Friday, July 29, 2016

Leveraging the Great Consensus on Infrastructure

Ingo Walter

Amid the hurly-burly of this year’s US political conventions and the gravitational pull of left against right there is one issue the two leading presidential candidates and their surrogates seem to agree on, the need to invest in America’s infrastructure - usually preceded by adjectives like aging, decrepit, obsolete and uncompetitive.

They are right. Research suggests that infrastructure is a key determinant of growth by providing the sinews of the economy that make everything else more efficient – consumption, production, investment, trade and government activity. As a result, the social benefits of infrastructure investments tend to far exceed what their direct users end up paying for them, and these valuable spillovers help explain their outsize impact on economic performance and growth.

Both major candidates’ allegiance to the beleaguered “middle class” makes serious infrastructure investments doubly attractive. The benefits tend to be spread widely and not concentrated at the top of the wealth and income pyramid. They might even be called “progressive.” Greenfield and brownfield projects employ a lot of well-paid people across the skills spectrum – from architects and structural engineers to steelworkers and stonemasons - jobs that are impossible to outsource abroad. And the multiplier-effects across the rest of the economy, from housing construction to pickup trucks and sandwich lunches, are impressive.

So what could be better? Stimulating demand while creating the basis for greater near-term efficiency and long-term growth across the whole economy, all while creating income and welfare gains for the general population in a way that broadens income distribution. And all this at a time when the cost of capital is at an all-time low, inflation is a distant memory and there seems to be ample excess capacity in key sectors. Of course, there are a few problems.

Major infrastructure projects completed on time and on budget in China or France would be almost unthinkable in the United States today, where even the redevelopment of obsolete and sometimes dangerous infrastructure can involve years of public debate, regulatory approvals, environmental impact statements, litigation and other blockages. If infrastructure is as important as the candidates seem to think, a significant part of the US growth slowdown during the last decade could be attributed to all manner of special interests scrapping over slices of a stagnant pizza rather than pouring political and economic capital into baking a bigger pie and sharing the gains.

The 1956 Eisenhower Interstate Highway System was arguably the sole post-war “grand design” infrastructure project. American infrastructure development today seems largely decentralized and localized with federal “program” support, along with commercial projects undertaken in the private sector such as rail lines and electric power distribution. At the state and local level, in turn, the main stumbling block seems to be the long-term focus required for infrastructure and the short-term focus of the electoral cycle. Can the current political consensus among presidential contenders recreate the national will that made possible the transformative Interstate initiative?

And then there’s the financing. Infrastructure is uniquely vulnerable to the “free rider” problem. “Let the other guy pay. I’ll benefit anyway since it’s so hard to exclude my use, either gratis or at a price way below cost.” So what if another state or local infrastructure bond issue fails?

But there’s plenty of hope. Advanced technologies and “big data,” micro-metering that makes possible usage charges which can more accurately capture benefits and costs, and similar innovations are already being applied or are just over the horizon. Before you know it, corralling the free riders will make possible sustainable infrastructure finance in many sectors. And once this happens, the burden on public finance will ease and, in a yield-hungry environment infrastructure revenue bonds will become a darling of institutional investors like pension funds and insurance companies.

Whereas most infrastructure finance is executed in the public sector today, there is much to be said for the private sector, which already dominates oil pipelines, electric power generation, hospitals and the like. From airports to toll roads, from bridges and tunnels to ocean terminals, there is no reason, other than lack of political will, why world-class infrastructure cannot designed, constructed, operated and financed mainly in the private sector.

Available evidence suggests that stocks of infrastructure project sponsors in recent decades have outperformed other asset classes like real estate, with the added benefit of low correlations to the major indexes – therefore good portfolio diversification value. And bank lending (the mainstay of front-end financing for infrastructure projects) has bounced back nicely from the financial crisis, even as infrastructure bonds with investment-grade ratings show good potential for the future once the markets for these instruments mature.

Bottom line: Undecided or dismayed voters today can find cheer in something they usually don’t think much about. Infrastructure. It won’t get them out in the streets or standing on their seats doing fist-bumps. But it’s a rare “sweet spot.” If the candidates walk the talk and read their Eisenhower, there’s something going on here that will affect voters more than they realize.

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