The idea that we are in a golden age for infrastructure investment is enjoying very wide circulation today.
The election of Donald Trump as U.S. president has galvanized excitement. Mr. Trump’s “Make American Great Again” slogan has pointed to infrastructure as a key arena for renewal. Trump has pledged to fix his nation’s inner cities and rebuild its highways, bridges, tunnels, airports, schools and hospitals.
Such work appears more than warranted. The American Society of Civil Engineers has given U.S. infrastructure a barely passing grade and estimated that patching it up will require $3.6 trillion in investments in the next three years.
That figure suggests that restoring America’s crumbling infrastructure alone would gobble up much of the global deficit in infrastructure investments, which suffer a $1 trillion annual shortfall according to a benchmark report published earlier this year by Moody’s Investor Services.
The author of the credit rating agency’s analysis noted that infrastructure is “high on the agenda” for policy makers and investors alike, and that tight public-sector balance sheets would require private capital to shoulder a larger role. As private capital seeks to earn a profit, the table appears set for a feast.
Still, there are reasons to be cautious.
In the most macro terms, it’s clear that there has been systemic underinvestment in infrastructure for some time now, so there is a lot of catching up to do. Plus, major works can be magnificent job-creation machines, serving an extra public function at a time of sub-prime economic activity. Many also claim that near-zero interest rates and borrowing costs make the effort a no-brainer.
The road ahead for Mr. Trump may be bumpy, though, for a set of intertwined reasons. First, the idea of leveraging near-zero interest rates into a big heave in infrastructure has been lionized by progressives including Paul Krugman for years now, while the main opponents blocking such a plan are congressional Republicans – Mr. Trump’s party. Second, the U.S. unemployment rate is now below 5.0%, its lowest level since 2007, so job creation may not be as urgent a need as, say, in continental Europe. Thirdly, if borrowing costs are low, where are all the newly-built bridges already? Fourthly, the spirit of most of Mr. Trump’s plans is to engineer a big reflationary push in the U.S., which if successful, may quickly make low interest rates be a thing of the past.
Savvy investors – not to mention managers – are aware that borrowing costs are never low per se. Logically, they can only be low when compared to something. Debt must be paid back, and unless one is banking on unexpected broad-based inflation to help, only savvy innovation and improved services drawing in more customer cash will make that happen.
For now, details on Mr. Trump’s plans are few. His advisors have drafted a “deficit-neutral” plan full of tax breaks. Such an approach could bear ample fruit when it comes to projects that investors see as attractive: toll roads and bridges, for instance, which have obvious revenue streams. It’s less clear how it will work for repairing existing city or rural roads or a dilapidated water system like that of Flint, Michigan, where 40 percent of residents live below the poverty line and already pay high rates for water they cannot drink from their taps.
Mr. Trump has hinted that “new revenues” will have a critical role in supporting an infrastructure plan his campaign web site said should aspire to be similar in scale to the postwar U.S. interstate highway network.
That may make mathematical sense, but pushing through user-pay models for formerly basic services is likely to create rugby-in-the-mud skirmishes between politicians and their constituents. Mr. Trump has signalled he’d devolve control over such matters to states, which could tailor solutions more closely to their local needs. However, while that would likely overcome the doubts of congressional Republicans, it may lead to a proliferation of different regulatory schemes.
That in turn could trigger a lengthy period for negotiation and potential pushback. Infrastructure operators will be reluctant to move from the drawing room to the work site until they have a clear picture of prospective tariff revenues and believe the regulatory framework is politically sustainable over several decades.
While the golden era is also explained in relation to interest rates, a key element of Mr. Trump’s plan is that he is not looking to leverage the U.S. government’s balance sheet to fund a boom.
The real price of equity is at the heart of Mr. Trump’s plan, which was drafted by a private equity wizard, Wilbur Ross. He argues that tax credits will be more effective in delivering equity-backed leverage than Hillary Clinton’s proposed infrastructure bank, especially for what he delicately termed “lower quality revenue stream projects”.
Traditionally, public works are publicly funded, allowing for cost-benefit analyses to weigh social benefits against taxes. Promoting even tax-advantaged private capital equity into “lower quality” infrastructure projects poses the risk that failed projects may one day need costly public bailouts. On the other hand, many public projects already do eventually require extra fiscal reserves, and delegating projects to private management may allow for more efficient execution that makes such implicit bankruptcy less likely and expensive.
Mr. Trump’s background in construction and real estate means he must know a lot about all that. It may be that his point in drawing in private-sector capital rather than deploying cheaply-borrowed government funds is precisely to make sure that shrewd managers rather than bureaucrats have a stronger role in making sure such regulatory frameworks are created. Investors, after all, have longer time horizons than elected officials, and more on the line than civil servants with gold-plated pensions.
The payback period for many infrastructure projects and concessions is measured in decades, during which time the cost of money may rise and, perhaps more significantly, dramatic technological disruption can occur.
Managerial acumen and agility, project flexibility and interlinkage with prospective future technology – driverless cars being the obvious one - are critical. And so, even at a time of apparently low interest rates, is capital discipline.