How can South-East Asia close its infrastructure gap?

South-East Asia requires trillions of dollars in new infrastructure over the next two decades just to keep pace with current urbanisation trends. Public and private funding is unlikely to meet this demand, leaving a gap that will affect not only public welfare, but also economic prosperity.

McKinsey research has shown, however, that governments can greatly improve the planning and structuring of major projects, cutting total costs by up to 40% and delivering greater social and economic benefits from finite resources.

The problems associated with inadequate infrastructure are felt throughout the region. In Indonesia and the Philippines, for example, about a quarter of the population remains without electricity. Staying with Indonesia, the country has about 27 kilometres of roadway for every 100 square kilometres of land, compared with 72 kilometres in the United States and 185 kilometres in Germany.

Inadequate infrastructure affects public health and well-being, contributing to air pollution, traffic congestion and slum creation, among other problems. It is also a core factor in economic weaknesses, such as low productivity, poor mobility, and decreased global competitiveness.

The task facing South-East Asia is massive. McKinsey research has shown, for instance, that ASEAN countries will need at least $7 trillion for new urban infrastructure and housing over the next two decades to accommodate current urbanization trends – an amount roughly twice Germany’s GDP. The estimate does not include investment required to maintain and restore existing infrastructure, so real investment needs are actually greater. In most South-East Asian countries, for example, more than a third of the population lives in substandard housing; in Cambodia and Laos, about 80% of the people live in slums.

Further, McKinsey research has also shown that for many well-provisioned countries, infrastructure stock, excluding housing, amounts to about 70% of GDP, while the average for South-East Asia is about 50% and would be much lower if highly developed Singapore were excluded. Countries like Indonesia, the Philippines and Vietnam would have to increase annual infrastructure spending by five to six times to reach these levels, while others, such as Malaysia and Thailand, would have to triple their current spending.

National budgets lack the money to cover these huge needs, and funding from public-private partnerships, while part of the solution, is not sufficient in the region to make up the shortfall. In addition, in many emerging economies, including those in South-East Asia, infrastructure programs compete for finite funds with other national priorities, such as public health and environmental protection.

In response, South-East Asian countries must be more diligent in assuring that infrastructure investment is spent wisely and creates as much public benefit as possible. Often, greater diligence early in the life cycle of a project can help prevent cost overruns, delays, and other problems later on.

To capture these benefits, governments must approach planning from a broad perspective. In practice, this means considering projects against the backdrop of a range of government objectives, such as environmental protection, quality of life, and sustainability. Governments too frequently consider infrastructure needs one project at a time, neglecting the project’s overall impact on other infrastructure assets or, indeed, government policies generally.

As projects are planned and designed, governments must also be vigilant to avoid common biases in infrastructure programs. For example, savings projections and use forecasts can be overly optimistic. In addition, designers often lean toward new construction, particularly in large projects, rather than squeezing more use from existing assets. Both these traps can lead to unnecessary spending and underused assets. McKinsey has also found that convening cross-functional teams from government and contractors during the planning and design phase can avoid alterations that lead to almost two-thirds of projects delays.

In addition, meticulous consideration of project structure can deliver substantial improvements. For example, well-structured contracts can encourage contractors to seek the lowest-cost solutions that meet specifications and discourage higher-cost options presented merely to avoid risk. The structure can also prompt contractors to use modern techniques, such as prefabrication and modularisation, and lean manufacturing measures to keep costs down. Provisions for enhanced oversight, such as regular inspections and audits, also can help.

To advance these measures, governments could establish an independent agency that weighs each project knowledgeably without political considerations and with a clear long-term vision that brings together the full range of government objectives. The agency should feel confident to judge projects on their merits. For example, the National Public Investment System in Chile uses standard forms, procedures, and metrics to evaluate each proposal and has recommended rejecting 25-35% of the projects it has considered. While such technical evaluations must be independent, final approval must remain with political leadership.

Without doubt, other aspects of infrastructure – financing and execution, for example – are important in delivering the greatest benefits from available funds. But effective planning and structuring can set projects on a course that avoids many problems later and allows problems that aren’t avoided to be solved more quickly.

Author: Diaan-Yi Lin, Partner, McKinsey, Singapore.

Image: A man works at a construction site of a bridge crossing in Hanoi December 30, 2011. REUTERS/Kham