Where next for Australia?

The Australian economy as a whole has been doing well on the back of a sustained resources boom. Australia’s recent annual gross domestic product (GDP) growth of 4.3 percent is the highest in the developed world, the unemployment rate is only 5.1 percent, the country retains an AAA credit rating, the debt-to-GDP ratio is a very manageable 23 percent and the terms of trade remain at high levels. On the major economic indicators, Australia is doing very well indeed – but the good times are not evenly spread.

In the resource-rich states of Western Australia and Queensland the growth rates for the year to March 2012 were a very healthy 14.5 percent and 7.5 percent respectively. On the other hand, the other major states showed fairly anaemic annual growth of 1 to 3 percent and the most populous state of New South Wales (NSW) reported negative growth for the latest quarter. Hence, there has been much discussion of the “two-speed economy”, which refers to ‘resources’ and ‘everything else’.

In the energy and resources sectors, massive investment and development is feeding Chinese and Asian demand primarily for energy, iron ore and coal. For example, as at the end of May 2012, investment commitments to energy and resource development projects were running at A$261 billion. Capacity expansions are impressive with liquefied natural gas (LNG) to rise from 19.6 million tons (MT) to 63.4 MT and thermal coal from 148 MT to 269 MT over the next five years while iron ore will add 189 MT within two years and another 110 MT shortly after.

That scale of development can’t occur without major infrastructure investment, starting with the multibillion-dollar rail and port facilities but including general infrastructure of roads, airports, water supplies, new housing, schools etc, such as, for example, entire new suburbs in Western Australia’s Pilbara region.

NOT SO ROSY

The economy outside resources and agriculture is not so rosy, particularly in the more populous eastern states. The high value of the Australian dollar has hit export-exposed industries hard. Massive demand for skilled personnel for the resource sector has caused labour shortages and salary pressures, which the rest of the economy is ill-equipped to handle. Energy costs are rising rapidly due to large increases in network distribution charges, the new carbon tax and the policy of international energy pricing parity.

These difficulties have exacerbated longer-term issues of a lack of capital renewal and insufficient scale in the face of massive Asian plant developments. As a result, food processing plants have moved offshore, the car industry is struggling and aluminium smelters and oil refineries are under threat of closure.

Ironically, the sector that would be expected to benefit most from a high Australian dollar, the retail sector, has also been struggling due to the switch to online purchases from cheaper overseas suppliers and lower spending overall. In fact, there has been a major increase in the household savings ratio from 0 to 4 percent prior to the global financial crisis to 9 to 10 percent following it in recent years, reflecting sombre consumer sentiment.

Falling productivity and projections of a looming fiscal gap have boosted calls for economic reform, with infrastructure investment being a key part of the solution. It is now widely accepted in Australia that there has been major under-investment in infrastructure over a sustained period, resulting in an infrastructure backlog variously estimated at between AS$300 billion to A$700 billion. This realisation and the associated productivity ramifications have unleashed a torrent of debate and discussion, with a great many reports and an even greater number of column inches devoted to addressing the issues.

ECONOMIC RIGOUR

The Australian government set up the peak body, Infrastructure Australia, to bring economic rigour to infrastructure planning and investment allocations. Various state governments have done the same at state level and have adopted national PPP guidelines. An Infrastructure Finance Working Group, set up by the Australian government, advised on impediments to infrastructure financing in its April 2012 report. The Federal Minister for Infrastructure, Anthony Albanese, has set up a national database of projects and funded an effort to improve the demand forecasts for toll road projects. Robust economic analysis and insight has also been provided by industry body, Infrastructure Partnerships Australia. After all this worthy activity and debate, I believe that a consensus for action is emerging, which is shared by business, governments and even the public. There is now a call for less talk and more action.

However, state governments, which are primarily responsible for infrastructure delivery, have highly constrained budgets, particularly in the non-resource eastern states, and so their capacity to invest in infrastructure is diminished. In theory, they could borrow more but this is very unlikely as it would jeopardise their established high credit ratings, which would be electoral suicide. When the American bank robber, Willie Sutton, was asked why he robbed banks, he replied “because that’s where the money is”. Similarly we might ask where the money is for infrastructure.

There are viable funding options including asset sales, PPPs [public-private partnerships], increasing user fees and potentially value-capture mechanisms. Asset sales of existing utility infrastructure are likely to accelerate. In NSW for example, Sydney’s desalination plant was recently privatised with port and forestry assets likely to follow. Also, industry leaders suggest that NSW’s electricity transmission and distribution system (A$50 billion) has a high probability of sale in the current government’s next term of office.

State governments have also become better at managing PPP processes with a good example being the PPP for the development of a new convention and exhibition centre in Sydney currently under final bids from Lend Lease and Plenary. In my view, the general public is also realising that, if they want better roads, trains, hospitals and other services, there is no free lunch – someone has to pay. Results from GA Research, the leading market research firm on consumer attitudes to infrastructure, suggests that the general public are quite receptive to rational and reasoned arguments on these issues, contrary to more cynical political views. For example, the NSW government recently felt comfortable enough to announce that tolls are a necessity for the expansion of the motorway system.

All this suggests that Australia is primed for a major expansion of privately financed infrastructure over the next few years and these developments may well involve some significant innovations in funding mechanisms.

AGRIBUSINESS

The third area of potential infrastructure investment is in agribusiness. Australia has strong agricultural export industries, including grains, wool and beef, among many others. The infrastructure supporting this industry includes water storage and distribution networks, roads, railways, storage and handling facilities like grain silos, and processing facilities such as abattoirs. A substantial portion of the installed base of infrastructure is of poor quality and needs upgrading. In addition, there is the potential for some major new projects.

There are increasing international concerns about food security, particularly in Asia. Australian Minister for Trade and Competitiveness, Dr Craig Emerson, has established a joint study with the Chinese government to look into developing northern Australia into a major food producing area, potentially utilising Chinese capital. Unlike southern Australia, this region receives substantial rainfall and is quite undeveloped. Of course this idea is not new, but the addition of ready access to end markets and large-scale capital may unearth some strong development opportunities.

In summary, real economic driving forces, like energy and resources demand, productivity improvements and food demand, are in place for Australian infrastructure development. While it is easy to list a dozen or so areas where infrastructure investment in Australia could be improved, this would ignore great progress on institutional frameworks which has set up the country for future success. Examples include the impressive Western Australian planning system and the economic analysis and rigour brought by Infrastructure Australia. Also, the lengthy debates on productivity and infrastructure have primed the Australian community and economy for action.

That’s why I’m quite bullish overall about the prospects for infrastructure investment in Australia. Having said that, I am also reminded of the man who drowned crossing a one-foot deep river – it was one-foot deep on average. In other words, generalities are fine but there’s no denying the need for specific market and project knowledge coupled with robust investment skills.

Brian McDonald is an infrastructure advisor at Promesse Consulting in Sydney