This document summarizes a presentation given by Prof. Fernando Fernholz on improving public sector infrastructure investment. It discusses key perspectives on public investment such as infrastructure spending being countercyclical, challenges occurring across countries and time periods, and an optimism bias in decision making. It also describes taking a systems approach to project appraisal and management to improve investment efficiency through guidelines, capacity building, and reviews.

1. Improving Public Sector
Infrastructure Investment
Prof. Fernando Fernholz
fernholz@duke.edu
Presentation at the
7th ANNUAL MEETING OF MIDDLE EAST AND NORTH AFRICA
SENIOR BUDGET OFFICIALS. (MENA-SBO). Session 3
Abu-Dhabi, United Arab Emirates. 10-11 December 2014

2. Outline
Importance of Public Investment/Infrastructure
Raising productivity [remove bottlenecks]
The stimulus effect
Challenges
Perspectives on Public Investment
Infrastructure spending can be counter cyclical
Challenges occur over range of countries and time
There tends to be a systematic optimism bias
What can be done? A Systems Approach
Project appraisal and overall PIM Improvement
Public Private Partnerships
Some Reflections for the MENA Region

3. The Global
Context

4. IS IT TIME FOR AN INFRASTRUCTURE PUSH?
THE MACROECONOMIC EFFECTS OF PUBLIC INVESTMENT. Chapter 3. IMF October 2014
According to the IMF and several other sources, increased public infrastructure
investment raises output in both the short and long term, particularly during periods
of economic slack and when investment efficiency is high. This suggests that in
countries with infrastructure needs, the time is right for an infrastructure push:
borrowing costs are low and demand is weak in advanced economies, and there are
infrastructure bottlenecks in many emerging market and developing economies.
To be efficient, public investment must meet two conditions:
 allocate to projects with the highest ratio of benefits to costs
 its aggregate level must align with fiscal sustainability.

5. Needs vary over
space and time

9. Key characteristics distinguish infrastructure from other capital
 First, infrastructure investments are often large, capital-
intensive projects “natural monopolies”—it is often more cost-
effective for services to be provided by a single entity.
 Second, they have significant up-front costs, but the benefits or
returns accrue over very long periods of time, often many
decades; this longevity (and difficulty of ascertaining adequate
returns) are a challenge to private financing and provision.
 Third, infrastructure investments have the potential to generate
positive externalities, so that the social returns to a project can
exceed the private returns it can generate for the operator.
 Fourth, because of high level of public resources, there is need
for high level of accountability.

10. 1. Public Investment as Counter Cyclical
Policy
Highlights from our Study on Active Public Investment
and Fiscal Stimulus and Growth Impacts
STUDY ON COUNTER CYCLICAL POLICIES:
ROLE OF PUBLIC INVESTMENT TO STIMULATE
DEMAND
Client: World Bank, 2012
Some
perspectives
on Public
Investment

11. Region or country
Average
2001-07 2008 2009 2010 2011
Growth
rate
Growth
rate
Growth
rate
Growth
rate
Growth
rate
Change Change Change Change
4.1% 2.8% -0.7% 5.3% 4.0%
-1.3% -3.4% 5.9% -1.3%
2.4% 0.1% -3.7% 3.2% 1.6%
-2.3% -3.8% 6.9% -1.6%
2.4% -0.3% -3.5% 3.0% 1.5%
-2.7% -3.1% 6.5% -1.5%
2.6% -0.1% -4.9% 2.1% 1.1%
-2.6% -4.8% 7.0% -1.0%
4.7% 1.8% -0.7% 8.5% 4.7%
-2.9% -2.5% 9.2% -3.8%
2.4% 0.7% -4.2% 2.0% 1.7%
-1.7% -4.9% 6.2% -0.3%
6.6% 6.0% 2.8% 7.5% 6.4%
-0.6% -3.2% 4.7% -1.1%
8.6% 7.7% 7.2% 9.7% 8.2%
-0.9% -0.6% 2.5% -1.4%
10.8% 9.6% 9.2% 10.4% 9.2%
-1.2% -0.4% 1.2% -1.2%
7.3% 6.2% 6.8% 10.6% 7.2%
-1.1% 0.6% 3.9% -3.4%
3.5% 4.3% -1.7% 6.2% 4.5%
0.7% -6.0% 7.9% -1.6%
5.4% 4.6% 2.6% 4.9% 4.0%
-0.8% -2.0% 2.3% -0.9%
6.3% 5.6% 2.8% 5.3% 5.2%
-0.7% -2.8% 2.5% -0.1%
Sub-Saharan Africa
Emerging and developing economies
Developing Asia
China
India
Latin America and the Caribbean
Middle East and North Africa
Table 1. Annual economic growth rates and changes in growth rates by region and selected
countries, 2001-07 and 2008 through 2011
World
Advanced economies
United States
United Kingdom
Source: IMF WEO database
Newly industrialized Asian economies
European Union

12. -6
-4
-2
0
2
4
6
8
2001-07 2008 2009 2010
Annualgrowthrate(%)
Figure 1. Average annual economic growth rates in 2001-07, 2008,
2009 & 2010 for the 84 countries with postive and the 90 countries
negative growth rates in 2009
Growth rate in 2009 positive
Growth rate in 2009 negative
Source: IMF World Economic
Outlook database

13. Result: Fiscal Stimulus has been positive in lifting growth rates.
Public Investment Stimulus
was high in the positive
2009 growth rate
performance countries

14. Berlin Mayor to Resign After Criticism Over Delays to New Airport
Klaus Wowereit Blamed After Cost of Building Airport Spiraled,
Europe News, Wall Street Journal. By Andrea Thomas. Aug. 26, 2014.
BERLIN—Longtime Mayor Klaus Wowereit said Tuesday he would resign in
December, following years of sharp criticism over delays and cost-overruns for a
new airport for the German capital.
At a news conference, Mr. Wowereit cited the embarrassing delays to opening the
new Berlin Brandenburg International airport as a major reason for his resignation,
two years ahead of the next election.
Mr. Wowereit, who also serves as chairman of the airport's supervisory board, has
been blamed for insufficient controls and the explosion of costs to more
than €5 billion ($6.6 billion), from an initial estimate of around €2
billion.
Some
perspectives
on Public
Investment
2. Challenges Occur in Developed and Developing
Countries, and at different periods of time
[examples: cost overruns, inaccurate forecasting]

15. ‘Efficiency: Unit costs of major projects’ Final Report, 25 October 2009 RGL Forensics, Frontier Economics, Aecom

17. Bent Flyvbjerg. Survival of the unfittest: why the worst infrastructure gets built—and what
we can do about it. Oxford Review of Economic Policy, Volume 25, Number 3, 2009
Given the data presented above, a
key recommendation for decision-
makers, investors,
and voters who care about ‘honest
numbers’ is that they should not trust
the budgets, patronage forecasts, and
cost–benefit analyses produced by
promoters of major infrastructure
projects. Independent studies should
be carried out and, again, such
studies should be strong on
empirically based risk assessment.

18. Public Investment Decisions [infrastructure] and optimism bias:
 Investment costs are significantly underestimated => Cost Overruns
 Operating costs are significantly underestimated => Fiscal Pressure (tighter
budgets)
 Demand conditions are overestimated => lower than planned revenues or
user streams
This leads to inefficient outcomes, negative returns (NPV <<0)
Example For PPPs and the Private Sector: The Channel Tunnel
Costs of investments exploded and demand below initial predictions.
Several studies show that the economies of France and England would
have been better off without the Channel Investment, by up to 12 Billion
Pounds (the net loss).
3. There is an optimism bias at time of
decision making
Some
perspectives
on Public
Investment

19. What goes wrong and why?
• Lack of systematic approach to demand high quality
project appraisal, selection, implementation and
monitoring by decision makers
– Lack of government capacity
– Lack of transparency and weak oversight by legislature and
public lead to lack of accountability pressures
– Lack of capacity or political will by decision makers to use
appraisal results allows poorly appraised “parachuted”
projects or “white elephants’ in budget
– Lack of performance budgeting and coordination
• Lack of guidelines or conflicting guidelines
– Undermines internal and external ability to conduct and
oversee project appraisal.
– Problem becomes more serious the greater the degree of
decentralization
• Lack of additional demand data and forecasting models
– Technical capacity gap in sector planning & analysis

20. Source: The Power of Public Investment
Management. Rajaram, et al. World Bank 2014.

21. Public Investment Management (PIM)
Study of international experience:
PIM Case study countries
The World Bank has been studying PIM experience across countries to
identify how to strengthen performance
• Initial core of 6 selected studies:
– Belarus, Chile, China, Ireland, Korea and Vietnam
• Further 13 cases arose from demand:
– Angola, Brazil, DRC, Congo, East Timor, Mongolia, Niger, Nigeria, Peru,
Rwanda, Sierra Leone, Uganda and Zambia
• Two separate Bank initiatives:
– A 2009 study of PIM in 6 Western Balkan countries: Albania, Bosnia,
Kosovo, Macedonia, Montenegro, and Serbia
– A 2008 study of PIM in transport infrastructure in 7 new and older EU
member states:
Ireland, Latvia, Poland, Slovakia, Slovenia, Spain and UK.
21

22. Country summary diagnostics
Institutional
Features
Chile Ireland Korea Belarus China Vietnam Brazil East
Timor
Nigeria
Investment guidance
& preliminary
screening
Formal project
appraisal
Independent review
of appraisal
Project selection and
budgeting
Implementation
Adjustment for
changes in project
circumstances
Facility operation
Evaluation
22
Legend: Green Highest; Yellow: Middle; Red: Lowest Capacity Indexes

23. The new
methodology
and
reporting has
71 middle
and low
income
developing
countries
2010
International
Monetary
Fund
WP/11/37
Investing in
Public
Investment:
An Index of
Public
Investment
Efficiency

25. PIM functions & stages of project cycle
“Must have” PIM functions
1. Investment Guidance &
Preliminary Screening
2. Formal Project Appraisal
3. Independent Review of
Appraisal
4. Project Selection and Budgeting
5. Project Implementation
6. Project Adjustment
7. Facility Operation
8. Project Evaluation
Stages of project cycle
1. Identification of projects & programs
2. Design, appraisal, and screening of
projects & programs with stages
1. Prefeasibility
2. Feasibility
3. Detailed blue print
3. Independent review of the appraisal
4. Budget authorization of services and
appropriation of funding
5. Project implementation:
procurement, contracting and
monitoring
6. Ex post program or project evaluation
25

26. Components of project appraisal cycle
• Identification of projects and programs
– current or expected excess demand
– sector demand information and models
– consistency with strategic priorities, plans and budget
• Appraisal of projects and programs
– Components or modules of appraisal of project
1. Demand or market analysis
2. Technical/engineering (including real options)
3. Organization, ownership, human resources and financing
4. Financial analysis including real options, internalized risks and
environmental costs
5. Economic analysis including external risks and environmental
costs
6. Distributional analysis 26

27. Appraisal of projects & programs
• Methodologies:
– Competing methodologies reconciled: Harberger approach
using weighted average economic prices in domestic currency
values (generally accepted worldwide)
• Basic criteria in project appraisal
– Net Present Values (NPVs) using Economic Cost of Capital
(EOCK) and internal rates of return (IRRs) from financial and
economic perspectives
• Self-financing or commercial projects: financially viable? default risks?
• Non-self financing or budget supported projects: budget support needs
and availability; economic cost of public revenues
• Targeted poverty alleviation projects: cost of transfer of benefits
• Cost-effectiveness for difficult to measure benefits; also unit pricing in
contracts and regulation
– Under NPV rules, VfM can also be calculated.
27

28. Appraisal of projects & programs
• Stages of appraisal
– Prefeasibility – screening and design issues
– Feasibility – detailed design and appraisal
– Detailed blue print – basis of procurement, construction and operation
• Level of effort in appraisal
– Appraisal as a project – information and alternatives (real options)
– Repetition and re-use of analysis – demand criteria
– Large projects and large programs of small similar projects
– Special approvals critical to feasibility of project completion
• Land access or allocation
• Environmental approvals (forests, land reclamation, water, etc)
• Major social externalities such as loss of property rights by indigenous
people, resettlement costs or job displacement
28

29. Components of project appraisal cycle
• Review of appraisal
– External professional review
• Budget authorization and appropriation of funding
– Degrees of transparency of budgeting affects quality of appraisals and
decision making
• Project implementation: procurement/contracting &
monitoring
– Construction phase
– Operations phase
• Ex post project or program evaluation
– Feed back to design, costing and decisions
– Portfolio analysis in addition to case by case analysis
29

30. Integration of project appraisal and capital
budgeting into budgeting systems
• Budget preparation, approvals, length of cycles, and
scope & organization
– Strategic priorities & plans vs project identification and
evaluation
– Filling the project pipeline with “good” projects: two basic
approvals
– Mismatch in time frames of budget/political and project
cycles
• Time limited authorizations vs automatic or variable length
authorizations
– Organization and management of public sector
• Decentralization, dual vs integrated budgets

31. Strategic priorities & plans
• New projects and programs entering budget from
pipeline should be consistent with strategic priorities &
plans
• Quality of strategic budget depends critically on quality
of
– Sector planning – ability to identify and forecast excess
demand for public services
– Project costing and ex post evaluation of projects and
programs to inform strategic plans of cost and expected
effectiveness of new projects
• Iterative process – good project preparation &
implementation enhances budget prioritization and
approvals
31

32. Improving Project Appraisal:
Roles of Central Agencies
1. Enhance demand for good project appraisal by
decision makers
• Transparent process creates accountability
– Opportunity cost of selecting a project should be clear: namely, good
projects remaining in pipeline
• Laws required in some countries; administrative regulations
or manuals in others
• Strengthen capacity of decision makers to use appraisal
results
2. Publish guidelines on the conduct of project
appraisal
• General and special sector manuals for all parties involved in public
investment including regulated sectors and PPPs
• Formats for spreadsheets to facilitate transfer of completed feasibility
studies to government decision makers

33. 3. Strengthen the capacity to conduct project appraisal
• Central core unit to maintain methods, economic prices, oversight and
technical assistance to other units
4. Improve service delivery and demand information
• Sector demand forecasting models
• Performance budgeting and management
5. Strengthen review, monitoring and evaluation
• Establish independent review process for feasibility studies
– Units in universities or research institutions
• Strengthen project implementation and monitoring
– Budget performance and cost information feedback
• Strengthen ex post project evaluation
=> MoF provides leadership in budget reform, especially strategic and
performance-based budgeting that links with capital budgeting
Improving Project Appraisal:
Roles of Central Agencies

34. Organization & management of public sector
• Roles of ministries of finance, economic planning and sectors
– Sector ministries – sector planning and co-ordination; oversight of
authorities and regulation
– Economic planning
• Macro planning and sector co-ordination
• Sector legislation and oversight
• Guidelines and methods (including economic prices)
– Finance
• Budget system and project approval process
• Revenue forecasting and O&M budget support
– Dual or integrated budgets:
• Under dual budget, new project and program budget may be delegated to
economic planning
• Outsourcing of project appraisal
– Importance of guidelines, oversight and transfer of spreadsheet models
• Donor agencies, international and other financial institutions
– Conditions on project
– Consistency in appraisal methods

35. Sample Institutional Chart - Complexity

36. 36
Institutional Arrangements
for Capital Budgeting
• A proper institutional design necessary at various levels.
• Agency/Department/Line Ministry levels: appraisal/evaluation
units with skilled personnel to appraise and manage projects
• Planning/Finance Ministry levels:
– Project formulation and evaluation division (including costing, demand
and sector analysis if not in departments or line ministries)
– Project/Program monitoring division
– Evaluation division
– Statistics division
• With growing decentralization of capital investments to
authorities, PPP arrangements and sub-national government,
actual conduct of investment appraisal needs to be delegated,
but standards and guidelines for selection and incorporation
into budgets needs to be set, enforced and monitored by
coordinating ministries
• Project and program appraisal capacity is critical for
government to control selection of donor funded projects

37. Public investment modalities
Performance
management
mechanisms (X)
Organization of investment
and service delivery
Debt finance Final revenue
source
Government budget
and personnel
systems
“Traditional government
investment” central or local:
all stages internal to
government w/o contracting out
of specific functions
Government debt Primarily public
revenue; some user
charges
Legislated functions;
performance
agreements
“Corporatization” -- publicly
owned corporation or authority
or special purpose vehicle (SPV)
Government debt
and/or guaranteed
corporate debt
Mixed public revenue
and user charges
Contractual
agreements and
contract management
(or regulated)
“PPP” -- privately owned
corporation or SPV
Private debt w/o
government
guarantees
Primarily user
charges; also grants,
tax incentives, rental
payments
Regulatory
arrangements
(especially for price)
Regulated private
corporation -- typically utilities
(electricity, telecoms, etc)
Private debt Primarily user
charges; also grants,
tax incentives
X: In all cases government investment guidelines , oversight and review should apply

38. Impacts of investment modalities on net
benefit relative to GOO
38
GOO GOO +
user
charges
BOO/T +
guarantees
BOOT +
lease
payment
BOOT
Productivity gain 0 Small pos? Small pos? Pos Pos
Added cost of risk 0 Neg Small neg Small neg Neg
Saving external cost of
public funds
0 Pos Pos 0 Pos
Examples
Public road Government
operated toll road
Utility with supply
contract
Facility with lease
payment
PPP toll road
Investment modality
Project parameter
GOO is similar to “public sector cost comparator” in VFM
justification of PPP

39. Some reflections for MENA Region
1. Build or strengthen capacity for the different
components of PIMs
2. Consider internal and independent (non-government)
systems of appraisal & evaluations
3. Improve access to relevant data for the public and
private sectors to share, in relation to public
infrastructure investment
4. Explore new modalities of procurement, information
and risk sharing and management (including PPPs)
5. Provide clear guidance and guidelines; for different
levels of government (when applicable)

40. THANK YOU