An Infrastructure Plan That Would Actually Work
From roads and bridges to airports and rail lines, US infrastructure has fallen into neglect and disrepair, prompting a search for new methods of funding, such as privatization and franchising schemes. But rather than leasing and selling off public assets, why not tap their latent investment value?
NEW YORK – US President Donald Trump’s plan to boost infrastructure spending through tax credits has received a cool reception from investors. His long-awaited proposal to upgrade and repair America’s crumbling roads, airports, bridges, tunnels, and other infrastructure will come to nothing unless all sides are open to new thinking about how such projects are to be financed.
Currently, infrastructure investments are paid for either with taxes or through user charges such as tolls. But there is an alternative for unlocking public wealth at the local level: professional management of existing public assets.
This does not mean asset recycling or privatization by another name. If privatization is to increase the resources available for funding public infrastructure, assets must be sold for more than the present value of the profits they generate under public ownership.Local politicians and voters have understandably grown skeptical of franchising schemes that separate public funding from the provision of goods and services.
There are plenty of examples to show that taxpayers can lose out on poorly structured franchise deals. In 2008, the City of Chicago leased its parking meters to a private consortium for almost $1 billion less than what it would have received in revenues over the course of the 75-year lease. Even after a public backlash against rising parking fees, the city could no longer change its parking policies without compensating the franchise investors.
Such undue transfers of public wealth to the private sector are largely the result of governments’ inability to manage commercial risk. Without effective oversight and accountability, financing schemes such as public-private partnerships too often award managerial responsibility to the private sector while foisting capital costs on taxpayers and end-users. It is not surprising that a public backlash would follow.
And yet local governments’ vast commercial assets could generate a significant positive future cash flow if they were consolidated and professionally managed by an independent government-owned holding company. As we show in a new Citi GPS report , public commercial assets represent a potential goldmine; but they have been underutilized, owing to fragmented ownership arrangements, inaccurate or opaque accounting, and suboptimal and outdated governance structures.
According to conventional estimates, the book value of federally-owned commercial assets in the United States is almost equal to annual GDP – around $16 trillion. If those assets are under competent management, the market or fair value is likely to be even higher than the book value.
The total value of commercial assets owned by state and local governments is sure to be of the same magnitude, or larger. After all, local governments own and operate most airports and ports, as well as utilities such as water, sewerage, and electricity – all of which are in desperate need of funding. But real estate comprises the bulk of public commercial assets. By some estimates, publicly owned assets account for as much as one-quarter of the total market value of real estate in a city or county. At the same time, many localities need additional funding for affordable housing.
All told, this public wealth represents a substantial opportunity for investors, local governments, and society as a whole. If professionally managed, the yield from such a vast portfolio of commercial assets could fund not just critically needed infrastructure investments, but also any other public goods and services that are in demand.
The key is to consolidate each municipality’s commercial-asset portfolio into independent, professionally managed Urban Wealth Funds (UWFs) that are protected from short-term political influences. A UWF would have the clout to interact on an equal footing with the private sector. And, it would have the means to channel the untapped value of the entire portfolio toward infrastructure investments and other public programs, which would then generate new returns.
In terms of governance structure and adherence to international transparency standards, a UWF would be comparable to a publicly listed company. Its executives would have incentives to plan investments with a view to the decades-long lifespan of an asset, rather than gearing projects to political cycles measured in months or years.
Moreover, a UWF would have an independent balance sheet, allowing it to fund the maintenance costs that often account for four-fifths of a project’s total expense. And because it would be funded by the returns on its own portfolio, it would not have to compete with other claimants for government budget outlays. At the same time, the government itself would have collateralizable assets to back its debt, rather than having to rely solely on future tax revenues.
A properly designed and managed UWF could act as both the financier and manager of commercially viable new projects in infrastructure and other services. Not only would it free taxpayers from having to provide additional funding; it would also enable local governments to double their total current spending on infrastructure and maintenance, assuming annual returns above 3.5%. Best of all, politicians across the political spectrum would be able to support such a proposal.
We already have the means to start upgrading and repairing the country’s transportation, power, water, and communications infrastructure. We need only tap into the country’s neglected stores of public wealth.
How Trump Could Rebuild America
BERKELEY – In the United States today, with partisan polarization at record levels, there is still at least one policy goal on which there is broad consensus, not only among Republicans and Democrats, but also among business and labor leaders, states and cities, and ordinary citizens: infrastructure.
The US has been short-changing infrastructure for years. Historically, federal, state, and local governments have together invested about 2.5% of GDP in non-defense infrastructure assets. But, over the last 35 years, federal investment as a share of GDP has dropped by more than half.
For a long time, state and local governments were able to cover the shortfall, increasing their contribution to three quarters of total spending. But when the Great Recession hit, states and cities were forced to slash their budgets. As a result, in the second quarter of this year, total public expenditure on infrastructure fell to an estimated 1.4% of GDP, the lowest share on record.
This is all the more worrying, given the already-poor state of US infrastructure, which earned a grade of D+ from the American Society of Civil Engineers in its 2017 quadrennial report. Almost 20% of US highways are in disrepair. The costs and consequences of deferred maintenance are apparent everywhere, and almost every city and state has its horror stories: dysfunctional subways in New York City, lead-contaminated drinking water in Flint, Michigan, the near-collapse of a major dam in Oroville, California.
The report estimates that restoring US infrastructure to “a state of good repair” would cost $4.6 trillion between 2016 and 2025. That is $2.1 trillion more than has been committed so far. Developing new funding sources for infrastructure investment is therefore critical.
An innovative strategy under discussion in Washington, DC, is linked to corporate-tax reform – a priority for President Donald Trump and congressional Republicans. Under the current tax system, US multinationals can defer tax payments on their foreign earnings until the earnings are repatriated. With foreign earnings growing and foreign corporate-tax rates falling, deferral has become increasingly attractive. As a result, US companies are holding an estimated $2.6 trillion in foreign earnings abroad, rather than repatriating it and paying taxes that could be used to finance, say, domestic infrastructure investment.
Since 2013, the US Congress has floated several reform proposals to increase revenues collected on the stock of foreign earnings. Two recent bipartisan bills – which seem to have the support of Speaker of the House Paul Ryan, among others – link such reforms directly to federal infrastructure funding.
But Trump seems eager for state and local governments, which are in the strongest position to assess the needs of their communities, to shoulder much of the burden. Federal funding, he has signaled, would be limited to “high priority,” “transformative” national projects and used as leverage to encourage public-private partnerships (PPPs).
Private investors have long been eager to invest in public infrastructure – such as transportation or energy – in exchange for a share of those projects’ future revenues. Of course, private investors are generally not interested in projects that don’t generate revenue – such as, say, school libraries, urban “greenways,” or low-income housing – despite the importance of those projects for the economy and society.
In some areas, however, PPPs can offer substantial value. Though private finance may be more expensive than tax-advantaged public finance, over a project’s entire life, a PPP can benefit its government partner in numerous ways: through innovation; reduced design, construction, and lifetime maintenance costs; and risk mitigation.
To date, PPPs have played only a minor role in infrastructure development in the US. Trump seems convinced that the problem is a lack of available private capital, and thus has proposed a tax plan that includes generous credits to encourage private investment in infrastructure.
That is the wrong approach. What is really limiting private infrastructure investment is, to some extent, public opposition to the private ownership of public assets and, mainly, impediments to matching private capital with infrastructure opportunities. While 37 states have some form of enabling legislation and regulatory framework for infrastructure PPPs, there are wide disparities among states. Moreover, many states and localities lack the capacity to evaluate the costs and benefits of PPPs – a problem that President Barack Obama proposed solving with a new federal PPP knowledge center.
Ultimately, restoring America’s failing infrastructure will require what we call “progressive federalism”: harnessing the strengths of each level of government and working with the private sector to address pressing social and economic challenges.
The federal government must promote national-level goals; impose tough criteria for project selection and rigorous performance metrics in construction and maintenance; and push state and local governments to eliminate bureaucratic red tape and costly internecine squabbles. From a financial perspective, it should provide adequate funding for projects of national and regional significance, and use its financial leverage to overcome obstacles and enforce best practices.
State governors and city mayors, for their part, must take the lead in setting state and local priorities, with each deciding whether to opt into national projects. And private investors can provide risk capital, innovation, and management expertise, both as contractors on publicly funded projects and as partners in revenue-generating projects.
To support such a process, we urge Congress to establish a “Commission on Twenty-First-Century Infrastructure,” co-chaired by teams from the National Governors Association (perhaps led by Republican Governor John Kasich of Ohio) and the Conference of Mayors (perhaps led by Democratic Mayor Eric Garcetti of Los Angeles). The Commission should include business leaders and cabinet-level representatives of the Trump administration, like Secretary of Transportation Elaine Chao and National Economic Council Director Gary Cohn.
At a time when Americans seem to agree on little else, almost everyone agrees that it is time to rebuild the country’s infrastructure. The task now is to turn consensus into action.
Bridging the Infrastructure Gap
Too many countries have been underinvesting in infrastructure for decades, resulting in everyday inconveniences and, worse, creating roadblocks to economic growth. While a major infusion of funding is needed to address infrastructure gaps, finding the money is only part of the solution.
SAINT PETERSBURG, RUSSIA – Every day, millions of people across the developed and developing world inch through gridlock or squeeze into packed subway cars to get to and from work. And that is likely to be only one of many frequent – if not daily – confrontations with infrastructure systems that are bursting at the seams. In advanced and emerging economies alike, roads and bridges need repair, water systems are aging or inadequate, and power grids are overburdened, leading to blackouts.
Too many countries have been underinvesting in infrastructure for decades, resulting in everyday inconveniences and, worse, creating roadblocks to economic growth. While a major infusion of funding is needed to address infrastructure gaps, finding the money is only part of the solution. Governments also need to reform infrastructure planning and oversight. The public can no longer afford to accept projects with costs that spiral out of control.
Infrastructure projects’ unique ability to create jobs in the short term and boost productivity in the long term is well known to policymakers. Yet talk has rarely translated into action, despite the record-low interest rates of the past eight years.
The world needs to increase investment in transportation, power, water, and telecom systems from $2.5 trillion a year to $3.3 trillion every year through 2030 just to support projected economic growth, according to new estimates from the McKinsey Global Institute. But despite the obvious need for action, infrastructure investment has actually declined in 11 of the G20 economies since the 2008 global financial crisis.
The conventional wisdom is that fiscal concerns make it impossible to marshal enough public funding. In fact, there is substantial scope to increase public infrastructure investment, particularly while borrowing costs remain historically low. In some cases, funding can be found without raising taxes: governments can create revenue streams by instituting user charges, capturing increases in property value, or selling existing assets and recycling the proceeds. Public accounting standards also could allow infrastructure assets to be depreciated over their life cycle, rather than immediately adding their costs to fiscal deficits during construction.
Governments can also do much more to encourage private investment, starting by providing regulatory certainty and the ability to charge prices that produce an acceptable risk-adjusted return. Even more broadly, they can take steps to create a market that more efficiently connects institutional investors seeking stable, long-term returns and projects that need financing.
Given that these investors have some $120 trillion in assets under management, the bottleneck is not a shortage of capital, but rather a dearth of well-prepared, bankable projects. One way to clear it would be to develop the regulatory and institutional groundwork needed to enable funding to flow more smoothly from institutional investors in advanced economies to projects in the emerging world, where huge populations still need access to essential infrastructure services.
Beyond financing, making the infrastructure sector more efficient represents an even bigger opportunity. Delays stretching into years, and cost overruns soaring into the billions of dollars, are a sadly familiar story in public works. And when bridges turn into boondoggles, the public grows more reluctant to invest.
Every dollar allocated to infrastructure needs to stretch much further. Part of that effort involves demanding better performance from the construction industry, where productivity growth has been flat for decades. There are some positive signs of innovation, from accelerated bridge building to pre-fabrication and modular construction techniques. But the sector as a whole needs a major push in terms of modernization, technology adoption, and standardization.
Governments must also transform the institutions and processes under their direct control. Our work with governments around the world has demonstrated that stronger governance and oversight of infrastructure projects can lower infrastructure costs by as much as 40%.
This starts with taking a systematic and data-driven approach to choosing the right projects. Top-performing countries such as Singapore and South Korea do not consider projects in isolation; they consider how each supports their policy objectives, and they weigh it against other projects that might yield better returns.
As projects move down the pipeline toward realization, it is critical to tighten management of the delivery and execution stages. Accelerating environmental reviews, approval processes, and land acquisition can minimize the costs and delays that mount before ground is ever broken. Meeting best practices could unlock huge value: as it stands, the price tags for similar projects can vary by 50-100% from country to country.
“Kicking the can down the road” is not a viable strategy for dealing with the world’s infrastructure needs. It’s up to us to avoid leaving a legacy of deferred costs and deteriorating fundamentals for the next generation. The money is available. Let’s put it to use.
Infrastructure Investment’s Missing Link
G20 countries have once again pledged to invest in advanced-economy infrastructure as a strategy to boost global growth. The world has heard this before, but it never seems to work out as promised, because policymakers continue to ignore the factors that deter investors.
CAMBRIDGE – It is breathtaking to watch world leaders put aside their differences and agree to a single strategy to boost global economic growth. It is heartbreaking when that strategy doesn’t do much good. At the G20’s recent summit in Hangzhou, China – its tenth since the 2008 global financial crisis – member governments once again pledged to invest in infrastructure in advanced economies to boost growth, and in the developing world to fight poverty. But it is still mainly a pledge.
According to the McKinsey Global Institute, the world still invests only $2.5 trillion annually in transportation, water, power, and telecommunication networks, well short of the estimated $3.3 trillion needed just to keep up with current trends. In fact, most G20 countries actually invest less today in infrastructure than they did before the financial crisis, even as national leaders acknowledge that these investments can spur growth.
This is still more confounding at a time when the world is awash with cash. With central banks keeping interest rates near zero – and in some cases even probing negative territory – it is hard to find another time in history when borrowing was so cheap.
While governments may be reluctant to take on new debt, private investors seeking higher returns than government bonds can offer have always participated in infrastructure financing. Even if post-financial crisis regulations are tying banks’ hands, pension funds and insurance companies still need precisely the kinds of long-term, steady-return investments that infrastructure projects offer. So why does so much infrastructure remain unbuilt?
One problem is that, while the infrastructure-investment shortfall is a global challenge, the solutions are mostly local. Investors must look at the specific risks and rewards of the project in front of them. That means that governments at all levels need to start on a long list of granular, targeted reforms that will slowly increase transparency and reduce the risk of these inherently large, complex, and immovable outlays.
So far, G20 governments have done what governments do best: commit money. They have also pushed the World Bank and other global lenders to free up more funding for infrastructure projects. In some cases, they have even conjured new multilateral banks from scratch – witness China’s Asian Infrastructure Investment Bank and the New Development Bank, established by the BRICS countries (Brazil, Russia, India, China, and South Africa).
Because bridges, power plants, and ports are complicated undertakings that often require extensive feasibility studies, environmental reviews, and regulatory approvals, G20 countries are also trying to boost the number of potential projects. After its 2014 summit in Brisbane, Australia, the G20 launched a “Global Infrastructure Hub” to help accelerate project preparation.
These efforts are a good start, but raising more money and generating longer lists of projects isn’t enough. Investors today are focusing overwhelmingly on all the different ways they could lose their money. They are unlikely to be drawn toward infrastructure projects until they get some help in dealing with the potential risks.
This doesn’t necessarily entail government guarantees, but it does mean that governments should make all the contingencies surrounding a project as clear and predictable as possible.
For starters, policymakers can improve the investment climate by making laws clearer, taxes simpler, courts faster, and bureaucrats cleaner. Potential investors will avoid projects where it is too hard to complete feasibility studies or secure licenses. Deficiencies in any of these basic areas are usually the first thing investors complain about, which reflects how important they are.
Governments can also improve their own long-term planning to anticipate future needs and make it easier for investors to understand the context of a project, and to sign up for a second one if the first one goes well.
As a part of planning, governments should help develop an impartial set of benchmarks, based on past and current comparable projects, to set reasonable expectations about returns. If a project’s returns are set too low, it will fail; if they are set too high, people will suspect incompetence or corruption. Benchmarks can help facilitate negotiations and protect both public and investor interests.
Moreover, governments should do more to create model contracts that are easier to analyze and negotiate, regardless of where a project is located. Legal systems differ across countries, but that does not mean that contracts to build similar power plants cannot be more alike.
Governments should also develop local capital markets and encourage more securitization. Despite securitization’s bad name since the United States subprime mortgage crisis, pooling and distributing highly concentrated risks can attract a larger group of potential investors with the right risk tolerance.
Finally, policymakers should embrace the Internet of Things. Cheaper sensors and better data analytics are already enabling infrastructure operators to track maintenance issues and predict investment obsolescence more accurately, and in real time. IoT technology can thus enhance project transparency, to the benefit of governments and investors alike.
While G20 leaders have already given a nod to some of these reforms, a far wider range of officials, regulators, and investors, across many local, national, and regional jurisdictions, must do the difficult work to deliver results. More money and more projects can help, but only more transparency and a clearer view of risks will jump-start progress.
Infrastructure’s Class of Its Own
It is time for Asia’s leaders to recognize that the lack of private funding for infrastructure projects cannot be reduced to one or even two problems – and develop comprehensive solutions that account for the full scope of the challenge. This requires, first and foremost, redefining infrastructure as a new asset class.
BEIJING – After several months of disappointing economic indicators, China’s State Council has unveiled a “mini-stimulus” package, focused on social-housing construction and railway expansion. The decision came a month after Premier Li Keqiang’s declaration that China had set its annual growth target at “around 7.5%” – the same as last year’s goal. The implication is clear: While consumption-driven growth remains a long-term goal for China, infrastructure will continue – at least in the short term – to serve as a key driver of China’s economy.
Of course, China is not the only economy that depends on infrastructure investment to buttress economic growth. The World Bank estimates that infrastructure investments accounted for nearly half of the acceleration in Sub-Saharan Africa’s economic growth in 2001-2005.
According to the Bank, a 10% increase in infrastructure investment is associated with GDP growth of 1%. Such investment also creates jobs, both in the short term, by creating demand for materials and labor, and in the long term, for related services. For example, every $100 million invested in rural road maintenance translates into an estimated 25,000-50,000 job opportunities.
But these benefits are diluted in China, owing to its excessive reliance on public funding. Indeed, in recent years, less than 0.03% of Chinese infrastructure investment – which amounted to roughly 9% of GDP – was derived from private capital.
This problem is not limited to China; of the 7.2% of GDP that Asian countries spend, on average, on infrastructure development, only about 0.2% is privately funded. By contrast, in Latin America and the Caribbean, private capital finances, respectively, 1.9% and 1.6% of infrastructure investment.
Discussions within the G-20 have produced two possible explanations for Asian countries’ inability to attract more private capital to infrastructure projects. Most developing countries argue that the problem is rooted in the provision of capital, with investors preferring to fill their infrastructure portfolios with low-risk projects, and insurance companies and banks facing overly restrictive regulations. OECD countries like Germany counter that the problem is the lack of investment-worthy assets; there are simply not enough bankable projects available.
In fact, both explanations are correct – but neither is complete. It is time for Asia’s leaders to recognize that the lack of private funding for infrastructure projects cannot be reduced to one or even two problems, and to develop comprehensive solutions that account for the full scope of the challenge.
This requires, first and foremost, abandoning the view that infrastructure assets fit into the paradigm of traditional asset classes like equity, debt, or real estate. Infrastructure must be redefined as a new asset class, based on several considerations.
For starters, there is the public-good element of many infrastructure projects, which demands contingent government obligations like universal coverage levels for basic services. In order to make such projects more appealing to private investors, economic externalities should be internalized, and a link should be established between the internal rate of return, which matters to a commercial investor, and the economic rate of return, which matters to society.
Moreover, innovative mechanisms to supply new assets to investors would be needed – and that requires the creativity found and priced by markets. To this end, private-sector sponsors must be given space to initiate valuable projects.
The new asset class would need its own standardized risk/return profile, accounting, for example, for the political risks that public-sector involvement may imply and for the lower returns from infrastructure relative to traditional private equity. Moreover, the risks associated with the new asset class would change as projects progress from feasibility study to construction to operation, implying that each phase would attract different sources of funding. A clear understanding of this process would enable potential investors to assess projects more effectively, which is critical to encouraging them to put up financing.
Another important consideration is the considerable technical expertise that infrastructure investments demand, which makes them more complex than most assets. Similarly, a specialized network of actors would be needed to ensure that intermediation of infrastructure transactions is efficient and cost-effective, instead of fragmented and slow, as it is now.
For countries that lack China’s strong fiscal position, the need to attract private capital to infrastructure investment is obvious. With nearly 70% of Sub-Saharan Africa’s population lacking access to electricity and 65% of South Asians lacking access to basic sanitation, there is no greater imperative than to plan, fund, build, and maintain infrastructure assets.
But private investment in infrastructure remains vital even in countries like China, because it brings the power and dynamism of the market, which improves the allocation of capital and promotes transparency. Indeed, more private-sector involvement would make the kind of scandals that have occurred in China’s railway sector far less likely.
In short, redefining infrastructure as a new asset class is the only credible way to attract funding for infrastructure construction, and thus to boost long-term economic growth and the employment rate. It is time for Asia’s leaders to step up.