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Infrastructure investment – mind the gap!

There is a gulf between actual global infrastructure investment and what is needed. But even if this is plugged, there are deeper-rooted problems when it comes to costing major projects that must be recognised.

The World Economic Forum has some interesting infrastructure sums.

Annual infrastructure investment needed: $3.7tn. Actual annual infrastructure spend: $2.7tn. Result, as Dickens’ Mr Micawber might have put it: misery.

Emerging economies are short of transport infrastructure, power, water, sanitation and internet; developed economies face ageing and inadequate infrastructure built decades ago.  But even if a global whip-round comes up with the missing trillion, that’s not the only problem.

Regular overspending

Construction and engineering overspends and delays grab the headlines with remarkable consistency, with the recent UK Industry Performance Report revealing that last year just 40 per cent of UK projects were delivered on time.

With serious bills to be met, it takes little for disputes over responsibility to escalate and end up in litigation or arbitration.

Various reasons are put forward for the problems. Frequent design changes and poor specifications and planning, for instance, in addition to pressure from the usual competing factors of time, cost and quality. But there is one ever-present issue – we’re all too optimistic.

“Construction and engineering overspends and delays grab the headlines with remarkable consistency”

This is not new. In 2002, the Treasury commissioned a report from Mott MacDonald on large-scale public procurement in the UK. It identified optimism as a source of risk in estimating project costs.

Bias or misrepresentation?

The most comprehensive study is perhaps the review by Bent Flyvbjerg of Oxford’s Saïd Business School and Denmark’s Aalborg University. Prof Flyvbjerg and his team researched time and cost overruns around the world on major infrastructure projects that failed to deliver projected results.

They came up with two main reasons. The first was “optimism bias” – a subconscious predisposition in most people to judge future events more positively than warranted by actual experience. The second was “strategic misrepresentation” – an intentional over-optimistic estimate on timing, budgets and project benefits for political and/or economic reasons.

Their antidote to optimism bias, ’reference class forecasting’, entails predicting a project’s performance by looking at the actual performance of similar projects already carried out. These similar projects, the team says, are more common than people assume. People often think their projects are unique, when they are not.

Reviewing the average performance of a number of similar projects, the team claims, can indicate the expected outcome from a proposed similar project.

Optimism bias meanwhile has achieved official status. The Treasury’s Green Book has 15 pages of guidance and tables on the topic because “there is a demonstrated, systematic tendency for project appraisers to be overly optimistic”.

To redress this, it recommends making adjustments to the estimates of project costs, benefits and duration based on data from past or similar projects, suitably tailored to the individual project. Which all sounds rather like reference class forecasting. Strategic misrepresentation, on the other hand, is trickier to address, for obvious reasons.

However, where a misrepresentation induces another party to enter into a contract, there can be legal consequences. In an extreme case: defendants who had won a contract to provide Sky with a new CRM system had represented to Sky that they had analysed the time needed and that they believed (on reasonable grounds) they could and would deliver within certain timescales.

But there was no “proper analysis” nor were there “reasonable grounds”. The representation was dishonest and a fraudulent misrepresentation, which gives a claimant the option of claiming rescission and damages suffered as a result.

Finding the missing trillion is one challenge, but making sure it plugs the gap is another. Which is where the likes of Prof Flyvbjerg and the Treasury could make a vital contribution.

Michael Regan is the senior partner and Wisam Sirhan is a senior associate in the construction and engineering group at Mayer Brown International

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