INFRASTRUCTURE RENEWAL

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The U.S. Department of Transportation estimates that the nation’s highways and bridges face an $808.2 billion backlog of investment spending, including $479.1 billion in critically needed repairs. More than two-thirds of the nation’s roads and nearly 143,000 bridges are classified in dire need of repair or upgrades.

In recent years, pessimism about the U.S. infrastructure has been growing, notes Wharton real estate professor Gilles Duranton, a specialist in urban and regional development, transportation and local public finance. “More and more, it is said that the overall infrastructure is old and decaying, that bridges collapse and roads are full of potholes. Water poisons residents in some places like Flint, Michigan; electricity is not always reliable; airports and seaports are under strain; cellphone coverage is piecemeal.”

How accurate is that picture? Although that image is sometimes exaggerated, “there is some truth to this,” Duranton asserts.

From left-wing progressives to right-wing libertarians, nearly every faction in the American political spectrum agrees that the infrastructure in the U.S. desperately needs a rapid upgrade — not just as a mechanism to generate job growth but as a tool to improve the country’s competitiveness. Yet when the Trump administration laid out its promised vision for a $1 trillion, multi-year national infrastructure plan on May 23, the plan sparked controversy about what kind of infrastructure deserved top priority, and how to finance it.

Donald Trump, a career real estate developer, could finally break the longstanding stalemate between Republicans and Democrats over what to fix and how to pay for it. Trump broadly proposed $1 trillion in federal spending to repair and rebuild roads, highways, bridges, tunnels, airports, railroads, and ports, as well as other vital but less-visible systems involving energy, water, and telecommunications.

Trump argues that having a national infrastructure that’s second to none will enhance economic growth and U.S. competitiveness and create millions of well-paying jobs. Since the election, he has signaled that getting an infrastructure plan off the ground will be a priority in his administration’s first 100 days.

The country indeed has many needs. American ports are clogged and need dredging to improve the flow of goods; railroad tracks need modernizing; airport communications technology needs updating and expansion; urban mass transit is old and inadequate; and bridges and roads urgently need repairs that have been deferred for years, she said.

While it’s true that repairs are less expensive than new construction, if we repair without reinventing, we’re not necessarily solving the problem. To do that, the nation needs to take advantage of its status as the world’s leading innovator in information and communications technology by incorporating that into smart roads and other data-enabled transportation tools, such as ride-hailing services or Street Bump, an app developed by the city of Boston that allows volunteer drivers to transmit data wirelessly about poor road conditions to public works crews more quickly and accurately.

According to the American Society of Civil Engineers (ASCE), an industry group that lobbies for more infrastructure spending, federal, state and local governments need to spend many times more than what the Trump administration is proposing to meet the nation’s infrastructure needs. The proposal calls for only $200 billion in direct federal spending over the next decade on such needs as roads, bridges, tunnels, railroads and expanded broadband, along with incentives for states, cities and private investors and efforts to reduce the burdens of regulations. “The administration’s goal is to seek long-term reform on how infrastructure projects are regulated, funded, delivered and maintained,” transportation secretary Elaine Chao told reporters. Chao added that the administration expects “to have more details forthcoming,” including a legislative package later this year.

While many Democrats and independents agree that infrastructure should be a significant priority for any U.S. administration, Chao’s proposal was criticized for allocating only $5 billion in federal funding for the effort in fiscal 2018, and providing no details about where the funding would go or how it would be paid for. Oregon congressman Peter DeFazio, the top Democrat on the transportation committee, called the plan a “sham.” Combined with Trump’s proposed budget cuts for the department of transportation, DeFazio charged that the president’s efforts amount to a recipe for “pushing the responsibility off federal balance sheets, and replacing it with unidentified incentives for Wall Street investors to invest in transportation.”

Former transportation secretary Ray LaHood, a Republican, said that the Trump administration’s proposals for infrastructure spending, which focus on public-private partnerships (PPPs), are “fine but they are only one piece of the formula. The Trump administration’s idea of investing a trillion dollars over 10 years — with only $200 billion of it coming from the federal government — is not going to get us where we need to be to rebuild America. There are 60,000 structurally deficient bridges in America today.”

LaHood added: “There’s not enough money in public-private partnerships to invest, so we need to look at raising the gas tax, to indexing it to the cost of living. Raise it to 10 cents a gallon.” LaHood noted that the gas tax has not been raised since 1993. “Look at an infrastructure bank, which President Obama proposed five different times. Make it $50 billion. That will tap some private money. [Also,] give states the ability to toll if they want to toll. Tolling has worked in some states. In my own state of Illinois, it has worked very well.”

Robert Inman, Wharton professor of business economics and public policy, addressed the strengths and weaknesses of public-private partnerships, “infrastructure banks” and other alternatives. Inman explained that there are four possible kinds of infrastructure projects: Interstate projects that are publicly funded; interstate projects that are privately financed; state and local projects that are publicly financed, and state/local projects that are privately financed.

The general logic behind favoring public-private partnerships, which play a major role in the Trump proposal, is that “the government is inefficient, and therefore we have to have the private sector do it,” notes Inman. Two important factors need to be considered when opting for private versus public financing: the incentives that should be given to the private sector, and the rates of return these projects should achieve. Also, some activities lend themselves to privatization more than others. “Assuming that the incentive for private firms is to make money, when does it make sense to hand over to the private sector what is ostensibly a public activity, in the sense that citizens as a whole collectively want to engage in this activity?” Inman asks. “People can buy hamburgers, but they can’t go and buy police protection. Any activity that has that economy of scale, you’re going to want to think about bringing those 50,000 people together and have them manage the activity jointly, and that’s going to be called ‘government.’” While governments can do that, in the case of a public-private partnership the government says, “Let me contract with a private firm to actually provide police services.”

Whatever the activity, “You’ve got to make sure that [the private contractors] are not short-changing quality in favor of lowering costs in order to make money. In the case of prisons, for example, you don’t want the private contractor to lock the prisoners in a cell for 365 days and give them gruel, just to minimize the contractor’s operational costs and make a larger profit. That’s not the public service we’ve got in mind.”

Because transportation needs are naturally intertwined, the federal government should take a holistic approach to infrastructure to optimize connections between air, rail and ground systems. If all we do is fix the potholes, then we don’t think that’s enough.

Historically, politicians have turned to infrastructure as the antidote to economic downturns. Proponents say that in addition to addressing a critical structural need, such spending stimulates economic growth, generates tax revenues, and, more importantly, puts people to work.

During the Great Depression of the 1930s, Presidents Herbert Hoover and Franklin Delano Roosevelt rolled out ambitious efforts to build public works projects that would create a vast number of construction jobs. New York City’s LaGuardia Airport, the Lincoln Tunnel, and the Triborough Bridge were all built as a result of FDR’s infrastructure push. Advocates today point to that record as evidence that a similar undertaking will directly benefit blue-collar Americans, among the hardest hit by globalization and technological change. But infrastructure building is not a tool to fight joblessness and that Americans should be “wary” of trying to draw parallels between the two eras.

Projects were simpler and easier to turn around back then. The Hoover Dam, for example, was built in five years; Boston’s Big Dig took 25 to complete. Projects now require approvals from multiple stakeholders both inside and outside government, which slows progress and drives up costs. Simply handing shovels to the unemployed isn’t realistic anymore given the technical complexity of today’s civil construction projects.

The government’s track record taking bright ideas and turning them into something akin to boondoggles has fed public skepticism about the value of infrastructure spending and has handed conservative budget hawks powerful ammunition to derail major initiatives.

Over time, the failure to vet projects tightly and keep them on schedule erodes the public’s trust in government and weakens its willingness to pay for public works that are supposed to improve daily life by enhancing safety, shortening commutes, and easing the flow of commerce.

Multiple factors are to blame for why major projects, like Boston’s Longfellow Bridge restoration or the MBTA Green Line extension, always seem to balloon in cost and take far longer to finish than originally expected.

Certainly, contractors will game the system by submitting unrealistically low bids, knowing they’ll be able to mark costs back up later during construction change orders. And increased regulations across a variety of local, state, and federal agencies do slow projects down and greatly increase costs — there’s no question about it.

But sometimes, dramatic cost spikes are the result of projections that simply fail to anticipate difficult or unique conditions that become evident only as a project progresses. Often, the less routine a project is, the more likely the cost estimates touted early on turn out to be guesstimates, without detailed engineering to support the figures.

There are terrifically strong incentives for the advocates of projects to overestimate the benefits and underestimate the costs while projects are still under consideration. Politicians want to deliver enhancements for their constituents. Community advocates want to make sure they get benefits they feel have been promised to them. Contractors trying to secure winning bids don’t want to price themselves out of the running by predicting worst-case scenarios. And so there’s little effort to be rigorously honest about what the true cost will be.

They’ll cite inflation, they’ll cite mitigation agreements, they’ll cite changes in design that became necessary because of a variety of factors. What they don’t like to talk about so much is that the project has been oversold from the beginning.

To rein in spending and limit surprises, governments should create independent panels to test and poke holes in project estimates before moving ahead. It’s very frequent that the project advocates are the only ones making estimates.

Lawmakers often go along with questionable projects in order to enjoy the short-term political benefits of ribbon cutting. Creating the right incentives to make long-term investment in projects that are essential to the functioning of government is a terrible problem and nobody has adequately solved it. It’s very tempting to spend money on other things.

Even with a new Republican president eager to start digging, the enduring battle in Congress over how much to spend and how to pay for it will undoubtedly rear its head again.

Trump has talked up the idea of offering significant tax credits to private investors who sink money into projects as a way to minimize government borrowing and debt, an anathema to Republicans. Publicly, Trump has promised that his plan will be paid for entirely through a variety of funding methods in the public and private sector, including tax credits, user fees, and cuts to unneeded regulations that he says further drive up costs.

Taxpayer-funded projects encourage waste and inefficiency because no one’s really minding the store. But privatization, too, is very thorny and very difficult and doesn’t work for every type of project. It’s not a panacea. Instituting user fees is the better way to go.

It absolutely makes no sense that the very well-heeled travelers who go through John F. Kennedy Airport should be subsidized by ordinary taxpayers. There’s no reason why they cannot pay for the entire cost of that airport through airline-generated fees. The larger point is: Don’t make taxpayers in Montana pay for New York City’s air travelers.

Not everything can be assessed a user fee or toll, but in some areas, fees can cover the bulk of a project cost. Adding a small amount of tax support for those efforts that can’t be self-funded isn’t the worst thing in the world. But once you go from that to $200 billion worth of tax credits, the possibilities for abuse, of course, are enormous.

A better idea would be to establish an infrastructure bank, as the city of Chicago did, to finance big-ticket improvements. An infrastructure bank removes some of the politics. Instead of waiting for federal authorizations or state legislatures to act, it would be possible to attract a pool of capital that could be used for loan guarantees, could accumulate some combination of federal grants, state grants, and localities offering municipal bonds, along with other options. The thing we’re missing is not the source of money, it’s the political will.

The public-private-partnership (PPP), or private-finance-initiative, model has been used since the early 1990s to finance and procure infrastructure projects around the world. In Australia, Britain, Canada, parts of continental Europe, and, more recently, in the United States, the use of private-sector capital and expertise has helped to fund many high-quality infrastructure assets.

Plenary Group, for example, is successfully delivering a government-accommodations facility in Canada, a highway project in Queensland, Australia, and a comprehensive university-development project in California.

But the private model is not without controversy. Specifically, while projects procured as PPPs have delivered high-quality infrastructure to taxpayers, the higher cost of financing PPPs—the difference between the government’s cost of borrowing and the cost of private capital—remains a topic of public debate.

It is fair to ask what taxpayers get for this financing premium. Do the benefits of PPPs outweigh the extra financing costs? Without a proper analysis of this question, getting a PPP program off the ground is likely to be challenging.

In Australia and Canada, such analysis has been carried out. Essentially, agencies in both countries have concluded that, while private finance is more expensive, the government gains private-sector innovation, transfers substantial risk, receives efficient whole-of-life treatment of the asset, and, ultimately, generates more value than if the government financed the project itself. Partnerships British Columbia and Infrastructure Ontario, which are responsible for the vast majority of Canadian PPP projects, as well as Infrastructure Australia, have published comprehensive methodologies that compare the private-financing premium with the value of the benefits that PPPs can provide. All three agencies have found that using PPPs or alternative financing and procurement methods can be cost effective.

While the financing model is sound, the delivery of big and complex public infrastructure projects in the United States under publicly run models is characterized far too often by construction delays, cost overruns, and longer-term performance failures. Even cost overruns of 10 or 20 percent—a level widely accepted as “success”—can compromise a government’s ability to deliver its agenda and meet its communities’ infrastructure needs. Contrast that with the record in Ontario, North America’s most active PPP market. According to an independent report commissioned by Infrastructure Ontario in 2014, the region delivered 36 of 37 recent PPP projects under budget.

There is now general consensus in the United States of the need to improve infrastructure delivery. There is also growing recognition that PPPs maintain public ownership while allowing for the full transfer of infrastructure asset risk away from the taxpayer. Done right, experience has proved that PPPs can provide delivery and operational certainty, protecting the public purse throughout construction and well into operation.

As PPP interest builds in the United States, the questions now focus on how to effectively mitigate project risks compared with other public delivery models and whether the associated private-capital premium is justified.

To understand the answers, it is useful to think of the incremental cost of private finance in a PPP, at least in part, as a guarantee against the risks of poor design, budget and schedule overruns, and deferred or inadequate maintenance, and also as a warranty on overall asset performance. In a traditional procurement, taxpayers pay more if these risks materialize. In a PPP, the private partner assumes these risks in exchange for returns on invested capital.

Also, the private partner has an incentive to not abandon a challenging project because the cost of delivery is financed up front and only repaid if and as the asset performs over time. As a result, and in order to efficiently bid for a project and still protect their long-term investments, private-capital providers take a whole-of-life view and provide an important oversight function not present in a traditional procurement.

Of course, the actual cost of this risk transfer—the premium paid—must be right. In a mature PPP market like Canada, where investors have developed confidence in PPP developers and their teams, the premium ranges from 130 to 220 basis points relative to pure public financing. The figure depends largely on the robustness of the project structure and state of the private-debt markets.

Although the PPP market in the United States is not as developed, the spreads between public and private finance have been comparable. This is particularly impressive given the depth and historically low costs of the US public-finance market. This includes products such as general obligation bonds; private activity bonds (PABs); certificates of participation; 63-20 financing, for not-for-profit corporations; and credit-assistance programs, such as the Transportation Infrastructure Finance and Innovation Act (TIFIA) and the Water Infrastructure Finance and Innovation Act. What is essential is that the projects have sufficient private equity at stake to ensure successful project management and long-term risk transfer.

While PPPs are still far from the norm in the United States, Plenary is already delivering five projects using different financing structures, including TIFIA, PABs, and taxable bank and bond debt—in each case backed by Plenary’s equity investment. These projects are the Long Beach Civic Center; campus development for the University of California, Merced; the US 36 Managed Lanes road in Colorado; the Pennsylvania Rapid Bridge Replacement Project; and the State Street Redevelopment Project in Indiana.

In the end, PPP projects are good value for taxpayers. They pay a relatively small finance premium in return for high-quality infrastructure, and they are delivered faster, at a fixed time and price, and with full asset-life guarantees and warranties from the private sector. Governments in the United States can use the lessons learned from other countries, as well as recent local success stories, to help advance the public discussion and ensure all stakeholders understand the value that private finance can bring to infrastructure delivery.

Ultimately, history will judge the use of PPPs in North America favorably, based on the scale, quality, and speed of infrastructure delivered and the lower whole-of-life-costs that can be achieved.

Measuring quality is also an important factor in judging the wisdom of contracting with a private provider. As Inman explains, “If quality is a difficult thing to judge, you’re going to have to supervise these guys pretty heavily. And if you’re going to supervise them, why don’t you just do it? If quality is going to be difficult to judge, there’s no big advantage in privatizing — if you care about quality. If you do care about quality, you might as well use government. People complain, ‘they’re so bureaucratic.’ But they’re bureaucratic for a reason; they’re trying to deliver quality services, and that means watching performance.”

Privatizing makes sense only if quality is very easy to monitor, Inman notes. He cites trash collection as one example: It’s not hard to judge whether your private-sector provider collected it or not. “I drive down the street the day they pick up the trash, and I see if it’s been picked up or hasn’t.” On the other hand, some aspects of waste disposal might benefit from government monitoring, such as managing the quality of public disposal centers where citizens bring waste, “to see if the waste is burned with a clean technology, not dumped in a river.”

Incentives are an even more complicated matter. Policymakers generally know that private-sector investors need to get a return on their capital but not an excessive return. That means addressing the question: How can the government keep a private contractor from charging a monopoly price? The answer, says Inman, is competitive bidding. “If quality is easy to monitor and you can have competition in the actual provision [of a particular service], then privatize away. But if you can’t have competition, then you’re going to be giving over monopoly power to the private sector, and they are going to charge a monopoly price.”

Monitoring the competitiveness of the bidding process is harder, requiring sealed bids in the bidding process, Inman continues. “It could be corrupt, in the sense that government officials are bribed to give the contract to a private firm. But that’s no different than the public employees’ union bribing the mayor to give them big fat labor contracts.”

Corruption “is an issue that gets a lot of people’s blood boiling but it’s not an argument for or against public or private,” Inman adds. PPPs are perfectly fine for state and local services, so long as you monitor corruption and quality, he says.

Meanwhile, the Trump administration’s $1 trillion proposal to reinvent America’s infrastructure is focused on privately funded projects that have a scope that is state/local, rather than national. This combination of attributes, while pleasing to some who advocate a stronger role for the private sector, is not generally popular in the U.S. Congress, explains Inman. “It is private [funding], so there is no money under the control of Congress. And it is state and local, so there is no spending under their control” as opposed to state and local governments. “Congress was hoping for a trillion dollars of federal money to build and improve highways such as Route 30 and Route 3 in Pennsylvania” and their equivalents in other states, as well as money to put into buses or improve the subway system — which are all local/state government responsibilities. “If I’m a national taxpayer in Texas, why should I care about the transit system in Pennsylvania? That’s Pennsylvania’s problem.” Concludes Inman, “To my mind, the public-private partnership really requires some very careful thinking.”

According to Duranton, public-private partnerships in infrastructure “can be made to work” under the right circumstances. “In France, which is always viewed as the type of country where the government runs everything, the French highway system is nearly entirely private, and so is the French water system. The big worry is that we need to balance the private sector — which has slightly higher efficiency — versus public sector inefficiency, especially when you have very influential unions.”

“One of the problems with infrastructure is the term ‘shovel ready.’ That sounds great, but it’s really the worst way of thinking about infrastructure.” –John Delaney

The bigger issue, Duranton notes, is creating the actual partnerships. “You can talk about PPPs all you want, but when the Obama administration looked really hard for PPPs, after a year they found only $27 billion worth of transportation projects.”

Infrastructure banks are another old idea whose time may have come, according to Congressmen John Delaney, who spoke at the Bloomberg conference. “An infrastructure bank could make a lot of sense because it could do two things. First, it could handle some of these projects that don’t fit well into some of the existing programs. Second, it could start people thinking differently about infrastructure. One of the problems with infrastructure is the term ‘shovel ready’ [when planning and engineering technology are in place, but funding is missing.] That sounds great, but it’s really the worst way of thinking about infrastructure. The right way of thinking about infrastructure is: ‘What’s good for the long term?’ and ‘Where is the economy going over 10, 20 or 30 years?’ and “How do we design the infrastructure to meet those needs?”

Delaney joined other speakers at the conference in arguing that an infrastructure bank could help erase the current focus on short-term fixes to the nation’s infrastructure. “The nicest thing about an infrastructure bank is that it could make long-term commitments, which you can’t really do in the current framework of government because it’s all funded on a budget cycle. If you had an independent bank that was a nonprofit structure, with independent governance, and it could go around the country and make 10 or 15 or 20-year commitments to say, ‘Yes, if you get all the regulatory [elements] in place, if you get the community behind it, and you do a few other things, you’ll get the money you need.’”

In a perfect world, Delaney added, “we’d have a map showing trillions and trillions of dollars” in government spending “with all the great priorities — and every year, we’d spend a little money on it, and then if we had a recession we’d spend a little more, so we’d have a counter-cyclical demand-driver in the economy. And when economic times got better, you might spend a little less. That would be the perfect way to run it. Unfortunately, that’s not how our government works.”

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