INSIGHTS: THE COST EFFECTIVE WAY TO REBUILD AMERICA’S INFRASTRUCTURE
Guest Columnist: Baruch Feigenbaum, Assistant Director of Transportation Policy at the Reason Foundation
The Trump administration’s $1 trillion program proposes using large-scale public-private partnerships (PPPs) to foster private investment in aging public-sector infrastructure.
Such projects have an impressive track record of:
• Major investments sooner, thanks to access to capital;
• Largely on-time completion;
• Innovation that reduces costs and/or improves performance;
• Lower life-cycle costs;
• Transfer of major risks (cost overruns, traffic shortfalls) from taxpayers to investors; and
• New tax revenues to government (as with investor-owned utilities).
U.S. candidate projects abound, including:
• 130 large, medium and small-hub airports;
• 44,000 miles of non-tolled Interstate highways nearing or exceeding their 50-year design lives;
• Over 2,000 municipal electric and gas utilities;
• 99 seaports;
• 56,000 municipal water systems; and
• 15,000 wastewater treatment facilities.
All of these facilities have bondable user-fee revenue streams or, in the case of Interstates, could implement such fees through state-of-the-art all-electronic tolling. Equity investment (20% to 30%) and long-term revenue bonds (70% to 80%) would finance these projects. Global infrastructure investment funds, U.S investment banks and large pension funds are eager to invest in such projects, but federal barriers to state and local PPPs make them difficult, financially disadvantageous, or impossible. For example, the U.S. has:
• A very restricted airport privatization program that erects many barriers;
• A federal ban on using toll revenues to finance reconstructing aging Interstate highways (except for a tiny pilot program); and
• An Office of Management and Budget (OMB) rule requiring repayment of any federal grant money received before a public facility privatizes (a de-facto tax on reinventing government).
But the greatest federal obstacle is the virtual ban on using tax-exempt revenue bonds for PPP projects. While state and local governments can issue tax-free revenue bonds, except for surface transportation projects, PPPs can only use taxable debt. This public-sector subsidization precludes a financial level-playing field in which private companies can compete.
Two policy changes would level the financial playing field:
1. Generalize the existing surface transportation Private Activity Bond (PAB) program to apply to PPP projects for all categories of public-purpose infrastructure; and
2. Allow use of those new PABs to acquire and reconstruct existing infrastructure. This is critical since the primary need is not new infrastructure but the reconstruction, modernization and enhancement of existing infrastructure.
The PAB program would likely be revenue-positive for the U.S. Treasury for two reasons. First, almost no public-purpose infrastructure today is being financed by taxable bonds (or where it has been, non-taxable entities such as pension funds have purchased most of those bonds). So, a large-scale expansion of infrastructure investment with tax-exempt PABs would not supplant nonexistent taxable bonds. Second, new federal tax revenue would accrue from (a) PPP companies’ corporate tax payments while building and operating the rebuilt facilities, and (b) additional personal income tax payments by more and better-paid construction and maintenance workers. Also, a trillion-dollar PPP infrastructure program would attract global equity investment now invested elsewhere. Over time American PPP infrastructure developer/operators would compete in global markets, generating service-export revenues and boosting the U.S. economy. The current PAB Program is heavily used and bumping up against a lifetime cap of $15 billion. Congress needs to eliminate this cap to maximize infrastructure investment.
ON THE ECONOMY: ROCK YOU LIKE A HURRICANE
John Dunham, Managing Partner, John Dunham & Associates
The night is calling, I have to go. The wolf is hungry, he runs the show. He’s licking his lips, he’s ready to win. On the hunt tonight for love at first sting. Here I am, rock you like a hurricane. What other lyrics can be used to open the September Monthly Manifesto. As I write this Manifesto, Hurricane Harvey is dumping dozens of inches of rain and causing biblical levels of flooding on one of the most populated areas of the country. As the German Rock band Scorpions sang in this 1984 song (written by Mikeal Anderssonm Hans Gardemar, Martin Hansen Matthias Jabs, Klaus Meine, Herman Rarebell, and Rudolf Schenker), The wolf is hungry, he runs the show, and it is obvious that Harvey is running the show in Texas in spite of the fact that hurricane warnings allowed many people to evacuate, and first responders to prepare. But to fully prepare for a storm of this magnitude would take an Arc, and Arcs take a long time to build.
The building of an Arc to help weather a flood brings to mind the junk economics that we hear every time there is a natural disaster. Our old friend Paul Krugman is always one of the first out of the gate discussing how increased spending repairing houses and roads, and replacing all of the material and machinery lost in the floods will help “stimulate” the economy. Dr. Krugman and his ilk have used the same argument to defend un-productive regulations and government spending for years (see for example: https://krugman.blogs.nytimes.com/2011/09/03/broken-windows-ozone-and-jobs/).
While I am sure that the good people of Texas would rather not have been flooded out of their homes to help “stimulate” the economy, it would be nice if there were some benefit from senseless destruction and loss of life. Unfortunately, there is not. Destruction reaps destruction not growth.
Dr. Krugman and his ilk fail to understand some basic points laid out by Frederic Bastiat when he wrote That Which Is Seen, and That Which Is Not Seen (also known as the Parable of the Broken Window) in 1850.
In the parable Bastait discusses how by-standers were shocked when a shopkeeper punished his son for breaking a window in the store. Noted the by-standers, “Everybody must live, and what would become of the glaziers if panes of glass were never broken?”
Bastait went on to explain that, yes, the glazier would benefit from the broken window in that it cost six francs to fix. He added that there was no doubt that this was true. However, that was only what was seen. What was not seen was that by spending six francs on the window the shopkeeper cannot spend them on something else, for example he can now not replace his old shoes, or add another book to his library. As Bastait argued, he would have employed his six francs in some way which this accident has prevented. Bastait said, “If the window had not been broken, the shoemaker’s trade (or some other) would have been encouraged to the amount of six francs: this is that which is not seen.”
Simply put what the parable of the broken window tells us is that unwanted or unnecessary spending does not create new economic activity. Rather than just having a window, Bastait’s economy would both have a window and pair of shoes, so while it is true the glazier benefits from the foibles of the shopkeeper’s son, the entire community, and the entire economy loses.
The Broken Window Fallacy is a well-known part of economics. We have even coined a complicated term to describe the unseen effects: Opportunity Costs. In fact, every purchase, every tax, every regulation or rule imposes opportunity costs. In most market transactions (as well as in well thought out rules and regulations) the opportunity costs pale in comparison to the invisible benefits. Take for example traffic signals. Stopping at a red light imposes opportunity costs on a driver – it wastes fuel, it wastes time, if the light is long the driver gets grumpy. But the visible benefits in terms of reduced accidents and carnage and less traffic congestion far outweigh these costs. The same is true of nearly all market transactions. When I purchase lunch at the deli next door for $10.00, I forfeit the opportunity to spend that $10.00 on a beer after work. But since I am hungry at noon, it is worth it to me to forfeit the opportunity to have a beer.
Krugman and his supporters poo-poo the idea that there are opportunity costs, arguing that since there is excess capacity in the economy, and we are in what they call a liquidity trap, then borrowing to have both the lunch and the beer makes since. Money is of course free (especially for the government) so by having both the lunch and the beer we somehow create $10.00 in additional economic activity.
First, let’s decode what the Keynesians are saying as they like to throw around strange terms to confuse the argument. A liquidity trap is a situation in financial markets where market interest rates are low and savings rates are high. In a financial market experiencing a liquidity trap, consumers choose to avoid investing and rather keep their funds in liquid deposit accounts because of the prevailing belief that interest rates will rise. Monetary policy breaks down because lower interest rates cannot “stimulate the economy.” This, the argument goes means that a situation that requires spending (such as replacing the damage done by a little boy – or to a larger extent a hurricane) would force people to take money out of deposit accounts and invest in new homes, businesses and infrastructure repairs. In other words, under this particular financial situation, a hurricane lead to more employment and economic activity.
This both confuses investment markets with the real economy and discounts the value of assets. Interest rates are set by markets (not monetary policy), and a market that does not demand capital for whatever reason will have lower interest rates. Forcing people to borrow more simply transfers wealth from borrowers to savers. The same is true of the idea that disasters can grow the economy by creating demand. No matter what causes the destruction in assets – war, hurricanes, terrorists, or (as in Venezuela) horrible economic policies, it simply transfers wealth from one group of people to another. This is the same thing that Bastait discussed in his parable.
Sure Hurricane Harvey is going to create tons of jobs for construction workers, or auto workers, or rescue workers, but this comes at a cost those living in the hurricane’s wake. Every dollar spent rebuilding a business, or a home, or replacing personal effects, needs to either come from the homeowner or businessman, or from their insurance company or the taxpayer. Every one of these dollars could also have been spent building new infrastructure, new hospitals, better schools, or investing in upgrades to existing homes. In other words, there is an opportunity cost for every dollar spent “stimulating” the economy.
And of course, this does not take into account the personal pain and suffering, the loss of live, and the loss of liberty that comes with natural disasters.
Natural disasters happen, and fortunately, the people of this great nation have the resources and the goodness in their hearts to help communities rebuild and move on from them. Just as New Orleans has recovered much of what was lost during Katrina, and Honolulu has recovered from the attack on Pearl Harbor, and Chicago from the Great Fire, so too will Houston from Harvey. The fact that we help our neighbors to recover is a good thing – it is a great thing – but it is not an economic benefit, and anyone who suggests so is not only callous and uncaring, but economically illiterate.