From Tracey McNaughton, Chief Investment Officer at Escala.
The debate is no longer just about what countries need to build, but who will pay for it. From AI infrastructure and data centres to energy networks and advanced manufacturing, the next wave of nation-building will require vast amounts of capital at a time when government balance sheets are under pressure. That has acute implications for sovereignty and investors.
Governments can’t afford nation building alone
Historically, governments were the primary funders, financiers, of nation-building. If a country wanted to build highways, electricity networks or space programs, governments generally had the fiscal capacity to do it.
Today the ambition is just as great, perhaps even greater but the fiscal space is more limited.
Countries need more of the traditional nation building stuff – defence, energy, transport. But now they need the infrastructure to support artificial intelligence.
We are experiencing the biggest, most expensive nation building program in history. This, at a time when the government coffers are low on cash.
One of the more revealing moments during the recent Senate scrutiny in Australia of the tax reforms was when the Treasury Secretary, Jenny Wilkinson, said basically we needed the money. Her response was refreshingly direct: governments ultimately need revenue.
So, we are in an awkward position. This infrastructure requires capital, lots of capital.
The question is whether sovereign balance sheets can support it.
Bond markets become a part of the story
For most of our investing careers we’ve almost taken government borrowing for granted.
There was an assumption that governments could simply issue more debt whenever they needed to.
I think markets may begin demanding greater compensation for providing capital to governments. That’s really what a sovereign risk premium is.
It’s the return investors require to lend money to governments. I don’t think we’re talking about developed countries defaulting on their debt.
Far from it.
But I do think we’re entering a world where investors become more discriminating. Countries with strong fiscal positions may continue to borrow relatively cheaply. Countries with weaker balance sheets may find the cost of capital steadily rising.”
In other words, sovereign risk may once again become something investors need to think about rather than simply assume away.
The price of sovereignty covers the build of infrastructure, and now the financing
Already, the bond market is providing debt finance to Amazon at a lower interest rate that it is to the US government on a 10 year basis.
The bond market is becoming more discerning. Governments will have to make choices. They can’t fund everything. And if governments can’t fund everything themselves, the obvious question becomes…Who does?
If governments can’t pay, who can?
When you step back, there really aren’t that many options.
Governments can borrow more – funding it by taxing more. We have seen what that does the tenure of political leaders in Europe. Or they can rely on private sector capital who in some case, as with Amazon, can fund it more cheaply.
And who should?
The UK and many countries across Europe are looking at the digital economy and asking a relatively simple question. The largest digital platforms generate enormous economic value within their borders. Yet much of the profit ultimately accrues elsewhere.
From their perspective, if governments need to invest more in the infrastructure to support artificial intelligence – energy infrastructure, datacentres, critical minerals etc shouldn’t some of the beneficiaries of the digital economy contribute more towards funding it?
The United States naturally sees that very differently. It argues these taxes disproportionately target successful American companies and reduce the returns to innovation.
What’s fascinating is that both sides are really debating the same issue. They’re debating who captures the economic value created in a digital economy. And ultimately, who uses that value to finance sovereignty.
What it means for private capital
Governments will still determine what capabilities matter. They will still establish industrial policy. They will still decide where strategic investment should occur. But increasingly they will rely on private sector capital to fund it.
We’ve moved from governments being the owner-builder behind nation building to, in a way, being the tenant. And once you recognise that, a lot of what we’re seeing in markets begins to make much more sense.
Why it is an important distinction for investors
It changes who captures the returns.
That creates extraordinary investment opportunities, but it also creates important policy questions.
Governments need to ensure the benefits of those investments remain broadly shared across society. This was easier to do when the government was the owner-operator and the spoils 3 would accrue to the government which could then be redistributed to ensure a sense of equality and fairness.
Now, much of the new nation building is owned by the private sector.
Governments are encouraging private companies to become partners
If you look at what South Korea is trying to achieve, it’s not simply an industrial policy. It’s a sovereignty strategy.
The government has identified a handful of industries that it believes will determine the country’s future prosperity, competitiveness and security. Semiconductors, artificial intelligence, robotics and the infrastructure that supports them are no longer viewed simply as commercial opportunities.
It isn’t proposing to nationalise these industries or build everything itself. Instead, it’s creating the policy framework, investing in enabling infrastructure and working alongside companies like Samsung and SK, who are expected to provide much of the capital, technology and execution.
Sharing the benefits (and the costs)
South Korea is already beginning to grapple with that issue. Alongside the excitement about becoming a global leader in semiconductors and AI, there are questions being asked about whether the benefits of that investment will be broadly shared across society.
It’s not just about sharing the benefits; it’s also about sharing the costs. Take data centres as an example. We all want the productivity gains that artificial intelligence promises but increasingly, communities are questioning whether they want large data centres built in their own neighbourhoods because of the demands they place on electricity, water and local infrastructure.
Society benefits from the capability they create but the costs are often concentrated in particular communities. So I think governments need to think carefully about who pays, who benefits and who bears the cost. If those three groups are the same, projects tend to have strong public support.
Success in this new era of nation-building isn’t just about raising capital it will be about aligning interests. I think we are in the early days of getting that alignment.
Can superannuation offer alignment for Australians?
I think it probably, almost certainly will. Australia’s superannuation system now manages 4.5 trillion dollars on behalf of Australians.
If governments are looking for patient, long-term capital to fund nation-building assets, it’s only natural that they’ll look towards superannuation. And in many respects, those projects are well suited to long-term investors.
But there is an important distinction we need to preserve. Governments naturally look at superannuation and see a source of capital.
Trustees look at exactly the same money and see something very different. They see the retirement savings of millions of Australians. Their responsibility isn’t to deliver government policy.
Their responsibility is to maximise long-term risk-adjusted returns for their members. Maintaining that distinction is fundamental to the integrity of our superannuation system.
