Tag Archives: economics

Are We Selling the Future Too Cheap?

Public concern and even occasional outrage over potholes, broken water mains, sewage spills, and closed bridges have been appearing with some regularity in the U.S. news media and blogosphere. Unemployment has been persistently high, particularly in construction. Interest rates have been at historic lows for several years. So why have we not seen an explosion of infrastructure investment?

Yes, we did have the 2009 American Recovery and Reinvestment Act (ARRA), meant to be a down payment on government action to modernize the nation’s infrastructure, enhance energy independence, and put people to work in the process.  The sudden spending sent government agencies scurrying for “shovel-ready” projects, but the law’s requirements that money be spent quickly precluded any real investment.

Before that, the sale to the private sector of long-term leases on the Indiana Toll Road and Chicago Skyway allowed the government sellers to redeploy some of the proceeds into new facilities, but no new resources were mobilized.

These instances notwithstanding, for the most part we have avoided what Adam Smith described as one of three duties of government, “the erection and maintenance of the public works which facilitate the commerce of any country, such as good roads, bridges, navigable canals, harbours” and the like. (The Wealth of Nations, Book 5, Ch. 1, Part 3)

Public works infrastructure, like a home, represents a commitment to the future.  We use  resources we have now to create something that we imagine will bring us benefits tomorrow.  For infrastructure, as for homes, we expect “tomorrow” to extend for decades.

An easily understood and accepted but nevertheless fundamental principle for making such investments is that we should get more benefits out of the infrastructure than the resources we have to put in for construction and and operation.  Putting the principle into practice, however, deciding exactly what resources we should invest and how, is not such a simple matter.  The future is uncertain.  People’s priorities change.  Our money, time, land, and other resources are limited.  We have many competing demands for using those resources.

So  it is not obvious if future benefits will be greater than the costs of a particular infrastructure investment. We need tools to help us decide.

One of the most widely used tools is “discounted cash flow” (DCF) analysis.  DCF is a way to compare costs incurred and benefits received over some defined time period to judge whether the total benefits exceed the total costs.

Essential to DCF analysis is the idea of a “time value of money,”  that everyone would prefer to have a dollar in hand today rather than waiting until next year for the same amount. We might be willing to wait if we were going to receive a larger amount, say $1.15. The idea is that funds to be received in the future are worth less than funds in hand today.

The measure of money’s time value is the “discount rate,” conventionally the percentage reduction in value per year of waiting.  In the example above, the discount rate is 15%.

Discount rates look a lot like interest rates, the rate to be paid for a home mortgage, for instance, the rate that what banks charge for credit-card loans, or what bondholders receive for lending their money to a corporation. In fact, there is not much difference, except that interest  rates really apply to money only.

Discounting is applied to many benefits and costs to which we assign monetary values. For example, we discount the value of time commuters will save over the next 15 years to a supposedly equivalent present amount to justify building the extra highway lanes that we expect will speed travel.

When the discount rate is larger, investments not likely to yield returns until many years after resources are invested look less attractive.  When the rate is smaller, future returns look more valuable in the present.  Most of the time, the very long time periods over which we expect to realize the benefits of physical infrastructure–three to five decades and longer–do not count for much in the economic analysis because the discounted present values are low. Given a choice between a short-lived but high-benefit investment (attracting a major sports event, for example) and a steady but lower annual return over many years (a new rail transit line, perhaps), high discount rates favor the former.

Very low interest or discount rates should then encourage investment in infrastructure.  For a variety of reasons, U. S. interest rates have been at historic lows for several years. In addition, expressions of public concern and even occasional outrage over potholes, broken water mains, sewage spills, and closed bridges appear with some regularity in the news media and blogosphere.

So, once again, why are we not seeing an explosion of infrastructure investment?

People are thinking about infrastructure as if there will be no tomorrow.  Interest rates may be low, but the discount rates people are using–subliminally–to assess their investment opportunities, are a lot higher.

People who study such matters suggest that rates have three components.  The first component is in fact a financial market interest rate representing the payments that presumably very reliable borrowers—governments and their central banks, for example—must make for the privilege of using other people’s money.  The second component represents a premium presumed to compensate for a possibly less reliable borrower and what risks the lender potentially faces related to the conditions of lending, such as the length of time until the loan is to be repaid and whether the lender has offered any security—the house in the case of a mortgage loan, for example.  The third component is meant to account for the uncertainty of future events and the risk that events will make it  impossible for the lender to recover fully the amount lent.

So if the public loses confidence that people responsible for infrastructure are not likely to be reliable stewards over the coming decades, they will insist on higher rates of return, discount rates. If they feel that the future is less certain to be like the conditions of the past, they will look for a higher discount rate. Sea levels rising, financial crises, political gridlock: higher discount rates demanded.

But we do not have to be paralyzed by such uncertainties. The creators of Iran’s qanats that still supply municipal and agricultural water after nearly 3 millennia, China’s Great Wall, Paris’ Notre Dame Cathedral, and even such recent works as the Panama Canal and the Golden Gate Bridge would not have persisted without a vision that they were building for a long-term future.  We should not discount so deeply our own future.

“Sustainability” may be fundamentally unsustainable, but we have a chance

The idea of “sustainability” has clearly taken root.  The word appears frequently in print as well as Internet media, and national governments around the world have established agencies and programs devoted to it.  There seems to be widespread agreement that the idea has something to do with energy supplies, environmental impact, and economic growth, and perhaps with social engagement and political stability as well, although the scope of what is to be sustained—individual well-being, national prosperity, global status quo, for example—seem to differ from one forum to another.  However, there seems also to be a dawning realization that the idea’s application as a basis for guiding humanity’s actions may not be sustainable.

An important early appearance of the meme, if not its initial source, is often attributed to the World Commission on Environment and Development, commonly known as the Brundtland Commission.  This group of international experts was convened by the United Nations in 1983 to propose long-term environmental strategies for achieving sustainable development; recommend ways that concern for the environment may be translated into greater co-operation among countries; and help define shared perceptions, aspirational goals, a long-term agenda for action.  The Commission’s 1987 report, Our Common Future  suggested that “Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs.”  Among the still-expanding literature on the subject, I have found no more cogent definition of the term.

It might seem like a small step from seeking humanity’s “sustainable development,” a steady advancement of people’s achievement and wellbeing, to the “sustainability” of humanity, our survival as a prosperous species.  For a number of reasons, however, I suggest there is a large gap between the two concepts.  The gap is so broad, in fact, that I doubt the value of sustainability as a meaningful basis for guiding our principles and policies. Let me explain why.

To begin, the time scale for thinking about our sustainability far exceeds our abilities—politically, socially, historically, perhaps psychologically—to plan, take meaningful action, or even pay attention.  Scientific evidence suggests that the biological genus of which humans are a part evolved into being and the first hominid use of stone tools began in Africa perhaps 2.5 to 3.5 million years ago.  Evidence of homo sapiens sapiens, our particular species, dates back about 250,000 years.  (In all of this, my phrasing is meant not to convey any skepticism, but rather to acknowledge that we rely entirely on inference from the limited data available to us to draw conclusions about past events and conditions.)

Our various experiments in culture, social, and political organization are rather brief when seen in sharp contrast with these time periods.  Damascus is often claimed to be the oldest continuously inhabited city in the world, but evidence for large-scale
settlement seems to date back only about 4,000 years. (The earliest Egyptian, Sumerian, and Chinese written records may have been created about 6,000 years ago.)  The community water-management schemes of Bali and other parts of Indonesia, arguably among the better models for sustainable relationship of humans and their environment, began to exist perhaps 1000 years ago.  England’s Magna Carta was first issued in 1215 and the United States, our ongoing experiment in capitalist democracy, was established less than three centuries ago.  Viewed against the backdrop of human history, “sustainability” has had a very brief span of influence.

In addition, there is the fundamental uncertainty of our existence as a species.  While some people prefer alternative explanations, the fossil evidence suggests that many varieties of creatures have come and gone since the first simple cells appeared.  The famously extinct dinosaurs died out, some scientists suggest, after an asteroid colliding with the Earth caused extreme global climate change.  On a less cosmic scale, scientists theorize that the ash from a volcanic eruption approximately 70,000 years ago at Lake Toba on the island of Sumatra, Indonesia, similarly caused such a dramatic global cooling that human population was drastically reduced.  Outbreaks of bubonic plague (the infamous Black Death of 14th Century Europe) and related famines in more recent times have dramatically reduced human populations in Asia and Europe.  Apart from simply not giving in to existential despair, probably the best we can do in light of such evidence is to limit our perspectives to decades at most.  Some government agencies already seem to be unable to maintain funding for the programs they established to enhance their communities’ “sustainability.”  (For example, see the commentary on Sustainable Cities Collective.)

Finally, we really cannot know whether our actions are “sustainable” with respect to either our development or our survival.  Application of the Brundtland definition requires forecasting not only the consequences of our current actions but also what future generations may judge to be their own “needs.”  On the one hand, our society and our global environment are a complex system, susceptible to the well-publicized “butterfly effect;” any small perturbation can cause unforeseen consequences.  On the other hand, our values, technologies, and culture change from one generation to the next, so that what may seem to us an inconsequential change may be seen very differently by our children; consider for example the shift in our views about air pollution pesticides.  In general then any assessments of the future consequences of our actions are more than likely to be inaccurate.  Even more fundamentally, it seems quite likely that we simply cannot do anything to meet our own present needs without in some sense compromising the options available to future generations.

While “sustainability” or even “sustainable development” may be problematic as directly useful concepts, the ideas nevertheless do point the way toward useable principles. Applying these principles will at least increase the chances of our long-term survival:

  • Use only renewable resources: No matter how large the supply reservoir may be, it will eventually be exhausted.
  • Eliminate all waste and pollution: What economists refer to as “residuals” are simply an indicator of inefficiencies in
    our production processes.
  • Stabilize our population: Increasing humans’ wellbeing and chances of survival as individuals and as a species depends ultimately on enhancing labor productivity as well as on applying strictly the first two principles.

What’s it worth?—Considering the value of our infrastructure

In the early 1990s, using unit-cost assumptions derived from major new-town and regional-development projects I had worked on, I estimated a value for the nation’s public infrastructure at greater than $1.4 trillion.  Economist Alicia Munell, then at the the Federal Reserve Bank of Boston, published an article in the January/February New England Economic Review that cited unpublished Bureau of Labor Statistics (BLS) data as a basis for estimating the 1987 value of non-military public capital stock at $1886.8 billion.  Munell’s number included public buildings such as hospitals and schools; mine did not.  Without the buildings, the BLS number was $1.35 trillion.  (The BLS estimates indicated that non-military public capital represented about 29% of the nation’s total capital stock, meaning all of our homes, factories, farms, and military bases, as well as what we usually mean by the term “infrastructure.”)

U. S. population in that period was estimated to be between approximately 243 and 257 million people. Our per capita investment in highways, transit, pipelines, sewers, and the like then works out to have been $5,500 to $5,600.  This would be a depreciated value, reflecting age and current condition of the facilities.  The cost of replacing the system entirely today would be much greater.

The nation’s population has grown to a bit more than 312 million people in 2011.  The consumer price index, one measure of how prices change over time, has grown in the past 2 decades to a level about 1.55 times what it was in 1990.  McGraw-Hill, publishers of Engineering News Record magazine, calculates several specialized indices that suggest construction and materials costs—that is, what it takes to build and repair infrastructure—have grown more rapidly than the consumer price index would suggest.  Any new infrastructure constructed to accommodate our increased population has almost certainly cost more, per capita, than the average investment value of 1990.  (For my “back of the envelop” calculation, I used a factor of 1.7, meaning approximately $9,400 per person at current prices. This value again reflects age and wear of facilities that have been in use for some years.)

Not only has our existing infrastructure aged and grown worn with use; according to such experts as the American Society of Civil Engineers—whose 2009 “report card” rated our systems as only a “D”—much of it has been seriously neglected.  In the same way that an old and poorly-maintained house may sell for less than its newer and better-kept neighbors, the value of our old capital stock may have depreciated substantially over the past 20 years.  (In my calculations I assumed that the average value of what was in place in 1990 is now worth only 90% of what it was then.)

I then figure that we have a net investment in our infrastructure that in 2011 is worth approximately $1.75 trillion, excluding school, city halls, hospitals, and other public buildings.  The per capita investment works out to be perhaps $5,700.

The Bureau of Economic Analysis (BEA) estimates per capita U. S. gross domestic product (GDP) for 2010 was approximately $14,527. The economic activities of the utilities, transportation and warehousing, and waste management and remediation sectors of the economy accounted for 5% of that GDP.  Manufacturing and construction accounted for another 15.1%.  Whether they are absolutely dependent on modern infrastructure is arguable, but these economic activities clearly could not occur in their contemporary form or level of productivity without water supplies, transportation, electric power, and the other service infrastructure delivers.  In addition, GDP as a measure of national production neglects many of the environmental and quality-of-life benefits that infrastructure delivers.  If the nation’s economy were to be viewed as a large corporation, analysts could argue that our sales-to-fixed-assets ratio is substantially greater than the 2.6 calculated from per capita GDP and the estimated

How much of U. S. GDP is attributable to our infrastructure’s enhancement of productivity of our labor, land, and other capital investments has not yet been well researched.  A recent McKinsey & Co. analysis of India (by Gupta, Gupta, and Netzer) suggests that under-performing infrastructure could reduce that nation’s GDP growth by 4 to 8%.  Studies by the World Bank in the 1980s (by Alex Anas and Kyu Sik Lee) found that the costs of goods and services in some countries with newly industrializing economies cost were as much as 30 percent higher than would otherwise have been expected, because inadequate infrastructure forced firms to provide their own water and power supplies.  Endemic traffic congestion clearly adds to the costs of companies operating in such places today.

Because of such evidence, it seems to me likely that our infrastructure produces benefits significantly greater than the 2 to 4% return on invested capital that many economists have attributed to it.  If public agencies must pay rates in that range to borrow funds in the bond market, one certainly would anticipate that infrastructures built with these funds are more productive and the investment is a good one.  Anyone who has travelled to countries that lack adequate infrastructure cannot help but appreciate that this is the case.

Living without electricity

Living without electricity for a while helps to focus the mind on how we rely on our infrastructure and our ability—or lack thereof—to make reasoned choices about that reliance.  Hurricane Irene swept up the mid-Atlantic coast on a weekend, likely reducing the storm’s impact on most businesses.  Forecasters did a nice job, giving plenty of warning of the approaching winds and rain, and many people seem to have been prepared for some inconvenience.  The hurricane’s actual path probably reduced the amount of damage at actually occurred, at least until the eye of the storm went inland and through New England to produce devastating floods.

Even so, disruption was extensive. Amid blowing winds and a torrential downpour, the power went out at my house at about 3 am Sunday morning.  A neighbor reported seeing the flashes of what we assumed to be the pole-mounted equipment blowing as downed branches and trees shorted out the overhead wires.  Baltimore Gas and Electric (BGE), the utility serving us, reported that some 750,000 of its 1.23 million customers in the region lost service. The public relations folks claim that crews have been brought in from as far away as Kentucky to help with repairs.

At home and still without power more than 72 hours later, I am able to use my laptop and communicate with the world thanks to cellular telephone service and 100 feet of extension cord plugged into my neighbor’s house across the street. His side of the block did not fail.  We plugged in the fridge, have a gas range and good supply of candles; I must admit that many others are suffering much more than we are at the moment.

At least three aspects of the situation nevertheless bother me.

First there is the customer service.  While BGE messages to customers claim they are working “around the clock,” local news reports that the repair crews shut down for the evening at 8 pm; the statistics reported for restorations of power show clearly there was no overnight progress. Four days since BGE claims to have started storm operations, more than 20 percent of customers who lost power are still in the dark.  Our local food market could not open and had to throw away thousands of dollars’ worth of spoiled goods.  The planned Monday opening for the city’s schools had to be pushed back to Wednesday.  I don’t think it is unreasonable to expect the utility to work around the clock to restore full service.  I don’t think it is unreasonable to expect that parts and materials should be available within a 2-day period from other parts of the continent to accommodate these foreseeable emergency demands.  Yet I cannot take my business elsewhere and there is no apparent way that failures of customer service will influence the company’s profitability or its executives’ income.

Second is the facility system.  Electricity is delivered to my city neighborhood and much of the region by overhead wires. Many storms far short of hurricane intensity cause frequent power interruptions. (To the BGE’s credit, my impression is such outages tend to be fixed within 4 to 6 hours, regardless of when and under what weather conditions they occur; this seems to me a reasonable standard.  Why are utilities and other infrastructure providers not required to make their performance statistics public, with standardized definitions and measurments?) While my definitely-leafy part of the city is less dense than many, I do not really understand why the poles have not been retired and the wires placed underground.  I know the initial cost would be high, but I not convinced it would not be more than offset by the avoidable out-of-pocket and inconvenience costs I pay for recurring outages and reductions in the utility’s maintenance expenses. I suspect that the idea of moving to underground installations throughout the city is made unattractive by utility accounting and regulatory systems (increased investment in fixed capital), not to mention the public-relations and political headaches of using cutting into city streets or securing private easements and connecting to each house and shop.  Nevertheless, I believe we should not have to consolidate to Manhattan-style densities to warrant the investment.

Finally, there is the thought of what the future may hold.  If costs for such new technologies as fuel cells, photovoltaic installations, and wind-powered generators continue to decline, as I expect they will, I think small customers located in less-dense areas will decide to cut their ties to the power grid.  Large corporate utilities will deal primarily with large consumers, whether they be businesses or multi-unit residential cooperatives and condominiums. A future in which a large fraction of households can meet their domestic energy demands from locally-supplied sun, breezes, and digested grass clippings and leaf collection is arguably more sustainable than what we now have, but it does imply maintaining what many people now call “sprawl.”

How Much Infrastructure Spending Is “Enough?”

Concern for the state of our public works infrastructure seems to have percolated to the forefront of current political discourse.  The web-based news and commentary site The Infrastructurist, for example, recently presented their “First Annual Infrastructurist Forum” on the future of U.S. infrastructure, attracting statements from such luminaries as Representatives John Mica (R-Fl) and Nick Rahall (D-WV), Chairman and Ranking Democratic Member, respectively, of the House Transportation and Infrastructure Committee; real-estate development expert turned pundit Chris Leinberger of The Brookings Institution; and Forbes magazine columnist Joel Kotkin.  Reports on both the national political scene and local issues in The New York Times, TheWashington Post, the Los Angeles Times, and other print media outlets feature the term almost daily.  There has not been so much attention to the topic since the months following the 1981 publication of America in Ruins: Beyond the Public Works Pork Barrel, by Pat Choate and Susan Walter.

Choate and Walter warned that government spending on infrastructure had failed to keep pace with the nation’s needs, causing our public facilities to wear out faster than they were being replaced.  The book sparked national debate about not only how much we should be investing in infrastructure, but also whether such public investment is worth making.

Suggesting that we were not then spending enough, Bill Clinton’s 1991 presidential campaign included a promise to “rebuild America,” but an $80 billion program proposed early in his first term never made it through the Congress. A recent Congressional Budget Office (CBO) report shows that total annual public spending for transportation and water infrastructure was higher in 2007 than in 1991, when viewed as a percentage of our Gross Domestic Product (GDP) the amount has declined steadily for four decades. (Public Spending on Transportation and Water Infrastructure, November 2010)  Whether or not America was “in ruins” in 1981, the American Society of Civil Engineers in 2010 issued a Report Card for America’s Infrastructure with an overall GPA of “D.”

On the question of whether public investment in infrastructure is worthwhile, economists have bickered about the measureable rate of return on investment.  Such academic heavyweights as David Aschauer, Douglas Holtz-Eakin, Alicia Munnell featured prominently in the late 1980s and 1990s.  A truce was called (or perhaps interest in an unwinnable dispute simply flagged) with widespread agreement that the rate of return, observed at the level of the nation or large regions, had been at least positive in recent decades.  Researchers continue to document examples of quite reasonable returns. (For example, nearly 16% on transportation investment; Alfredo M. Pereira and Jorge M. Andraz, 2005, “Public Investment in Transportation Infrastructure and Economic Performance in Portugal,” Review of Development Economics 9:2 (177-196))

So an argument can be made that public investment does yield net returns.  But how much investment is needed to maintain productivity and growth?  Walter Rostow’s seminal book The Stages of Economic Growth: A Non-Communist Manifesto appeared in 1960, asserting that economies launching into modern industrial growth show investment rates rising from about 5% of the national income to 10% or more. The CBO study shows U. S. investment in transportation and water infrastructure has been below 2.5% for some years; allowing for spending on other infrastructure (such as waste treatment facilities or schools, for example) would certainly increase this percentage, quite possibly to a level within Rostow’s range. 

Economist A. O. Hirschman, at about the same time that Rostow’s work was being completed, argued that temporary shortages of infrastructure can be tolerated, that facilities can be built later to catch up with demand derived from private industry’s growth.  (The Strategy of Economic Development, 1958)  He went on to suggest that what retards economic advance in most cases is a shortage of management capability rather than physical facilities.  More recent analyses have provided supporting evidence. (Charles R. Hulten, “Infrastructure Effectiveness as a Determinant of Economic Growth:  How Well You Use it May Be More Important than How Much You Have,” 1996 and 2005)

What has been neglected in all of the analyses that I have seen is an explicit consideration of maintenance spending, as distinct from investment.  Infrastructure, like most engineered systems, requires periodic care to keep it functioning properly.  Leaves, trash and other debris clog drains that channel rainwater away from roadways must be cleaned out.  Filters that remove silt and bacteria from drinking water must be flushed.  The costs of such maintenance effort typically are accrued in different accounts from those the represent “investment.”  But if maintenance is neglected, the quality of services and longevity of facilities will be impaired.  My discussions with people who manage maintenance in public works agencies suggest that maintenance budgets are often squeezed, forcing neglect.

In the absence of data and solid analysis for estimating appropriate levels of spending, I have found that many facilities managers use as a rule of thumb that about 2% of the current replacement value of the facility should be spent annually on routine maintenance.  (For example, see Committing to the Cost of Ownership: Maintenance and Repair of Public Buildings, 1990, The National Academies Press, the report of a study I worked on with a number of government facilities managers.)  Spending less (assuming the money is used effectively) risks premature deterioration and failures.  Failure of the Interstate 35W bridge collapsed in Minneapolis in August 2007 and rupture of a 66-inch water main in suburban Washington, DC, in December 2008 are two of many examples of such risks becoming reality. 

The point is, we really do not know how much we need to spend for our infrastructure.  But the evidence suggests we need to spend more than we do now.