The political stability achieved by Colombia and Peru over the past 15 years, along with accelerated economic growth, have led to a significant increase in total trade (the sum of exports and imports) from US$125 billion in 2008 to US$188 billion in 2012. In addition to stability and economic growth, another key factor is both countries’ success in establishing free trade agreements (FTAs) with major economies such as the U.S.,China, and the EU. Nevertheless, for Colombia and Peru to compete with these countries and truly benefit from free trade, they must narrow their infrastructure gap to increase their competitiveness.

One of the primary limitations in both countries’ competitiveness rankings is their infrastructure, particularly in the transportation sector. According to the Global Competitiveness Report, prepared by the World Economic Forum in 2012,Colombia and Peru were ranked 114 and 97, respectively, among 144 countries and territories in terms of transportation infrastructure — below Puerto Rico (45) and Rwanda (67).

The Colombian Infrastructure Chamber published a study in 2012 showing a deficit of more than 30,000 kilometers of paved roads in the country and a lack of roughly 1,000,000 containers in port capacity. This study also highlighted the poor conditions of existing roads, where only 10% to 15% of secondary and tertiary roads are considered to be in “good” condition. One of Peru’s primary newspapers,La República, estimated that, in order to maintain its current level of competitiveness,Peru would need US$88 billion in infrastructure investment between 2012 and 2021. Transportation accounts for almost 25% of the deficit, with the primary transportation areas being roads (roughly US$13 billion) and railways (US$7 billion).

As a consequence of poor infrastructure,Colombia and Peru face extremely high transportation costs. Xavier Duran, a professor at Universidad Los Andes in Colombia, noted that logistics costs in Colombia and Peru represent 23% and 32% of their GDP, respectively, compared to 9% on average in OECD countries. Other evidence from the World Bank’s 2012 Doing Business report shows that the cost of exporting a commodity is approximately US$2,270 per container in Colombia and US$850 in Peru, much higher than the cost in countries such as Malaysia (US$435) and South Korea (US$695).

Both the Colombian and Peruvian governments are aware of the current situation and the need to invest in order to improve their global competitiveness. Colombian President Juan Manuel Santos stated in 2012 that, “Only with major investments and ambitious projects will we be able to recover and provide the productive sector with an infrastructure that allows us to be truly competitive.” What are the root causes of poor infrastructure in these countries? What is the role of government in addressing the challenges? What progress has been achieved, and what lies ahead to ensure that increased investment will close the infrastructure gap? What are these governments doing, and what do they still need to do to close the gap?

Origins of the Deficit 

Indirectly emphasized by President Santos, one of the primary factors that explains the gap in transportation infrastructure is the historical lack of ambitious projects and investment. During the 9th National Congress of Infrastructure in 2012, Leonardo Villar, president of the Foundation for Education and Development in Colombia (Fedesarrollo), argued that over the past decades,Colombia and Peru had each invested about half a percent of their GDP on infrastructure, whereas developed countries invested more than 2% and emerging countries invested roughly 9%.

In Villar’s view, part of the problem is that the constitutions of both countries create strong distinctions between productive and social investments, with an emphasis on the latter. He argues that some social investments are misclassified. For example, large pensions paid to former government officials are often categorized as social investments, while new road construction connecting an impoverished village to a commercial center might be classified as a productive investment and, thus, deprioritized.

“Only with major investments and ambitious projects will we be able to … provide the productive sector with an infrastructure that allows us to be truly competitive.” –Colombian President Juan Manuel Santos

This view is also shared by other experts, such as former Colombian Minister of Finance Juan Carlos Echevery. In a 2012 interview with The Wall Street Journal, he stated that, “for years,Colombia has not paid attention to the infrastructure. We paid attention to education, health care and pensions — and the war. Now we are getting back to building the infrastructure.”

According to Carlos Casa, a professor at Universidad de Los Andes in Peru, the limited access to capital has also played an important role in constraining investments in infrastructure. The government has not had sufficient funds to make the necessary investments, nor has the private sector been properly incentivized to support projects of public interest. For example, a 2012 study by Apoyo Consultoría showed that of all private investment projects in Peru slated for 2013 and 2014, only 5% will be allocated to infrastructure; of these projects, the vast majority (62%) will be directed toward mining and hydrocarbon. In the public sector, there is also a misalignment of government incentives, creating an unwillingness to make investments that benefit future governments, as seen in the lack of investments for road maintenance and rehabilitation.

In addition, Carlos Parodi, a professor at  Universidad de Los Andes, highlights two important aspects in Colombia and Peru that contribute to low-quality infrastructure: corruption and a lack of human capital. In the World Economic Forum’s Global Competitiveness Report for 2012-2013, Colombia and Peru are ranked among the countries with the highest rate of diversion of public funds (130 and 103, respectively, out of a total of 144 countries). In Parodi’s opinion, corruption not only discourages private investment, but also leads to low technical standards and poor prioritization of infrastructure projects. With regard to human capital, there is a shortage of qualified professionals at all levels within these governments, which makes infrastructure projects unmanageable.

Other factors that explain the high cost and low competitiveness of the transportation sector in these countries are their challenging topographies and geographies. According to Villar,Peru and Colombia are marked by a mountainous topography that increases distances between cities. By land, it takes more than 15 hours to go from Lima to Cuzco, another major inland city in Peru. The situation is even worse in Colombia, where there are three distinct mountain ranges and the largest cities are far from the coast. For example, it takes roughly 10 hours to go from Bogota to Medellin by land, a stretch of only 270 miles. Dario Londoño, a professor at Universidad Javeriana in Colombia, writes that the average distance from a primary city to the nearest port within Colombia is three to eight times greater than the distance in comparable countries such as Chile (3.2 times), Brazil (3.6 times), and Argentina (8.0 times).

According to the Competitiveness Report, published by the Consejo Privado de Competitividad in Colombia, some minor factors also impact the infrastructure in these countries, including serious competition among industries for transportation resources, poor fleet quality, and a high level of informality. The recent boom in the mining and oil and gas industries in Colombia and Peru has increased the demand for logistics resources and, thus, transportation costs. With regard to fleet quality, the average vehicle age is 22 years old in Colombia and 18 years old in Peru; it is closer to seven years old in the U.S. An old fleet increases transportation costs (e.g., higher maintenance and poorer fuel efficiency) and negatively impacts society (e.g., pollution). Along with the absence of formal contracts in the transportation industry (informality), these factors lead to low standards in service delivery, adversely affecting the sector’s competitiveness.

The Role of Government  

Due to each government’s control of construction licensing for infrastructure projects, observers cite the need for public funds to make many transportation infrastructure projects financially viable along with the need for a long-term strategic plan that extends beyond most private investors’ time horizons. Responsibility for successful long-term infrastructure development falls wholly on governments. As noted above, government officials in both Colombia and Peru are aware of their responsibility and the importance of increasing the pace of infrastructure investments to maintain and bolster their countries’ level of competitiveness. Both governments have already undertaken a number of initiatives to improve transportation infrastructure, ports, and roads.

While Colombia is focused on all aspects of its road system — from primary to tertiary — it has not formally created a comparable decentralized program and is still managing similar projects under its umbrella roadway institution, the National Roads Institute (INVÍAS). The benefit of this type of program is its ability to provide focused coordination, promotion, and technical assistance to local authorities and municipalities for prioritizing, developing, and structuring transportation infrastructure investments. On the regional and municipal levels,Peru implemented a decentralized program, called PROVÍAS, focused on paving and maintaining secondary and tertiary roadways. Richard Webb, a former president of Peru’s Central Bank, argues in his new book,Conexión y Despegue Rural, that since 2006 this program has developed institutional capacity in road infrastructure management and has already rehabilitated 15,000 kilometers of roadways. This work successfully decreased land travel times between impoverished areas and primary cities from 13.2 hours in 2001 to just 5.0 hours in 2011.

The scale of infrastructure projects relevant on the national level can easily exceed hundreds of millions or even several billion dollars.

In addition, to increase the pace of new projects, both countries have passed legal reforms that simplify and promote infrastructure investments. One example is Peru’s recently enacted eminent-domain law that streamlines the use of land for priority infrastructure projects, such as roads and the construction or expansion of ports and airports. Colombia has also instituted similar legislation.

While these efforts have spurred progress, there are still large hurdles to overcome. The scale of infrastructure projects relevant on the national level can easily exceed hundreds of millions or even several billion dollars. This magnitude of investment and the required personnel with the necessary training and expertise simply cannot be provided by public institutions alone. Thus, both Colombia and Peru have turned their attention to resolving these issues by creating an environment that attracts and promotes private investment through public-private partnerships (PPPs). Inviting private domestic and multinational firms to participate and lead large-scale infrastructure projects provides access to economic and human resources not otherwise available to these governments. As discussed below, the shift to focus on PPPs is a first step, but is not an easily attainable solution.

The Role of Public-private Partnerships

 The unique structure of PPPs makes them appropriate to finance public projects with high initial costs and long asset lives. As Javier Serrano Rodriguez writes in his 2010 paper, “Financing Transportation Projects,” the main objectives of the PPP structure are to transfer construction risk from the government to the construction contractor, who is arguably in a better position to manage such risk, and to postpone government payments, stretching them over a 20-30-year term, commensurate with the useful life of the project, thus allowing the government to better manage its fiscal position.

Colombia was the first country in South America to utilize PPPs, beginning in 1993. Now in their fourth generation, these partnerships in Colombia have seen a significant number of contract renegotiations due to unforeseen economic challenges, necessitating a complete overhaul of the structures on a go-forward basis. Under the current PPP structure, projects are bid out to private companies — both domestic and international — that are responsible for the financing, construction, and operation, while the government, in return, makes payments based on road availability and quality. If the maintenance and operation of a project are not deemed to meet the standards of the contract, payments by the government can be reduced by up to 10%. Payments by the government will be covered by tax revenues, as established by Law 1508, thus providing a dedicated source of payment that reduces uncertainty for investors while still holding operators accountable for nonperformance. Certainty of government payments and nonperformance disagreements were issues seen in previous iterations of the PPP structure. Under this new structure,Colombia successfully undertook the financing of Ruta del Sol, a 1,000-kilometer highway connecting the country’s capital to other major cities.

In contrast, transportation projects in Peru have been financed under a PPP scheme that separates construction and operational risks. The current structure, in place since 2006, ascribes construction risk to private companies and commercial banks. However, once the project is finished, the government inspects the road and issues a certificate of completion, which then effectively allows the bank debt to be replaced with a 20-30-year bond guaranteed by the government. Investors in the completed project then take sovereign risk rather than company risk, which results in greater access to international financial markets.

Certainty of government payments and nonperformance disagreements were issues seen in previous iterations of the public-private partnerships.

With the recognized need to attract private investment,Colombia and Peru have passed laws and enacted policies to create a friendlier environment for accomplishing this. Both countries have sought to (1) provide transparency for all the parties in the bidding and construction processes; (2) create legal, political, and tax stability; and (3) treat foreign and domestic investors equally — all critical factors for building investor confidence.

Colombia has also formed new institutions, such as the National Infrastructure Agency (ANI) and the National System of Competitiveness and Innovation, and strengthened other institutions, such as INVÍAS, to execute the country’s infrastructure plan more effectively. ANI, in particular, was created to build relationships with private investors, manage all aspects of project evaluation and prioritization, and ultimately improve the country’s PPP programs. Other initiatives by Colombia include the introduction of the Royalties Act, which will provide 10% of the General System of Royalties for infrastructure construction.

While all of these efforts to increase the flow of private capital into Colombia and Peru are important and relevant steps on the path to improving global competitiveness, there are still significant challenges ahead. The changes implemented to date under these programs will require time to be proven and accepted by the capital markets.

This article was written by Cristina Camiz, Troy Ford, Matheus Schmidt, and Daniela Toleva, members of the Lauder Class of 2015.