US Cities Need Private Spending on Public Works

Wednesday, 24 Apr 2013 01:02 PM

 

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For a country that prides itself on a robust private sector, the United States lags behind many other nations in using the private sector to finance, build and operate infrastructure. From 1990 to 2006, for example, public-private partnerships financed five times as much transportation infrastructure in the United Kingdom as in the United States — even though the U.S. economy is more than six times larger than that of the United Kingdom.

Partnerships between the public and private sectors cannot solve the entire problem of decaying and neglected infrastructure in the United States. They do not represent “free” money, and many have gone wrong. But done right, they can boost investment and help efficiently manage projects once they are in place.

What’s getting in the way of infrastructure investments today? That’s a question that 17 U.S. big-city mayors took up last week at the first meeting of a new task force formed by the Clinton Global Initiative and the United States Conference of Mayors. (I serve as a special adviser to this Infrastructure Financing for Cities Task Force.)

Presumably, this should be an ideal time to work on roads, bridges and other public works because interest rates are low and the spending would help reduce high unemployment in the United States.

Revenue Challenge

The discussion among the mayors was wide-ranging, but they seemed to generally agree that access to low-cost financing isn’t the crucial obstacle. The more basic problem is the complex decision-making and approval process, along with the challenge to generate future revenue streams sufficient to pay for the ongoing costs of the project and the original loans to build it.

Economists Barry Bosworth and Sveta Milusheva of the Brookings Institution, who have pointed this out previously, say decision makers too often look to obtain free federal funding for projects whose benefits are largely local. They also focus too much on new construction, and too little on operating costs and maintenance, which account for more than half of the total spending on infrastructure, according to the Congressional Budget Office. In mass transit and aviation, the share is more like two-thirds.

Partnerships with the private sector don’t make these operating and maintenance costs disappear — ultimately, someone still pays — but they provide a way to finance those costs, as well as the up-front investment, by leaning on people who directly use the infrastructure rather than the city’s taxpayers as a whole. A private operator of a toll road, for example, would charge a user fee to recoup the cost of building and running it. (The approach works only where there is a specific revenue source associated with the project. Other kinds of infrastructure still have to be financed by general revenue. And projects that have specific income sources don’t necessarily need a public-private partnership.)

For projects that generate revenue, one question that the mayors had is how best to design a public-private partnership — since not all succeed. Here’s one approach I like: Insist that projects be bid out based on the present value of revenue. This strategy was proposed in 2011 by the economists Eduardo Engel of Yale University, Ronald Fischer of the University of Chile in Santiago and Alexander Galetovic of the Universidad de los Andes in Santiago.

Under this approach, potential private partners would bid on the present value of the user fees they would require to undertake the project. The winning bidder would get to collect the user fees until it hit the present-value target.

Auction Strategy

This type of auction, already demonstrated in Chile, has several advantages. First, it directly addresses the risk that demand will turn out to be greater or weaker than expected. If it’s weaker, the private operator continues to collect user fees for longer than planned, and if it’s greater, for a briefer period.

Second, the present-value framework allows the government to set the user-fee level efficiently, based on traffic patterns, and also to create alternative capacity with less opposition from the operator (since all that is affected is the payback period, not the present value of revenue).

Finally, this approach provides a natural benchmark for any renegotiations that may be needed during a long contracting period. For example, what happens if, for whatever reason, the city wants to end the concession early? Under traditional contracts, the harm to the private operator is often hard to calculate, and therefore becomes the subject of dispute. Under a present-value framework, though, the amount that should be paid to the private operator would be clear.

Bidding based on present value of revenue is just one of many potential best practices that the mayors discussed last week. I’m hopeful that this mayoral infrastructure task force will produce real results over the next year. The leaders of the effort — including President Bill Clinton, Chicago Mayor Rahm Emanuel and Philadelphia Mayor Michael Nutter — deserve credit for even trying.

Peter Orszag is vice chairman of corporate and investment banking and chairman of the financial strategy and solutions group at Citigroup Inc. and a former director of the Office of Management and Budget in the Obama administration. The opinions expressed are his own.

© Copyright 2014 Bloomberg News. All rights reserved.

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