Infrastructure investment is crucial to the modern economy. Infrastructure refers to long-lived fixed assets that provide a backbone for other production and consumption activities in society. In the United States, most infrastructure is provided by the private sector, such as pipelines, power stations, freight railways, and cell phone networks.
Government infrastructure, such as highways and bridges, is also important. Some advocates say that our infrastructure is crumbling and that more federal spending is needed to fix the problems.1 However, infrastructure investment will only spur economic growth if it is allocated to high-value projects and constructed in a cost-effective manner. Federal investments have a poor record in this regard.
Decades of experience show that federal involvement in infrastructure often leads to waste and inefficiency. Funds are misallocated and projects get bogged down in mismanagement and cost overruns. These sorts of problems have plagued federal infrastructure since the 19th century.
This study discusses the problems of federal spending on infrastructure. It argues that the states and private sector are more likely to make sound investments without federal aid and regulations distorting their decisionmaking. The study also examines the global trend toward privatization. Many countries have partly or fully privatized highways, airports, air traffic control, seaports, and other infrastructure over the past three decades.
Federal policymakers should study the reforms abroad and work to reduce barriers to private infrastructure investment in the United States. Harnessing entrepreneurs and private investors to fund, build, and manage infrastructure would reduce taxpayer burdens, improve economic efficiency, and spur innovation.
Federal Infrastructure in Perspective
Most of America's infrastructure is provided by the private sector, not governments. In 2015 gross fixed private nonresidential investment was $2.3 trillion, according to national income accounts data.2 That includes investment in pipelines, power stations, refineries, freight railways, cell phone networks, factories, and many other items.
By contrast, total federal, state, and local government infrastructure investment in 2015 was $613 billion.3 Excluding national defense, the total was $472 billion, of which $120 billion was direct federal spending, $72 billion was federal aid to the states, and $280 billion was funded by the states.
Private infrastructure investment of $2.3 trillion was about five times larger than total nondefense government investment of $472 billion. Thus, if policymakers want to boost infrastructure spending, they should make policy reforms to increase private investment. One reform would be to cut the federal corporate income tax rate, which would increase the returns to a broad range of private infrastructure, and thus spur greater investment.
Government infrastructure is also important to the 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 in the United States is similar to the average share among nations in the Organization for Economic Cooperation and Development (OECD). In recent years, the U.S. and OECD averages have both been about 3.4 percent.4
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.5 Of the more than 600,000 bridges in the nation, the share that are "structurally deficient" has fallen from 22 percent in 1992 to 10 percent in 2015, 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).6 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."7
Problems with Federal Infrastructure Spending
There are frequent calls for increased federal spending on infrastructure, but advocates ignore the inefficiencies and failures of past federal efforts. Here are some of the problems:
- Investment is Misallocated. Federal aid for infrastructure is mainly based on formulas and political factors, not on marketplace demands. Thus, highway aid does not favor the fastest-growing states that need it the most. Airport aid favors smaller airports, not the largest airports that have the most passengers. And Amtrak investment is spread around to low-population areas where passenger rail makes little economic sense. Every lawmaker wants an Amtrak route in their state, so investment gets directed 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, underprices irrigation water in the western 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 have little incentive to ensure that infrastructure projects are constructed and operated efficiently. Federal highway, energy, airport, and air traffic control projects, for example, often experience cost overruns.9 The Big Dig in Boston—which was two-thirds funded by the federal government—soared in cost to five times the original estimate. And for decades, the Army Corps of Engineers and Bureau of Reclamation were known for boondoggle projects, harming the environment, and spending on projects to further private interests, not the general public interest.10
- Mistakes are Replicated. When Washington makes mistakes, it replicates them across the nation. High-rise public housing projects were a terrible idea that federal funding helped spread nationwide in the 20th century. Federal aid for light-rail projects have biased cities to opt for these expensive systems, even though they are less efficient and flexible than buses.11 High-speed rail subsidies were another federal effort to induce the states to spend money on uneconomical infrastructure.12
- Burdensome Regulations. Federal aid for infrastructure comes combined with costly regulations. Davis-Bacon rules mandate higher labor costs on construction projects. Environmental laws, such as the National Environmental Policy Act (NEPA), push up costs and cause delays. A report for the Obama administration on infrastructure noted, "The average time to complete a NEPA study increased from 2.2 years in the 1970s, to 4.4 years in the 1980s, to 5.1 years in the 1995 to 2001 period, to 6.6 years in 2011."13 The number of environmental laws and executive orders that transportation projects must comply with has increased from 26 in 1970 to about 70 today.14
Global Trend toward Privatization
The solution to America's infrastructure challenges is not greater federal intervention, but greater involvement of the private sector. There has been a worldwide trend toward privatizing infrastructure in recent decades. Governments in more than 100 countries have transferred thousands of state-owned businesses worth more than $3 trillion to the private sector.15 Railroads, airports, seaports, energy utilities, and other infrastructure businesses have been privatized.
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.
What spurred the trend toward privatization? An OECD report on infrastructure noted that the "public provision of infrastructure has sometimes failed to deliver efficient investment ... 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."16
Another OECD report on infrastructure noted:
Worldwide, consensus is growing that mobilizing private investors to finance and participate in national infrastructure maintenance and development can ease the pressure on public funds and supplement resources for investment. ... By delegating the construction and oftentimes the management of infrastructure projects to the private investors, governments are also likely to reap cost and efficiency gains.17
Unfortunately, the United States "has lagged behind Australia and Europe in privatization of infrastructure such as roads, bridges and tunnels," says the OECD.18 We also lag Canada in shifting government infrastructure to the private sector and using the P3 process. According to information in Public Works Financing, few of the top global firms doing P3 deals are American, and a relatively small share of P3 projects are located in the United States.19
Nonetheless, a number of U.S. states have moved ahead with P3s and privatization. Some transportation projects in Virginia illustrate the opportunities:20
- Capital Beltway. Transurban and Fluor built and now operating new toll lanes along 14 miles of the 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 is being paid back to investors over time with toll revenues.23 FIGG is also constructing the new $150 million Cline Avenue Bridge in East Chicago, with the full cost being financed privately.24
When private businesses put their own profits on the line, infrastructure spending is more likely to get allocated to high-return projects and constructed efficiently. An Australian study compared 21 P3, or PPP, projects with 33 traditional government 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 Canadian expert testified at House hearings on infrastructure that the P3 effort in that country has "focused primarily on transferring construction and asset availability risks to the private sector concessionaire, in an attempt to stem the trend of infrastructure mega-projects being plagued by endemic cost overruns and delays."26 The effort has been a success: "Canadian PPPs have a strong reported record of projects coming in on time and on budget."27 The head of a Canadian P3 agency testified that P3s create discipline in the planning stages of projects, and they are more likely to be completed on time and on budget.28
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."29 Reinhardt says that P3 projects often enjoy capital cost savings of 15 to 20 percent compared to traditional government contracting.
A Brookings Institution study noted that traditional government contracting decouples the construction from the future management of facilities, which results in contractors having little incentive to build projects that minimize long-term costs.30 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," noted the study.31
Another advantage of privatized infrastructure is that businesses can tap capital markets to build capacity and meet market demands, without having to rely on unstable government budgets. Our air traffic control (ATC) system, for example, needs major upgrades, but the Federal Aviation Administration cannot count on a stable funding stream from Congress. The solution is to privatize the system, as Canada did with its system in 1996. The system is run by a nonprofit corporation, Nav Canada, which raises revenues from its customers to cover its operational and capital costs.
Privatizing Federal Infrastructure
Despite the global success of privatization, such reforms have bypassed our own federal government. Many types of infrastructure that have been privatized abroad remain in the government's hands in this country. Congress should study foreign reforms and privatize the following federal infrastructure:
- Air Traffic Control. ATC is a high-technology industry, but we still run it as an old-fashioned federal bureaucracy.32 Meanwhile, Canada's privatization has been a success. Nav Canada has won International Air Transport Association awards as the world's best ATC provider.33 Nav Canada is a "global leader in delivering top-class performance" noted the association.34 In an interview, the head of Nav Canada argued, "This business of ours has evolved long past the time when government should be in it ... Governments are not suited to run ... dynamic, high-tech, 24-hour businesses."35
- Amtrak. The federal government's passenger rail company has a costly union workforce, a poor on-time record, and it loses more than a billion dollars a year. A large share of the losses stem from running trains on routes that have low ridership. Congress should privatize Amtrak and allow entrepreneurs to create a better system. Reforms in Britain, Japan, and elsewhere show that rail privatization works.36
- U.S. Postal Service. The government's postal company owns or leases a lot of infrastructure, including more than 30,000 buildings and 200,000 vehicles. As mail volume has plunged over the past decade, the USPS has lost billions of dollars. Other nations with money-losing postal systems have privatized them and opened them to competition in order to improve efficiency. Most European Union countries now have more entrepreneurial postal systems than we do, with postal companies privatized in Germany, Britain, the Netherlands, and other countries.37
- Tennessee Valley Authority. One of the largest utilities in the nation is owned by the federal government. The Tennessee Valley Authority (TVA) has a bloated cost structure, a poor environmental record, and has wasted billions of dollars on its nuclear program. Electric utilities have been privatized around the world, so privatizing TVA should be a no-brainer.38
- Power Marketing Administrations. The federal government owns four Power Marketing Administrations (PMAs), which transmit wholesale electricity in 33 states. The power is mainly generated by hydroelectric plants owned by the Army Corps of Engineers and the Bureau of Reclamation. The PMAs receive numerous subsidies and sell most of their power at inefficient below-market rates. Congress should privatize the PMAs and the hydro plants.39
- Army Corps of Engineers. The civilian part of the Army Corps constructs and maintains infrastructure such as locks, waterways, and flood control facilities. But these are roles that state governments and private engineering and construction companies should fill. When the states need to construct and maintain levees, harbors, beaches, inland waterways, and recreational areas, they should hire private companies to do the work. The Army Corps should be privatized and compete for such work.40
- Bureau of Reclamation. This agency builds and operates dams, canals, and hydro plants in the 17 western states. It is the largest wholesaler of water in the nation. The bureau sells irrigation water at below-market prices, which distorts the economy and causes environmental harm. The agency's facilities should be transferred to state ownership or privatized.41
Removing Barriers to State and Local Privatization
Federal aid, regulations, and tax provisions create barriers for state and local governments to privatize their infrastructure. Congress should work to reform these barriers to private investment:
- Federal Aid. Federal aid tilts state and local officials in favor of government provision. Before the 1960s, for example, most urban transit services were privately owned and operated. But that ended with the passage of the Urban Mass Transportation Act of 1964, which provided aid only to government-owned bus and rail systems.42 That prompted state and local governments across the country to take over private systems, ending more than a century of private transit investment in American cities. A similar thing happened with airports. There were numerous private commercial airports in U.S. cities in the 1930s, but when federal aid began flowing to government-owned airports, the private facilities were squeezed out.
- Subsidized Prices. The existence of government infrastructure deters or "crowds out" potential private investments. This is especially true when government services are provided free to the public or at artificially low prices. Private highways, for example, face an uneven playing field because drivers using the private facility—such as the Dulles Greenway in Virginia—have to pay the private tolls as well as the gasoline taxes that fund the government's "free" highways.
- Tax Exemption on 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 projects at a lower cost than private businesses, which stacks the deck against the private provision of infrastructure. Policymakers should end the tax exemption on state and local bond interest, perhaps in exchange for reducing overall tax rates on capital.
- Income and Property Taxation. Government facilities do not pay income taxes on their earnings. While state-owned airports are tax-exempt, for example, a for-profit airport would have its earnings taxed at both the federal and state levels. 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 equipment.43
- Federal Regulations. Federal regulations unnecessarily restrict efforts to privatize state and local infrastructure. One restriction is that states receiving federal aid for their facilities must repay part of their past aid if facilities are privatized. Another restriction is that proceeds from privatization must be reinvested in other infrastructure by a state or local government, and may not be used for other budgetary purposes. A third restriction is that tolling is prohibited on most existing interstate highways, which has blocked P3 projects.
- Social Security. 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 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 driven by the pools of savings created by reformed government retirement programs. In the United States, restructuring Social Security as a system of private accounts would create a pool of long-term savings that could fuel private infrastructure investment.
The airport industry illustrates some of these points. Virtually all U.S. airports with commercial flights are owned by state and local governments today. But that did not used to be the case. In the 1930s, airports in some major U.S. cities were owned and operated as private businesses.44 But federal policies pushed out the airport entrepreneurs over time. The U.S. military and the Post Office promoted government-owned airports over private ones. Cities were able to issue tax-exempt bonds to finance government airports, which created a financial edge over private airports. And beginning in the 1930s, federal aid was steered to government-owned airports, but not private ones.
Today, outside the United States, the airport industry is rapidly changing. Hundreds of airports around the world have been partly or fully privatized in recent years.45 A 2016 study by Airports Council International found that 47 percent of airports in the European Union are now either "mostly" or "fully" private, which is up from 23 percent in 2010.46
The ACI report concluded that there is "no denying the tangible benefits" of market-based reforms in Europe's airport industry, including "significant volumes of investment in necessary infrastructure, higher service quality levels, and a commercial acumen which allows airport operators to diversify revenue streams and minimize the costs that users have to pay."47
Policymakers are concerned that America have top-notch infrastructure in order to compete in the global economy. The way to meet that challenge is for the federal government to privatize the infrastructure that it owns, while also eliminating barriers to state and local privatization. Federal policymakers should cut aid for state and local infrastructure and eliminate regulations that block state and local reforms.
The beneficiaries of such reforms would be consumers, travelers, and other users of infrastructure. Passenger rail privatization in Britain boosted ridership and led to better on-time performance than America's Amtrak. Airport privatization in Britain has created a more efficient aviation industry and encouraged competition by low-cost airlines.48 And air traffic control privatization promises to spur innovations that would reduce congestion and flight delays.
America has always been a land of investors and entrepreneurs looking for new opportunities. We should give them a crack at improving the nation's infrastructure by privatizing facilities and repealing subsidies and regulations.
3 U.S. Bureau of Economic Analysis, National Income and Product Accounts, Tables 3.1, 3.2, and 3.3.
6 Federal Highway Administration data cited in Randal O'Toole, "Ending Congestion by Refinancing Highways," Cato Institute Policy Analysis no. 695, May 15, 2012.
7 Jeffrey R. Campbell and Thomas N. Hubbard, "The State of Our Interstates," Federal Reserve Bank of Chicago, July 2009.
8 Chris Edwards and Peter J. Hill, "Cutting the Bureau of Reclamation and Reforming Water Markets," Cato Institute, February 1, 2012, www.downsizinggovernment.org/interior/cutting-bureau-reclamation.
9 Chris Edwards and Nicole Kaeding, "Federal Government Cost Overruns," Cato Institute, September 1, 2015, www.downsizinggovernment.org/government-cost-overruns.
10 Chris Edwards, "Cutting the Army Corps of Engineers," Cato Institute, March 1, 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 1, 2012, www.downsizinggovernment.org/interior/cutting-bureau-reclamation.
11 Randal O'Toole, "Urban Transit," Cato Institute, January 4, 2017, www.downsizinggovernment.org/transportation/urban-transit.
12 Randal O'Toole, "High-Speed Rail," Cato Institute, June 1, 2010, www.downsizinggovernment.org/transportation/high-speed-rail.
13 AECOM and Build America Investment Initiative for the Department of the Treasury, "40 Proposed U.S. Transportation and Water Infrastructure Projects of Major Economic Significance," December 2016, p. 7.
14 Associated General Contractors of Alaska, The Alaska Contractor, Fall 2012, p. 10. See also the chart entitled "Federal Environmental Requirements Affecting Transportation" at www.agc-ca.org/uploadedFiles/News-Press/News_Forms/Fed_Enviro_Laws_Trans....
15 Worldwide privatization proceeds between 1988 and August 2015 were $3.3 trillion. See William L. Megginson, "Privatization Trends and Major Deals in 2014 and Two-Thirds 2015," in "The PB Report 2014/2015," Privatization Barometer, www.privatizationbarometer.net.
16 Organization for Economic Cooperation and Development, "Pension Funds Investment in Infrastructure: A Survey," September 2011, p. 34.
17 Organization for Economic Cooperation and Development, "Fostering Investment in Infrastructure: Lessons Learned from OECD Investment Policy Reviews," January 2015, p. 9.
18 Organization for Economic Cooperation and Development, "Pension Funds Investment in Infrastructure: A Survey," September 2011, p. 107.
24 Michelle L. Quinn, "Construction on the New Cline Avenue Bridge Project Begins," Post-Tribune, May 26, 2016.
25 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.
26 Testimony of Dr. Matt Siemiatycki, University of Toronto, before the House Committee on Transportation and Infrastructure, April 8, 2014.
27 Testimony of Dr. Matt Siemiatycki, University of Toronto, before the House Committee on Transportation and Infrastructure, April 8, 2014.
28 Testimony of Dr. Larry Blain, Partnerships British Columbia, to the House Committee on Transportation and Infrastructure, April 8, 2014.
29 William G. Reinhardt, "The Case For P3s in America," Public Works Financing, January 2012.
30 Eduardo Engel, Ronald Fischer, and Alexander Galetovic, "Public-Private Partnerships to Revamp U.S. Infrastructure," Brookings Institution, February 2011.
31 Eduardo Engel, Ronald Fischer, and Alexander Galetovic, "Public-Private Partnerships to Revamp U.S. Infrastructure," Brookings Institution, February 2011.
34 International Air Transport Association, "IATA Announces 2011 Eagle Awards," June 6, 2011.
35 Susan Carey, "Nav Canada Draws Interest in U.S.," Wall Street Journal, October 18, 2015.
36 Chris Edwards, "Privatizing Amtrak," Cato Institute, October 17, 2016, www.downsizinggovernment.org/transportation/privatizing-amtrak.
38 Chris Edwards, "Privatizing the Tennessee Valley Authority," Cato Institute, October 14, 2016, www.downsizinggovernment.org/privatizing-tennessee-valley-authority.
41 Chris Edwards and Peter J. Hill, "Cutting the Bureau of Reclamation and Reforming Water Markets," Cato Institute, February 1, 2012, www.downsizinggovernment.org/interior/cutting-bureau-reclamation.
42 National Research Council, "Contracting for Bus and Demand-Responsive Transit Services," Special Report 258, 2001, Chapter 2. And see Randal O'Toole, "Urban Transit," Cato Institute, January 2017, www.downsizinggovernment.org/transportation/urban-transit.
43 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," December 2016.
44 Chris Edwards and Robert W. Poole, Jr., "Privatizing U.S. Airports," Cato Institute, November 28, 2016, www.downsizinggovernment.org/privatizing-us-airports.
45 The Government Accountability Office notes: "at least 450 airports around the world have been privatized to some degree." Government Accountability Office, "Airport Privatization: Limited Interest despite FAA's Pilot Program," GAO-15-42, November 2014, Executive Summary.
46 Airports Council International (Europe), "The Ownership of Europe's Airports, 2016," 2016.
47 Airports Council International (Europe), "The Ownership of Europe's Airports, 2016," 2016, p. 1.
48 David Starkie, "The Airport Industry in a Competitive Environment: A United Kingdom Perspective," Organisation for Economic Cooperation and Development, July 2008.