Forbes | 11 April 2016
By Parag Khanna
While recession fears have faded as markets have rallied over the past month, there are still many reasons for pessimism. Equities look overvalued and the BIS says debt is unsustainable and will repress growth for a generation. Even a stable “new normal” is a minimal growth scenario, but more likely seems an odious “secular stagnation” of inadequate investment opportunities. Economist Robert Gordon’s new book is titled TheRise and Fall of American Growth–emphasis on the latter. To make matters worse, we are reaching “peak humanity”: A world population of 7.5 billion likely to plateau around 9 billion, with the median age of advanced economies well past their earning prime, meaning more liabilities in times of austerity. Economics is supposed to bring us predictable cycles, but all anyone can see is structural muddling.
As is often the case in life, sometimes the answer is staring us in the face, even if it seems invisible: We need more connectivity.
Good companies are connectors
Connectivity is not a thing but a category that captures the many ways we optimize the distribution of labor, resources, goods, capital and ideas. These infrastructures generally fall into the buckets of transportation (roads, railways, ports, etc.), energy (pipelines, electricity grids, etc.) and communications (cellular towers, Internet cables, data centers, etc.). The Internet, if you will, is only the newest planetary-scale conduit of connectivity. What all such infrastructures do is allow the most basic law of economics to operate more efficiently: supply and demand.
The connectivity asset class spans everything from railways to data centers. Good companies bridge connectivity gaps and ride out the highs and lows of volumes and prices. Oil and gas are cheap, but we still need Kinder Morgan. Data is free, but Google is making sure its Fibre is the conduit for it to profit from other add-on services. Uber and AirBnB are red-hot logistics companies whose breakthrough is simply unlocking the marketplace of transportation and hospitality services by ordinary people. FinTech, too, capitalizes on the rise of broadband and mobile Internet to connect individuals to financial services more efficiently.
The case for connectivity
The historical case for investing in connectivity is ironclad. During the Industrial Revolution, it the combination of new technologies and higher productivity together with an expansion of global trade raised Britain and America’s growth rates to 1-2% for more than a century. As Nobel laureate Michael Spence has argued, the internal growth of economies would never have reached today’s rates without the cross-border flows of resources, capital and technology. Since only one-quarter of world trade is between countries that share a border, connectivity is the sine qua non for growth both within countries and across them. Connectivity itself is thus a major source of momentum in the global economy. Think of the global economy like a watch whose battery is constantly charged through kinetic energy: The more you walk, the more power it has.
The financial crisis has given investment-led growth a bad reputation. Spain’s over-built society was mocked for years after 2008; its youth unemployment figures often cited as a pre-revolutionary condition. Today it is outperforming the rest of the Eurozone; solid infrastructure has meant a strong tourism rebound, export resilience and a gradual re-sorting of workers. It’s always better to have built too much than not to have built at all.
China too frequently comes under attack from Western economists deriding its “bridges to nowhere.” But as the World Bank capably demonstrated in 2014, southern China’s dense and subsidized high-speed rail network was a crucial factor in the labor force’s ability to relocate to other cities and employers during the export slump. Dongguan’s “New South China Mall,” the world’s largest shopping center, was declared a “ghost town” by CNN in 2013, but by 2015 was reported to be operating near full capacity. Whether an economy is export-led or consumption-driven, it literally can’t move without infrastructure. Alibaba, the runaway IPO success of 2015, would be impossible in India, a country of equivalent population, because the latter has nothing like China’s physical and digital infrastructure. Indian e-commerce companies simply can’t deliver to the masses the way China’s can.
The new infrastructure finance
A time when interest rates are expected to rise may seem an odd one to advocate something vaguely neo-Keynesian, but the clock on America’s infrastructure has been ticking for a long time, and it’s better late than never. After 34 transportation budget extensions lasting as little as three weeks, Congress finally passed a $300 billion infrastructure spending bill in December 2015, but it still feels like plugging holes compared to the $1.6 trillion gap estimated by the Society of Civil Engineers. America only seems to appreciate infrastructure when delivered by comedian John Oliver, whose early 2015 spoof on the sorry state of roads, bridges and dams garnered six million views on YouTube.
Rebuilding the skeleton of America’s economy for the 21st century doesn’t have to involve fiscal profligacy. Proposals for a National Infrastructure Bank have long had bipartisan support. Republican senators proposed a Build U.S.A Act in mid-2015, and democratic presidential candidate Hillary Clinton has explicitly backed a National Infrastructure Bank. Such a bank would attract private capital and allow European-style covered bonds to ensure steady financing.
With Congress eager to penalize the waves of companies conducting inversions to Ireland or other tax havens–and not yet prepared for the accelerating offshoring that a stronger dollar will encourage–now is the time to provide clear regulations and offer lower taxes for investments on American soil that can’t be offshored. In late 2015, Transportation Secretary Anthony Foxx launched a “Build America Transport Investment Center” to smooth public-private partnerships (PPPs) in many desperately lagging projects. Major asset managers such as Global Infrastructure Partners and pension funds TIAA-CREF are sensibly attracted to an asset class with lower volatility than equities, better returns than fixed income, and steady dividends.
Foreign capital has also eagerly been pouring into the U.S. due to the volatility of the financial crisis, special schemes in the construction and real estate markets, and of course the energy revolution. Mega-banks from Canada to China are financing downtown redevelopments, housing projects and toll roads, and shale gas fields–to say nothing of their eagerness to acquire American technology. Infrastructure services advisory groups such as CG/LA have emerged as strong advocates of well-orchestrated public-private partnerships with a presence across North and South America. With the U.S. economy steadying and archaic real estate taxes repealed, America is set to regain its top ranking as a global foreign investment destination, and Moody’s estimates the U.S. will become the largest infrastructure PPP market in the world.
Let’s not forget the 5 billion people of the developing world–the same population added to the planet since the end of World War II. Population growth, urbanization and exports to China together account for a significant share of the past decade’s emerging and frontier market growth surge from Africa to Southeast Asia. But now these same markets have been hit with the triple whammy of rising U.S. interest rates, falling commodities prices, and slowing Chinese growth. More than $1 trillion in capital has fled emerging markets since hints of a “taper tantrum” nearly two years ago. Africa’s commodities exports to China dropped 40 percent in 2015. Much of the developing world therefore has little time to waste in refocusing on human capital rather than resources. And yet without better connectivity, unlocking the developing world’s huge demographic potential is a lost cause. (By contrast, countries that have built supply to meet future demand–such as China and the UAE–begin to look like the role models they really are rather than the targets of Western academic derision.)
A wide array of institutional investors are willing to give emerging markets another chance. From pension funds to private equity, the allure of an organically rising urban consumer class and a significant infrastructure deficit are cause for expansion into new frontiers. Australia’s Macquarie (the world’s largest infrastructure asset manager) and Canada’s CPPIB are among the numerous mature funds presently opening more offices in India and Indonesia to capitalize on the opportunities.
In fact, it is worth remembering that many emerging markets that are not commodities export dependent are huge beneficiaries of the price collapse, allowing them to free up more capital for much-needed infrastructure projects without overly straining budgets. This is how India pulled off a nearly $1 billion commitment to capital expenditure in its 2015 budget. Asia’s billions of people across India and China all win from lower energy prices, even as the Mideast and Russia’s millions will have to tighten their belts. Overall, cheap oil is better for the world.
Importantly, growth markets are also far wiser than during the 1990s crises, much more readily willing to privatize assets to generate revenue and improve management. Pemex’s opening to foreign investment in anticipation of plummeting oil prices, which opened the door to BlackRock and First Reserve taking a 45% stake in a new gas pipeline from the U.S. to central Mexico, is emblematic of this trend. Next up are Vietnam Airlines and potentially even 10 percent of Saudi Arabia’s crown jewel Aramco.
If you want productivity, invest in connectivity
Even modern economies such as the U.S. won’t achieve their growth goals and ambitions of equitable living standards without a far greater commitment to the connectivity asset class. Ranting about productivity is all the rage among politicians and cynical economists, with all agreeing there is no silver bullet to a workforce largely comprised of people either under-qualified or at risk of displacement through automation. But the solution is, in fact, clear: mobility and access to quality education or health services all depend on better connectivity.
Hal Varian, Google’s chief economist, is spot on that we should focus much more on tools of empowerment and lowering costs than the techno-pessimists’ obsession with industrial-age productivity metrics. Is it more sad that driverless trucks will put up to 8.7 million truck drivers out of jobs, or that truck driver is still the most common job in all fifty states? Does America want to be an empire of truckers, or should we be training more IT consultants, logistics specialists, teachers and medical professionals? That’s what countries with strong vocational educational systems and low unemployment such as Germany and South Korea do.
The world’s stock of financial assets has ballooned since the 2008 crisis to more than $300 trillion, nearly four times greater than the world’s nominal GDP. For the debts created in financial markets to ever be repaid, financial supply chains are needed to spread that liquidity into value creating infrastructures and businesses. If forecasts hold such as PWC’s projection that global infrastructure investment will reach $9 trillion per year by 2025, that amounts to roughly $1 trillion for every billion people in the world. As a rule of thumb, it’s a good guide for how to put the world economy on a synchronized upward track again.