Tag Archives: investment

Battling Aging Infrastructure, the Enemy Is Us

Awash in local media headlines about Baltimore’s recent major water-main and sewer failures—and the flooding, street closures and business disruptions the inevitably accompany such events—Maryland’s Senator Ben Cardin and the city’s Mayor Stephanie Rawlings-Blake jointly signed an editorial in the local newspaper calling for reinvestment in our failing water systems. (Baltimore Sun, “Commentary”, 7/31/2012, p. 15)  The need, they wrote, is national.  They did not elaborate, but spectacular failures in other cities—Chicago in December 2011; suburban Atlanta and Washington, DC, in May 2012; and Kansas City in July, to give a few recent examples—offer persuasive support.

That these officials would go on record together in the cause of at least a portion of our nation’s infrastructure is certainly admirable.  However, the scope of their concern is too limited.  The problems of age, obsolescence, and catastrophic failure are not confined to water and sewer systems.  Across the nation bridge closures, natural-gas leaks, potholes, power outages, and erratic data connections have become painfully frequent.

It is also disappointing, albeit understandable, that the senator and mayor failed to acknowledge that we—a profligate citizenry and our elected leaders—are largely to blame for decades of deferred maintenance and failures to upgrade to new technology that have left our infrastructure in many places decrepit.

Parents generally understand that leaving their children a dilapidate house or car is not a great gift, but the typical taxpayer has little knowledge and less redress when a government executive or legislator chooses to satisfy vocal current interests at the expense of silent infrastructure. All residents and businesses suffer from this failure of fiduciary responsibility and leadership. We have systematically squandered a legacy built through the hard work of preceding generations.

Fool me once, so the saying goes, shame on you; fool me twice, shame on me.  If the time has come to reinvest, as Senator Cardin and Mayor Rawlings-Blake wrote, then as voters and taxpayers we should insist on a new deal: First, we should require that adequate funds are dedicated to infrastructure maintenance and upgrading so that decades hence our grandchildren are not confronted with the same crisis we now face.  Second, we should insist that our infrastructure is designed, constructed, and managed to provide reliable service and to be quickly repaired when failures occur.  Finally, we should rebuild with an eye on the future by incorporating smart information technology throughout the system. The people responsible for the infrastructure itself know how to do these things, but it will take leadership from elected officials to get them done.  Calling for reinvestment is only a small first step.

(An edited version of this post was published in the Baltimore Sun web edition in August 2012.)

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.

Addendum on Abuja: Estimating costs

Estimating costs for a construction project many years in the future is always very uncertain.  When the project is very large, complex, and likely to require years to complete, the uncertainty will be even greater. When the project is located in an area where access is difficult; supplies of materials, equipment, and skilled labor may not be adequate to ensure steady progress; and the ability of the project’s owner to maintain long-term financial and managerial commitment is unclear, uncertainties increase further.

We therefore developed only a very approximate estimate of the cost for implementing the Abuja master plan at its initial, conceptual stage. Our first report, presented in December 1977 to the Federal Capital Development Authority, included this estimate (Table 14 of that report, shown below).  We envisioned Abuja at that time as a home for approximately 1.6 million people, occupying an urbanized area (including all the parks, roadways, and other infrastructure) of nearly 25,000 hectares.

Source: International Planning Associates, 1977. A New Federal Capital for Nigeria: Report No. 1, Concept Plan.


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.

Making infrastructure investment more attractive through consumption

I must have been offered at least a dozen credit cards in the past week, each one an opportunity to spend on clothes, electronic toys, food, travel, and other items for consumption. Each of the financial institutions hoping to attract my business was also hoping, I imagine, that I might by choice or chance not pay their bills in full and thereby convert my debt to a longer-term and high-yielding asset on their books.  I would be bound, according to terms typical of the offers, to pay interest on my unpaid balance at rates significantly above 10% annually, 5 to 10 times what the banks would pay me to lend them money by purchasing a certificate of deposit.

While I am certainly annoyed by the steady barrage of credit-card offers, particularly within the context of my recent memories of financial meltdown, mortgage crisis, and federal debt-limit bickering, my deeper concern is why are there no attractve offers to buy into my city’s or state’s or nation’s infrastructure.  With aging bridges and pavements, bursting water mains, and straining levees almost everywhere apparent in this country, the demand for infrastructure investment should be booming.  Meeting that demand—whether through private initiative or government action—would not only create immediate jobs in materials, construction, and facilities management, but also provide the services to support sustained growth in the economic sectors that depend on efficient transportation, clean water supply, and flood-free operations.  Can we create ways to make infrastructure investment—a good thing—as attractive and painless as—a bad thing—going deeper into consumer debt?

I think we can.  Here’s one idea.

Suppose a state government joined with an appropriate team of banks, utility companies, and local authorities, that is, form a serious public-private partnership. (PPP)  The PPP would begin by marketing an affinity-branded credit card and matching debit card.  The attraction for consumers using the cards would be a credit—say 3 to 5 percent of all purchases—to be applied against current infrastructure services (for example, transit fares; water, electric power, and natural gas fees; tolls and or parking fees), property and real estate transaction taxes, or purchase of tax-advantaged bonds issued by the government members of the PPP.  The bonds could be of the zero-coupon variety, to reduce the need for current cash flow and to encourage longer-term consumer saving.  Employers and utilities could use the card to store transit credits and demand-management incentives for employees and customers.

The cards’ branding could celebrate the social as well as physical infrastructure of the target market region. Card-holders would receive their credits only by using the card to pay for infrastructure services and taxes (or by investing in bonds), accelerating the trend toward reducing cash processing costs and revenue leakage.  The bankers gain access to a large population for associated marketing and data mining.  There seem to me to be a lot of winners in this scheme.

Feasibility seems proven.  Affinity cards and employee-benefit debit cards are well developed, of course.  There are rudimentary versions of what I am imagining in use, such as multi-system transit fare cards (Washington’s SmarTrip and Baltimore’s CharmCard), the E-ZPass highway toll-collection system, and the services offered by Toronto-based Skymeter.  While we are not likely to change from a consumption-driven economy, perhaps we can channel some of the consumption painlessly in savings, investment, and a sustainable infrastructure.

Our roads, our legacy

The nation’s network of roads, taken together, is the legacy of investments made over the course of many decades. The legacy includes land committed to enabling people and goods to be moved from place to place, and with that land forests and grasslands cleared, streams diverted, and flora and fauna displaced. Added to these natural resources are concrete, steel, and other materials, and the human labor of planning and construction to produce the pavement and bridges, signs and signals, guardrail and rest areas that daily carry millions of vehicles.

Despite the efforts of clever analysts, there is no authoritative appraisal of this legacy’s current value. That the legacy has any value at all is a proposition based on our society’s desire for access and mobility and our adoption of  economics as a way of understanding and directing our behavior.  The protracted discussions in the U. S. Congress and many state legislatures concerning how we pay for roads and government’s role in their management is a reflection of our lack of consensus on the value of the legacy and what we should do with it in the future.

It’s as though we are beneficiaries gathered for the reading of the will following the demise of a wealthy relative. We’ve inherited a family estate and now must decide what’s to be done with the property.  Is there a substantial bank account, stocks and bonds?  Do any of us want to live in the mansion; can we afford it?  What’s to be done with the art collection?  Is the land still to be farmed or subdivided for development?  Can the gardens and fen be conserved?

Our legacy is a diverse collection of assets.  The fundamental questions facing us are whether to use these assets to realize the greatest return to the beneficiaries or to keep the legacy intact at the lowest cost.  We may seek advice from the financial advisers, groundskeepers, curators, and other staff who have cared for these assets in the past.  The answers will depend, however, on what we judge to be important, what we think we can afford to do, and how well we can agree among ourselves.  It’s all very complicated.

These are the issues facing the people who take responsibility for managing our roads  For more than a century the network was growing as the nation moved across the continent and trucks and cars began to compete with trains, wagons, and trams as primary means for moving from place to place.  Today we have more than 4 million miles of public roads in the 50 states, District of Columbia, and Puerto Rico, according to the U. S. Department of Transportation; about 2.7 million miles of these roads are paved. The strategic core of the network is the National Highway System (NHS), about 160,000 miles of paved roads judged to be important to the nation’s economy, defense, and mobility. Within the NHS, the Interstate Highway System, inaugurated by President Eisenhower in 1956, accounts for just over one-quarter of that, about 47,000 miles.  While the Interstates represent just over 1% of the nation’s road mileage, they carry about 25% of the nation’s traffic, measured by vehicle-miles of travel. (1)

We have reached a point where the demand for new roads nationwide has been largely satisfied. Additional capacity would be welcome in some places where population and jobs are growing, and this means adding lanes and upgrading standards on some routes. Substantial revisions of facilities will be wanted in other areas to enhance livability and improve safety, for example replacement of Seattle’s Alaska Way Viaduct with a tunnel. It may be that we will choose in coming years to make substantial new investments in rail transit and other forms of mass transportation, and this may necessitate alterations in communities’ roads.  But in much of the nation the primary task facing the people responsible for our roads will be managing our legacy assets.

When it comes to roads and other public works, the job of “asset management” has come to mean primarily looking after the facilities’ condition and maintenance to ensure they can provide the services for which they were constructed.  Other than re-purposing a freeway lane for use by high-occupancy vehicles only, dedicating road right-of-way for transit use or installation of fiber-optic cable, or converting abandoned rail lines to bicycle trails, road assets are not particularly fungible, that is, easily converted into other forms of assets. (Stock markets, for example, make it possible for owners to easily exchange shares for cash and vice versa.)  The nascent market in private-sector leasing and operation of toll roads (the Chicago Skyway, for example) and other facilities are a step toward encouraging infrastructure asset managers to think about how the value of  might be redeployed to increase public benefit, but we are still a long way from managing a road system as though it were a mutual fund.   In the meantime, asset preservation seems to be the primary objective, simply making sure that everything is still presentable and in working order when the family finally decides what to do.

(1) See http://www.bts.gov/publications/national_transportation_statistics/html/table_01_04.html,