What critical infrastructure tells us about economic resilience

The two major economic crises of the past years (Covid & the energy crisis) exposed deficiencies in the world’s supply chains. Global trade was slow to adjust to the pandemic’s violent halt in demand, and supply bottlenecks inhibited a timely and smooth return back to normalcy after restrictions were lifted. Inflation soared after 2022, especially in Europe, where countries scrambled to balance geopolitics with finding cheap and reliable sources of energy.

The chart below paints a telling picture. Plotted against the World Bank’s Logistics Performance Index (1 worst; 5 best), it indicates a moderate-to-strong link between European countries’ poor logistics and a high average level of volatile inflation. Volatile in this case refers to both energy and food, which are prone to price fluctuations.

This makes sense. Highly developed infrastructure should be prepared to fend off against unanticipated shocks such as we have seen these last few years. Critical infrastructure, however, spans far beyond simple downstream value chains: instead, it serves as a holistic reflection on the state of an economy’s level of development, adaptability against adversity and—most importantly—the direction it is headed in.

Critical infrastructure made headlines recently through a resurgence in suspected sabotage attacks on Baltic Sea cables. Hidden under the sea, the news highlight the precarious state of things we often overlook make the backbone of our functioning societies. This does not only apply to physical infrastructure such as electricity grids or water refineries, but also more widely to financial/banking systems and digital infrastructure.

A functioning economy relies on a few critical components. For instance, when almost a third of global freight trade passes through a 3km-narrow straight, a flair up in regional geopolitical conflict can contribute to a 470% rise in shipping costs from Europe to Asia. This physical choke point is analogous to the countless other (less tangible) channels we rely upon for our safe bank transfers, communication, transportation, medicine, food and electricity needs. A cyber attack on the world’s largest healthcare clearing house last year disrupted the provision of healthcare for millions in the US and resulted in billions of dollars in damages––just one of the many examples that can be used.

This is the reason stress testing against adverse scenarios is done to banks. With the potential ripple effects of a bank failure amounting to a recession such as in 2008, the European Banking Authority conducts EU-wide stress tests every two years, the latest of which began last week.

Critical infrastructure is not only indicative of the present state of an economy, but also of its future. An important determinant of potential output, and thereby potential living standards, is the quantity and quality of an economy’s factors of production. Reliable, cheap and fast transportation & digital networks, as well as a financial system that assists the movement of capital, bolster investment and productivity. They help enhance factor mobility and encourage both investment and innovation.

This is something that needs fixing in Europe. Although its logistics may be well developed, regulation stifles innovation and productivity is at a decline, dragged down by a lagging manufacturing sector. Core countries such as Germany face a housing crisis, energy insecurity, aging public transportation infrastructure and a laughably lagging adoption of high-speed information technologies. This is an add-on to its urgent investment needs to curb a demographic decline and the green transition.

The health of a society can be found in the state of its roads and bridges; before Rome or the Soviet Union fell, cracks began appearing in buildings and streets deteriorated. Whilst our modern-day infrastructure is far less visible in a physical sense, our societal stability is still being held up by a few (critical) pillars. As a weak foundation cannot support a house, it is imperative that these systems be vetted for systemic risks and are resilient towards shocks that have proven to often be waiting around corner. Decoupling from fossil fuels and turning towards autonomously produced sustainable energy is a great step towards this. Critical infrastructure needs to be constantly monitored, defended and updated: although a building’s facade gives an indication of its state, often what truly matters is what hides behind.