This memo was sent in response to the Planning Committee's Workshop Announcement and Proposed Program. Although it was not written as a blog entry, it may be of interest to a broader audience, and thus I am posting it here.

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April 5, 2007 -- I read with great interest the draft announcement of the workshop on the development of sustainable infrastructures in developing countries. The problem of creating infrastructure in emerging countries is indeed challenging and worthy of fresh funding and analysis.

Despite billions of dollars in aid and myriad private sector and multilateral attempts and models, it has proven very difficult to develop advanced infrastructure networks in emerging countries under the auspices of highly bureacratic and sometimes corrupt and volatile governmental regimes, and many attempted projects now stand as white elephants. And with the failures, infrastructure has fallen out of favor in many development circles, despite the overwhelming positive benefits of enhancing economic development and overall quality of life that could be achieved if better infrastructure could be provided!

In the Collaboratory for Research on Global Projects at Stanford University, we have been exploring the topic of sustainable infrastructure development in emerging countries for a number of years. Our work has been conducted primarily with industry money thru our annual General Counsels' Roundtable series. As an outcome of the Roundtable series, we have recently published 18 background papers and proceedings documents as a special issue in Transnational Dispute Management. The title of the special issue is "The Legacy and Lessons of Distressed and Failed Infrastructure Investments in the 1990s".

Based on the work of the Roundtable and the Collaboratory, I have two comments to submit to the planning committee:

1) The Failure of Infrastructure Finance Models in Emerging Countries The absence of advanced infrastructure networks in emerging countries is not wholly an engineering problem, it is largely a problem of inadequate governance, regulation and financing. Please allow me to elaborate; there are three general models on which infrastructure has been financed worldwide over the past century, and each faces its own unique difficulties when applied in the emerging markets context:

a) Public Financing - Most emerging markets governments are fiscally constrained, and are limited in their capacity to raise financing by issuing bonds in the international capital markets due to low ratings and high costs of borrowing.

b) International Aid Model - The international aid model with financing provided by multilateral institutions has provided limited success, despite billions upon billons of dollars being allocated to infrastructure worldwide over a period of 40+ years. For a recent review of the past 20 years of successes and failures of the World Bank's program on infrastructure development, see here.

c) Public-Private Partnerships - The private sector provision of large scale infrastructure, although trumpeted by the Bank thru the 1990s, has had a mixed track-record in emerging markets. A majority of independent power projects set up in the 1990s have been cancelled or renegotiated; and an even greater number of private water projects have come under distress. Based on the work of our Roundtable, we believe the reason foreign financing of infrastructure in emerging markets has largely dried up is the difficulty of protecting the rights of private investors. At its nub, there are three interlinked problems:

• The Political risk problem - How do you tie the hands of a sovereign? How do you get a host government to make credible commitments? And to keep its promises? Even with changes in political leadership and political parties? And if you can;t do this, then you have the...

• The Legal-contracting problem - How do you write a contractual agreement that will sustain over successive changes in governments, economic conditions, and social attitudes? So that lenders have reasonable certainty that their loans will be repaid? And if you can't do this, then you have the...

• The Financing problem - How do you get private-sector equity providers and lenders to come in, if they are not assured of a return on their investment? If they do not have reasonable certainty that their investment will be repaid over the 30 year life of the asset?

But, notice that the three problems are not equal. Ultimately it is the political risk problem that leads to the legal-contracting and the financing problems, so the political risk problem trumps the others in terms of importance.

Of the 1000s of reports that our researchers in the Collaboratory have analyzed, perhaps the most helpful in thinking about the many variants of the private sector model and about the feasible options for private sector financing of emerging markets infrastructure is the one by Antonio Vives and colleagues at Inter American Development Bank, "Financial Structuring of Infrastructure Projects in Public-Private Partnerships". Dr. Vives would be an excellent person to invite to the NSF workshop, given the thorough study of contingent governance approaches that he led at IADB.

2) The Problem of Natural Monopolies An additional concern that must be recognized for anyone interested in the sustainable provision of emerging markets infrastructure is that large scale infrastructure service provision (particularly power and water) have all of the characteristics of a natural monopoly. So, for these services to be provided, either a benevolent government needs to provide them directly, or the government needs to regulate the private sector in order to avoid excessively high prices, rent-seeking, and inequities in service provision. But, based on the experience of the 1990s, it turns out that regulating the private sector may actually be more difficult for governments than just stepping up and providing the service in the first place, particularly in emerging countries with a lack of institutional capacity and without a strong tradition of the separation of the executive and regulatory branches of government or the decentralization of governmental powers to the local level where the infrastructure is needed.

3) A Candle in the Darkness: The Marginalization of Natural Monopolies thru Technological Innovation and Decentralized Provision of Infrastructure The candle in the darkness for emerging markets infrastructure, I believe, is technological innovation that will eventually allow consumer demand to drive the decentralization of the provision of infrastructure services to the household and neighboorhood level. For example, recall the history of the innovation in cellular phone technology that turned the old fixed-line phone industry on its head. The fixed-line phone industry had existed in the US as a natural monopoly--remember back to companies like AT&T with attendant poor service levels and high prices?

With the advent of mobile technology, competition was introduced into the marketplace. Ever since, there has been dramatic reduction in prices and a marvelous improvement in innovation and quality of service in the sector. In emerging markets, the introduction of mobile phone technology has resulted in even more astonishing improvements. Indeed, many countries did not even have functioning fixed-line phone networks, or if they did, it took upwards of several years to get a connection or to get a damaged line maintained. Not surprisingly, the natural monopolies that were operating the fixed-line telephone services in emerging markets behaved just as we expect natural monopolies to behave in the absence of regulation--as corrupt, lazy, incompetent providers--and thus service provision was very poor or non-existent in these places. But, enter mobile phone technology and the wonders of competition, and suddenly the scene in emerging markets has changed dramatically. Poor farmers and fisherman can own telephones and get firsthand information on market prices! Today, mobile phone infrastructure is one of the few infrastructure classes that actually functions in emerging markets.

The power and water sectors are arguably two of the most critical for human development in emerging countries. With the advent of photovoltaics and wind energy together with enhanced storage batteries, it should eventually be possible to produce power at the household or village level. Likewise, with the advent of small-scale water providers and technologies to treat water via sunlight, low power ultra-violet purification, or membrane reverse osmosis, we could see similar progress in the water sector. With the development of these kinds of technologies, state-owned entities that presently occupy and abuse positions of monopoly power would be seriously undermined.

The key is that the technology to produce power and treat water be decentralized and affordable! If the average person in a developing country can afford it, then it will diffuse organically driven by consumer demand, as has happened for mobile telephone, and as is now happening for micro-finance!

Of course, even small, decentralized infrastructure projects will raise financing and governance challenges, but they will be far more manageable and distributed than for monopolistic provision of services via mega-projects that require large tranches of external funding for development and governmental tariff regulation in their operation.

4) Recommendation In conclusion, if NSF is considering funding a program of research and development to improve emerging markets infrastructure, we would strongly recommend that, in addition to research on new approaches for governance of such projects, NSF Engineering programs or other sources should, in parallel, fund research on technological innovation in the power and water sectors to enable low-cost, decentralized provision of these services to unleash innovation and, thereby, undermine the natural monopolies that block progress in these sectors!

Posted by rjorr at April 11, 2007 7:07 PM