Financing Infrastructure

Today’s Irish Times reports that the IMF had warned that NAMA would not significantly increase lending (separate thread). Increased lending is something businesses are looking for, but with public budgets being squeezed one area of investment that will also need to attract significant non-public funds is infrastructure.

A story by Louise McBride in the Sunday Independent argues that “Greece and Spain’s financial woes are making it tougher than ever for Governments to raise cash for vital state projects”. She argues that the €70 bn held by Irish pension funds is being targeted by Brian Lenihan.

While the key issue here is the level of government debt rather than the ability to raise cash, the article makes an important point that is being discussed in many countries – how do we fund our infrastructure in the current fiscally constrained environment?

Given that infrastructure is typically a fairly safe investment that can yield a certain inflation indexed return, pension funds should find it useful to invest in infrastructure. A range of possible projects is presented in an accompanying article, including Metro-North, Western Rail Corridor, Landsdowne Road and National Parks.

What the article does not properly consider is that of the €70bn only a fraction should be invested in infrastructure given the need to hold a balanced portfolio. The other point is that it is not obvious why Irish pension funds should necessarily invest in Irish infrastructure or indeed why we should not expect foreign pension funds to invest here.

The key issue in attracting private funding into projects is a revenue stream. Without a relatively certain income private funding will not materialise. That would seem to rule out national parks unless anyone is proposing to charge an entrance fee and the construction of very long fences. A certain and sufficiently large income or rather the likely absence of one would rule out private finance for the Western Rail Corridor. In other words the projects need to stack up as a business proposition, and those that are driven more by political or redistributive goals will have to be ditched (in the absence of other funding). Thus, private funding should have a significant positive impact in that there will be less ‘gold-plating’ and only likely winners will be get funded.

The issue of private finance for public infrastructure and services should also ignite a debate about what services should be provided publicly in the first place. Should public transport and water be provided publicly or could they be privatised? As was highlighted recently our water supply infrastructure (primarily the pipes) is in serious need of investment, which may not be forthcoming from public funds, yet to get private sector involvement the sector will need to consolidate significantly.  

By Edgar Morgenroth

Professor of Economics at Dublin City University Business School

21 replies on “Financing Infrastructure”

“She argues that the €70 bn held by Irish pension funds is being targeted by Brian Lenihan.”

Over my decaying body.

HANDS OFF MY PENSION.

“She argues that the €70 bn held by Irish pension funds is being targeted by Brian Lenihan.”

Well that’s exactly what the President of Argentina did last year. Scary stuff, if we were to take our policy cue from Argentina.

As was highlighted recently our water supply infrastructure (primarily the pipes) is in serious need of investment, which may not be forthcoming from public funds, yet to get private sector involvement the sector will need to consolidate significantly

Privatised utility monopolies have a rather poor record in infrastructure investment. See Eircom for details. And why am I having to tell this to a supposedly competent economist from the ESRI?

(And will ESRI be doing a sponsored follow-up on this topic, to join last week’s scribblings on Dublin’ incinerator? We wait with bated breath)

@EM: “In other words the projects need to stack up as a business proposition, and those that are driven more by political or redistributive goals will have to be ditched (in the absence of other funding).”

This is fantasy stuff. Presumably you hold a Permagrowth economic Model-in-Use. This model assumes that the income stream from the completed project will be adequate to repay loan + interest + fees, etc. This assumption cannot be valid. The ‘private’ sector never lent much cash to any ‘public-private’ scheme: it consisted mostly of the virtual credit of roll-over loans. This is exactly the nature of the levered Ponzi scams that have landed us in the mess we – in the western economies – are in. No harm in trying the scam again; there are always a few suckers left.

“Thus, private funding should have a significant positive impact in that there will be less ‘gold-plating’ and only likely winners will be get funded.”

This is pure ideological claptrap! Where are the ‘losers’ yachts?

Permagrowth economies are like ex-smokers suffering from emphysema – gasping for the oxygen of credit as their alveoli are unable to exhale the toxic debt.

Debt levels MUST be crammed down fast, not increased. Default or inflation are the only options. Cash flows are diminishing fast. Only a matter of time until an adult decision has to be made.

B Peter

The article is very badly written:

“Louise McBride reveals that the €70bn held by Irish pension funds is now being targeted by Brian Lenihan”

“If Finance Minister Brian Lenihan decides to dip into our pension money to fund infrastructure…”

Evil bug-eyed Brian is going to snatch your pension fund while your back is turned! The later part of the article does acknowledge that the investment would only happen if it was attractive to fund managers, but the Indo can’t resist throwing in a few alarmist phrases. It’s more fun that way.

That sentence continues:

“… we won’t be the first country to do so.”

She then gives three examples of foreign countries investing in infastructure in Britain. That’s a pretty different situation to Irish pensions funds investing in Irish infastructure. Pensions funds are (or should be) big on diversification.

Jim Power’s point about interest payments leaving the country also strikes me as bogus. The net effect of switching from a foreign investment to Irish infastructure bonds would be the difference between the two interest payments. If the Irish bonds pay a high rate of interest then this would be positive. But that’s to compensate for the risk, which we have kept in the country along with the interest payments. What am I missing here?

A lot of these projects have cost benefit analyses that assume much lower interest rates than are actually going to be available to us. They are also predicated on growth that is no longer there and not expected to return.

I am concerned about the idea that we can build our way out of trouble by borrowing money from someone else. It’s fine if we can really get a direct return in terms of foreign earnings from the projects, but if not, we have to tread very carefully if we don’t want to end up with the whole economy in negative equity.

The low-density of the Irish population makes it hard to build major transport projects that will show a clear return. Unlike places like Singapore, we are not really under any pressure to build gigantic water projects (though we do need some upgrading for sure). After a decade of investment, we now have a passable core road infrastructure, the main problem with it now is the low density of the housing which requires us to maintain a very long network of roads.

We should find a way to build a broadband network, but that’s really only two billion. But even that is slowly coming from the private sector, with a minimal and somewhat chaotic injection of public cash.

The challenge is really to do the simple things well (public transport, maintain the roads, maintain the water system and the clean environment, look after the weak) rather than building megaprojects. It is worth reading Perkins’ Dogs and Demons (http://www.alex-kerr.com/html/dogs___demons__english_.html) about what happened in Japan, largely as a result of the focus on megaprojects (‘demons’) rather than the more humble, pedestrian jobs of simplifying and streamlining the economy and government, preserving the environment and maintaining quality of life (‘dogs’).

B P Woods

Couldn’t agree more and have called for banks to be wound down (if necessary!!!!) but some growth may be made available in five years or so, for social and sound investment reasons. No NO! borrowing should be made.

Not from an Irish government obviously, they have forfeit all claim to the word. Government. They are a shambles, including the “opposition”

@ EWI
You are of course right about Eircom and indeed we might be able to find a few more bad examples. The primary problem in those examples is poor regulation. There are also lots of examples where the opposite is the case. However, you fail to deal with the issue that we need to improve our infrastructure but we don’t have the money to do it – what would you propose?

@ BP
If you go back to the 19th century you will find that most of the infrastructure such as railways and canals were privately financed and managed. Even if you do not believe in growth you will need to maintain/replace infrastructure as it wears out. Have a look at our roads after the cold spell – even with modest use (if you just look at the rural ones or those in housing estates) they have deteriorated serioiusly simply due to weather conditions. In other words even in a zero growth scenario you will have to save or borrow to provide a minimum of infrastructure – you fail to deal with the issue that we need to maintain our infrastructure but we don’t have the money to do it – what would you propose?

@ Antoin
If you look back at some of my comments on this blog you will find that I am also concerned about trying to spend our way out of the recession or more to the point trying to get out of it by spending on construction projects. This does not mean that we should stop all construction projects – we should be careful to pursue only those that are worth doing, which is something that is greatly facilitated by private sector involvement.

@Edgar,

Your post is very welcome. It would be very valuable if your desire to “ignite a debate about what services should be provided publicly in the first place” were to be realised. But, given the long shadow of NAMA and the traffic the resignation of an opposition TD generates, I have my doubts.

This is an issue that has come forcefully to the fore recently in the UK and will resonate with even greater force throughout the EU. Ofgem, in Britain, has finally conceded that the “privatised/restructured/lightly-regulated” model for the electricity sector is not capable of securing the large volume of investment required in the specific, long-term assets required:
http://www.ofgem.gov.uk/Media/PressRel/Documents1/Ofgem%20-%20Discovery%20phase%20II%20Draft%20v15.pdf

In effect, the government will have to step in to provide the necessary commitments to ensure full recovery of the investment. And this concession by Ofgem has implications for the water and surface transport sectors.

I have no doubt that this concession will be spun by the powers-that-be here to advance the “superiority” of the “Irish model”. The key problem, which, of course, is never conceded, is that the Irish model in electricity and gas only survives by imposing excessive costs on final consumers – and the limit on increasing this burden in the context of a large demand for energy infrastructure is rapidly being reached.

The real problem, throughout the EU, is that the “liberalisation” of the energy sectors has destroyed the previous ability to convert the long term commitments, particularly of small volume Residential & Commercial (R&C) consumers, into bankable commitments to ensure the financing of the specific, long-term assets required. In the member-states which have retained some semblance of local distribution businesses, it may be possible to re-establish their effective functioning. But in those countries where these never really existed – or have been restructured out of existence – it seems inevitable that governments will have to step in.

This, of course, does not mean that governments will be required to invest directly. There is considerable scope for private sector participation in both service provision and financing.

In the Irish context, the energy regulatory framework would require limited amendment to ensure effective control of privatised energy networks. The principal requirement would be a mechanism to attract pension and long-term infrastructure funds – and to exclude the private equity financial engineers and asset-strippers. The funds released could be applied to invest in and restructure the communications and water sectors with a view to eventual privatisation of the latter once an appropriate regulatory revenue model were established.

But is there any chance that this retaional path will be chosen? Not with this Government – and probably less so with any conceivable alternative.

@ Paul – I raised the issue a few times before but as you say NAMA seems to swamp a lot of other important debates. Thanks for the link to the OFGEM press release.

I think this issue is very important – it determines the quality of the infrastructure we get and the price we pay.

Ultimately infrastructure is a necessary but not sufficient condition for growth. The cost of providing the infrastructure is an important determinant of the growth effects (BP – I know you don’t believe in growth).

By Post Author

@Edgar:
“If you go back to the 19th century you will find that most of the infrastructure such as railways and canals were privately financed and managed.”

I don’t know much about railways, but a quick look at the figures for the main waterways now in the republic suggests that public and private money were about half and half. That is because rivers were much more important to navigation in Ireland than in Britain: the rivers got most of the public money. But many of the Irish canals went through a period of public control, often in an effort to get them finished to a satisfactory standard, with the government providing a sort of Navigation Asset Management Agency.

Not a lot of people know that. And it may not affect your discussion with BPW.

bjg

@ BJG – there are lots of interesting stories about the development of waterways, not just in Ireland. I think in considering the issues it is useful to look beyond these shores though, since we can learn from the (bad) experience elsewhere.

By Post Author

@all. I’m all for private sector envolvment in infrastructure projects for the obvoius (please can I avoid getting into this argument now) efficiencies that private companies achieve. Where competition is possible to achieve the the private sector should be encouraged (e.g hospitals, waste, energy). Stringent regulation is then needed in these sectors of course. These companies can find their own finance. But for infrastructure such as wastewater, water, roads, where competition is not direct to the consumer and only possible through public tenders then I think it is clear that exquequer financing is more cost effective than private sector financing. Even now the state can borrow cheaper than any private sector company and the cost of financing is built into the operating cost (tender price) anyway. We end up paying more in the long run and any clever bond anaylsts etc would see this.
….As a rule of thumb on private sector provision I would say the public sector should finance and regulate as much as possible and the private sector should operate (where competition direct to end user is not achievable). Of course this does not fit all, education being one.

@ sam

I largely agree. The big trick is to get the regulation right.

With respect to the government being able to borrow cheaper one can make the argument that that is only possible because the governemnt is able to internalise some of the risk, which is passed on to the tax payer. If you factored this in, the cost of borrowing for the government would equal that of the private sector. Indeed you could argue that projects run by the public sector are more risky than those run by the private sector (within infrastructrure) and there are certainly some examples of serious cost overruns or non-performance (think of PPARS).

@sam,
“As a rule of thumb on private sector provision I would say the public sector should finance and regulate as much as possible and the private sector should operate (where competition direct to end user is not achievable).”

I think Edgar’s point about the “true” cost of Govenrment funds is very relevant, but, in the context of the current – and likely continuing – constraints on the Government’s ability to finance capital expenditure, your “rule of thumb” doesn’t do very much for us. Yes, the privatisation of Eircom created an economy and consumer-damaging mess, but I’m constantly bemused at the apparently firmly held belief that the private sector will rip off consumers right, left and centre while Government will always and everywhere put the interests of the country and consumers first.

One only needs to look at the consumer-gouging price decisions of the energy regulator that fatten up the existing semi-states and avoid any State investment to see that the Government and its semi-states are far more rapacious than any private sector entity.

@edgar and paul. Fair enough ‘rules of thumb’ are not much use, every sector is different. The main area where I see public financing being beneficial is DBOF contracts such as for water and wastewater infrastructure such as Ringsend wwtp. Celtic-anglian water would have simply added the cost of the
there during tendering they would have simply added the cost of the F(plus margin) to the DBO price. My point is certainly not against private sector envolvment, quite the opposite.

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