33526 CONNECTING EASTASIA A NEW FRAMEWORK FOR INFRASTRUCTURE ASIAN DEVELOPMENT BANK JAPAN BANK FOR INTERNATIONAL COOPERATION THE WORLD BANK Connecting East Asia: A New Framework for Infrastructure ASIAN DEVELOPMENT BANK JAPAN BANK FOR INTERNATIONAL COOPERATION THE WORLD BANK © 2005 Asian Development Bank, The International Bank for Reconstruction and Development/The World Bank, and Japan Bank for International Cooperation Asian Development Bank 6 ADB Avenue Mandaluyong City, 1550 Metro Manila Philippines Telephone: +63 2 632 4444 Internet URL: www.adb.org E-mail: information@adb.org The International Bank for Reconstruction and Development/The World Bank 1818 H Street, NW Washington, DC 20433 USA Telephone: 1-202-473-1000 Internet URL: www.worldbank.org E-mail: feedback@worldbank.org Japan Bank for International Cooperation 4-1, Ohtemachi 1-Chome, Chiyoda-ku, Tokyo 100-8144 Japan Telephone: 81-3-5218-3101 Internet URL: www.jbic.go.jp E-mail: https://www.jbic.go.jp/english/opinion/index.php All rights reserved. 1 2 3 4 08 07 06 05 The findings, interpretations, and conclusions expressed herein are those of the author(s) and do not necessarily reflect the views of the Asian Development Bank or its Board of Governors or the governments they represent, the Executive Directors of the International Bank for Reconstruction and Development/World Bank or the governments they represent, or Japan Bank for International Cooperation. 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For permission to photocopy or reprint any part of this work, please send a request with complete information to the Copyright Clearance Center Inc., 222 Rosewood Drive, Danvers, MA 01923, USA; telephone: 978-750-8400; fax: 978-750-4470; Internet: www.copyright.com. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: pubrights@worldbank.org. ISBN-10: 0-8213-6162-7 ISBN-13: 978-0-8213-6162-7 e-ISBN: 0-8213-6163-5 DOI: 10.1596/978-0-8213-6162-7 Library of Congress Cataloging-in-Publication Data has been applied for. Contents Countries Covered byThis Study xi Foreword xiii Acknowledgments xv Abbreviations and Acronyms xvii Executive Summary xxi 1. The Infrastructure Challenge 1 The economic story 4 The spatial and demographic story 12 The environmental story 20 The political story 24 The funding story 29 Annex 1: Estimation of infrastructure needs 43 2. Inclusive Development 49 Development, inclusiveness, and infrastructure 49 What is so different about infrastructure anyway? 51 Connecting growth, poverty reduction, and investment through infrastructure 54 Making the links: Infrastructure, trade, and logistics 61 Focus on Vietnam: Infrastructure and inclusive development 68 3. Coordination 75 Infrastructure is hard to do 75 The "high-flying geese" theory of infrastructure 76 Coordinating infrastructure levels 80 Coordinating infrastructure through subnational government 84 iii C O N T E N T S Coordinating urban infrastructure 88 The geese catching up: Four snapshots 90 From coordination to accountability and risk management 107 Spotlight 1. Coordination and a tale of three cities: Mass Rapid Transit in Bangkok, Kuala Lumpur, and Manila 108 4. Accountability and Risk Management 113 When accountability and risk management fail 114 Mechanisms to strengthen accountability 118 Risk-sharing, accountability, and managing government support 138 Concluding remarks 149 Spotlight 2. Learning how to share risk: The case of Partnerships Victoria 150 Spotlight 3. Consumer participation, regulators, and accountability 154 5. The Way Forward 159 Spotlight 4. The way forward in Indonesia and the Philippines 170 Appendix A. Statistical Annex: Infrastructure Indicators 177 Notes 217 Bibliography 229 Index 241 Boxes 1 Infrastructure and the Millennium Development Goals xxxii 1.1 The demographic dividend 6 1.2 Infrastructure challenges in the Pacific Island countries: A case apart 10 1.3 Emerging urban infrastructure gaps in East Asia 16 1.4 Indications of the high cost of environmental pollution in China 22 1.5 Strategic environmental assessments: The Bali urban infrastructure project 23 1.6 What about efficiency? 32 iv C O N T E N T S 1.7 So why didn't the private sector solve East Asia's infrastructure problems? 36 1.8 Risk, return, and private investment in East Asian infrastructure 41 2.1 Inclusive development with Chinese characteristics 50 2.2 Infrastructure and the Millennium Development Goals 57 2.3 The importance of infrastructure in particular poverty reduction programs varies 60 2.4 Inclusive development on a regional scale: Opportunities for landlocked Lao PDR 62 2.5 East Asia's logistics challenge--country differences 64 2.6 Integration of ports and land transport networks in Korea 68 2.7 Inclusive development: Transport access for the disabled 72 3.1 Poorly coordinated planning and finance in the Vietnamese roads sector 82 3.2 Infrastructure and fiscal space--arguments and counterarguments 83 3.3 Urban management in Vietnam 90 3.4 "Pork-Barrel" interventions in infrastructure in the Philippines 92 3.5 Indonesia's renegotiated power purchase agreements 97 3.6 Coordination from the bottom up in Indonesia: Community-driven development programs 99 3.7 Coordinating local government infrastructure, macroeconomic stability, and urban land use 102 3.8 Vision, infrastructure, and spatial planning in Thailand 106 3.9 MRT in a nutshell 110 4.1 Corruption in infrastructure in the Philippines 116 4.2 Public spending in Indonesia and the search for accountability 116 4.3 Infrastructure, accountability, and NGO perceptions: Survey results 119 4.4 Community action in rolling back environmental externalities in postwar Japan 121 v C O N T E N T S 4.5 Making a deal with the community: Water supply and accountability in Indonesia 122 4.6 Putting accountability mechanisms into large infrastructure projects: The Nam Theun 2 dam project 123 4.7 Technology, competition, and regulation: The push and pull of accountability in the telecoms sector 127 4.8 Choice of power sector structure in East Asia 129 4.9 Manila water: The challenges of structuring competition for the market 131 4.10 Holding regulators accountable through transparency 134 4.11 Contracting out regulatory functions 136 4.12 Franchising in Fiji 140 4.13 Top-down turnaround: The Phnom Penh Water Supply Authority 142 4.14 Coordination failure: Regulators and subsidies in the Philippine electricity sector 145 4.15 "Now you see it, now you don't": The case of currency risk 147 5.1 Managing the contribution of infrastructure to inclusive development 160 Figures 1 The "new framework": Inclusive development, coordination, and accountability and risk management xxii 1.1 The association between infrastructure outcomes and per capita income levels varies 3 1.2 Savings and investment (percent GDP), average, 1993­2002 6 1.3 Infrastructure quality ranking, World Competitiveness Report, East Asia 8 1.4 Poverty headcount index ($2/day), percent, East Asia, selected countries 12 1.5 East Asia's urban population is not yet high by global standards, but it is rising exponentially 14 1.6 Urbanization and increasing income levels are correlated in East Asia 15 vi C O N T E N T S 1.7 Changes in vehicle ownership and road lengths 16 1.8 East Asia has attracted significant levels of private sector investment in infrastructure, although largely concentrated in a small number of countries 26 1.9 Levels of cancelled private sector infrastructure investment in East Asia are among the highest in the world 28 1.10 Estimated annual infrastructure need, East Asia, 2006­10 30 1.11 The circular flow of funds for infrastructure 31 1.12 Few water utilities cover even operating and maintenance costs 33 1.13 Private sector investment in infrastructure (US$ billion) 37 1.14 Private sector intentions to invest in East Asian infrastructure 38 1.15 Cost of capital, by region, percent, 1998­2002 41 1.16 East Asia, cost of equity versus returns on equity, percent, 1998­2002 42 2.1 Links among infrastructure, poverty reduction, and growth 55 2.2 In the most open economies of the region, logistics costs are typically much lower 63 2.3 Interdependence of auto manufacturing within ASEAN 66 2.4 Vietnam: Poverty, growth, and infrastructure 69 3.1 Infrastructure development in the high-flying geese 78 3.2 Indonesia has gone through a period of fiscal contraction with important implications for infrastructure 96 4.1 Accountability as an obstacle 119 4.2 Level of stakeholder involvement 119 4.3 Corruption 120 4.4 Information 120 4.5 Public participation 120 4.6 Lao PDR governance indicators 124 4.7 Measures to enhance transparency 134 4.8 Independent regulators: Predictability and discretion 138 4.9 Comparing the costs of public and PPP procurement 154 vii C O N T E N T S Maps 2.1 Comparison of the growth rate and poverty reduction rate of each province in the Red River Delta region 71 4.1 Competition in international voice communications, 2003 128 Tables 1.1 Growth, income, poverty, and population, East Asia 2 1.2 Infrastructure investment, percent GDP 5 1.3 Total road network and electricity generating capacity, 1990­2000 5 1.4 Infrastructure access and stocks 9 1.5 There is significant variation in the speed and level of urbanization across East Asian countries 14 1.6 Inequality in access to infrastructure services in urban areas 17 1.7 Even in fast-growing Thailand, regional income and access to infrastructure can diverge significantly 18 1.8 Aid dependency in East Asia and the Pacific, 2003 40 1.9 Investment and maintenance needs, East Asia 2006­10, $ and percent GDP 43 1.10 Investment and maintenance needs, China 2006­10, $ and percent GDP 44 1.11 Investment and maintenance needs, East Asia excluding China, 2006­10, $ and percent GDP 44 2.1 Distribution of study findings on impact of infrastructure investment on productivity or growth 56 2.2 Potential positive impacts of infrastructure services on the poor 59 3.1 Hierarchy and average population size by local government 86 3.2 Augmentation funds for local infrastructure, DPWH budget, 1997­2001 (P billion) 92 3.3 Real gross regional product per capita in areas of Thailand, 1981­95 (1988 prices) 106 4.1 Distribution of developing and transition countries by structure of power supply (mid-2004) 129 viii C O N T E N T S 4.2 Comparison of performance, 1993 and 2003 142 4.3 Common types of central government fiscal support for infrastructure 144 Appendix A Statistical Annex 1 Energy 183 2 Water supply and sanitation 191 3 Telecommunications 196 4 Road transport 203 5 Rail transport 208 6 Urban 212 7 Infrastructure finance 215 ix Countries Covered by This Study T HIS STUDY FOCUSES ON THE DEVELOPING COUNTRIES IN EAST ASIA and the Pacific Region, which are members of the Asian Development Bank and the World Bank. These countries include Cambodia, China, Fiji, Indonesia, Kiribati, the Lao People's Democratic Republic (Lao PDR), Malaysia, Marshall Islands, the Federated States of Micronesia, Mongolia, Myanmar, Palau, Papua New Guinea, the Philippines, Samoa, the Solomon Islands, Thailand, Timor-Leste, Tonga, Vanuatu, and Vietnam. Developing countries are low- and middle-income countries as defined in the World Bank publication, World Development Indicators 2004. The findings of this study are also relevant to other developing countries within the region and elsewhere in the world. This publication follows the World Bank practice of reference to countries. In the Asian Development Bank, Hong Kong (China) and Taiwan (China) are recognized as Hong Kong, China and Taipei,China, respectively. xi Foreword I NFRASTRUCTURE HAS ALWAYS PLAYED A CENTRAL ROLE IN THE EAST Asian development model: to promote economic growth, to share the benefits of growth with poorer groups and communities, and to connect countries within the region and with the rest of the world. There is little doubt that infrastructure development--by both the public and private sectors--has contributed to the region's enviable record on growth and poverty reduction. At the same time, questions and concerns have often been raised about the impact of infrastructure development on the environment and local communities, about waste through corruption in public spending and pri- vate contracts, and about the appropriate roles of the public and private sectors in infrastructure financing, ownership, and management. While infrastructure can be a force for good, we also have to make sure it is done well. These questions are the motivation for this joint study by the Asian Development Bank, the Japan Bank for International Cooperation, and the World Bank. The report is organized around three main themes: inclusive development, coordination, and accountability and risk man- agement. It is aimed at senior policy makers and development practi- tioners who have to look at infrastructure in the context of countrywide policies and programs. It does not provide detailed recommendations by country and sector. But it does provide a new way of thinking about infrastructure issues, which is relevant to all countries in the region. These three agencies support infrastructure development through project financing and guarantees, as well as by assisting governments to put in place policies to improve public sector performance and to attract private investment. Therefore, this study is also relevant to our own oper- ations. We will look closely at the implications for our technical assis- tance, capacity building, financing, and guarantee activities. Each agency will follow its own operational strategy in each country. But we hope this new framework will enable us to take a more coherent and con- sistent approach. We will also look for more opportunities to work together--as experienced recently in Indonesia. xiii F O R E W O R D The recent Indian Ocean tsunami took many lives and devastated communities in its path. In Indonesia alone, the damages and losses are estimated at US$4.5 billion, of which about 20 percent would be required to rebuild infrastructure. This report is not about the tsunami. But many of the policy lessons--about coordination, community involvement, and accountability, for example--are also relevant to infra- structure reconstruction. Similarly, in the design of new infrastructure projects, we must take into account their vulnerability to natural disas- ters, to reduce the risk of future damage. We offer this report as a contribution to the ongoing debates about the role of infrastructure in promoting growth and reducing poverty. We real- ize from our own consultations that policy makers in the region do not have to be convinced about the importance of infrastructure. They are keen, however, to learn from the experiences of other countries about how to better manage infrastructure. We hope you will find that this report provides a refreshing and provocative look at familiar issues--and sheds new light on the way forward. Mr. Geert van der Linden Vice President, Knowledge Management and Sustainable Development Asian Development Bank Mr. Seiichi Nakamura Director General, JBIC Institute Japan Bank for International Cooperation Mr. Jemal-ud-din Kassum Vice President, East Asia and Pacific Region World Bank xiv Acknowledgments T HIS REPORT HAS BEEN PREPARED BY A CORE STUDY TEAM LED BY Mark Baird and comprising Rita Nangia, Asian Development Bank (ADB);Yasuo Fujita, Japan Bank for International Cooper- ation (JBIC); and Jonathan Walters, World Bank. The principal author of the report was Jonathan Walters, with support from Adam Schwartzman. Additional contributions were provided by Marc Shotten, Elisa Muzzini, Philip Lam, Ivan Velev, Atsushi Iimi, Takuro Takeuchi, and Shigeki Furukawa. The core team was ably assisted by Evangeline Sucgang, Aggie de Sagon, Marivic de la Cruz, Motoko Kanamaru, and Melissa Morris. The study was prepared under the general guidance of Khalid Rahman (ADB), Toru Tokuhisa and Seiichi Nakamura (JBIC), and Christian Delvoie (World Bank). Background papers for the study were prepared by Roger Allport (Halcrow), Shinji Asanuma (Hitotsubashi University), Michael Bennett, John Besant-Jones, Steven Burgess (World Bank), David Ehrhardt (Castalia), Sharon Felzer (World Bank), Yasuo Fujita and Shoichi Hisa (JBIC), Timothy Irwin and Hana Brixi (World Bank), Shizuo Iwata (ALMEC Corporation), Stephen Jones (Oxford Policy Management), Mahesh Kotecha (Structured Credit International Corporation), Zhi Liu (World Bank), Felipe Medalla (University of the Philippines), Shigeru Morichi (Institute for Transport Policy Studies), Lee Schipper and Wei-shiuen Ng (World Resources Institute), Alex Sundakov (Castalia), Yutaka Takamine (University of the Ryukyus), John Ure (University of Hong Kong), Liz Urquhart (Castalia), Jeremy Warford, Douglas Webster, Hiroo Yamagata (Nomura Research Institute), and Tito Yepes (World Bank). Valuable comments on a draft of this report were provided by man- agers and staff of the ADB, JBIC, and World Bank, as well as by an external advisory group, including Joseph Anderson (Morrison and Forester), Dai Dongchang (Ministry of Communications, China), David Hawes (AusAID), Haresh Jaisinghani (AES Corporation), Takashi Kudo (Nippon Keidanren), Gilbert Llanto (Philippine Institute for Develop- ment Studies), Shigeru Otsubo (Nagoya University), Roel Ravanera (Asia-Japan Partnership Network for Poverty Reduction), Vijay Sethu xv A C K N O W L E D G M E N T S (ANZ Investment Bank), Frances Seymour (World Resources Institute), Bambang Susantono (Coordinating Ministry of Economic Affairs, Indonesia), Hidekazu Tanaka (Engineering and Consulting Firms Asso- ciation, Japan), and Douglas Webb (Telecommunications Commissioner, New Zealand). The study was supported by generous funding from the Government of Japan (Policy and Human Resources Development Fund [PHRD] and Japan Special Fund), the Public-Private Infrastructure Advisory Facility (PPIAF), the ADB, the JBIC, and World Bank. This funding enabled the study team, among other things, to organize consultations with govern- ment officials, private investors, civil society, academics, official lenders, and donors through three regional workshops in Manila (January 2004), Tokyo (January 2004), and Bali (June 2004) and a series of country visits. Some preliminary findings from the study were presented at the Asia Pacific Infrastructure Forum (Melbourne, December 2004) and the Indonesia Infrastructure Summit (Jakarta, January 2005). A draft of this report was launched in Tokyo on March 16, 2005. xvi Abbreviations and Acronyms ADB Asian Development Bank APEC Asia-Pacific Economic Cooperation ARBAC Bucharest Agency for Water and Sewerage Regulation ASEAN Association of Southeast Asian Nations BAPPENAS Badan Perencanaan Pembangunan Nasional BOI Board of Investment BOT build-operate-transfer BRT bus rapid transit CALA Cavite-Laguna Provinces CDD community-driven development CoC cost of capital CoE cost of equity CPC Communist Party of China CPRGS comprehensive poverty reduction and growth strategy DAT Department of Air Transportation DEL direct exchange line DfID Department for International Development EAP East Asia and Pacific ECTEL Eastern Caribbean Telecommunications Authority EdL Electricité du Laos EDI electronic data interchange EGAT Electricity Generating Authority of Thailand EIA environmental impact assessment EKUIN Coordinating Ministry for the Economy and Industry EPA extraordinary price adjustment ERR economic rate of return ESB Eastern Seaboard FDI foreign direct investment GDP gross domestic product GMS Greater Mekong Subregion GNI gross national income GVRD Greater Vancouver Regional District HIPC heavily indebted poor countries ICD inland container terminal xvii A B B R E V I AT I O N S A N D A C R O N Y M S ICT information and communications technology IPP independent power producer JBIC Japan Bank for International Cooperation JICA Japan International Cooperation Agency JETRO Japan External Trade Organization KDP Kecamatan Development Project LAC Latin America and the Caribbean (developing countries only) LRT light rail transit MDGs Millennium Development Goals MEA Metropolitan Electricity Authority MIME Ministry of Industry, Mines and Energy MoF Ministry of Finance MoT Ministry of Transport MPI Ministry of Planning and Investment MRT mass rapid transit MWSS Metropolitan Water Supply and Sewerage System MWCI Manila Water Company, Inc. MWSI Manila Water Services, Inc. NDRC National Development and Reform Commission NEDA National Economic and Development Authority NESDB National Economic and Social Development Board NGO nongovernmental organization NPC National Power Corporation NRB National Roads Board NRW nonrevenue water NT2 Nam Theun 2 OBA output-based aid ODA official development assistance OECD Organisation for Economic Co-operation and Development PASO Pacific Aviation Safety Office PERPAMSI Indonesian Water Supply Association PDAM Perusahaan Daerah Air Minum (Local Water Supply Enterprise) PLDT Philippine Long Distance Telephone Company PLN Indonesia State Electricity Utility PPA power purchase agreement PPI private participation in infrastructure xviii A B B R E V I AT I O N S A N D A C R O N Y M S PPIAF Public-Private Infrastructure Advisory Facility PPP public private partnerships PPWSA Phnom Penh Water Supply Authority PSC public sector comparator PSTN public switched telephone network ROCKS Road Cost Knowledge System SAR South Asia region SEA strategic environmental assessment SEZ special economic zones SOE state-owned enterprise SPUG Small Power Utilities Group TEU twenty foot equivalent units USAID U.S. Agency for International Development UNESCAP United Nations Economic and Social Commission for Asia and the Pacific VoIP voice over Internet protocol WSS water supply and sanitation WUA Water Users Association Units of Measure gw gigawatt km kilometer kWh kilowatt hours mW megawatt VA volt-amp Note: All dollar figures are in U.S. dollars, unless otherwise noted. xix Executive Summary T HIS STUDY IS ABOUT EAST ASIA, AND IT'S ABOUT INFRASTRUCTURE. It's about poverty and growth, and it's about transport, water, sanitation, power, gas, and telecommunications--both the infra- structure, and the infrastructure services.1 Infrastructure is but one part of the development challenge, but its impacts are among the most important. In this study we show how. We look at the role that infrastructure has played in supporting East Asia's growth and poverty outcomes. We look ahead at what the challenges are for the future, and how to think of approaching them. We will discuss these many challenges--in this summary and in the body of the study--but, in sum, they amount to this: responding to and shaping change. Much of East Asia continues to grow rapidly, driven to a considerable extent by China. Urbanization is proceeding at a rapid pace. Demand for infrastructure services is increasing massively, particularly in cities. Much of the demand comes from the newly urbanized poor. Infrastruc- ture has to meet the needs of this population, but also has to continue to provide the underpinnings for the region's growth. The complexity of responding to these demands is greater than ever, and the cost of getting things wrong is high. Poorly conceived infrastruc- ture investments today will have huge environmental, economic, and social impacts--and be costly to fix later. Neglecting the infrastructure needs of people remaining in poor parts of East Asia--particularly in rural areas and in isolated countries of the region--and failing to include them in growth will also be costly in human and political terms. The "new framework" In this study, we set out an approach around which to structure a response to these challenges. The approach is organized in four chapters, each of which discusses a different part of the infrastructure story. Chapter 1 sets the scene. It's about infrastructure in East Asia today, and explains how the region got to this point. It tells five infrastructure xxi E X E C U T I V E S U M M A RY "stories," each of which provides a different aspect of the context for the region's current infrastructure challenge: the economic story, the spatial and demographic story, the environmental story, the political story, and the funding story. Chapters 2, 3, and 4 then set out what we have called the "new framework," picking up the key elements of the stories in Chapter 1 (see Figure 1). Chapter 2 is about goals. It's about how infrastructure can reinforce East Asia's typically inclusive development. By inclusive development we mean improving the lives of all members of society, particularly the poor, by generating economic growth, sharing its benefits, and enhancing access to services. We organize the chapter around the idea of the connecting role of infrastructure. We see how this works at the regional and the country levels. Chapters 3 and 4 are about what needs to be done to achieve infrastructure goals. We divide the issue into two parts. Chapter 3 looks at the big picture: the state's ability to generate strategic vision and translate that vision into infrastructure outcomes. This requires making trade-offs between multiple objectives, particularly when multiple actors are involved. Who makes those trade-offs is important, and how Figure 1 The "new framework": Inclusive development, coordination, and accountability and risk management Improving the Coordination Generating strategic incomes and lives of vision and turning all members of that vision into society, especially reality the poor. Inclusive development Making risks and Rewarding rewards organizations that commensurate perform well for their with each other in Accountability stakeholders (and order to drive and penalizing those good performance risk management that perform badly) xxii E X E C U T I V E S U M M A RY leadership and participation are balanced in that process. This we describe as coordination. Chapter 4 is about what happens lower down in the service delivery process. It's about the various players involved in service delivery-- consumers, communities, service providers, regulators, investors, governments, and nongovernmental organizations (NGOs)--and how to ensure that their interactions result in the right infrastructure outcomes. We structure our analysis around two ideas: mechanisms that can be used to bring about accountability, by rewarding good performance and punishing bad; and the risk management required to ensure that potential costs and benefits are equitably and sustainably allocated. Chapter 5 charts the way forward. It sets out 12 policy messages, answering to some of the key preoccupations of the region's policy makers, policy implementers, infrastructure service providers, civil society organizations, and other stakeholders consulted in the process of putting together this report. It also outlines the role that the official lenders, donors and development agencies can play in supporting countries to meet their infrastructure challenges. Chapter 1. The infrastructure challenge In Chapter 1 we take stock of East Asia's infrastructure challenges in the context of five broader stories that have defined, and will continue to define, the region's development: The "economic story" is about the role that infrastructure has played in underpinning poverty reduction, investment, and growth in the region--it's about levels of expenditure, stocks of infrastructure assets, access to infrastructure services, and infrastructure competitiveness, and what this implies for the future. The "spatial and demographic story" is about the demands of rapid urban growth on infrastructure, and the contribution of infrastructure to that growth and to meeting the needs of urban areas. But it's also about the challenge of linking the poor in rural areas, both to services and to growth centers. And it's about the challenges of infrastructure on a regional level, supporting trade and spreading the benefits of growth across borders. The "environmental story" is about dealing with the impacts of infrastructure on a range of environmental concerns--air quality, xxiii E X E C U T I V E S U M M A RY emissions, the availability of clean water and sanitation, and the function of ecosystems that provide livelihoods and other benefits. The environ- mental challenge is how to mainstream environmental issues, addressing environment not only at the project level but also more broadly in policy. The "political story" is about who captures the benefits of infrastructure--whoprovidesit,towhom,atwhatprice,andatwhosecost. The "funding story" is about the scale of East Asia's infrastructure needs, and how to resource these needs. Ultimately, there are only two groups who pay for infrastructure--consumers and taxpayers. And there is another set that can finance it--the private sector, and official lenders and donors. What needs to be taken into account in structuring the roles of each? What can be expected of them? The economic story Regionally, EastAsia has seen strong growth and strong poverty reduction outcomes. Output has increased by an annual average of more than 7 percent over the past 15 years, lifting 250 million people out of poverty in the past five years. Investment levels are generally high, averaging more than 30 percent of gross domestic product (GDP) since the 1990s. Much of this investment has been to provide infrastructure services. A number of countries invest more than 7 percent of GDP in infrastruc- ture (Table 1.2). Infrastructure stocks are increasing at a significant pace in a number of sectors. Energy generation capacity grew by more than 80 percent (and as high as 180 percent) in six countries throughout the 1990s, and road networks expanded at similarly impressive rates--by over 25 percent (and as high as 104 percent) in four countries over the same period (Table 1.3). But there is great divergence behind these aggregate outcomes, and East Asia still has a long way to go. Half the countries in the region grew by less than 2.8 percent a year between 1994 and 2003. And there are still significant levels of poverty in many of the large, fast growers-- close to 400 million in China; 40 million in Vietnam; and 100 million in Indonesia (Table 1.1). Access to infrastructure services is similarly uneven. In approximately 40 percent of East Asian countries for which we have data, access to water supply is lower than the average for all low- and middle-income countries. The equivalent figures for sanitation, electricity, telephone, and Internet access range between 52 and 79 percent. xxiv E X E C U T I V E S U M M A RY There are similar disparities between countries in East Asia: more than 90 percent of the population has water supply access in four countries; in three countries, it's less than 50 percent. Access to sanita- tion is 93 percent in Thailand, and 30 percent in Mongolia; access to electricity is 97 percent in Malaysia, and 15 percent in the Solomon Islands (Table 1.4). What is the story behind these numbers? East Asian growth is largely driven by fast-growing urban agglomerations in coastal China, Indonesia, Thailand, Malaysia, and Vietnam. Connections between countries within the region have been important, with significant regional trade, much of it geared toward China's expanding markets (a theme we pick up in Chapter 2). A number of the countries in the region have seen simultaneously high levels of growth and investment, a focus on infrastructure, and improved infrastructure performance outcomes. Malaysia and Thailand have achieved internationally competitive infrastructure networks (Figure 1.3). Other countries in the region are further behind, but in general, East Asia has provided the infrastructure underpinnings for economic growth better than in other regions. High levels of investment have not necessarily meant efficient invest- ment. China and Vietnam in particular (with investments rates of more than 30 percent of GDP, and investment in infrastructure at more than 7 percent of GDP) face the challenge of addressing efficiency, avoiding overheating, and managing a soft landing. A number of countries emerging from the Asian crisis of 1997--Thailand, Malaysia, Indonesia, and the Philippines--have restrained investment, in general, and infrastructure investment, in particular. Thailand and Indonesia are both placing renewed emphasis on infrastructure, and face the challenge of enhancing the investment climate, and increasing investment to underpin sustained growth. In other East Asian countries--for example, Lao People's Democratic Republic (Lao PDR) and Cambodia--the mutually supportive relation- ship among growth, poverty reduction, infrastructure, and investment is less evident. Yet other countries and regions are landlocked, or isolated, and relatively unconnected to the major growth centers of East Asia-- most rural areas, the outlying islands of Indonesia and the Philippines, Mongolia, and most Pacific island states. Infrastructure has an important role to play in all of these regions, forging connections to growth centers, and providing services to the poor. xxv E X E C U T I V E S U M M A RY The spatial and demographic story East Asia's spatial and demographic story is dominated by urbanization. Levels of urbanization in EastAsia are not high by international standards (36 percent of the population was urbanized in 2000), but these levels are expected to reach more than 57 percent by 2025 (Figure 1.5). By then, 500 million more people will live in urban areas. Again, there are variations--Indonesia and the Philippines have high urbanization levels and high growth in urban populations; the opposite pertains to Thailand, where there are low levels of urbanization and low growth rates. Other countries span the range between these extremes (Table 1.5). Cities drive East Asia's growth. Cities account for up to 70 percent of East Asian GDP growth. In general, urbanization has been associated with increasing incomes (Figure 1.6). The growth of cities has been associated with unprecedented prosperity (and growing inequality)--for example, the per capita GDP of Shanghai alone is about 11 times that of China's overall per capita GDP. Densely populated urban areas have provided markets for outputs, inputs, labor, and other services and have allowed firms to profit from economies of scale and scope, specialization, and the rapid diffusion of knowledge and innovation. Agglomeration economies have been strong. But urban growth brings with it a host of infrastructure challenges: increasing population drives increasing demand for infrastructure services. Gaps are emerging across urban infrastructure sectors, and these gaps tend to affect the poor (who are frequently found in peri-urban, informal settlements) more than the rest of the population (Table 1.6). At the same time, infrastructure has an enormous role to play in maintaining the competitiveness of East Asian cities. Among the most challenging aspects of this role is to make infrastructure choices before land use patterns are established, thus avoiding the prohibitive costs of infrastructure retrofitting. Long-term planning and strategic vision are essential, as are mechanisms to deal with the cross-jurisdiction and cross- agency coordination challenges raised by decentralization. These issues are discussed in detail in Chapter 3, on coordination. As important as the demands of urban growth are, 60 percent of the region's population (roughly 1.1 billion people) continues to live outside of cities. Poverty tends to be concentrated in rural areas, with a number xxvi E X E C U T I V E S U M M A RY of generally fast-growing countries, including significant pockets of rural poverty. Rural economies depend on urban economies, but urban economies also depend on rural economies for human capital and agriculture products. While improving the livelihoods of rural people, the contribu- tion of infrastructure to rural incomes, to health, and to education out- comes also has implications for urban areas--for example, in the supply of perishable foods or the productivity of future migrants. But the unit costs of delivering rural infrastructure in sparsely populated areas are often higher than urban infrastructure, and striking the balance between urban and rural is difficult, particularly when budgets are constrained. Providing rural infrastructure as cost-effectively as possible is one of the key challenges. As in urban areas, delivery of rural infrastructure raises a number of coordination problems. Decentral- ization, if not carefully managed, may sometimes enhance rural isolation, rather than global connectivity. Finally, the regional challenge for East Asia is to strengthen the connections between countries to spread the benefits of growth. In part, the challenge is to create the infrastructure required to connect isolated countries and areas of the region--the Pacific islands, land-locked Mongolia, and China's western provinces. And in part it's about the logistics required to facilitate trade (and lower costs through economies of scale where possible). These issues are discussed in Chapter 2, on inclusive development. The environmental story Infrastructure choices have important environmental impacts. Sometimes they are positive,2 but frequently they are not. The environmental challenge is to take these impacts on board, and mainstream efforts to mitigate and limit negative environmental outcomes. Project-level interventions have an important role to play. They can include environmental safeguards, measures to mitigate (or compensate for) environmental risk and cost, alternative projects design, or even alternative projects. But the underlying causes of environmental problems cannot be addressed at this level. Environmental considerations need to be embedded within national policy-making agendas. There are a number of ways of doing this--for example, through environmental legislation, capacity building in environmental agencies, xxvii E X E C U T I V E S U M M A RY improved information and transparency, training at the community level and within infrastructure agencies, and the systematic use of strategic environmental assessments (SEAs) at the national and sectoral levels. But mainstreaming environmental issues in this way is primarily a governance challenge, and a difficult one at that. Asymmetry in access to information, capture of the processes of information dissemination, and ease in manipulating environmental assessments all benefit powerful political groups. The ability to mainstream depends on the development of broader accountability, participation, and the existence of transparency mechanisms. Environmental mainstreaming also poses significant policy and agency coordination challenges. Shifting from individual to mass transit may improve urban air quality, but this involves a host of interventions, from investment in urban rail to taxation on fuel and private vehicles to traffic management. And this is all the more difficult with the fragmenta- tion of policies with environmental impacts across state agencies, and where the private sector and civil society are intimately involved. Coordi- nating across all these dimensions challenges government capabilities in any country. The political story The political economy of infrastructure is essentially a struggle over who captures the considerable benefits of infrastructure services and who bears the costs. Governments, consumers, and service providers (whether public or private) all have an interest. Tariff levels are the issue around which much of this struggle takes place. The high economic benefits of infrastructure make a strong case for government intervention. So does the monopoly power that frequently accompanies the economies of scale required to deliver many infrastructure services. This intervention usually takes the form of tariff controls. There are a number of reasons why this happens. Governments may want to protect a certain level of service, but they may be unwilling to allow tariffs to rise to levels required for cost recovery. Fiscal constraints may prevent them from providing subsidies to make up the difference. And the interests of those groups who benefit from lower prices-- infrequently the poor, who are often excluded from formal services and thus remain voiceless--may provide a similarly binding constraint. xxviii E X E C U T I V E S U M M A RY While public sector provision was the only service provision model in East Asia, the costs of low tariffs were absorbed by government budgets, quasi-fiscal loans from state-controlled financial institutions, capital consumption (that is, lack of maintenance and capital replacement), or by reducing operations. This began to change in the late 1980s when the private sector became an increasingly important force in East Asian infrastructure; however, in the process, they took on considerable political risk--much of which was realized after the Asian crisis of the late 1990s. Addressing the political challenge has little to do with whether the public or private sectors deliver infrastructure. An environment that's lousy for the private sector is equally lousy for the public sector.Address- ing the challenge depends on whether governments have long-term economic vision, can plan for the future, acknowledge the importance of efficiency incentives for infrastructure, and are intent on ensuring sustainable infrastructure financing mechanisms. The funding story East Asia's funding challenge is to resource estimated infrastructure needs of approximately $200 billion annually over the next five years. It is estimated that 65 percent of expenditure would need to take the form of new investment, with the remaining 35 percent channeled toward maintenance of existing assets--an equally and sometimes more cost- effective way of meeting service goals (Figure 1.10, and Chapter 1, Annex 1). Ultimately, there are only two sources from which these needs can be funded: consumers (via user changes) and taxpayers (via subsidies). Financiers--whether in the private sector or in the development community--can change the requisite time profile of taxes or user charges, but eventually their contributions have to be repaid or remuner- ated (and if they aren't, the consequences will generally rebound on consumers or taxpayers at some later point) (Figure 1.11). When consumers pay for infrastructure: Charging consumers for use of infrastructure services is common. The challenge is deciding the degree to which their contributions cover costs. The ability of infrastructure providers to cover costs varies by sector. In the water sector, for instance, it is unclear whether any East Asian water utilities have full recovered operational and capital costs (Figure 1.12). Non-cost- reflective tariffs may arise for a number of reasons: they may reflect xxix E X E C U T I V E S U M M A RY excessively high costs of inefficiently run services, or they may reflect costs that are high for good reason. Sometimes tariffs are low for politi- cal reasons (as we saw above), and sometimes they are kept low to protect the poor. There is general consensus now that consumption of services by the poor can be subsidized, although there are considerable challenges in targeting the benefits of below-cost consumption. When taxpayers pay for infrastructure: Subsidizing infrastruc- ture from taxes raises micro issues, including ensuring that subsidies are channeled to expenditure with the highest returns, ensuring transparency, designing exit strategies, and balancing the emphasis on investment and maintenance. These issues are discussed in Chapter 4. Subsidizing infrastructure from taxes also raises macro issues, including whether too much subsidization of infrastructure threatens fiscal stability, or whether too little endangers economic growth and poverty reduction. These issues are discussed in Chapter 3. When the private sector finances infrastructure: The private sector has invested approximately $190 billion in East Asian infrastruc- ture since 1990 (Figure 1.8). This is a minor share of the region's needs, and a minor share of total infrastructure investment in the past. Since the Asian crisis, private sector investment has diminished significantly (although signs of upturn are now evident). A survey undertaken for this study, however, shows that private sector sentiment toward East Asia is optimistic, but varies by country, and is contingent on policy improve- ments and reduced risk (Figure 1.14). The key issue is not whether financing should be public or private, but how the public and private sectors share the risks and rewards in a way that works for both sides. Financing and ownership are secondary. When official lenders and donors finance infrastructure: In purely monetary terms, the role of official lenders and donors has never amounted to more than a small percentage of total infrastructure needs overall (although this varies considerably by country). Official financing fell temporarily after 1997, but it is again on the rise, as the contribution of infrastructure to poverty reduction--indeed, of growth to poverty reduction--has been reappraised. In most infrastructure sectors there are activities in which private sector interest is likely to be limited, and others in which private interest needs external support. Official lenders, donors, and development agencies have an important role to play in both cases. The challenge is to maximize the role of those relatively small amounts of official financing--for example, by stimulating experimentation and xxx E X E C U T I V E S U M M A RY innovation; supporting efficiency gains; mainstreaming environmental and social considerations; attracting private investors to share risks with the public sector; and building effective institutions to plan, coordi- nate, and regulate infrastructure services. We will revisit this topic in Chapter 5. Chapter 2. Inclusive development At the core of this study is the idea of the role of infrastructure in foster- ing inclusive development. Inclusive development is about improving the incomes and lives of all members of society, particularly the poor. It depends on generating economic growth, sharing its benefits with the poor, and enhancing their access to basic services. Infrastructure is highly intertwined in our lives. Knowing that infrastructure is important per se is easy. Measuring the precise importance of a particular piece of infrastructure is difficult. But choices need to be made about infrastructure, and so we need to identify the impacts, understand how they are channeled, and recognize what they depend on. We can look at this in a number of ways. This study primarily examines the ways that infrastructure connects. Conceptually, we can think about the role that infrastructure plays in a series of mutually reinforcing relationships that connect growth and poverty reduction--a subject on which the development world is coming to broad consensus. Infrastructure provides people with the services they need and want. The absence of some of the most basic infrastructure services is an important aspect of what we mean when we talk about poverty. But infrastructure also has an important impact on poverty through growth. Infrastructure is an input into production and raises the productivity of factors of production. Through its impact on welfare, it provides people with the capabilities to fill (and create) jobs. Infrastructure connects goods to markets, workers to industry, people to services, and the poor in rural areas to urban growth centers. Infrastructure lowers costs, and it enlarges markets and facilitates trade. In sum, infrastructure impacts on poverty in two ways: First, it supports the processes of growth on which much poverty reduction depends; and second it helps the poor access basic services, which can improve their lives and income opportunities. And at its best, xxxi E X E C U T I V E S U M M A RY infrastructure can draw poverty reduction, service provision, and growth into a reinforcing cycle (Figure 2.1). A large body of empirical literature documents the impacts of infrastructure on poverty reduction and on growth. The specific impact of infrastructure on poverty, in particular, has been studied in a number of ways, and depends on how one defines poverty. The narrowest poverty definition focuses on the incomes and livelihoods of people living below the poverty line and is concerned with how infrastructure increases real incomes of the poor. But another body of literature looks at poverty more broadly, reflecting some of the key dimensions mentioned in the Millen- nium Development Goals (See Box 1). And broader still, a third strand focuses on enhancing social inclusion, human capabilities, and freedoms, focusing, for example, on the affect that transport and telecommunication services might have on people's ability to engage and participate in collective activities and access wider sources of information. Impacts vary by each kind of infrastructure (Table 2.1). Overall, the literature suggests that transport, telecommunications, and electricity are important overall for growth and poverty reduction, and that rural roads, water, and sanitation are critical to the reduction of poverty among the poorest. Most important, however, it emphasizes that most infrastructure is effective only when combined with other interventions. This does not imply, however, that everyone benefits from investment in infrastructure, nor even that the benefit are shared equally. Infrastruc- ture undertakings--like all projects and sectoral reforms--have winners and losers. At the same time, there may be genuine choices to be made Box 1 Infrastructure and the Millennium Development Goals The Millennium Development Goals (MDGs)--the international community's agreement on the goals for reducing poverty--include eight objectives to be achieved by 2015. The goals are as follows: 1. To eradicate extreme poverty and hunger-- Halve the proportion of people living on less than $1 a day. Halve the proportion of people who suffer from hunger. 2. To achieve universal primary education-- Ensure that boys and girls alike complete primary schooling. (Continued on the next page) xxxii E X E C U T I V E S U M M A RY Box 1 (Continued) 3. To promote gender equality and empower women-- Eliminate gender disparity at all levels of education. 4. To reduce child mortality-- Reduce by two-thirds the under-five mortality rate. 5. To improve maternal health-- Reduce by three-quarters the maternal mortality ratio. 6. To combat HIV/AIDS, malaria, and other diseases-- Reverse the spread of HIV/AIDS. 7. To ensure environmental sustainability-- Integrate sustainable development into country policies and reverse loss of environmental resources. Halve the proportion of people without access to portable water. Significantly improve the lives of at least 100 million slum dwellers. 8. To develop a global partnership for development-- Raise official development assistance. Expand market access. How does infrastructure relate to the MDGs, and how is this relationship addressed in this study? Poverty and infrastructure are at the core of the concept of inclusive development around which this report is written. In Chapter 2 we look at poverty from three angles, and consider how infrastructure in each of the sectors makes an impact. We look not only at income poverty (MDG 1), but also the impacts of infrastructure on education, health, and the environment (with impacts on MDGs 2, 4, 5, 6, and 7). Some of the channels through which impacts are felt are not as obvious as might be expected. It may seem intuitive that the ability of people to earn a living is increased when transport, information, power, and water are readily available. But infrastructure has some less obvious impacts--one study we refer to, for instance, examines the impact of transport and electricity on education.The impact of health services may be similarly affected by the ability of the poor to access facilities. A road or a telephone call can make an enormous difference. Poor access to water and sanitation is an important part of the discus- sion about poverty, and this is addressed in the seventh MDG (environmental sustainability). But the role of infrastructure in the environment is much wider than this. In Chapter 1, we focus on the challenges of mainstreaming environ- mental issues, although the environmental theme cuts across this study. Finally, the role of infrastructure in creating livable cities and providing service to slum dwellers is a theme of Chapter 1 and is included in our discussion of urban management in Chapter 3. xxxiii E X E C U T I V E S U M M A RY between infrastructure investments that have an impact on growth, and those that have an impact on poverty reduction. Finally, institutions often face difficult trade-offs between the interests of different groups of poor and non-poor. Participation of affected groups in decision making is one measure that can help--a theme we pick up in Chapter 4, on accounta- bility and risk management. We can see how infrastructure fosters inclusive development at various levels. In this study, we examine this from the regional level and from a detailed country perspective. Getting the goods to market has been the key to East Asia's prosperity. Trade has been crucial to rapid growth, and trade expansion (particularly exports to China) will continue to be important. The ability of poorer countries to share in this process will depend, in part, on their ability to develop an infrastructure that supports regional trade opportunities. For the most isolated and land-locked countries and regions, regional infrastructure cooperation will be crucial. Superior logistics has played an important role in supporting this regional story. This is particularly so in the region's most advanced developed economies, but it is also true in a number of developing countries, including Malaysia, Thailand, China, and the Philippines (Figure 2.2). East Asia's performance varies across countries (Box 2.5). On the whole, however, East Asia's logistics efficiency appears to be falling behind. Increased logistics costs stem from inadequate transport infrastructure, underdeveloped logistics and transport services, and bureaucratic (and sometimes corrupt) import and export procedures. Issues of coordination--the subject of Chapter 3--feature prominently in the broad measures required to address East Asia's logistics challenges. This requires, in particular, coordination across national boundaries (in harmonization and simplification of customs procedures, for instance, or information sharing), and in urban manage- ment (most important, in the implementation of land use policies for the location of roads, ports, and other infrastructure related to logistics). We then move from the regional to the country specific: Vietnam serves as a useful example of how infrastructure can support inclusive development. Over the last decade Vietnam has grown at an annual average rate of 7.6 percent, placing it among the fastest growing countries in the world. Economic development has been remarkably pro-poor, lifting around 20 million people out of poverty in less than a decade. xxxiv E X E C U T I V E S U M M A RY Infrastructure and investment have been important parts of that process, complementing the country's many targeted poverty reduction initiatives. Forty-four percent of government investment has been targeted to infrastructure. The impacts on poverty have been well documented for large- and small-scale infrastructure undertakings. Improvements to National Highway No. 5, linking Ha Noi and Hai Phong Port, for instance, are associated with significantly higher per capita incomes and poverty reduction in the Ha Noi-Hai Phong corridor. Studies of small infrastruc- ture undertakings have revealed similarly impressive impacts, again most prominently in roads. One study found, for example, that the establish- ment of a new road in a village raised the per capita income of households by 30 percent between 1993 and 1998 (see Chapter 2 for details). Chapter 3. Coordination The East Asian experience demonstrates that the "big picture" is at least as important as the quality of a specific infrastructure ministry or service provider. The big picture is about generating strategic vision, and the state's ability to turn that vision into reality. This is what we mean by "coordination"--the focus of Chapter 3. The advanced economy coordination model Strong coordination is a prominent feature of the infrastructure stories in the region's now-developed economies--Hong Kong (China), Japan, the Republic of Korea, Singapore, and Taiwan (China)--as well as in the most advanced developing economy (Malaysia). In these six advanced economies, political leaders and senior policy makers played a major role in creating long-term development visions, and the sectoral strategies that flowed from that vision. Each country had strong planning agencies to drive infrastructure development, and these agencies enjoyed considerable political influence--Korea's Economic Planning Bureau, Singapore's Economic Development Board, Malaysia's central planning agency and policy-making body in the Prime Minister's Office, or Japan's strong sector ministries and advisory boards. Sustained periods of high growth helped create the policy consensus behind the infrastructure investment needed to support that growth, while the discipline of needing to remain competitive injected efficiency into project choice and service delivery. xxxv E X E C U T I V E S U M M A RY Sometimes infrastructure investment anticipated demand. But when investment was reacting to constraints--as was still largely the case-- reactions were rapid and strategic. A number of bold infrastructure projects were undertaken--the Kobe Nagoya Highway in Japan, and the Seoul Pusan Highway in Korea--although inevitably there were some white elephants. Sector strategies tended to adapt as production structures changed, as opposed to making piecemeal adaptations. Much of the workings of this approach was hidden from view, with individual accountability being largely internal to an elite, as long as the broader public was enjoying the benefits of growth. By the 1980s, however, the strains and contradictions of the model were beginning to show. The model did not deal well with financial crisis or slowdown, revealing risks that had been hidden until then. Government-directed lending from the financial sector, lack of transparency, and corporate governance failures all began to prove problematic. In some cases, strategic investment proved to be supply driven, and cases of cronyism and corruption were not unknown. As the state's role became more complex, and its objectives more diverse, its ability to squeeze efficiency gains from the existing system of public sector monopolies diminished. Greater complexity meant that the state, at the center, needed to focus more on the big picture and delegate more of the details to companies, regulators, local governments, civil society, and markets. Key aspects of the developing country coordination challenge A number of East Asia's developing countries appear to be pursuing similar models in their infrastructure development strategies. In doing so, they face a number of challenges--some of them new, some of them similar to those faced by the more advanced economies. They include the coordination challenges involved in getting levels of infrastructure expenditure right, of coordinating through decentralized government structures, and, in particular, of coordinating urban infrastructure. Establishing the right infrastructure levels requires various kinds of coordination. One of the reasons that governments sometimes spend too much, or with unacceptably high levels of inefficiency, is poor coordina- tion between planning and financing agencies. The separation of planning xxxvi E X E C U T I V E S U M M A RY and financing functions is a common feature of planning frameworks in the region, and in a number of cases it gives rise to poorly and ineffi- ciently resourced infrastructure undertakings (Vietnam and China provide good examples that we draw on in this chapter). These undertak- ings often have implications for fiscal and financial stability, as well as for related sectors--for example, the construction sector in Vietnam. Other kinds of coordination failures may be responsible for expenditure levels that are too low, particularly in times of fiscal retrenchment. When budget deficits need to be cut, infrastructure projects are frequently a target--because they are large and lumpy, and their benefits take years to materialize. But infrastructure investments typically have high rates of return, and cutting such projects may jeopardize long-term fiscal solvency. Agencies responsible for fiscal adjustment therefore need to coordinate long-term fiscal policy with those responsible for infrastructure develop- ment spending. But liquidity crises can also force infrastructure reform. Central agencies need to coordinate with agencies in the infrastructure sectors to ensure that reform is promoted as much as possible, as well as ensure that liquidity pressures don't just shift state liabilities off-budget. While the challenges of coordination to establish the right infrastruc- ture levels are not new, the challenges of coordinating through decentral- ized government are. Twenty years ago East Asia was highly centralized. But today, subnational expenditure as a percentage of total expenditure ranges from 10 percent in Thailand to 70 percent in China. Decentralization can bring significant benefits, by tailoring service provision to the needs of local constituencies. But it raises a number of problems for coordination. The first of these is managing spillovers in service provision--that is, cases in which projects bring benefits and incur costs outside of any single jurisdiction. Voluntary cooperation between local governments is unfortunately rare. Local governments largely lack the necessary short-run political incentives to cooperate, and governments therefore have to develop adequate coordination tools: Thailand's and Vietnam's matching grants are one example; the creation of special districts and regions in the United States and Canada present another model that might be adopted in the region. Other inefficiencies that arise from poor coordination include excessive fragmentation (when municipalities are too small to provide services at efficient scale) and destructive competition (when local governments compete to build or upgrade prestige investments like ports or airports, rather than rely on facilities in adjacent jurisdictions). Central xxxvii E X E C U T I V E S U M M A RY governments have an important role to play in filling in the "missing middle" of coordination. These coordination problems are essentially challenges of horizon- tal coordination--coordination between jurisdictions. Similar problems present themselves in vertical coordination--coordination between central and local levels of government. Central governments have a key role to play in ensuring that local government infrastructure is in line with policy and regulatory frameworks. When fiscal and regula- tory policies are poorly coordinated, and central governments provide financing, while local governments provide delivery, local govern- ments have little incentive to achieve efficiency gains--and sometimes even to respect private sector contracts. This situation is exacerbated in the absence of effective reporting and expenditure tracking mechanisms. A further important coordination challenge is the challenge of coordi- nating urban infrastructure--arguably the most complex coordination issue, given the pace of urbanization, and the number of functions that need to be aligned. Effective land use management is the key to urban planning, but insuffi- cient legal frameworks, deficient application of existing restrictions, and political intervention frequently hamper urban managers. Weak outcomes can be exacerbated by poor timing. When urbanization precedes the investment necessary for livable cities, the costs of improving infrastruc- ture tend to escalate significantly, and retrofitted infrastructure solutions tend to be suboptimal. Coordination among multiple agencies, and across urban boundaries present additional challenges. The state of play in the Philippines, Indonesia, China, andThailand How are the larger developing economies of the region addressing the challenge of coordinating infrastructure? The main theme of the Philippines' experience is that long-term vision and development plans are often undermined by short-term pressures within a fluid and fragmented political system, which in turn diminishes accountability and nurtures corruption. The role of the Filipino planning agency, the National Economic and Development Authority (NEDA), is subordinated, in times of bust, to the goal of fiscal retrenchment and, in periods of boom, to pressures to xxxviii E X E C U T I V E S U M M A RY support highly politicized infrastructure projects. Long-term develop- ment plans and budgets frequently bear little relation to each other. While the formulation of the national development plan is highly consultative, with significant mainstreaming of social and environmental issues, there is a large gap between what plans say and how resources are allocated and policies are implemented. Civil society influences decisions not primarily through participation in planning, but through campaigns and protest at the permitting or implementation stage of infrastructure undertaking. The effects of weak coordination present themselves across the Philippines' infrastructure sectors, with significant impacts on invest- ment and competitiveness. The power sector, in particular, imposes significant financial pressure on the government and cannot fund needed expansion. Poor policy coordination has led to generally inadequate space for infrastructure expenditure and low levels of private investment: In 2002, total infrastructure investment was only 2.8 percent of GDP. Indonesia's coordination story is that of an incomplete progression from autocratic technocracy to greater participation and decentraliza- tion. In the process, the country's planning apparatus has been largely dismantled. Under the Suharto regime, policy planning and coordina- tion was centralized in two institutions that operated more or less in tandem, and had substantial ability to plan strategically and oversee the implementation of planning: Badan Perencanaan Pembangunan Nasional (BAPPENAS), which prepared national five-year develop- ment plans, and the Coordinating Ministry for the Economy and Industry (EKUIN). Under the post-Suharto reformasi regime, the power of the planning agencies has been significantly diffused. Power has been redistributed downward to local government, and fiscal crisis shifted influence to the Ministry of Finance and the central bank. BAPPENAS is now left with a planning advisory role, and EKUIN's successor focuses mainly on short- term implementation issues. Fiscal space for infrastructure has been limited in the last few years, and significant infrastructure backlogs have emerged. The state's ability to pursue growth and poverty reduction objectives through infrastructure provision has become highly constrained since the crisis. Over the last 10 to 15 years, infrastructure service provision has been increasingly delegated to corporatized state enterprises or the private sector, with modest efficiency gains. However, this has been xxxix E X E C U T I V E S U M M A RY accompanied by little restructuring to allow for competition. Nor has the rule of law yet replaced the rule of a strong leader. The ability of the judicial system or of capital markets to bring better corporate governance, or encourage further private investment, remains limited. The country's radical decentralization program has laid the foundation for greater government responsiveness to communities, but it also has created considerable uncertainty about interjurisdictional responsibilities and has limited fiscal space for central initiatives. Since the onset of reformasi, civil society has flourished, and with it a new awareness of local and environmental issues in infrastructure planning and implementation. It has also given rise to experimentation with community-driven development in situations in which the state has failed to deliver--most notably in the Kecamatan Development Project (KDP). But the state's ability to mainstream these efforts into policies and programs is weak. China's experience differs significantly from that of Indonesia and the Philippines. In China, authority has been extensively decentralized to the provincial and municipal levels, but the center remains substantially in charge and generates the strategic vision that binds the system. Account- ability is essentially upward, and civil society's role is limited. Planning has become more strategic and flexible, and market forces play an increasingly important role. China's principal planning agency, the National Development and Reform Commission (NDRC), remains powerful and--unlike BAPPENAS or NEDA--has not seen its strategic planning role undermined. But infrastructure decentralization in China brings with it a number of coordination challenges. Central government is decreasingly able to control the infrastructure investment choices of the decentralized govern- ment. And the ability of provinces and cities to borrow from the state- owned financial sector for infrastructure investment, with limited credit assessment, has challenged the government's ability to exercise macroeconomic control. At the same time, China is advancing with measures to strengthen the coordination of interjurisdictional infrastructure, with local municipali- ties beginning to group together in cross-jurisdictional infrastructure initiatives. China is also drawing on the experience of more advanced neighboring economies (as well as that of Thailand) in its development of special economic zones. xl E X E C U T I V E S U M M A RY Like China, Thailand's record of infrastructure coordination is similar to that of the advanced economies of the region. Strategic long-term vision has played a major role, and coordination among technocrats has been effective. At the same time, participation has played a fairly limited role, although civil society is active. However, the relationship between politicians and technocrats has been a changing one, with each taking responsibility for generating the country's development vision at different times. With coalition govern- ments weakening the ability of the Cabinet to plan and coordinate for most of the 1990s, the country's principal planning agency--the National Economic and Social Development Board (NESDB)--played a preemi- nent role. With the Thai Rak Thai party's dominant control over govern- ment since 2000, the responsibility for setting the strategic vision shifted toward the Prime Minister's Office, with the role of the Ministry of Finance also increasing in importance. The role of the NESDB was uncertain for a while, although it appears to have regained some of its role in infrastructure planning, and involvement in the country's new infrastructure megaprojects. Decentralization in Thailand has been limited.After perceived failures with decentralization to lower levels of government, decentralization has been focused on the 76 provinces. However, the provincial governors are appointed, rather than elected, and their role is more a deconcentration of central authority than a real decentralization. Stakeholder participation in infrastructure has made significant progress at the local government level. Nationally initiated large-scale projects, however, have shown less progress. Although environmental impact assessments are prepared, they frequently take the form of formal attachments to projects treated by their proponents as faits accomplis. On the whole, Thailand's planning and coordination system has been flexible and adaptive. It has dealt well with crisis and long-term strategy. The system has evolved effectively as the political context has changed, and strategic vision has managed to play a central role. Chapter 4. Accountability and risk management Coordination is about the big picture. But we also have to think about what happens at the level at which services are delivered and outcomes xli E X E C U T I V E S U M M A RY achieved. In this study, we approach this in terms of two connected concepts: accountability and risk management (the focus of Chapter 4). We think of accountability as a set of institutional tools that rewards organizations according to performance. Governments, communities, investors, service providers, and NGOs are all engaged with each other in dynamic tension, with their own goals and expectations, trying to hold each other accountable for delivery against those expectations. In doing so, they try to maximize their rewards and minimize their risks, subject to the constraint that everyone else is doing the same thing. This is what we mean by risk management. Effective accountability and risk management are often most recognizable when they are absent. Most often this takes the form of poor service delivery. In its most dramatic form, we see it in financial collapse, as one stakeholder or another is shouldered with obligations they cannot bear. It also frequently takes the form of corruption. While corruption arises for a variety or reasons, infrastructure has a number of peculiarities that make it a frequent target: The monopoly structure of supply can provide significant opportunity for rent-seeking. The political protection and intervention given to infrastructure often blurs financial accountability, and provides cover for a range of corrupt activities, including corruption in allocating scarce services, overstaffing, and excessively high wages. With difficulties in establish- ing the relationship between level of capital investment and service outputs, infrastructure providers can inflate levels of capital spending or hide underinvestment. The large scale of infrastructure often creates opportunities for large kickbacks associated with procurement. East Asian infrastructure is replete with examples of these kinds of practices. Mechanisms to strengthen accountability Active community participation, competition, and regulation each have important roles to play in avoiding these kinds of outcomes. For some types of infrastructure services the best way to ensure accountability is to empower communities to plan and manage their own infrastructure, and ensure that once built, service delivery remains relevant to their needs. Indonesia's KDP is among the largest and best- known East Asian examples, but community participation in infrastruc- ture is increasingly common across the region. xlii E X E C U T I V E S U M M A RY Community empowerment works best when infrastructure is small- scale. For large-scale infrastructure, however, sheer scale can make direct community management difficult. But this does not preclude community participation in aspects of infrastructure that affect them--Japan has useful lessons for the region about how community participation turned around the country's approach to environmental externalities. Competition can also be used to hold service providers accountable. When competition exists, and customers are dissatisfied with a service, they can simply go elsewhere. Although most infrastructure networks cannot be provided competitively, services over those networks can. On the whole, however, East Asia has not been in the forefront of introducing infrastructure service competition. In telecommunications, competition is still limited by international standards. In the electricity sector, East Asia has typically brought the private sector into generation through the least competitive means possible--that is, through a market structure in which a state-owned single buyer intervenes between private generators and customers. Across the region, the choice of this model reflects some of the broader reasons behind the limited introduction of competition in infrastructure: the state's desire to maintain cross-subsidies for sociopo- litical reasons, monopoly rent-seeking, the protection of incumbent state enterprises, risk mitigation for the private sector, and the political control of strategic assets. Regulation is a further tool that can be used to hold service providers accountable. Independence and accountability are traditionally cited as key prerequisites to regulatory effectiveness. There are various ways of holding regulators accountable. Some relate to process and participation: clear statutes, judicial reviews, or subjecting the performance of regula- tors to independent audit. Others relate to transparency: requiring regula- tors to publish decisions, licenses, and benchmarked performance. East Asian countries pursue these measures to various degrees. But infrastructure--in East Asia as elsewhere--is intensely political, and the accountability of the regulator cannot be divorced from broader institu- tions of political accountability. Nor can the ability of the regulator to hold service providers accountable be separated from the political context. Moving toward regulatory independence is proving slow in East Asia, which is not surprising given the region's tradition of strong central control. Independence is difficult to measure, but in one survey of East Asian infrastructure regulators, less than 40 percent of the regulators xliii E X E C U T I V E S U M M A RY described themselves as even nominally independent (see Chapter 4, Spotlight 3). The key issue for East Asian infrastructure regulation is how to accommodate the evolutionary nature of independence. Ensuring that regulators are not given more discretion than the political culture can absorb is critical. One option is to delegate to a regulator the day-to-day application of a concession contract negotiated between investors and the government. Contracting out key aspects of regulation to third parties, until greater discretion can be allowed, is another. Granting regulators more discretion over time, and liberating them gradually from political pressures, could enhance predictability and reduce policy-based risk that currently is so high in East Asia. Risk sharing, accountability, and managing government support Issues of risk management and accountability arise with equal prominence in the relationship between government and service provider, in particular through the support that governments frequently give to service providers in the form of subsidies or guarantees. Subsidizing the provision of services can be important for many reasons. Environmental protection and poverty reduction are the least controversial. It may also be politically important, however, to retain subsidies captured by influential, nonpoor groups, gradually phasing them out over time (particularly if reform eventually brings benefits that can be sustained without subsidies). But subsidies have implications for risk and accountability. By weakening the incentive to provide services in the most efficient manner possible, they weaken the accountability relationship that binds providers and governments. And they can be highly risky: the more you get, the more you ask for. There are various ways East Asian countries manage subsidies: reducing the need for them by addressing excessively high costs through competition, regulation, technology choice, or public enterprise reform; or reducing them directly by making them transparent (and thus subject to scrutiny), making them as one-time payments, channeling them through performance-based arrangements, or adjusting taxes or subsidies on competing products. Cross-subsidies are one option of maintaining accountability of the bottom line, although they come with xliv E X E C U T I V E S U M M A RY other costs--primarily, lack of transparency and difficulties to introduc- ing competition. There are a range of less direct mechanisms besides subsidies that provide fiscal support and share risk--power-purchase obligations in the Philippines, for example, or Thai government backing for state railway borrowing. The accountability issues that these raise are all the more difficult given the contingent nature of the claims to which many of them give rise. Addressing these contingent liabilities requires high-quality fiscal information and utilization of this information during the budget process. Ideally, governments should decide on an overall ceiling for fiscal risk, issue guidelines on risk assumption to sector agencies and local govern- ment, monitor risk, and require approval for the assumption of risk. Many governments in the region have resorted to risk-sharing transac- tions with the private sector, rather than undertaking investment through the budget, to get an expenditure "off the books." But whether this improves solvency, as well as liquidity, depends on whether the transfer of risk to the private sector brings efficiency gains. This depends on the accountability framework for service providers. In East Asia's electricity sectors, for instance, governments frequently have to provide guarantees, because they prevent private sector partici- pants from competing for lucrative parts of the market. In this case, efficiency gains are likely to be limited, and governments are left carrying most of the risks. Who in fact carries risk, however, is not always clear. Risk is hidden in certain arrangements and is more open in others. Additionally, risks are often reassigned in the lifetime of a concession contract, in response to shocks, but equally as part of a learning process involving both govern- ment and private sector providers. And so to the eternal ownership issue: Are privately owned infrastruc- ture service providers more or less accountable for performance than publicly owned providers? Accountability cannot be measured directly, but performance can be. Empirical evidence shows that private providers perform better, on average, when the incentive environment gives them a good reason to do so, but private ownership on its own doesn't seem to make much difference. When ownership is public, and markets are not competitive, accountability is a considerable challenge indeed. In other words, ownership does not generally matter by itself. There have been plenty of disappointments in private provision in East Asia. xlv E X E C U T I V E S U M M A RY What does matter, however, is that private provision tends, on average, to respond better to competition and well-crafted regulation than does public provision. In short, it is easier to use incentives to hold the private sector accountable for performance than to do so for the public sector. Outgrowing the top-down model means greater delegation and the use of decentralized incentive mechanisms. The more this happens, the more necessary it will become to attract the private sector, if infrastructure provision and efficiency are to keep pace with East Asia's needs. But this time around, private participation should come with competition and good regulation. Chapter 5. The way forward The framework set out in this study is analytical. It suggests a way of approaching problems, but is not a "tool kit" for implementing particular policies. Nonetheless, the framework has important policy implications. Here we trace 12 of them. These reflect key concerns articulated in the consultations undertaken in preparing this report, with the region's policy makers, policy implementers, infrastructure service providers, civil society organizations, and other stakeholders. The 12 policy messages constitute an approach to strengthening infrastructure's contribution to inclusive development, as set out in Chapter 2. They promote the role of infrastructure in underpinning growth and poverty reduction. Infrastructure does not lead to inclusive development on its own--it requires actions that support the delivery of services to the poor who need them, and that underpin the growth dynamics on which improvements in welfare depend (Box 5.1). What do we need to think about to achieve this? The discussion of coordination in Chapter 3 provides the basis for three of the policy messages arising from the framework. In Chapter 3, we saw how strategic vision has proved crucial for ensuring the effective- ness of infrastructure interventions. We also looked at a number of the challenges that arise in formulating and implementing this vision-- coordination across financing and planning institutions, coordination across infrastructure and fiscal institutions, and coordination across decentralized government. The analysis set out in Chapter 3 gives us the following three policy messages: xlvi E X E C U T I V E S U M M A RY 1. The center matters--infrastructure demands strong planning and coordination functions Infrastructure provides basic services on which survival and livelihoods depend; infrastructure is the backbone of economies and societies; infrastructure has major environmental impacts; infrastructure can bring powerful monopolies and foreign participation into areas of great sensitivity. As such, infrastructure is intensely political. But infrastructure is also economically and technically complex, and has long-term implications. So the technocrats, too, have a critical role to play as they complement the role of politicians. This extraordinary blend of technocracy and politics places a premium on high-level, central institutions, which can articulate strategies that are politically sustainable and economically effective. Institutions that can formulate those long-term strategies, and can coordinate the policies of different agencies to implement them, are essential to effective infrastructure service provision. Objectives that move beyond the purely economic, to mainstream environmental and social considerations, demand higher levels of coordinating capacity than hitherto. Sector ministries and local governments cannot work in policy-making isolation. Old top-down models of detailed economic planning should be eschewed, but new models of strategic planning and central coordination need to evolve. This should underpin tendencies toward democratization, decentralization, independent regulation, private participation, and the commercialization of service providers. 2. Decentralization is important, but raises a host of coordination challenges There has been substantial decentralization of government in East Asia, and this has often increased the responsiveness of infrastructure service provision to local needs. Decentralization has undoubtedly played an essential political role. However, decentralization poses a number of coordination challenges, both vertically (between central and local governments) and horizontally (between various subnational institutions). Decentralized governments have sometimes been isolated within their own jurisdiction. This is problematic because most network infrastruc- ture has interjurisdictional backbones. Isolation can mean secondary or xlvii E X E C U T I V E S U M M A RY tertiary infrastructure lacks connections to primary infrastructure--in a sense, it goes nowhere. Some municipalities may be too small to achieve the scale necessary to deliver infrastructure efficiently. In competing with each other, municipalities may duplicate expensive infrastructure facili- ties, when such facilities, in fact, could have been shared. Avoiding these pitfalls depends critically on interjurisdictional cooperation--on filling in the missing middle. Higher tiers of government need to encourage lower tiers to collabo- rate where primary infrastructure requires such collaboration. Matching grants to induce decentralized governments to participate in such invest- ments, and institutional mechanisms to encourage cooperation in infrastructure planning will play a major role. Central governments also have to ensure that they maintain sufficient capacity to monitor, manage, and coordinate in a manner that is in line with policy and regulatory frameworks. The inadequacy of such systems is a frequent cause of suboptimal service delivery and confused authority. 3. Fiscal space for infrastructure is critical Ultimately, all infrastructure is paid for by users through tariffs or taxpay- ers through subsidies. Covering costs through user charges is a critical long-term objective. In the short term, user charges might be legitimately constrained by a variety of factors (see below under "subsidies") or large investment needs might require upfront financing to be recovered gradually from user charges. Sometimes those financial shortfalls can be filled by the private sector, but sometimes private financing will be insufficient, unavailable, or unacceptably expensive. Even where the private sector comes in, it often requires risk-sharing with the public sector. In cases in which the private sector cannot or will not provide all the financing or bear all the risk, investments with adequate economic rates of return should be allocated fiscal space.3 Adequacy will depend in part on competing claims from noninfra- structure expenditures and from the need to keep fiscal deficits low. It will also depend on the veracity of the claim that user charges or private financing cannot fill the gap; sometimes it requires fiscal tightening to induce sector agencies to make reforms and seek other sources of funds. In some East Asian countries, expenditure on infrastructure appears to have been less than optimal in recent years. Cambodia, Indonesia, xlviii E X E C U T I V E S U M M A RY Lao PDR, the Philippines, and Thailand could be candidates for this list of countries. This may have undermined economic growth and poverty reduction, and even long-run fiscal solvency. This does not mean that more fiscal space for infrastructure should be the first step in those countries. In several cases, fiscal tightening for macroeconomic stability and debt sustainability would take higher priority. In most cases, the possibility exists for stronger promotion of private financing in infrastructure and for higher user charges. And there can be opportunities for cost reductions, or better management and maintenance of existing assets. In some cases, strengthening public expenditure management should come before more public expenditure. If adequate institutions and controls are not in place, countries can easily veer from underspending to overspending. But if and when those difficult preconditions are met, governments should allocate fiscal space based on long-run growth objectives and in pursuit of fiscal solvency. Infrastructure spending on worthwhile projects can create a virtuous circle: more growth, more fiscal revenue, more fiscal space. The challenge is to select the right projects--and put in place the policy and institutional frameworks that actually make them worthwhile. *** Our discussion of accountability and risk management in Chapter 4 provides the basis for five additional policy messages. In this chapter, we looked at the a number of mechanisms through which accountability in infrastructure service provision can be strengthened--through the community, through regulation, and through competition--and how accountability and risk management arrangements can play out when governments provide support to infrastructure providers. The analysis set out in this chapter supports the following five policy messages: 4. "Subsidy" is not a dirty word--subsidies can be important, but are always risky, and should be handled with care Infrastructure subsidies can be justified on a number of grounds, includ- ing environmental protection and poverty reduction.Although they would enjoy the environmental benefits, people often won't pay the full cost of sanitation, mass rapid transit, or renewable energy. In cases in which those benefits are external to consumers, subsidies may be needed to realize the benefits. Clean water or rural roads may have an important impact on xlix E X E C U T I V E S U M M A RY poverty, but they may not be affordable by the poor. Such projects may require subsidies. And reform programs that help the poor or the environ- ment may not be politically sustainable without subsidies for those with the power to derail the reforms. Similarly, transitional subsidies sometimes may be worth considering during short periods of economic crisis. But subsidies can become open-ended and addictive, their fiscal impact can explode, they can undermine financial discipline and blur accountability, and they can postpone much-needed reform. Subsidies need to be employed with great care. Subsidies should be a last resort after costs have been minimized through competition, regulation, appropriate technology and service standards, or public enterprise reform. Subsidies can be minimized through transparency, making them contingent on performance, or through subsidy bidding processes. 5. Competition is hard to achieve in infrastructure, but it's the best way to bring accountability Infrastructure is quite often a natural monopoly, but institutional and technological innovation are expanding the potential for competition. It is now feasible to provide most infrastructure services (if not always the infrastructure itself) competitively. The most direct, and hence most effective, way of holding service providers accountable is through competition. East Asia has been cautious about the introduction of infrastructure service competition; it has often preferred to "throw" more infrastruc- ture at a problem rather than provide incentives for more efficient infrastructure services or address the political economy obstacles to competition. This approach may have been effective when the basic infrastructure was being built, when economic objectives were relatively simple, and when top-down command solutions prevailed. But, as complexity increases, those approaches can be expected to work less well, and the role of competition will need to increase. 6. Regulatory independence matters more in the long run than in the short run When competition is not yet firmly in place, regulation of monopolies will be needed. Regulatory independence from politics is an important l E X E C U T I V E S U M M A RY long-term goal to ensure that service providers can cover costs and earn an adequate return on investments. However, regulators can establish their credibility with consumers, politicians, and investors only gradually. If regulators exercise more discretion than the political culture can absorb, a backlash can occur, creating unpredictability and instability. Regulatory independence is a relative concept, and independence should grow step-by-step. New regulators should rely more on transpar- ent rules than on discretionary power, and some responsibilities should be delegated to outside experts until in-house capacity can be built. Credibility, and hence independence, can be enhanced by transparency: Hearings should be public, as should contracts and licenses whenever possible. Accountability for regulators is key to their independence. 7. Civil society has a key role to play in ensuring accountability in service provision Local communities within civil society can often manage local projects. They can participate in decision making about the large infrastructure networks that touch their community, or those aspects of large projects that affect them directly. They may need special protection, as long as the larger needs of society don't get lost. Civil society can play an important role in accountability of infrastruc- ture institutions through parliaments or through consumer participation in regulation. Civil society organizations and NGOs can provide small- scale infrastructure services, act as watchdogs against corruption and vested interest, and play an advocacy role for more sustainable infrastruc- ture policies and services. Advocacy NGOs face difficult choices between representing the interests of specific groups or issues, and representing the interests of society at large. How effectively and accountably they make those choices can have a significant impact on development outcomes. 8. Infrastructure has to clean up its act--addressing corruption is a priority Infrastructure is often provided by monopolies, and can generate large rents. It often provides vital services, which are highly prized and highly political. As a result, financial discipline can be weak, political intervention intense, and rent-seeking prevalent. And the benefits of infrastructure can be easy to claim and hard to verify. li E X E C U T I V E S U M M A RY This combination of circumstances can create fertile ground for corruption. But that corruption discredits the very infrastructure on which it preys. This can undermine the political sustainability of infrastructure development, and deter those investors and financiers concerned about reputational risk and other costs of corruption. Combating corruption is a long, hard struggle requiring strong top- down political commitment. Major reforms of the judiciary and civil service lie at the heart of any anticorruption effort. While these longer- term reforms are being put in place, significant progress can be made by removing rent-seeking opportunities and exposing transactions to public scrutiny. *** Four additional policy messages derive from analysis developed across this study, although they all take their departure from what we described as the "funding story" in Chapter 1. Here we saw that infrastructure can only be funded from two sources: the resources of consumers, and the resources of taxpayers. But infrastructure can be financed by two other actors: the private sector (which may also include service providers), and official lenders and donors. The policy messages are as follows: 9. The private sector will come back--if the right policies evolve Private investment in East Asian infrastructure peaked in 1997 and declined dramatically thereafter. It is now showing modest signs of recovery, but it still has not come close to matching the levels initially expected in the mid-1990s. A perceptions survey was carried out for this study among 50 private companies active or interested in East Asian infrastructure investment. One survey response stood out above all others: A majority of investors said they were keen to invest, and would do so if policies were more predictable. The private sector certainly has not disappeared from East Asian infrastructure; however, it is not actually making large investments. More predictable policies would bring it back. Moreover, if it came back, better regulation or more competitive market structures would help ensure efficiency gains from its return. 10. Public sector reform matters, but be realistic In some places, the private sector won't come in sufficient scale, or will only do so on terms that are politically unacceptable (at least to specific lii E X E C U T I V E S U M M A RY groups with strong voice). This is likely to be particularly relevant in countries with small markets (population or purchasing power), those which are emerging from conflict, those where ideological opposition to private or foreign investment is particularly strong, or those where adjust- ment of large state-owned infrastructure is politically difficult because of employment effects. In some sectors, natural monopoly remains strong, so competition to induce the efficiency gains from private participation is not yet possible. In sectoral terms, water and sanitation, large-scale hydropower and electricity transmission, some types of transport, and rural or cross- border infrastructure seem to have the hardest time attracting private investment, or using it to promote efficiency (although there are notable exceptions). In those situations, reform of the public sector may sometimes be the most feasible option for efficiency gains, at least in the near term. But public sector reform is difficult to achieve, and even harder to sustain, so expectations should be modest. If the private sector can't be attracted because the state is unpredictable and lacks vision, or because tariffs and subsidies are below costs, then public sector performance is likely to be disappointing as well. Even if costs are covered, public resources may be better used in sectors other than infrastructure. The alternative of more thorough reform in the medium term to attract private investment should always be considered. 11. Local capital markets matter, but are not a panacea East Asia's success is built, in part, on channeling high savings into domestic investment in infrastructure. The 1997 crisis underlined that domestic savings tend to be less footloose than foreign savings, and that domestic currency financing is less exposed to foreign currency risk. As domestic savings become more scarce, their efficient allocation becomes more necessary. As government functions become more complex, the delegation of resource allocation and risk assessment becomes more important. For these reasons, the contribution of the domestic financial sector to infrastructure development needs to grow. Government will play an important role in regulating the domestic financial sector and encouraging financial innovation, as well as in promoting regional capital market initiatives. In countries where the policy--or quasi-fiscal role--of the financial sector has led to high levels of nonperforming loans to infrastructure, commercialization of the sector liii E X E C U T I V E S U M M A RY will be a priority in the near term. This will restore health to the financial sector and financial discipline to the infrastructure sector. But to promote the financial sector's contribution most effectively over the long term, policies to improve the investment climate for infrastructure should take the highest priority. Trying to make a poorly designed infrastructure project work through financial engineering can have only limited effect; making it into a viable project through reform beyond the financial sector will usually have a greater impact. 12. Infrastructure needs reliable and responsive development partners The development community is now reasserting its role in infrastructure in East Asia. But infrastructure is a long-term asset, and development partners need to stay for the long haul. Reliable partnerships--with quick response and harmonized procedures--are critical. Moreover, the nature of this partnership (financing, guarantees, policy advice, capacity building, and so on) will have to be tailored to country conditions. The needs of East Asia's large, middle-income countries are different from the smaller and poorer countries in the region. Official development assistance (ODA) accounts for approximately 1 percent of gross investment in low- and middle-income countries of East Asia. However, aid financing plays a more significant role in the poorer countries of the region, accounting for more than half of gross investment in Mongolia and Cambodia. Aid flows also play a significant role in most Pacific island countries, Timor-Leste, Papua New Guinea, and Lao PDR. The level of aid, and how it is allocated (including the share for infrastructure), plays a big role in the public spending and investment priorities of these countries. The case for official financing depends on how well it can be used, the availability of other sources of financing, and the overall debt position of the government. The level of aid usually declines, and the blend of loans and grants usually becomes harder, as income levels rise in recipient countries. However, even higher-income countries may see benefits in tapping official financing to ease the debt burden on their budget and to catalyze private sources of funds. The technical assistance embedded in aid-financed projects--for project preparation, environmental and social assessments, and procurement practices--can be beneficial for shaping the government's overall policies and procedures. liv E X E C U T I V E S U M M A RY During the 1990s, some key development partners in East Asia focused their efforts away from infrastructure, at least from infrastructure on a large scale. These partners felt that poverty reduction should be more targeted or that the private sector should step in to finance infrastructure projects. This tendency was intensified by the 1997 financial crisis, as the creditworthiness of affected countries and many infrastructure service providers declined. Aid financing in crisis-affected countries shifted to program support, as budgets were cut and new invest- ments in infrastructure were sharply curtailed. The role of official financing for infrastructure is now being reappraised. It is acknowledged that growth is crucial to poverty reduction, that targeting complements growth, and that infrastructure is essential for both. The private sector did step in, then partly stepped out, and may now step in again. But even at its peak, the private sector was a relatively minor player in financing terms, especially in the poorer countries of the region, and official financing could be helpful to catalyze private investment. Some countries are now emerging from fiscal compression and need official financing to catalyze the private sector and provide more fiscal space for infrastructure spending. Support for more complex projects and new approaches can be particularly valuable. As official financing for infrastructure increases again, it's important that it is used in a way that maximizes development impact. In the past, infrastructure projects have not always been well linked to a country's overall development and poverty reduction strategy. Aid must be used to support (rather than undermine) good policies. In some cases, this may mean funding sectoral programs, including recurrent spending for operations and maintenance and even subsidies. The broader impact of large-scale projects on government revenues must also be taken into account (as seen in the case of the Nam Theun 2 dam project, Chapter 4, Box 4.6). Some official lenders and donors can provide instruments to back up government commitments to the private sector at a time when credibility with the private sector is still being established (for example, guarantees, insurance, official lending to the private sector). The overall case for the use of those instruments depends on a number of factors: first, the economic justification for the project; second, the proper allocation of risks between stakeholders and the ability to structure the guarantee to strengthen rather than dilute operators' incentives to deliver; and third, a lv E X E C U T I V E S U M M A RY robust budget framework for managing any contingent liabilities arising from government commitments. However, in no case should such instruments be substitutes for good policies. Sound policies can reduce risks and demonstrate the govern- ment's commitment to reform. They are therefore more valuable to investors than official agency support per se. Finally, official lenders and donors can provide important knowledge about what works and what doesn't in different countries and sectors. Some of this knowledge comes from higher-income countries that have been there before and learned from their mistakes and successes. It's therefore important that countries like Singapore and Korea stay engaged with the broader development community. The type of knowledge needed will also vary by country--from basic institution and capacity building in poorer countries to more sophisti- cated market instruments in middle-income countries. For the latter, innovative ways are needed to combine private and public financing to extend maturities for long gestation projects. New approaches to develop- ing financing mechanisms at subsovereign levels also need special attention. lvi 1 The Infrastructure Challenge E AST ASIA'S RECENT DEVELOPMENT PERFORMANCE MAKES FOR impressive headlines: As a group, the economies of the region have grown by more than 7 percent annually over the last 15 years.And the number of people living on less than $2 a day has fallen by more than 250 million.1 The story is similar in its infrastructure performance: Investment exceeds 7 percent of gross domestic product (GDP) annually in some countries, with a doubling of electricity generation capacity in only a decade in others, and increases in road networks of between 25 percent and 100 percent in still others. Beyond the headlines, however, the story is more complicated. With large numbers of people surviving on less than $2 a day in even the fastest growing countries of the region, the remaining challenges are daunting. And much of the aggregate growth and poverty reduction numbers are driven by a single country­­China. Behind the aggregates, the develop- ing countries of East Asia in fact differ vastly­­by growth rates, wealth, population, and poverty incidence (see Table 1.1). The group includes the most populous country in the world, and the Pacific island states, which have among the smallest populations in the world. It includes Malaysia, with a gross national income (GNI) per capita of more than $3,000, and Cambodia­­the people of which enjoy less than one-tenth of that amount on a per capita basis. It includes the fast growers, like China and Vietnam, and a number in which growth is sporadic and slow. And, as we shall see, countries of the region differ too in their infrastructure performance. 1 C O N N E C T I N G E A S T A S I A : A N E W F R A M E W O R K F O R I N F R A S T R U C T U R E Table 1.1 Growth, income, poverty, and population, East Asia Average annual Gross national income Number of poor growth, (current $, million), Population GNI per capita (million), 2005 1994­2003 2003 (million), 2003 (current $), 2003 projected Malaysia 4.8 97,809 24.77 3,880 1.7 Thailand 2.8 140,277 62.01 2,190 11.6 Philippines 4.0 86,607 81.50 1,080 -- China 8.5 1,409,162 1,288.40 1,100 391.1 Indonesia 2.5 199,028 214.67 810 99.1 Vietnam 7.3 39,157 81.31 480 41.1 Cambodia 6.3 4,060 13.40 300 10.3 Lao PDR 5.9 2,084 5.66 340 4.3 Mongolia 0.1 1,252 2.48 480 -- Palau 3.0 130 0.02 6,500 -- Marshall Islands 1.7 139 0.05 2,710 -- Fiji 2.7 1,955 0.84 2,240 __ Micronesia, Federated States of 0.1 261 0.12 2,070 -- Samoa 4.2 265 0.18 1,440 -- Tonga 2.1 161 0.10 1,490 -- Vanuatu 0.9 279 0.21 1,180 -- Kiribati 4.7 85 0.10 860 -- Papua New Guinea 0.2 2,739 5.50 500 4.1 Solomon Islands 1.3 247 0.46 560 -- Timor-Leste 3.05b 341 0.88 460 -- Myanmar -- -- -- -- -- Sources: World Bank 2004d, 2004h. Note: -- Not available. a. living under $2/day, 2005. b. annual average growth, 1998­2003. There are a number of ways to tell the story of infrastructure in East Asia. In this chapter, we look at it from five interlinked perspectives. Each of these perspectives defines the context of infrastructure delivery in the region in different ways. We start with the economic story, which places infrastructure squarely in the context of the region's remarkable growth performance, and its record in reducing poverty. Although growth and poverty reduction depend on much more than infrastructure alone (see Figure 1.1), the contribution of infrastructure to the region's macroeconomic story has been considerable. The context established here lays the ground for a 2 T H E I N F R A S T R U C T U R E C H A L L E N G E Figure 1.1 The association between infrastructure outcomes and per capita income levels varies 8,000 6 (kWh) 2 5 6,000 km capita 4 per 4,000 roads/100 3 2 production paved 2,000 Log 1 Electricity 0 0 4 5 6 7 8 9 4 6 8 Log income per capita Log income per capita 100 150 80 (percent) (percent) 100 60 access access 40 50 supply 20 Telephone Water 0 0 4 6 8 10 4 5 6 7 8 9 Log income per capita Log income per capita East Asia, excluding Pacific island states Pacific island states All middle- and low-income countries Sources: IEA 2004;World Bank 2004h; country-specific sources (publications, interviews, etc.); ITU Télécommunications Indicators Database. detailed discussion of inclusive development in Chapter 2­­the how of infrastructure, growth, and poverty reduction. We then look at the spatial and demographic story, in particular at the region's fast-growing urban areas, and the challenges of connectivity and coordination that this raises. Approaches to addressing these challenges are dealt with in Chapter 2 and, through the focus on coordination, in Chapter 3. 3 C O N N E C T I N G E A S T A S I A : A N E W F R A M E W O R K F O R I N F R A S T R U C T U R E In our third story, we look at infrastructure from the perspective of the environment. Many infrastructure investments have a positive impact on the environment, most prominently water and sanitation. But other kinds of infrastructure undertaking entail significant environmental risks­­risks that can be mitigated if the political will is present. But mainstreaming environmental concerns in the design and implementa- tion of infrastructure raises difficult coordination problems, similar in nature to those that we raise in Chapter 3. Our fourth infrastructure story is the political story, which provides some of the context for our discussion of coordination in Chapter 3 and risk management and accountability in Chapter 4. And finally to the question of East Asia's infrastructure service needs, and how they can be resourced. This is the subject of the last of our infrastructure stories­­the funding story. The economic story The economic performance of developing East Asia has been driven largely by fast-growing urban agglomerations in coastal China, Indonesia, Thailand, Malaysia, and Vietnam. It is associated with high investment, low or significantly decreasing poverty, and rapidly expanding output. The performance of these countries­­particularly that of China­­powers the region through an increasingly dynamic and complex web of trade, information, innovation, and investment links. The forging of connections among countries in the region, as well as between East Asia and the rest of the world, has been an important part of the region's performance. Developing countries of East Asia have seen their share of world exports more than triple over the last 25 years (World Bank, 2005b).2 East Asia intraregional trade now constitutes more than 7 percent of world trade (Ng and Yeats 2003).3 China has been central in this trade and growth equation.4 Regional trade has allowed other East Asian countries to benefit from the remark- able expansion of the Chinese economy and markets. Since 1995, East Asia'sexportstoChinahavebeengrowingatarateof11.5percentannually (NgandYeats 2003).Theroleoflogisticalinfrastructure--ports,roads,and rail­­in supporting these connections is one of the themes of Chapter 2. Within countries too, infrastructure has been an important part of the economic story. Investment has been sustained­­in China and Vietnam, in particular, where gross fixed capital formation has averaged about 4 T H E I N F R A S T R U C T U R E C H A L L E N G E 40 percent of GDP and 30 percent of GDP respectively over the last five years.And much of this investment has been in infrastructure (Table 1.2). As a result, the faster growing developing countries of the region manage substantial infrastructure assets. In many cases, the stock of these assets has accumulated, and capacity to generate services has increased at remarkable rates (Table 1.3). Sustained investment and efficiency in operations have helped some economies in the region­­in particular Thailand and Malaysia--to achieve considerable competitive advantage across infrastructure sectors, both in international terms and when compared with the region's developed economies (a comparator group to which we shall return in Table 1.2 Infrastructure investment, percent GDP 0­4% 4­7% More than 7% Cambodia Lao PDR China Indonesia Mongolia Thailand Philippines Vietnam Sources: Latest year available, based on available data from country-specific sources (publications, interviews);World Bank PPI Database 2005. Note: GDP gross domestic product. Table 1.3 Total road network and electricity generating capacity, 1990­2000 Total road network (km) Electricity generating capacity (GW) Annual average 1990 2000 Growth (%) 1990 2000 Growth (%) GDP growth (%) China 1,028,348 1,679,848 63 127 299 136 10.1 Indonesia 288,727 355,951 23 13 25 98 4.2 Lao PDR 13,971 23,922 71 0 0 92 6.3 Philippines 160,560 201,994 26 7 12 81 3.0 Thailand 52,305 60,354 15 8 19 125 4.5 Vietnam 105,557a 215,628 104 2 6 180 7.6 Argentina 215,357 215,471 0 17 24 37 1.5 Brazil 1,670,148 1,724,929 3 52 69 32 4.5 India 2,000,000 3,319,644 66 72 108 51 2.7 Poland 363,116 364,656 0 27 29 9 5.5 South Africa 185,751 362,099 95 31 40 28 3.7 Korea, Rep. of 56,715 86,990 53 20 50 150 1.7 Sources: Country-specific sources;World Bank 2004h; U.S DOE; Energy Administration Information Database. Note: Italics refer to data from prior year; GW Giga Watts. a. 1992 figure. 5 C O N N E C T I N G E A S T A S I A : A N E W F R A M E W O R K F O R I N F R A S T R U C T U R E Box 1.1 The demographic dividend East Asia has benefited greatly from its "demographic dividend." A baby boom has been traveling through the age structure of the region's population since the 1950s and 1960s. These young people began entering the labor force from the late 1960s and early 1970s (at around the same time as the proportion of births started to decline). The working-age population rose from 56 percent of the total population in 1965 to 66 percent in 2000. It is expected to reach about 70 percent by between 2015­20 (World Bank 2004e). One of the distinctive features of East Asia is that the high working-age population has been combined with institutions, traditions, and policies that have encouraged high savings levels in that age group and that have channeled those savings into domestic investment (Figure 1.2). Infrastructure has been a major beneficiary of that phenomenon. Figure 1.2 Savings and investment (percent GDP), average, 1993­2002 Malaysia China Thailand Indonesia Vietnam Philippines Mongolia Vanuatu Cambodia East AsiaandPacific Middle East and North Africa EuropeandCentralAsia SouthAsia LatinAmericaandtheCaribbean Sub-Saharan Africa 0 10 20 30 40 50 Investment Savings Source: World Bank 2004h. 6 T H E I N F R A S T R U C T U R E C H A L L E N G E Chapter 3). In other large economies in this group­­China, Indonesia, Vietnam, and the Philippines­­performance has been less impressive (Figure 1.3). This overall impression is mirrored in the response of EastAsian firms to World Bank Investment Climate Surveys, nearly 20 percent of which report that inadequate infrastructure service provision is a serious obstacle to the operation and growth of their business.5 This is a lower percentage than in the rest of the developing world, but it is high enough to be of considerable macroeconomic consequence. In short, East Asia has provided the infrastructure underpinnings for economic growth better than other developing regions (on average), but there is much room for improvement, and supply needs to keep pace with rapidly rising demand.6 In those countries in which infrastructure investment has been most sustained­­China and Vietnam in particular­­high levels of investment have not always implied optimal investment. Often efficiency in the selection and management of investment, in general, and infrastructure, in particular, has been lacking. Too much investment may be as dangerous as too little. The governments of these countries now face the challenges of improving efficiency, avoiding "overheating" by restraining excessive investment, and managing a "soft landing" with sustainable growth and investment­­a point we pick up in our discussion ofVietnam in Chapter 2. In the countries most affected by the 1997 crisis, growth has recovered (that is, in Thailand, Malaysia, and to a lesser extent Indonesia and the Philippines), but this has been driven primarily by domestic consumption and exports, rather than by investment. In the Philippines, physical capital per worker has been growing at barely 1 percent per year since the early 1990s. In Indonesia, Malaysia, and Thailand, capital per worker was grown by 4 to 7 percent per year before the 1997 crisis, but by less than half that rate since then (World Bank 2004d).7 Clearly, the postcrisis recovery in growth has come from increased capacity utilization and enhanced labor productivity and innovation; however, these factors will eventually reach limits without an investment recovery. In these countries, therefore, the challenge is to enhance the investment climate and increase investment to underpin sustained economic growth (while continuing to realize efficiency gains in manage- ment of assets). Access to infrastructure services in Malaysia and Thailand, as well as the Philippines, and to a lesser extent China, is generally higher than that 7 C O N N E C T I N G E A S T A S I A : A N E W F R A M E W O R K F O R I N F R A S T R U C T U R E Figure 1.3 Infrastructure quality ranking, World Competitiveness Report, East Asia Overall infrastructure Telephones Electricity supply quality Malaysia Malaysia Malaysia Thailand Thailand Thailand China China China Indonesia Indonesia Indonesia Vietnam Vietnam Vietnam Philippines Philippines Philippines Singapore Singapore Singapore Hong Kong Hong Kong Hong Kong (China) (China) (China) Korea, Rep. of Korea, Rep. of Korea, Rep. of Taiwan Taiwan Taiwan (China) (China) (China) Japan Japan Japan 0 2 4 6 8 0 2 4 6 8 0 2 4 6 8 1 poorly developed and inefficient 1 scarce and difficult to obtain 1 worst than in most other countries 7 among the best in the world 7 widely available and highly reliable 7 equal to the highest in the world Railroads Ports Air transport Malaysia Malaysia Malaysia Thailand Thailand Thailand China China China Indonesia Indonesia Indonesia Vietnam Vietnam Vietnam Philippines Philippines Philippines Singapore Singapore Singapore Hong Kong Hong Kong Hong Kong (China) (China) (China) Korea, Rep. of Korea, Rep. of Korea, Rep. of Taiwan Taiwan Taiwan (China) (China) (China) Japan Japan Japan 0 2 4 6 8 0 2 4 6 8 0 2 4 6 8 1 underdeveloped 1 underdeveloped 1 infrequent and inefficient 7 as extensive and efficient 7 as developed as the world's best 7 as extensive and efficient as the world's best as the world's best Source: World Economic Forum 2003. Note: Rankings are shown for developing East Asian economies (darker bars) and advanced East Asian economies (lighter bars). Black vertical line is the average for all 102 surveyed countries, both within and outside of East Asia. 8 T H E I N F R A S T R U C T U R E C H A L L E N G E Table 1.4 Infrastructure access and stocks Access to water, electricity, and telecommunications Transport networks Water supply Sanitation Electricity Telephone Internet Road network Percentage Rail network accessa accessb accessc accessd accesse (km per 100 km2) paved road (km per 100 km2) Malaysia 93 -- 97 62 34.4 Malaysia 20 76 0.49 Thailand 93 98 84 50 11.1 Thailand 12 97 0.79 Philippines 86 83 79 31 4.4 Philippines 68 22 0.16 China 76 39 99 42 6.3 China 19 91 0.64 Indonesia 78 55 55 13 3.8 Indonesia 20 58 0.25 Vietnam 49 25 81 9 4.3 Vietnam 29 25 0.97 Cambodia 44 22 17 4 0.2 Cambodia 22 4 0.42 Lao PDR 58 30 41 3 0.3 Lao PDR 14 15 -- Mongolia 60 30 90 19 5.8 Mongolia 3 8 0.15 Palau 79 100 60 42 -- Palau -- -- -- Marshall Islands -- -- 100 9 2.6 Marshall Islands 35 -- -- Fiji -- 43 80 26 6.7 Fiji 19 49 -- Micronesia -- -- 45 16 9.3 Micronesia 34 18 -- Samoa 99 99 95 13 2.2 Samoa 28 80 -- Tonga 100 -- 85 15 2.9 Tonga 94 27 -- Vanuatu 88 100 26 7 3.6 Vanuatu 9 24 -- Kiribati -- 48 40 6 2.3 Kiribati 92 -- -- Papua New Guinea 42 82 46 1 1.4 Papua New Guinea -- 4 -- Solomon Islands 71 34 15 2 0.5 Solomon Islands 5 3 -- Timor-Leste -- -- 22 -- -- Timor-Leste 25 41 -- Myanmar 72 64 5 1 0.1 Myanmar -- -- -- Low and Low and Middle Income 77 70 64 27 6.5 Middle Income 38 41 1.70 Sources: IEA 2003;World Bank 2004h; country-specific sources (publications, interviews, and so on); ITU database. Note: Shaded values above category average for low- and middle-income countries; -- Not available. a. Percentage of population with access to at least 20 liters per person per day from "improved" water supply technologies from a source within one kilometer of the user's dwelling (see W1 in the Statistical Annex). b. Percentage of population with excreta disposal system "under improved" sanitation technologies, adequate if it private or shared (but not public) and if hygienically separates human excreta from human contact (see W4 in the Statistical Annex). c. Percentage of households with electricity access through commercially sold electricity, both on-grid and off-grid (see E1 in the Statistical Annex). d.Telephone subscribers per 100 inhabitants. e. Number of users per 100 inhabitants. of its less wealthy (in per capita terms) neighbors (Table 1.4). Similar outcomes have been achieved in some of the tiny Pacific island nations, although­­as we set out in more detail in Box 1.2­­the context of this achievement is substantially different. 9 C O N N E C T I N G E A S T A S I A : A N E W F R A M E W O R K F O R I N F R A S T R U C T U R E Box 1.2 Infrastructure challenges in the Pacific Island countries: A case apart The nine Pacific island countries covered by this study stand apart from the rest of the region in a number of respects, with important implications for their infrastructure challenges. Together, the nine islands have a combined population smaller than Jamaica's, in a total land mass smaller than Cuba's, spread over an area larger than China. The challenging topography and the low population density clearly com- plicate the task of infrastructure service provision. The spread of the high fixed cost of infrastructure investment over a small customer base inflates unit costs and depresses revenues from service provision. Because of their remoteness and lack of economies of scale, the Pacific island countries, in relation to other East Asian countries, have a significant comparative disadvantage in attracting private sector participation and sustaining competition in infrastructure. The Pacific island countries are lagging behind East Asian countries in terms of access and quality of service provision. A stunning 70 percent or more of inhabitants lack access to electricity. Telecommunications access is largely limited to urban areas. Because of a lack of transport alternatives, interisland shipping and civil aviation play a crucial role in a complex transport system serving hundreds of sparsely populated small islands. Nevertheless, airports and ports are characterized by low throughput on a per capita basis. But poor performance in infrastructure cannot be attributed exclusively to geography and lack of economies of scale.The Pacific Islands have lower lev- els of access to telecommunications, electricity, and improved water and sani- tation, than similar countries with the same level of income (for example, in the Caribbean). Policy and institutional choices also matter: Poor coordination. Many Pacific island countries suffer from poor coordination in infrastructure policy and implementation. Hidden subsidies to corporatized utilities do not compete with other fiscal priorities in a transparent manner. Regulatory and policy frameworks are often not fully aligned or contradict each other­­for example, Fiji adopted the "landlord" model for port opera- tions, but contracted out stevedoring operations to a monopoly government- owned provider, thus diluting the potential efficiency benefits stemming from competition in service provision. Low accountability. In most of the Pacific island countries, government-owned utilities are in charge of providing the service and sanctioning its quality. Most of the governments have now recognized that this model does not create an enabling framework for accountability to end users, and have moved toward more accountable institutional arrangements, through corporatization of state- owned utilities. However, with only a few exceptions, accountability to end users has remained low, as corporatized utilities are often still subject to micromanage- ment by the government. When the prospect for private sector engagement exists, the imbalance between the public sector and the private utilities in terms of monitoring capacity can sometimes lend excessive power to the (Continued on the next page) 10 T H E I N F R A S T R U C T U R E C H A L L E N G E Box 1.2 (Continued) privatized utilities or lead to collusive outcomes, with little improvement in accountability. Low capacity to manage risk. The risk management model in the Pacific island countries is often based on a model of government as absorber of risk­­gov- ernment-owned utilities are generally insulated from risk, as losses flow through to the government and are eventually born by taxpayers. The cost of govern- ment risk-bearing is often high, as the Pacific island economies are particularly vulnerable to external shocks (such as oil price shocks), which also tend to have an impact on the cost of infrastructure service provision. The total cost of risk-bearing could be reduced through more sophisticated project design, which would enable more effective risk-sharing. Consumers and service providers should be called on to bear at least part of the risk, to the extent that they are able to absorb it. Notwithstanding the specific infrastructure challenges faced by the Pacific island countries, a few successful examples of corporatization (such as the Fiji Electricity Authority, Samoa Ports Authority, and Samoa Water Authority) and the positive performance of the private electricity and water utility in Vanuatu demonstrates that the possibility exists for improved performance and accountability through better management and commercial focus. The chal- lenge is to design time-bound performance-based subsidies to encourage more efficient and inclusive infrastructure service delivery.The establishment of regional bodies (such as the existing Pacific Power Association) should be encouraged as the way forward to ease individual country capacity constraints and promote policy coordination among the Pacific island countries. Sources: Castalia 2004b; Mellor and Jabes 2004. The larger, faster growing economies also stand apart in the degree to which growth, investment, and poverty reduction have accompanied and supported each other. The poverty headcount in China has dropped from around 70 percent of the population in 1990 to close to 30 percent of the population today.8 Vietnam has seen its poverty headcount drop from around 90 percent to 48 percent over the same period (Figure 1.4). The risk of poverty, however, is much higher than the poverty headcount may suggest at any particular time. In all developing countries of East Asia, a far larger number of households fall intermittently below the poverty line than are permanently below it.9 The 1997 crisis dramat- ically exposed this underlying risk, with lasting effects on policies and attitudes toward poverty, social stability, and vulnerability in the region. In contrast to the region's best performers, a number of countries have been less successful in simultaneously nurturing growth and poverty reduction. In Cambodia­­despite significant growth (albeit from a very 11 C O N N E C T I N G E A S T A S I A : A N E W F R A M E W O R K F O R I N F R A S T R U C T U R E Figure 1.4 Poverty headcount index ($2/day), percent, East Asia, selected countries Thailand, Malaysia China, Vietnam, Indonesia Lao PDR, Papua New Guinea, Cambodia 90 90 90 Lao PDR 80 80 Vietnam 80 70 70 70 60 60 60 50 Thailand 50 50 40 40 Indonesia 40 PNG Cambodia 30 Malaysia 30 30 20 20 China 20 10 10 10 0 0 0 1990 1993 1996 1999 2002 2005 1990 1993 1996 1999 2002 2005 1990 1993 1996 1999 2002 2005 Source: World Bank 2004d. Note: Data interpolated between 1999 and 1996. low base)--78 percent of the population is estimated to live on less than $2 a day. The corresponding figure for Lao People's Democratic Republic (PDR) is about 73 percent (World Bank 2004d). Infrastructure access, particularly those stocks that serve to connect and link (roads or rail), are significantly lower in Lao PDR and Cambodia (Table 1.4). And with investment levels at between one-third and one-half that of faster growing neighbors, a mutually supportive relationship between infrastructure, investment, growth, and poverty reduction is less apparent than elsewhere in the region. Finally, other regions in East Asia remain isolated and relatively disconnected from the major growth centers of East Asia­­most rural areas, the outlying islands of Indonesia, the Philippines, land-locked Mongolia, and most Pacific island states. In the Pacific island countries, the poverty headcount is generally much lower, but economic growth rates tend also to be quite low and incomes are heavily dependent on aid flows, migrant labor remittances, or nonrenewable natural resources with volatile revenue streams. Popula- tions in those countries therefore remain particularly vulnerable to poverty through slow economic growth and lack of economic diversity. The spatial and demographic story East Asia's spatial and demographic challenge plays out across three interlinked dimensions. The first is the urban dimension: Cities drive East 12 T H E I N F R A S T R U C T U R E C H A L L E N G E Asian growth, and as they do, their populations are expanding rapidly. Infrastructure not only has to keep up with demand for services, but also has to play a crucial role in maintaining cities' competitiveness. The second challenge relates to rural areas, where poverty levels are at their highest. Infrastructure can help improve livelihoods; it also has an important role to play in spreading the benefits of urban growth. And the third challenge is a regional challenge: to create regional markets; enhance trade and regional integration; and connect poorer, isolated areas to the region's growth centers. The urban challenge The urban agglomerations driving East Asia's growth have profound consequences for economic development. Cities account for 70 percent of the region's GDP growth. Urban populations are expanding rapidly. And with it come a host of infrastructure opportunities and challenges: challenges that entail integration and connection; and challenges that entail foresight and coordination. How to meet these challenges is one of the themes of our next two chapters. The urban share of East Asia's population is not yet high by global standards, but it is rising exponentially. From 16 percent in 1960, to 21 percent in 1980, and to 36 percent in 2000, it is expected to rise to 57 percent by 2025 (Figure 1.5). By then, East Asia will have about 500 million more urban dwellers than it does now, mainly as a result of migration from rural areas (World Bank 2004c).10 From 2000 to 2015, the population living in cities with more than 1 million residents is expected to increase by about half (to 500 million) and the population living in megacities with more than 10 million residents will rise by a similar proportion (to 120 million). The most rapid population growth is taking place in peri-urban periph- eries. In Chinese cities alone, peri-urban areas will grow by about 250 million people over the next 25 years (World Bank 2004c). And increasingly, neighboring East Asian cities are connecting with each other and forming large urban clusters. These include large parts of China's coastal zone, Bangkok's Eastern Seaboard, the Philippines' National Capital Region, and the cross-border cluster of Singapore- Riau-Johor. In general, urbanization in East Asia is correlated with increasing national income levels (Figure 1.6). Cities have driven growth. The rapid growth of cities has been accompanied by a striking change in economic 13 C O N N E C T I N G E A S T A S I A : A N E W F R A M E W O R K F O R I N F R A S T R U C T U R E Figure 1.5 East Asia's urban population is not yet high by global standards, but it is rising exponentially Urban population (percent total population), 2000, East Asia, 1960­2025 90 80 70 2025 60 50 2000 40 30 1980 20 1960 10 0 Asia and and OECD Pacific Africa East Africa South and Sub-Saharan America Caribbean MiddleNorthLatin the Asia East Sources: World Bank 2004c, 2004h; United Nations 2003;World Bank staff calculations. Note: OECD Organisation for Economic Co-operation and Development. Table 1.5 There is significant variation in the speed and level of urbanization across East Asian countries Level and rate of urbanization, percent total population, 2000, growth rate, 1995­2000 Urbanization level Low Middle High Fast Cambodia Indonesia Lao PDR Philippines rate Intermediate China Malaysia Vietnam Myanmar Urbanization Slow Thailand Mongolia Source: UTCE/ALMEC 2004a, based on World Bank 2003e. Note: Urbanization level: High >40%, 20% 6%, 2%