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6. The Global Infrastructure Development Sector

© New York University/Stern School of Business, CC BY 4.0

Studies of global infrastructure development often omit a perspective on the infrastructure development industry itself. Infrastructure development is the industry that turns infrastructure ideas into physical reality — contractors, engineering firms, hardware suppliers, and so on. Consequently, market penetration, cost functions, scale and scope economies, and other competitive variables that characterize infrastructure development have a direct effect on its economics. Vibrant competition among suppliers in executing infrastructure projects to the highest possible standards at the lowest possible cost is in the interests of the various project stakeholders — lenders, investors, and end users.

Available data covering the global cluster of the top 250 infrastructure contractors worldwide suggests that the sector is much more interregional than is typical for most global industries. US-based contractors rank 17th in the cohort of these 250 firms. Geopolitics, although relatively insignificant for most industries, thus becomes highly relevant for infrastructure project execution.

A concrete example involves China, which in recent years seems to have gained the most in its share of the global infrastructure development market, and the US, which appears to have lost more share than any other single country during the same period. The value proposition of successful Chinese competitors in this space relative to their US rivals centers mainly on lower prices. There are several possible explanations for this dynamic.

Lower absolute costs of capital equipment. As in other manufacturing categories, China holds significant absolute cost advantages in terms of capital equipment thanks to well-developed and improving supply chains, as well as low labor and capital costs. Cost levels are thought to be at least 10% to 20% lower for basic categories of capital goods compared with Western suppliers.

Lower absolute costs of labor. Absolute competitive advantages embedded in equipment costs are augmented by lower labor costs for on-site construction services. The usual Chinese practice in Africa, for instance, is to bring in Chinese workers for construction, which generates significant savings relative to the Western practice of relying mostly on local labor. The Chinese approach sometimes incurs local political resentment, but it helps assure that that an entire project operates from the same well-rehearsed playbook.

Lower costs of capital. Especially for Chinese state-owned enterprises (SOEs), capital costs are often very low given higher-level objectives related preserving (or ideally, augmenting) employment and political gains deemed to be in China’s national interest. In addition to reducing the costs embedded in local capital equipment, lower capital costs decrease the markup that contractors must charge to break even economically on the amount of capital they deploy.

Economies of scale. China has been the largest, most rapidly growing national construction services market in the world, whereas the US and Europe both exhibit declining shares. Static scale economies, as well as the opportunities that growth offers, enable Chinese competitors to deploy the latest technology in their own operations (vintage effects), which should complement the absolute advantages identified above. And the predicted long-term eastward shift of the world’s center of economic gravity, from the North Atlantic toward Asia-Pacific, can only amplify the effects of realizable economies of scale.

Coordination gains. In the presence of monopoly power — and by extension market power — coordination may enhance competitiveness relative to a benchmark in which, say, potential equipment suppliers and potential financiers set their terms independently of each other. The Chinese model involves more coordination of this sort than the US model (where, for example, the Export-Import Bank has come under threat), and Chinese international economic engagement is often seen as an extension of international political engagement.

Subsidization. Chinese practice often seems to go well beyond exploiting complementarities to building a subsidy component into infrastructural deals for a range of reasons. Absorbing excess foreign exchange reserves exposed (until recently) the nation’s apparent desire to move beyond being a “lonely power” without close allies to prioritize capital goods as the next stage in its ascent of the technology ladder. Public commitments to foreign infrastructure are also contained for example, in the announcement of the New Silk Road and the formation of the Asian Infrastructure Investment Bank

Articulating all of these potential sources of lower infrastructure execution costs should help explain why US and European competitor claims of Chinese underpricing by 50% or more are not outlandish. China’s competitors have their own value propositions, however, which revolve around some distinct sources of differentiation. Here are some concrete examples:

Quality. Quality advantages can help offset US, Japanese, and European competitors’ price disadvantages against Chinese rivals. Compare Caterpillar and Komatsu competing with Chinese construction equipment leader Sany. In advanced economies, contractors buy heavy equipment based on quality and expect it to last for decades. In China, poorly capitalized local enterprises, often linked to corrupt officials, buy the cheapest machines possible and rent them out to local contractors on a job-by-job basis. So Sany builds a cheaper, less durable design and sells (with attractive financing) in this price-sensitive segment. Caterpillar and Komatsu cater more to quality-sensitive purchasers [Hout and Michael, 2014]. The Chinese saying that equipment needs only to be “good enough” reflects many of these attributes.

Learning advantages. Western competitors may, along some dimensions, hold advantages over Chinese rivals that the latter must surmount over time rather than in the short term. For instance, Chinese manufacturers have mastered relatively simple manufacturing, involving fewer than a thousand parts per product, but they still lag Western competitors in systems integration capabilities and software development, as well as in manufacturing systems with far more parts (e.g., aircraft engines, high-speed rail networks, and nuclear power reactors).1

More sophisticated management approaches may also play a role in the Chinese learning advantage. For instance, US-based Cummins develops and manufactures diesel engine families with varying prices and features around the world. Cummins leads within China in the higher-performance segment and can, because of its distributed production and R&D capabilities, ship more engines into China than it ships out (both highly advanced and lower-priced varieties). Such global operating architectures and sourcing flexibility require internationally experienced middle managers, subtle cross-border coordination mechanisms, and technical depth in many locations that can be built only with time.

Technological upgrading. The effect of lags can be extended by continuing to upgrade and raise the bar for less (vertically) differentiated competitors. This idea is consistent with traditional literature on the multinational enterprise, and John Sutton recently explored it in the context of global escalation games.2 A study of competition between Western and Chinese firms through this lens looks broadly within China, at 44 industries in which foreign competition is allowed, and finds that non-Chinese firms (e.g., Corning, GE, Intel, Pfizer, and Merck) lead in 10 of the 13 industries in which R&D exceeds 6% of sales.3 The Chinese government has taken many measures to force more technology transfer to local firms (Hout and Ghemawat, 2010). A study of competition between Western and Chinese firms through this lens looks broadly within China, at 44 industries in which foreign competition is allowed, and finds that non-Chinese firms (e.g., Corning, GE, Intel, Pfizer, and Merck) lead in 10 of the 13 industries in which R&D exceeds 6% of sales.4

Compliance expertise. Another potential advantage has to do with Western competitors’ generally superior ability to comply with the procurement, environmental, and other standards. Chinese competitors generally admit to being well behind in this regard. Nonetheless, the Chinese looseness in this arena, such as the lack of an equivalent to the US Foreign Corrupt Practices Act, may actually help Chinese companies in some ways. Strict anticorruption measures may well be socially optimal, although not necessarily from the (private) perspective of a competitor. For this situation to change in countries that rank worst on indexes related to corruption or lack of transparency will require a fundamental transformation at the local level, although global anti-corruption initiatives can play an important supporting role.

This discussion highlights the roles of governmental policies and managerial decision-making in determining how competitive positions in infrastructure execution may evolve over time. It implies, for Western companies and governments, a strategy based on selectivity rather than across-the-board competition, and a shift from the pursuit of market share to economic value maximization.

1 Nomura Securities (2014).

2 Caves (1971); Sutton (2012).

3 Ghemawat and Hout (forthcoming).

4 Hout and Ghemawat (2010); Ghemaway and Hout (2016).