Infrastructure Investment

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Chris Edwards

August 2013

Overview
Federal Infrastructure in Perspective
Problems with Federal Infrastructure
Global Trend Toward Privatization
Hurdles to Privatization
Conclusions
 

Overview

Infrastructure investment is very important to the modern economy. The word "infrastructure" generally refers to long-lived fixed assets that provide a backbone for other production and consumption activities in the economy. In the United States, most infrastructure is provided by the private sector in the form of pipelines, power plants, freight railways, and many other types of facilities.

Government infrastructure, such as highways and bridges, is also important. But there are differing views on how large the government role in infrastructure ought to be, particularly the federal role. Some advocacy groups argue that America's infrastructure is crumbling and that more federal spending is needed to fix the problems.1 But budget experts are concerned that the federal government is running large deficits and has no funds available for extra investments.

However, a more important issue than the level of government spending on infrastructure is the efficiency of the nation's investments. Infrastructure investment will only spur economic growth if it is allocated to high-value projects and constructed in a cost-effective manner. This is where the shortcomings of federal infrastructure spending are apparent.

Decades of experience show that federal involvement in infrastructure investment often leads to waste and inefficiency. Funds get misallocated based on politics, and projects get bogged down in mismanagement and cost overruns. These sorts of problems have plagued federal infrastructure since the 19th century.

This essay discusses the advantages of reducing the federal role in the nation's infrastructure. It argues that state and local governments and the private sector are more likely to make sound investments without all the federal subsidies and regulations that currently distort their decision making. The essay also examines the global trend toward moving government infrastructure activities to the private sector. Highways, bridges, airports, and other facilities have been privatized or partially privatized in many countries.

Federal policymakers should study these innovations abroad and work to reduce barriers to private infrastructure investment in the United States. Privatization of infrastructure promises to improve efficiency, reduce burdens on taxpayers, and spur badly needed growth in the U.S. economy.
 

Federal Infrastructure in Perspective

Most of America's infrastructure is provided by the private sector, not governments. In 2012 gross fixed private investment was an enormous $2 trillion, according to national income accounts data.2 That includes investment in factories, pipelines, refineries, cell phone towers, and many other facilities.

By contrast, total federal, state, and local government infrastructure investment in 2012 was $472 billion. Excluding national defense, government investment was $367 billion. Thus, private infrastructure investment in the United States is five times larger than total nondefense government investment.

One implication of the data is that if policymakers want to boost infrastructure spending, they should make policy reforms to spur private investment. One reform would be to cut the federal corporate income tax rate, which would increase the net returns to a broad range of private infrastructure, and thus spur greater investment.

Nonetheless, government infrastructure is important to the U.S. economy. But complaints that the United States has a crisis of government underinvestment are off base. For one thing, government investment as a share of gross domestic product (GDP) in the United States is similar to the levels in other high-income nations. In 2010 government gross fixed investment in the United States was 3.5 percent of GDP, which was similar to the 3.3 percent average in the nations of the Organization for Economic Cooperation and Development.3

Another reason for skepticism that governments are underinvesting is that some measures of infrastructure quality are improving. For example, Federal Highway Administration (FHWA) data on the nation's bridges show steady gains in quality.4 Of the roughly 600,000 bridges in the country, the share that are "structurally deficient" has fallen from 22 percent in 1992 to 11 percent in 2012, while the share that are "functionally obsolete" has fallen from 16 percent to 14 percent.

The surface quality of the interstate highways has also improved. Since 1989 the FHWA has reported the International Roughness Index (IRI) for U.S. highways, with lower numbers meaning smoother roads. Here are the average IRI scores for different types of highways in 1989 and 2009: urban interstates (115 and 92), other urban freeways (124 and 101), rural interstates (101 and 77), and other rural arteries (104 and 87).5 Federal Reserve economists examining IRI data found that "since the mid-1990s, our nation's interstate highways have become indisputably smoother and less deteriorated," and they concluded that the interstate system is "in good shape relative to its past condition." 6
 

Problems with Federal Infrastructure

There are frequent calls for increased federal spending on infrastructure, but advocates usually ignore the inefficiencies and failures of past federal efforts. Here are some of the problems:

  • Investment is misallocated. Federal investments are often based on political pork-barrel factors rather than actual marketplace demands. Amtrak investment, for example, has long been spread around to low-population areas where passenger rail makes little economic sense. Most of Amtrak's financial losses come from long-distance routes through rural areas that account for only a small fraction of all riders.7 Every lawmaker wants an Amtrak route through their state, so investment gets misallocated away from where it is really needed, such as the Northeast corridor.
  • Infrastructure is utilized inefficiently. Government infrastructure is often utilized inefficiently because supply and demand are not balanced by market prices. The vast water infrastructure operated by the Bureau of Reclamation, for example, greatly underprices irrigation water in western United States. The result is wasted resources, harm to the environment, and a looming water crisis in many areas in the West.8
  • Investment is mismanaged. Federal agencies don't have the strong incentives that businesses do to ensure that infrastructure projects are constructed and operated efficiently. Federal highway, energy, airport, and air traffic control projects, for example, have often experienced large cost overruns.9 The Big Dig in Boston—which was two-thirds funded by the federal government—exploded in cost to five times the original estimate.10 And over much of the last century, the Army Corps of Engineers and the Bureau of Reclamation were known for spending on boondoggle projects, distorting their analyses, harming the environment, and spending on projects to further private interests rather than the general public interest.11
  • Mistakes are replicated across the nation. Perhaps the biggest problem with federal intervention in infrastructure is that when Washington makes mistakes it replicates them across the nation. High-rise public housing projects, for example, were a terrible idea that federal funding helped spread nationwide. Federal subsidies for light-rail projects have biased cities to opt for these expensive systems, even though they are generally less efficient and flexible than bus systems.12 High-speed rail represents another federal effort to induce the states to spend money on uneconomical infrastructure.13
  • Burdensome regulations. A final problem with federal infrastructure spending is that it usually comes part and parcel with piles of regulations. Federal Davis-Bacon labor rules, for example, raise the cost of building state and local infrastructure. In general, federal regulations impose one-size-fits-all solutions on the states even though the states may have diverse infrastructure needs.
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Global Trend toward Privatization

The answer to America's infrastructure challenges is not greater federal intervention, but greater involvement of the private sector. In recent decades there has been a worldwide trend toward infrastructure privatization. Since 1990 about $900 billion of state-owned assets have been sold in OECD countries, about 63 percent of which has been infrastructure assets.14 What spurred the trend? The OECD says that "public provision of infrastructure has sometimes failed to deliver efficient investment with misallocation across sectors, regions, or time, often due to political considerations. Constraints on public finance and recognized limitations on the public sector's effectiveness in managing projects have led to a reconsideration of the role of the state in infrastructure provision."15

Short of full privatization, many countries have partly privatized infrastructure through public-private partnerships ("PPPs" or "P3s"). P3s differ from traditional government contracting by shifting various elements of financing, management, operations, and project risks to the private sector. In a 2011 report, the OECD found a "widespread recognition" around the world of "the need for greater recourse to private sector finance" in infrastructure.16

Unfortunately, the United States "has lagged behind Australia and Europe in privatization of infrastructure such as roads, bridges and tunnels," notes the OECD.17 About one fifth of public infrastructure spending in Britain is now through the P3 process, and in Canada P3s account for between 10 to 20 percent of public infrastructure spending.18

According to Public Works Financing, only 1 of the top 38 firms doing transportation P3s around the world are American.19 Of more than 700 transportation projects listed in the newsletter, only 28 are in the United States. Canada—a country with one-tenth of our population—has about the same number of P3 deals as we do.

Nonetheless, a number of U.S. states have moved ahead with P3s and privatization. Some projects in Virginia illustrate the opportunities:20

  • Capital Beltway. Transurban and Fluor have built and are now operating new toll lanes along 14 miles of I-495. The firms used debt and equity to finance most of the project's $2 billion cost.21 The lanes were completed on time and on budget in 2012.
  • Dulles Greenway. The Greenway is a privately owned toll highway in Northern Virginia completed in the mid-1990s with $350 million of private debt and equity.22
  • Jordan Bridge. FIGG Engineering Group and partners financed and constructed a $142 million highway bridge over the Elizabeth River between Chesapeake and Portsmouth. The bridge opened in 2012, and its cost will be paid back to investors over time with toll revenues.23

There are many advantages of infrastructure P3s and privatization. Most fundamentally, when private businesses are taking the risks and putting their profits on the line, funding is more likely to get allocated to high-return projects and completed in the most efficient manner.

U.S. and foreign studies have found that privately financed infrastructure projects are more likely to be completed on time and on budget than traditional government projects.24 An Australian study compared 21 P3 (or PPP) projects with 33 traditional projects and found: "PPPs demonstrate clearly superior cost efficiency over traditional procurement . . . PPPs provide superior performance in both the cost and time dimensions, and . . . the PPP advantage increases (in absolute terms) with the size and complexity of projects."25 A government official overseeing the Capital Beltway P3 lauded the private firms in charge for their rapid and nonbureaucratic way of solving problems that arose during construction, which is "not the way government works typically," he said.26

The publisher of Public Works Financing, William Reinhardt, notes that "the design-build contracting approach used in a P3 guarantees the construction price and project completion schedule of large, complex infrastructure projects that often befuddle state and local governments, as was the case with Boston's Big Dig."27 Reinhardt says that P3 projects typically experience capital cost savings of 15 to 20 percent compared to traditional government contracting.

A Brookings Institution study noted that the usual process of government investing decouples the construction from the future management of facilities, which results in contractors having little incentive to build projects that minimize long-term costs.28 P3s solve this problem because the same company both builds and operates new facilities. "Many advantages of PPP stem from the fact that they bundle construction, operations, and maintenance in a single contract. This provides incentives to minimize life-cycle costs," notes the study.29

Another advantage of privatized infrastructure is that businesses can tap capital markets to build capacity and meet market demands—without having to rely on the instability of government budgeting. Our air traffic control (ATC) system, for example, needs major upgrades, but the Federal Aviation Administration cannot count on a stable federal funding stream. The threatened disruptions to the ATC system from federal budget sequester cuts in 2013 illustrated the hazards of having infrastructure depend on federal funding.

The solution in this case is to privatize the air traffic control system, as Canada did with its system in 1996 with very favorable results.30Canada's ATC is run by a nonprofit corporation, Nav Canada, separate from the government. It raises revenues from its customers to cover its operational and capital costs. Nav Canada is a "global leader in delivering top class performance," says the International Air Transport Association, which has given the company multiple awards.31
 

Hurdles to Privatization

Despite the benefits of private infrastructure investment, federal policies have long created hurdles for state and local governments in pursuing privatization. Federal policymakers should free the states from regulations and subsidies so that they can become "laboratories of democracy" for infrastructure. Here are some barriers to private infrastructure that policymakers should examine:

  • Tax exemption on municipal bond interest. When state and local governments borrow funds to build infrastructure, the interest on the debt is tax-free under the federal income tax. That allows governments to finance infrastructure at a lower cost than private businesses, which stacks the deck against the private provision of infrastructure. Policymakers should consider phasing-out the tax exemption on state and local bond interest, perhaps in exchange for reducing other tax rates on capital income.
  • Income and property taxation. Government facilities don't pay income taxes. While state-owned airports are tax-exempt, for example, a for-profit airport would have its net earnings taxed at both the state and federal levels.32 Similarly, government-owned facilities are exempt from property taxes almost everywhere in the United States, while for-profit businesses often bear a heavy burden of property taxes on their land, structures, and machinery and equipment.33 Note that by privatizing infrastructure and thus subjecting it to taxation, governments would broaden the tax base. They would gain added revenues from base broadening, which could be used to reduce tax rates and spur greater overall investment.
  • Crowding out. The existence of government infrastructure—which is often provided at artificially low prices to the public—deters potential private investments. Private highways, for example, face an uneven playing field because drivers on a private highway would have to pay the private tolls plus the gasoline taxes that fund the government's "free" highways.
  • Federal subsidies. The crowding out problem is exacerbated when federal subsidies tilt state and local decisionmakers in favor of government provision. Private airports, for example, are not eligible for most federal airport subsidies. Or consider that before the 1960s most urban bus and rail services in America were privately owned and operated. But that ended with the passage of the Urban Mass Transportation Act of 1964. That Act provided subsidies only to government-owned bus and rail systems, not private systems.34 That prompted state and local governments across the country to take over private systems, swiftly ending more than a century of private transit investment in America's cities.
  • Federal regulations. Federal regulations have restricted efforts to privatize state and local infrastructure. One issue has been that states receiving federal aid for their facilities have been required to repay the past aid if the facilities are privatized. These rules have been liberalized over the years, but they may still create a disincentive to privatize in some cases.35 Another issue is that tolling has been generally prohibited on interstate highways, which has prevented P3 projects. However, the 2012 highway bill (MAP-21) allows for the tolling of new capacity on the interstates, which is a step forward.36 Federal policymakers should work to eliminate remaining regulations that stand in the way of infrastructure privatization.37
  • Labor Unions. Privatization would undermine the power of the public-sector unions that often dominate government services, and so unions actively lobby against reforms. For example, unions lobby against contracting out airport security screening operations.38 The National Air Traffic Controllers Association lobbies against ATC privatization. And in the District of Columbia, unions are trying to block a proposal to allow private operation of some buses.39 A good solution to the problem would be to ban monopoly unions ("collective bargaining") in the public sector, which is the rule in a number of states, such as Virginia.40
  • Social Security. The structuring of Social Security as a pay-as-you-go system is a negative factor for privatized infrastructure. One of the fuels for the rise in P3s in other countries has been growing investment by pension funds. Infrastructure investment is a good fit for pension funds because it provides a return over a very long period of time, which matches the pattern of long-term liabilities of these funds. In Canada and Australia, the growth in P3s has been partly driven by the pools of savings created by reformed government retirement programs. In the United States, reforms to create Social Security private accounts would create a large pool of long-term savings to help fuel private infrastructure investment.
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Conclusions

Many experts and policymakers are concerned that America have top-notch infrastructure to compete in the global economy. The best way forward is for the federal government to cut subsidies and to devolve control over infrastructure to state and local governments and the private sector. To meet demands for new infrastructure capacity, the states should innovate with privatization and PPPs to the full extent possible.

Private infrastructure is not a new or untried idea. Urban transit services used to be virtually all private.41 And before the 20th century, private turnpike companies built thousands of miles of roads.42 America has always been a land of entrepreneurs looking for new opportunities. Let's give entrepreneurs a crack at improving the nation's infrastructure by reducing subsidies and regulations, and encouraging market-based efforts to tackle our infrastructure challenges.


1 American Society of Civil Engineers, "Report Card for America's Infrastructure," 2013, www.infrastructurereportcard.org.

2 U.S. Bureau of Economic Analysis, National Income and Product Accounts, Table 1.5.5, www.bea.gov.

3 This is OECD data for government gross fixed capital spending. See Figure 2.1 in OECD, "Pension Funds Investment in Infrastructure: A Survey," September 2011.

4 Federal Highway Administration data available at www.fhwa.dot.gov/bridge/deficient.cfm.

5 Federal Highway Administration data cited in Randal O'Toole, "Ending Congestion by Refinancing Highways," Cato Institute Policy Analysis no. 695, May 15, 2012.

6 Jeffrey R. Campbell and Thomas N. Hubbard, "The State of Our Interstates," Federal Reserve Bank of Chicago, July 2009.

7 Tad DeHaven, "Privatizing Amtrak," Cato Institute, June 2010, www.downsizinggovernment.org/transportation/privatizing-amtrak.

8 Chris Edwards and Peter J. Hill, "Cutting the Bureau of Reclamation and Reforming Water Markets," Cato Institute, February 2012, www.downsizinggovernment.org/interior/cutting-bureau-reclamation.

9 Chris Edwards, "Government Cost Overruns," Cato Institute, March 2009, www.downsizinggovernment.org/government-cost-overruns.

10 For background, see the Boston Globe's "Easy Pass" series of reports by Raphael Lewis and Sean Murphy, www.boston.com/globe/metro/packages/bechtel.

11 Chris Edwards, "Cutting the Army Corps of Engineers," Cato Institute, March 2012, www.downsizinggovernment.org/usace. And see Chris Edwards and Peter J. Hill, "Cutting the Bureau of Reclamation and Reforming Water Markets," Cato Institute, February 2012, www.downsizinggovernment.org/interior/ cutting-bureau-reclamation.

12 Randal O'Toole, "Urban Transit," Cato Institute, June 2010, www.downsizinggovernment.org/transportation/urban-transit.

13 Randal O'Toole, "High-Speed Rail," Cato Institute, June, 2010, www.downsizinggovernment.org/transportation/high-speed-rail.

14 Organization for Economic Cooperation and Development, "Pension Funds Investment in Infrastructure: A Survey," September 2011.

15 Organization for Economic Cooperation and Development, "Pension Funds Investment in Infrastructure: A Survey," September 2011, p. 34.

16 Organization for Economic Cooperation and Development, "Pension Funds Investment in Infrastructure: A Survey," September 2011, p. 27.

17 Organization for Economic Cooperation and Development, "Pension Funds Investment in Infrastructure: A Survey," September 2011, p. 107.

18Public Works Financing, October 2011, p. 18, www.pwfinance.net.

19Public Works Financing, October 2011, p. 3, www.pwfinance.net.

20 Details on Virginia's PPPs are available at www.vappta.org/projects.asp.

24 For example, see Allen Consulting Group and the University of Melbourne, "Performance of PPPs and Traditional Procurement in Australia," November 30, 2007. And see Richard Kerrigan, "P3 Study: Over 80% of U.S. Highway P3s Were On-Time and On-Budget," Public Works Financing, November 2012, p. 16.

25 Allen Consulting Group and the University of Melbourne, "Performance of PPPs and Traditional Procurement in Australia," November 30, 2007.

26 Comments of Ron Kirby, Washington Council of Governments, Public Works Financing, December 2012, p. 21.

27 William G. Reinhardt, "The Case For P3s in America," Public Works Financing, January 2012.

28 Eduardo Engel, Ronald Fischer, and Alexander Galetovic, "Public-Private Partnerships to Revamp U.S. Infrastructure," Brookings Institution, February 2011.

29 Eduardo Engel, Ronald Fischer, and Alexander Galetovic, "Public-Private Partnerships to Revamp U.S. Infrastructure," Brookings Institution, February 2011.

30 Chris Edwards and Robert W. Poole, Jr., "Airports and Air Traffic Control," Cato Institute, June 2010, www.downsizinggovernment.org/transportation/airports-atc. And see Chris Edwards, "Privatize the FAA!" Daily Caller, April 24, 2013.

31 Quoted in Chris Edwards, "Privatize the FAA!" Daily Caller, April 24, 2013.

32 There is just one private for-profit commercial airport in the United States, which is the Branson Airport in Branson, Missouri, opened in 2009. See www.flybranson.com.

33 For background on the tax exemption on government land, see H. Woods Bowman, "Reexamining the Property Tax Exemption," Lincoln Institute of Land Policy, July 2003. For information on property tax payments by businesses, see Council on State Taxation and Ernst and Young, "Total State and Local Business Taxes," July 2012.

34 National Research Council, "Contracting for Bus and Demand-Responsive Transit Services," Special Report 258, 2001, Chapter 2.

35 President George H. W. Bush's 1992 Executive Order 12803 was designed to encourage federal approvals of state privatizations, and it liberalized the grant repayment requirements.

36 Robert S. Kirk, "Tolling of Interstate Highways," Congressional Research Service, February 13, 2013.

37 For a discussion of the regulatory barriers to privatizing airports, see National Academy of Sciences, Transportation Research Board, "Considering and Evaluating Airport Privatization," Airport Cooperative Research Program report no. 66, 2012, pp. 45-46. See also Jerry Ellig, The $7.7 Billion Mistake: Federal Barriers to State and Local Privatization, Joint Economic Committee Staff Report, February 1996.

38 Joe Davidson, "Decision to Keep Federal Screeners at Calif. Airport Buoys Labor," Washington Post, January 10, 2013.

39 Dana Hedgpeth, "Union Aims To Block D.C. Bus Plan," Washington Post, July 20, 2013.

40 Chris Edwards, "Public-Sector Unions," Cato Institute Tax and Budget Bulletin no. 61, March 2010.

41 Randal O'Toole, "Urban Transit," Cato Institute, June 2010, www.downsizinggovernment.org/transportation/urban-transit.

42 Gabriel Roth, "Federal Highway Funding," Cato Institute, June 2010, www.downsizinggovernment.org/transportation/highway-funding.