and forecasting models
–Technical capacity gap in sector planning & analysis

20. Source: The Power of Public Investment
Management. Rajaram, et al. World Bank 2014.

21. Public Investment Management (PIM) Study of international experience: PIM Case study countries
The World Bank has been studying PIM experience across countries to identify how to strengthen performance
•Initial core of 6 selected studies:
–Belarus, Chile, China, Ireland, Korea and Vietnam
•Further 13 cases arose from demand:
–Angola, Brazil, DRC, Congo, East Timor, Mongolia, Niger, Nigeria, Peru, Rwanda, Sierra Leone, Uganda and Zambia
•Two separate Bank initiatives:
–A 2009 study of PIM in 6 Western Balkan countries: Albania, Bosnia, Kosovo, Macedonia, Montenegro, and Serbia
–A 2008 study of PIM in transport infrastructure in 7 new and older EU member states: Ireland, Latvia, Poland, Slovakia, Slovenia, Spain and UK.
21

22. Country summary diagnostics
Institutional Features
Chile
Ireland
Korea
Belarus
China
Vietnam
Brazil
East Timor
Nigeria
Investment guidance & preliminary screening
Formal project appraisal
Independent review of appraisal
Project selection and budgeting
Implementation
Adjustment for changes in project circumstances
Facility operation
Evaluation
22
Legend: Green Highest; Yellow: Middle; Red: Lowest Capacity Indexes

23. The new methodology and reporting has 71 middle and low income developing countries 2010 International Monetary Fund WP/11/37 Investing in Public Investment: An Index of Public Investment Efficiency

25. PIM functions & stages of project cycle
“Must have” PIM functions
1.Investment Guidance & Preliminary Screening
2.Formal Project Appraisal
3.Independent Review of Appraisal
4.Project Selection and Budgeting
5.Project Implementation
6.Project Adjustment
7.Facility Operation
8.Project Evaluation
Stages of project cycle
1.Identification of projects & programs
2.Design, appraisal, and screening of projects & programs with stages
1.Prefeasibility
2.Feasibility
3.Detailed blue print
3.Independent review of the appraisal
4.Budget authorization of services and appropriation of funding
5.Project implementation: procurement, contracting and monitoring
6.Ex post program or project evaluation
25

26. Components of project appraisal cycle
•Identification of projects and programs
–current or expected excess demand
–sector demand information and models
–consistency with strategic priorities, plans and budget
•Appraisal of projects and programs
–Components or modules of appraisal of project
1.Demand or market analysis
2.Technical/engineering (including real options)
3.Organization, ownership, human resources and financing
4.Financial analysis including real options, internalized risks and environmental costs
5.Economic analysis including external risks and environmental costs
6.Distributional analysis
26

27. Appraisal of projects & programs
•Methodologies:
–Competing methodologies reconciled: Harberger approach using weighted average economic prices in domestic currency values (generally accepted worldwide)
•Basic criteria in project appraisal
–Net Present Values (NPVs) using Economic Cost of Capital (EOCK) and internal rates of return (IRRs) from financial and economic perspectives
•Self-financing or commercial projects: financially viable? default risks?
• Non-self financing or budget supported projects: budget support needs and availability; economic cost of public revenues
•Targeted poverty alleviation projects: cost of transfer of benefits
•Cost-effectiveness for difficult to measure benefits; also unit pricing in contracts and regulation
–Under NPV rules, VfM can also be calculated.
27

28. Appraisal of projects & programs
•Stages of appraisal
–Prefeasibility – screening and design issues
–Feasibility – detailed design and appraisal
–Detailed blue print – basis of procurement, construction and operation
•Level of effort in appraisal
–Appraisal as a project – information and alternatives (real options)
–Repetition and re-use of analysis – demand criteria
–Large projects and large programs of small similar projects
–Special approvals critical to feasibility of project completion
•Land access or allocation
•Environmental approvals (forests, land reclamation, water, etc)
•Major social externalities such as loss of property rights by indigenous people, resettlement costs or job displacement
28

29. Components of project appraisal cycle
•Review of appraisal
–External professional review
•Budget authorization and appropriation of funding
–Degrees of transparency of budgeting affects quality of appraisals and decision making
•Project implementation: procurement/contracting & monitoring
–Construction phase
–Operations phase
•Ex post project or program evaluation
–Feed back to design, costing and decisions
–Portfolio analysis in addition to case by case analysis
29

30. Integration of project appraisal and capital budgeting into budgeting systems
•Budget preparation, approvals, length of cycles, and scope & organization
–Strategic priorities & plans vs project identification and evaluation
–Filling the project pipeline with “good” projects: two basic approvals
–Mismatch in time frames of budget/political and project cycles
•Time limited authorizations vs automatic or variable length authorizations
–Organization and management of public sector
•Decentralization, dual vs integrated budgets

31. Strategic priorities & plans
•New projects and programs entering budget from pipeline should be consistent with strategic priorities & plans
•Quality of strategic budget depends critically on quality of
–Sector planning – ability to identify and forecast excess demand for public services
–Project costing and ex post evaluation of projects and programs to inform strategic plans of cost and expected effectiveness of new projects
•Iterative process – good project preparation & implementation enhances budget prioritization and approvals
31

32. Improving Project Appraisal: Roles of Central Agencies
1.Enhance demand for good project appraisal by decision makers
•Transparent process creates accountability
–Opportunity cost of selecting a project should be clear: namely, good projects remaining in pipeline
•Laws required in some countries; administrative regulations or manuals in others
•Strengthen capacity of decision makers to use appraisal results
2. Publish guidelines on the conduct of project appraisal
•General and special sector manuals for all parties involved in public investment including regulated sectors and PPPs
•Formats for spreadsheets to facilitate transfer of completed feasibility studies to government decision makers

33. 3. Strengthen the capacity to conduct project appraisal
•Central core unit to maintain methods, economic prices, oversight and technical assistance to other units
4. Improve service delivery and demand information
•Sector demand forecasting models
•Performance budgeting and management
5. Strengthen review, monitoring and evaluation
•Establish independent review process for feasibility studies
–Units in universities or research institutions
•Strengthen project implementation and monitoring
–Budget performance and cost information feedback
•Strengthen ex post project evaluation
=> MoF provides leadership in budget reform, especially strategic and
performance-based budgeting that links with capital budgeting
Improving Project Appraisal: Roles of Central Agencies

34. Organization & management of public sector
•Roles of ministries of finance, economic planning and sectors
–Sector ministries – sector planning and co-ordination; oversight of authorities and regulation
–Economic planning
•Macro planning and sector co-ordination
•Sector legislation and oversight
•Guidelines and methods (including economic prices)
–Finance
•Budget system and project approval process
•Revenue forecasting and O&M budget support
–Dual or integrated budgets:
•Under dual budget, new project and program budget may be delegated to economic planning
•Outsourcing of project appraisal
–Importance of guidelines, oversight and transfer of spreadsheet models
•Donor agencies, international and other financial institutions
–Conditions on project
–Consistency in appraisal methods

35. Sample Institutional Chart - Complexity

36. 36
Institutional Arrangements for Capital Budgeting
•A proper institutional design necessary at various levels.
•Agency/Department/Line Ministry levels: appraisal/evaluation units with skilled personnel to appraise and manage projects
•Planning/Finance Ministry levels:
–Project formulation and evaluation division (including costing, demand and sector analysis if not in departments or line ministries)
–Project/Program monitoring division
–Evaluation division
–Statistics division
•With growing decentralization of capital investments to authorities, PPP arrangements and sub-national government, actual conduct of investment appraisal needs to be delegated, but standards and guidelines for selection and incorporation into budgets needs to be set, enforced and monitored by coordinating ministries
•Project and program appraisal capacity is critical for government to control selection of donor funded projects

37. Public investment modalities
Performance management mechanisms (X)
Organization of investment and service delivery
Debt finance
Final revenue source
Government budget and personnel systems
“Traditional government investment” central or local: all stages internal to government w/o contracting out of specific functions
Government debt
Primarily public revenue; some user charges
Legislated functions; performance agreements
“Corporatization” -- publicly owned corporation or authority or special purpose vehicle (SPV)
Government debt and/or guaranteed corporate debt
Mixed public revenue and user charges
Contractual agreements and contract management (or regulated)
“PPP” -- privately owned corporation or SPV
Private debt w/o government guarantees
Primarily user charges; also grants, tax incentives, rental payments
Regulatory arrangements (especially for price)
Regulated private corporation -- typically utilities (electricity, telecoms, etc)
Private debt
Primarily user charges; also grants, tax incentives
X: In all cases government investment guidelines , oversight and review should apply

38. Impacts of investment modalities on net
benefit relative to GOO
38
GOO GOO +
user
charges
BOO/T +
guarantees
BOOT +
lease
payment
BOOT
Productivity gain 0 Small pos? Small pos? Pos Pos
Added cost of risk 0 Neg Small neg Small neg Neg
Saving external cost of
public funds
0 Pos Pos 0 Pos
Examples
Public road Government
operated toll road
Utility with supply
contract
Facility with lease
payment
PPP toll road
Investment modality
Project parameter
GOO is similar to “public sector cost comparator” in VFM
justification of PPP

39. Some reflections for MENA Region
1.Build or strengthen capacity for the different components of PIMs
2.Consider internal and independent (non-government) systems of appraisal & evaluations
3.Improve access to relevant data for the public and private sectors to share, in relation to public infrastructure investment
4.Explore new modalities of procurement, information and risk sharing and management (including PPPs)
5.Provide clear guidance and guidelines; for different levels of government (when applicable)

40. THANK YOU