Private firms offer a route to financing infrastructure

President Trump and his advisors have identified recruiting private firms as active participants as one solution to the choking shortage of money to finance critical infrastructure needs. He’s right, but maximizing the private sector’s impact will require the administration to think outside the box.

If properly structured, public-private partnerships could tap into billions of dollars of private capital hungering for low-risk investment opportunities that offer decent returns. Piles of dough would be deposited on the front steps of city halls and state houses with the steely hand of the private sector at the tiller, minimizing the need for scarce taxpayer dollars to get infrastructure projects underway.

This means designing such partnerships as overtly commercial enterprises able to demonstrate reasonable prospects for earning reliable income streams large enough to pay consistent returns to their private investors. Not a simple challenge to be sure. But scarcely one that’s beyond the capabilities of Wall Street’s more innovative investment bankers.

Making this work on a sufficiently large scale would require significant rethinking of how government deals with private firms (which may be overdue anyway), since some of these partnerships may require user charges to generate the necessary income streams. If approached creatively, this could actually enhance the likelihood that the activities of these partnerships would meet environmental goals and other regulatory mandates that serve the public interest.

In many jurisdictions, the public may not sit still for turning over the responsibility to operate an infrastructure project to the private sector because they know a business’ natural instinct is to maximize profits. Government could set up some sort of regulatory commission to oversee the project like they do for utility companies. But a better approach might be to set up an independent commercial corporation fully funded by user fees to build, own, and operate the infrastructure asset so taxpayers can participate in any upside from the project.

The state or local government could solicit bids from private investors to buy shares of equity ownership in return for annual dividends paid by the corporation. That brings private equity capital to the corporate balance sheet, reducing the amount of debt capital it has to issue.

In theory, government’s incentive is to offer the most service for the lowest cost. Private investors, on the other hand, have the opposite incentive: to charge the highest user fees the market can bear while providing the least service it can get away with.

But a second class of private investors would likely purchase equity shares in the enterprise mainly because they have a vested interest in assuring better roadways or other transportation infrastructure in the area. These investors might be private utility companies, local banks, and other local firms whose future revenue growth depends heavily on rising levels of economic activity. This class of owners would push for user fees that make sense from a financial standpoint and service levels that meet public needs in a financially responsible manner.

This model may be a reliable way to ensure that, for example, the original cost of every facility is evaluated on a lifecycle basis so customers and operators alike don’t wind up being confronted by expensive ongoing maintenance nightmares. There would also be the certainty of long-term financial commitments so taxpayers never have to deal with orphaned facilities displaced by disruptive technologies such as autonomous ride sharing vehicles.

This model holds owners responsible for sound asset management in a clear and unambiguous way. Opportunities for abuse by limited-life warranties, guarantees written by “paper companies” that melt into the woodwork when push comes to shove, and the kind of multi-party finger pointing that only ends up enriching the legal profession would be minimized. These realities are unlikely to be lost on the relevant parties.

Alternative models based on elaborate legislative mandates might accomplish the same thing. That is, if you believe the necessary legislation could be passed without being riddled with compromises, trade-offs, escape clauses and weasel language.

originally published: April 15, 2017

No easy or cheap fix for America’s infrastructure

Earlier this month, the American Society of Civil Engineers’ “2017 Infrastructure Report Card,” which looks at 16 categories of infrastructure from schools to airports to dams, gave the nation an overall grade of D+. Creative approaches can be used to finance some of the needed improvements, but others will need to be paid for the old-fashioned way.

The report is yet another in a series of reports making the case that America has under invested in infrastructure for decades. Such chronicles of wretched conditions are a national sport that is nearly as popular as the Kardashians. But although much of the material is familiar, infrastructure is a gift that keeps on giving; there always seems to be something new to chew on.

The report card projects that $4.59 trillion will be required to bring America’s infrastructure to a grade of B. That is more than the nation’s annual budget of about $4 trillion.

Americans can quibble about the actual size of these projections, just as maritime historians quibble about the size of the iceberg that sank the Titanic. But it scarcely matters whether the estimates are off by 5 or 10 percent (give or take). What matters are the general proportions of these needs and the risks for the U.S. economy if they are not addressed. The longer we wait, the bigger the problem becomes.

Most who deal with this issue agree that the country’s infrastructure is in a bad way, but there is much partisan disagreement over how to pay for the fix.

Using public-private partnerships to invest in infrastructure was one of President Trump’s major campaign promises, but fiscal conservatives in Congress are reluctant to back massive spending that exacerbates the federal budget deficit and skyrocketing federal debt.

Democrats, on the other hand, are for more direct federal spending. By reducing taxes on overseas profits, they believe some of the estimated $2-$3 trillion companies have kept outside the U.S. could be repatriated. The result is that the political hills come alive with the sound of heated debates over proposals to address the infrastructure gap.

The permanent political aristocracy’s failure to deal with infrastructure reflects the simple fact that talking about balancing the budget is easy, but doing the things you have to do to balance it is hard. By the very nature of the process, politicians are focused on the very near term.

Upcoming elections, like hangings, have a way of focusing the mind on the here and now. That is why the federal gasoline tax of 18.4 cents per gallon and the diesel tax of 24.4 cents per gallon, the most important sources of federal transportation funding, have not risen since 1993. During that time, they have lost about 40 percent of their purchasing power due to inflation. Fuel tax revenues can no longer keep pace with needs.

This is not just a problem with politicians, it’s also a problem with voters, who say the deficit is a major concern, yet favor lower taxes, more benefits and fixing our infrastructure. Put simply, they don’t want to pay for the government they want.

It’s time to get real. Nothing works without a funding source and we will need hard cash to correct our under-investment in infrastructure. The feds, state and local governments, and the private sector have plenty of access to capital markets to finance infrastructure; the real issue is identifying revenue sources such as user fees or taxes to repay the debt.

A partial solution is to minimize the need for scarce government dollars by recruiting private firms as partners to help start, fund, and run infrastructure projects that have predictable revenue streams, like toll roads. But a larger universe of projects such as schools, dams, and local roads, for example, cannot be monetized.

Infrastructure’s biggest challenge is funding. In the real world, that comes down to a choice between taxes and user fees. There is no free lunch.

originally published: April 1, 2017

Privatization is as American as guns

It’s surprising that privatization makes some people feel uneasy. It just makes me feel long in the tooth, since privatization is as American as handguns.

Privatization is an arrangement under which private firms become involved in the financing, designing, building, owning or operating of public facilities or services. Another name for such arrangements is public-private partnerships. The underlying concept is that the public and private sectors both benefit by cooperating to provide services.

Public-private partnerships are more common than most people realize. For example, governments have always used private firms to prepare the engineering and architectural designs for public buildings. Essential public services such as electricity, gas, and telephone communications have traditionally been provided by private firms functioning as regulated monopolies.

More recently, private firms operate prisons, sanitation services, toll roads and other functions normally associated with public agencies.

If public officials had to list 10 reasons for their rising interest in public-private partnerships, the first nine would be saving money. This is driven by tight fiscal conditions and taxpayer demand for more services than governments have the resources to provide.

Since private firms must pay taxes and earn profits- two costs that public agencies don’t have- it is reasonable to wonder how profit-generating firms can deliver services at lower costs than public agencies can.

The usual answer involves vague references to “private sector efficiency.” But such vapid cliches undermine privatization’s credibility. An important factor that enables private firms to deliver services less expensively is that few of them are subject to the regulations that hamstring public agencies. As a result, their procurement procedures are simpler, faster and more strategic.

Private firms are always on the lookout for new technologies and other tools that promise to make  service delivery more effective. They understand we did not get out of the Stone Age because we ran out of stones. Most public agencies are risk averse. so the only practical way for government enterprises to get things done in new and better ways is to let private firms assume the risk of failure.

Public agency managers rarely have the option of choosing a supplier based on timely delivery, quality, and lower life cycle costs. They’re usually restricted to a small group of suppliers who have mastered  the intricacies of government contracts, are willing to dot every “i”, cross every “t” (often several times) and wait months to be paid.

Avoiding “waste, fraud and abuse” guide public agency procurement. The standard assumption seems to be that the public would rather waste countless extra dollars to avoid any possibility of losing a single dollar to fraud or abuse. And few public agency managers can be expected to lay his or her career on the line to exploit more efficient trade-offs.

The bottom-line focus of most private firms forces them to live in the real world, where practical results, not procedures, are what count, That’s why private managers can exploit the benefits of just-in-time inventory management, economies of scale in purchase orders, and meaningful supplier performance measures to make their operations more efficient.    ·

Greater efficiency also means being able to aggressively exploit new technology to improve customer service, streamline production, and reduce costs. But there’s always some risk in being among the first to embrace new technology.

Private managers are paid to accept and manage risk; public sector managers are paid to avoid risk. This, coupled with elaborate procurement rules, is why public agencies usually end up with trailing  technology. They prefer not to “risk the public’s money” until a better technology has been so totally proven that it’s often obsolete.

Persuading government officials to outsource the risk of developing, financing, operating, and maintaining new innovative technology is a full time job, one with plenty of opportunity for overtime.

originally published: March 29, 2014

Privatization: Old wine in new bottles?

Privatization, or public-private partnerships, is an arrangement under which the private sector becomes involved in the financing, design, construction, ownership, and/or operation of public facilities or services. The underlying concept is that both the public and private sectors can benefit from cooperating to provide services and/or facilities.

The concept is a valid one, as long as public officials consider privatization’s impact on tomorrow’s taxpayers, not just what the effect will be during their own terms in office.

Privatization is more common than most people realize. Governments routinely use private firms to prepare engineering and architectural designs for public facilities. Essential public services such as electricity, gas and telecommunications have traditionally been provided by private firms that function as regulated monopolies. Public-private partnerships are as American as handguns.

But the concept of private firms operating public libraries, prisons, sanitation services, toll roads or other functions normally associated with public agencies is newer. Contemporary privatization represents a collaborative effort, with the public and private sectors sharing risks, rewards and responsibilities.

Interest in privatization is increasing, partially driven by fiscal challenges. The assumption is that private firms can often deliver these services for less, even though they must pay taxes and make a profit ­ expenses that public agencies do not have.

How is this possible? There are at least five factors that can work in a private firm’s favor:

Higher salary and incentives: A public agency’s salary structure and inability to offer things like stock options may make it impossible to attract a sufficient number of talented managers.

Faster procurement: Public purchasing processes are often constrained by regulations originally implemented to prevent fraud. Purchases can take an inordinately long time to complete.

Economies of scale: By providing the same service to a number of public entities, a private firm can develop both market power and specialized expertise. This can be particularly critical for high-technology services.

Less restrictive work rules: Public sector collective bargaining agreements often saddle public agencies with work rules that prevent implementation of new and more efficient procedures. Private firms are often in a better position to negotiate rules that promote efficiency.

Availability of tax deduction: Finally, private firms have access to two federal subsidies that are not available to public agencies: tax deductions for accelerated depreciation on capital equipment and interest payments on borrowed funds.

Sadly, the nation’s most restrictive anti-privatization law all but prevents Massachusetts taxpayers from reaping benefits from public-private partnerships. Under the so-called Pacheco law, named after its author, State Sen. Marc Pacheco, state managers must overcome virtually insurmountable obstacles before contracting out any service currently delivered by state employees. As a result, few privatizations have even been attempted during the two decades the law has been in effect.

The privatization debate has waxed and waned since 13 colonies became the United States of America. Should we let government take care of our problems or should we rely on private enterprise? As governments struggle to figure out how to handle mega-problems created by a stagnant economy, the prudent use of privatization is more important than ever.

originally published: August 3, 2013

Invest in capital partnerships

There is a simple reason for the federal government’s dismal financial outlook: its outlays are growing far faster than its revenues. Typical solutions for this problem involve some combination of slowing the rate of spending growth and increasing revenue collections.

It’s a sound strategy, but its implementation encounters major political problems. As that prolific author Anonymous said, “Watching the Republicans and Democrats argue over these issues is like watching two drunks fight over the bar bill on the Titanic.”

The problems associated with actually cutting spending and increasing revenues make major capital investments- the kind that can create new jobs, boost productivity and create tangible assets that can continue promoting economic activity long after the federal dollars have been spent- another option for solving our daunting problems.

Raising revenue usually means boosting tax rates or eliminating tax deductions, like the one for home mortgage interest. This is politically difficult to achieve, given the perception among many in Congress that voting for tax increases is tantamount to announcing your forthcoming retirement from elective politics.

Similarly, slowing spending growth probably means cutting Social Security, Medicare and Medicaid, all of which are bound to be opposed by retirees- a large and growing component of the nation’s voters.

How else can we boost gross domestic product (“GDP”) so the federal government can grow its way out of the economic crisis?

One option is to have the Federal Reserve work overtime to pump up the nation’s money supply. If this leads to a rise in prices, the same number of widgets sold tomorrow would produce more income for the widget firm and more tax revenue for the government.

Inflating the current dollar value of GDP will generate more revenue with no change in tax rates (which is why it’s been so popular throughout history among many national governments). However, raising prices will reduce the buying power of federal outlays. Total outlays will have to be increased to keep up with higher prices, leaving us right back where we started.

Increasing GDP without raising prices would progressively narrow the gap between the growth of total outlay dollars and the growth of total revenue dollars. This would be the macroeconomic equivalent of being home free. Major capital investment is a way to get there that has a proven track record.

A too-often forgotten legacy of President Roosevelt’s New Deal was massive federal capital investment in economic growth projects like rural electrification, the Tennessee Valley Authority and Boulder Dam, not to mention hundreds of commercial airports like LaGuardia and JFK in New York City, thousands of modern post offices, schools and local courthouses. Two decades later President Eisenhower, the Republican New Dealer, began building the 41,000-mile Interstate Highway System.

America has been living off these investments ever since. Their contribution to decades of job growth and increasing national prosperity has been so enormous that we’ve come to take them for granted.

Now is the time to again develop a series of major capital programs to create jobs and build a better, stronger, more prosperous nation.

Capital investment programs can generate the kind of near-term, non-inflationary economic growth needed to solve our looming financial problems without having to raise taxes or cut popular middle­ class benefit programs. They can, in fact, enable us to grow our way out of financial trouble.

But escalating federal budget deficits and skyrocketing debt, even at historically low interest rates, raise questions about government’s ability to come up with the start-up dollars. One solution is to recruit private firms as active partners to help start, fund, and run as many of these programs as possible.

If properly structured, such public-private partnerships could tap into the billions of dollars in private capital hungering for low-risk investment opportunities that offer decent rates of return. These New­ Deal style programs provide such an opportunity, greatly minimizing the need for scarce government dollars.

If the common-sense approach of cutting spending and raising revenue isn’t politically feasible, a partnership between the federal government and the private sector to embark on a program of major capital investments is the best route to growing our way out of a daunting fiscal mess.

originally published: September 29, 2012