In the US, the one thing Main Street and Wall Street, Republicans and Democrats, and the 99 percent and the 1 percent can agree on, is the need for substantial immediate investment in the nation’s infrastructure.
The Treasury Department’s March 2012 report, “A New Economic Analysis of Infrastructure Investment,” states that 19 out of 20 Americans are “concerned” about the nation’s infrastructure, and 84 percent support greater infrastructural investment. The ULI/ Ernst & Young “Infrastructure 2012” report points out that US voters are willing to tax themselves for infrastructure: “Between 2008 and 2011…US voters approved tax or fee increases to fund transit capital and operations 73 percent of the time.”
America’s problem can be solved by (re)allocating 1 percent of Federal income tax revenue (some $20 billion annually) to underpin Federal guarantees that would support more than $400 billion per year in private capital dedicated for infrastructure investment. This would be the economic catalyst to drive the US economy for the next decade.
Economists consistently affirm that infrastructure investment benefits everyone – from individual households to large businesses. Economist H. Woody Brock provides compelling justifications in “American Gridlock” for why public and private sector borrowing, spending, and investment in infrastructure is the only stimulus that can “perform the heavy lifting [of our economic] recovery”. Infrastructure investment should be viewed as a driver of job creation, both directly – architects, contractors, and engineers – and indirectly, as businesses reap the benefits of infrastructural improvements.
History has rarely seen a more propitious moment to embark on major investment in all forms of public infrastructure. With a weak US economy, the availability of significant human capital, and relatively low construction costs, the relative impact of infrastructural investment will be greater and more immediate. However, the government cannot fund the investment required, because budget deficits and extreme policy gridlock inhibit thoughtful and bold actions by political leaders. The core challenge is both how best to fund infrastructural investment and how to ensure that the right projects are prioritised: infrastructure mistakes are extremely costly.
In order to catapult the US into state-of-the-art transportation, energy, public school, and public heath infrastructure, a bold and comprehensive approach is needed. Namely:
– (Re)allocation of 1 percent of Federal revenue explicitly for investment in the nation’s infrastructure;
– The creation of a “credit reserve” funded by the “1 percent for infrastructure” revenue to underpin Federal government guarantees to facilitate infrastructure project financing;
– Extensive use of public-private partnership (PPP/P3) structures to attract private sector capital and to ensure that projects are efficiently selected, constructed and managed;
– Project identification, sponsorship, and approvals by state governments;
– Use of transparent and sophisticated techniques – including geospatial analysis – to pre-qualify and assess proposed projects.
The estimated cost to eliminate the infrastructure backlog is $2.2 trillion. Investing $20 billion annually (or 1 percent of Federal income tax revenue) would take 110 years to solve the problem. However, if this annual revenue is used as a credit reserve to back Federal guarantees, it could generate some $400 billion annually from global investors.
The Federal Credit Reform Act (1990) requires that Congress appropriate only the “subsidy cost” of federally guaranteed and direct loans. The subsidy cost is broadly equivalent to a credit reserve to cover the expected loss to the government from a default. All Federal government direct or guaranteed loans are assessed a subsidy rate, based on their estimated credit risk; this subsidy rate is multiplied by the loan amount to calculate the subsidy cost. With the appropriate terms and structuring, a new infrastructure loan guarantee should conservatively achieve a subsidy rate of 5 percent or less. Thus the $20 billion would support over $400 billion annually in private capital for infrastructure investment.
Public-Private Partnerships (PPPs) play a pivotal role in a vibrant infrastructure investment programme, as they encourage private sector investment in public sector projects; bring private sector investment discipline both in terms of selecting projects and optimising capital structures; and result in superior project execution, with experience demonstrating that well-structured PPP projects are delivered on time and on budget.
Globally – notably in Australia and the UK – PPP has been a feature of public sector investment programmes since the early 1990s. Much has been achieved, but the recurring criticism is that it is inherently more expensive than traditional procurement because of the investment return needed by the private sector partner (PSP) and that private sector debt capital is always more expensive than government bonds.
These statements are true, but misleading. PPPs are not just about funding; the PSP takes an allocation of the project risks and “whole life” responsibility for the assets. The most successful PPPs are those in which:
Risks are borne by the party who is best positioned to absorb them;
The public sector only pays if an asset – throughout the contract term – meets the agreed output specifications;
The PSP and the public sector need to agree that a project is viable in the long term – bringing more discipline in the selection of contracts to be procured;
The PSP is encouraged to innovate; for example, it may elect to invest more heavily in the initial construction to minimise ongoing maintenance costs; and
The public sector has to commit to the whole life cost of the asset – translated as the payment stream under a long-term contract and not just front-end expenditure.
The question of the PSP’s cost of capital is substantially mitigated by the infrastructure loan guarantee, since the PSP will be issuing debt that is 100 percent government backed: the PPP’s debt cost would be only fractionally higher than that of the government itself.
PPPs are most heavily criticised when governments seek to move the associated debt off balance sheet. This involves allocating more risk than is appropriate to the PSP, which increases the level of equity required and the cost of its capital. The infrastructure loan guarantee appropriately puts the subsidised portion of the debt on the Federal balance sheet, permitting a more sensible allocation of project risks.
Successful infrastructure investment depends heavily upon focusing capital on projects that deliver the best economic and social results, which will require:
“De-politicising” the decision-making process;
Ensuring that projects are rigorously analysed – with both direct and indirect benefits being taken into consideration;
A holistic view of the interplay between projects across the nation; and
Separating the guarantee programme from the project-based decision. The decision to prioritise a project must be driven by sound socio-economic principles rather than by its funding.
In conclusion, US infrastructure is at risk. (Re)allocating 1 percent of tax revenues to infrastructural investment and leveraging the proceeds through a Federal guarantee programme would optimise the use of scarce financial resources. As a result, with the creation of jobs and establishment of secure investments for global capital, both businesses and families alike will benefit, ushering in a renewed sense of American prosperity and economical advancement.
*Jay Brown (managing director) is national leader for A&M’s Public Sector Real Estate Services practice and an expert in PPP and Federal Credit Programs. Robin Priest (managing director) is a leader of A&M’s Real Estate Advisory Services practice in London and a PPP expert