BUS604: Innovation and Sustainability

Investment in sustainable infrastructure is the type of investment most critical to achieving the Global Goals: gains from most other types of investment depend on the supporting infrastructure being in place. Economists generally consider infrastructure investment as a key to growing the productive capacity of an economy. The IMF has estimated that in advanced economies, a one percentage point increase in infrastructure investment leads to a 0.4 percent rise in GDP in the first year and up to 1.5 percent rise in GDP four years out. According to some estimates, a one percent increase in infrastructure spending could increase employment in India by 3.4 million jobs.

To achieve the Global Goals, infrastructure is needed in a range of sectors – energy, transportation, agriculture, water – and in many forms, from schools and hospitals to broadband networks giving high-speed Internet access. However, unlocking the infrastructure investment needed to achieve the Global Goals requires tackling the obstacles that are choking the flow of capital to infrastructure generally. 

The total estimated infrastructure investment needs across the global economy amount to US$90 trillion over the next 15 years, or approximately US$6 trillion per year. Over 70 percent of the projected investment will be needed in emerging and developing economies. Such large infrastructure investment could have the additional benefit of reigniting global growth However, based on current levels of investment from public and private sources, the next 15 years will see a US$2-3 trillion annual shortfall in infrastructure investment. (These are higher estimates than the SDSN figures mentioned earlier due to differing methodologies, but both show a significant, multi-trillion dollar investment gap in global infrastructure). Exhibit 13 shows possible sources of finance to fill the gap.

Exhibit 13: 
Proposed annual incremental financing from different sources to close infrastructure gap

Making good the shortfall from these sources – and in the process ensuring that Global Goals infrastructure projects are fully financed – will require a significant overhaul in infrastructure financing mechanisms globally. The current architecture of public and private financing for core infrastructure is not yet up to the task. 

Historically, there has been a sharp distinction between, on the one hand, public sector projects funded by governments, multilateral development banks (MDBs), and overseas development assistance (ODA), and on the other hand, private sector growth funded by commercial banks and private investors. 

One solution is to make greater use of the ability of development finance institutions (DFIs), which include the MDBs together with sovereign wealth funds (SWFs), to mobilize much more private finance, including through blended finance. This emerging practice involves the strategic use of public capital to leverage multiple amounts of private capital. Specifically, blended finance entails public funders using market-driven risk mitigation tools to mobilize multiples of additional private capital, as outlined in the work of the Redesigning Development Finance Initiative, led by the World Economic Forum and the OECD. It is a striking example of the concept of "billions to trillions" coined during the 2015 Spring Meetings of the World Bank Group and IMF. The concept envisages converting billions of official development assistance into trillions of private capital supporting investment in developing countries. 

Other obstacles currently restricting infrastructure financing include a shortfall in DFIs' lending capacity, lack of private investment generally, lack of focus on project preparation, poor legal frameworks and protection for private investors, and the limited availability of a liquid asset class for private investors.

Closing the global infrastructure investment gap needs long-term thinking and greater collaboration between public and private entities, from the project-level up to institutions. The Commission believes that business and financial sector leaders can contribute to closing the gap in the following ways. 

First, they can advocate for different kinds of public sector engagement in infrastructure in many regions of the world. Historically, most infrastructure spending has come from public sources. However, as noted above, many developed countries, like the United States, have significantly decreased public expenditure on infrastructure. Governments may be constrained in putting a lot more money into infrastructure at present but they can do three other things to make sure projects in line with Global Goals get the funding they need. They can attract more finance from other sources by being more consistent in how they structure the finance for major projects. For example, they can take on unusual planning or unproven technology risks, reducing the risk for other investors. They can improve legal frameworks and protections for private investors. And they can increase the credibility of public institutions involved in executing projects on the ground. Business leaders should advocate strongly for these practical actions that would enable greater private sector participation in infrastructure investment and operations. 

Second, business leaders can support the revitalisation and re-orientation of DFIs. Their power to raise blended finance makes them a critical bridge between private investment and public projects. (See Box 9: Hydroelectricity from blended finance). The World Bank, for instance, can raise US$28 from international markets for every dollar put in to the bank as paid capital, as can the International Finance Corporation (IFC), which has financed over US$200 billion of private sector projects in a variety of sectors on the basis of only US$2.6 billion of paid-in capital. The IFC has now established its own fund business to manage third-party capital as well. In addition, a recent Standard & Poor analysis estimated that, under certain assumptions, the 19 largest multilateral lending institutions could increase their credit exposure by US$1 trillion without losing their current credit ratings, provided the right project selection criteria are in place. Despite this potential, at present the eight major MDBs, excluding the European Investment Bank, invest only US$35-40 billion a year in infrastructure. 

The Commission believes that the capital base of the MDBs and also the major regional development banks and DFIs should be expanded significantly and their business models re-directed towards mobilizing private finance into all areas of Global Goals financing, including infrastructure. Recognizing the critical role of the private sector in achieving the Global Goals, the three-yearly funding commitments made to the International Development Association (IDA) in December 2016 for the first time includes a private sector window to promote blended financing of development projects. The recent announcement that the World Bank is partnering with BNP Paribas to launch a set of equity-index linked 

World Bank bonds, in which the index is based on companies selected for their SDG alignment, is a further innovative step in the right direction. The Commission also believes that domestic DFIs should be strengthened and directed towards sustainable finance solutions. 

The need for more blended finance mobilized by these institutions has never been greater: if executed well, it could be the single most important lever for delivering the Global Goals. An efficient blended finance strategy, one that crowds in US$20 of private capital for each public dollar, could raise the additional US$2.4 trillion a year needed for sustainable infrastructure development at a yearly cost of only US$125 billion of public capital. Despite fiscal constraints in many countries, this aggregate amount of public investment seems feasible. However, a less efficient model, crowding in just US$5 of private capital for every public dollar, would require up to US$500 billion of additional public investment a year. This would be much harder to finance. 

"Blended finance is too important to the Global Goals to get wrong".

Data from blended finance initiatives across countries, institutions, instruments, and asset classes indicates big variations in their efficiency, with ratios of private to public capital ranging from two to one all the way up to the mid-20s to one. The Commission therefore believes it is time to take a fresh strategic look at how best to mobilize and deploy blended finance to drive sustainable investments. Blended finance is a lever whose ability to deliver the Global Goals infrastructure investment is too important to get wrong. 

There are major new pools of capital, including in the developing world, which need to generate stable, long-term positive rates of return. There is an increasing appetite to invest in asset classes that could provide additional diversification, less correlated to the main equity and bond markets, and options for large institutional investors to hedge their accumulated exposure to climate and other key risks. A growing group of private investors, both millennials and older individuals, is now benefiting from inter-generational wealth transfers and appears willing to pay more attention to the total returns of their investments. This is expanding the potential for blended finance beyond infrastructure to new fields, such as sustainable agriculture, social housing, girls' education, and off-grid clean energy provision. Leading global companies are also accessing development finance to improve the social and environmental performance of their supply chains and, in some cases, extending those supply chains into frontier countries and regions.

In 2017, the Commission will therefore seek to mobilize a task-force of leading institutional investors, sovereign wealth funds, development finance institutions, and private companies to lay out a potential "blended finance action plan" for delivering the Global Goals. Its aim will be to answer the question: "what is the most efficient way to mobilize the incremental US$2.4 trillion a year needed to deliver the Global Goals?" By including key stakeholders in the work, it will put more emphasis on action than on planning. 

Box 9: Hydroelectricity from blended finance 

Today, the Nam Theun 2 (NT2) hydroelectric dam is generating electricity in Laos, one of Asia's poorest countries, and generating national income as well. On track to generate US$2 billion in revenues over 25 years, the 1,070-MW plant could contribute significantly to development and poverty reduction in Laos. The US$1.3 billion dam was jointly financed by a host of multilateral development banks, bilateral funding agencies, and commercial banks from around the world. In all, 27 parties were involved, including the World Bank, Asian Development Bank, and French Development Agency AFD to BNP Paribas and Fortis Bank. While a portion of the electricity generated stays at home, the bulk is exported to Thailand under a 25-year fixed-price power purchase agreement, meaning a big income boost for Laos. That revenue is largely reinvested in programmes to tackle poverty, boost health and education, and improve environmental management domestically. The Nam Theun 2 Power Company, whose owners include Electricité de France, the Laos government, the Italian-Thai Development Public Co Ltd., and Thai power producer EGCO, have also sought to mitigate environmental and social impacts, investing heavily in local conservation efforts as well as new housing and infrastructure on the Nakai Plateau. For more detail, see report.businesscommission.org. 

The third thing business leaders, particularly those from the financial sector, can do to unlock infrastructure finance is to support the creation of a global, liquid asset class for infrastructure investments. Instruments for financing infrastructure are highly heterogeneous: they finance projects in different kinds of sectors (energy, transportation, social and more); create different assets (debt, equity); and are subject to different regulations depending on geography. This makes creating a tradable, liquid asset class for infrastructure investments very complicated. But despite its complexity, leaders in the global financial industry should make this goal a top priority over the next five years. Progress has been made recently, for example, by the European Financial Services Roundtable. Now more effort is needed. The Commission will try to put this topic on the G20 and Financial Stability Board agenda for 2017.