THE BEAR'S LAIR Infrastructure's inefficiencies
By Martin Hutchinson
Both The Economist and the Washington Post have recently denounced the poor
state of US infrastructure; it is obviously becoming fashionable to do so.
Notwithstanding incidents such as recent flooding due to an overflowing
Mississippi River, the breaks in New Orleans' levees after Hurricane Katrina,
to the collapse of a bridge in Minneapolis last summer notwithstanding, much of
their criticism is ill-founded.
Infrastructure failures are inevitable because infrastructure decisions have
become politicized and suffer from the results of that politicization.
Infrastructure investment has thus become a particularly economically
inefficient area, the reform of which
would add greatly to national and global wealth.
When England's Duke of Bridgewater built the Bridgewater canal in 1758 to
transport coal from his mines at Worsley to newly industrial Manchester he
didn't need political permission to do so. Neither did he raise outside
capital; the canal was financed out of his own resources. Hence his own
entrepreneurial judgment that money could be made from the canal was the sole
factor in his decision. His investment was spectacularly successful; the price
of coal at Manchester dropped by three quarters within a year after the canal
was completed in 1763. The canal operation remained a profitable independent
company until being sold to the Manchester Ship Canal (also private) in 1885 -
the canal itself remains active to this day.
Since around 1900, most infrastructure investment has been financed by the
public sector. This has introduced a number of additional complications that
the Duke of Bridgewater did not need to consider. Politicians are elected on a
short term electoral cycle, so long-term projects have little appeal - even the
modest-scale Bridgewater canal took five years from conception to completion,
longer than most electoral cycles. Much of their power comes locally, so
projects that benefit several jurisdictions are difficult to get off the ground
and small projects benefiting only the immediate community are preferred.
Politicians are also almost entirely ruled by popular fashion. Thus in periods
when infrastructure is fashionable, say 1920-1960, it is built in great
profusion (think for example of the complex spaghetti of poorly planned, poorly
integrated and environmentally destructive highways built by New York�s
Robert Moses during that period). Conversely in periods such as that since 1970
in which environmentalist and "not in my backyard" objections have been given
priority, infrastructure spending is neglected.
As an example of how this works, consider the state of Connecticut. Connecticut
benefited enormously from the first wave of suburbanization; it already had the
New Haven Railroad in place and no state income tax, so until 1980 it filled up
rapidly with the more affluent toilers in the New York metroplex. The Hudson
Valley had equally good infrastructure, in the form of the local rail line, but
its towns of Ossining, Peekskill, Beacon and Poughkeepsie were blighted by the
remnants of earlier industrial development; in any case it did not offer
wealthy New Yorkers the same tax benefits as Connecticut.
The downside of having no income tax was that the state was always short of
money, and so built infrastructure less aggressively than New York. It also
made the mistake of attracting financial services company headquarters to
Stamford, and then building no road infrastructure to support them - in the
1980s, when the major influx occurred, it still had no state income tax, and
was attempting to maintain a Massachusetts level of social services on a New
Hampshire tax base.
Connecticut voters foolishly elected Lowell Weicker, a leftist independent as
governor in 1990, and as a result they were saddled with a state income tax but
no improvement in infrastructure (the Democrats had been terrified of
introducing a state income tax themselves for fear of facing the wrath of the
voters.)
Nevertheless, Connecticut's state income tax remained lower than New York's,
and its suburbs of Greenwich and Westport in particular were highly
fashionable, so in the late 1990s and onward it attracted large numbers of
hedge fund managers, who found they could carry out their nefarious but
profitable activities from the comfort of Connecticut, without the bother of
commuting into Manhattan.
The result of economic growth without infrastructure provision has been
gridlock, more or less permanent except at 5am Sundays, on the Connecticut
Turnpike between Greenwich and New Haven, a distance of 72 kilometers. Even
outside the rush hour, it can take about two-and-a-half hours to navigate the
Turnpike, which now runs at over 200% of "capacity."
There are few alternatives available, since Connecticut has built a maze of
small highways that may serve local voters but don't go anywhere and relieve
little if any of the congestion in East-West traffic. The cost of this gridlock
is immense, not only in the time of drivers but in the additional environmental
damage caused by hundreds of thousands of vehicles proceeding in low gear for
several hours.
The solution is simple if you look at a map. Indeed it was contemplated by
Moses half a century ago, even before the Connecticut Turnpike was completed,
when he built the Sunken Meadow State Parkway across Long Island with a spur
facing Connecticut. However, even Moses, a Yale graduate born in New Haven,
could not get the Connecticut state government to cooperate, so he doubtless
ground his teeth in frustration and proceeded to demolishing more of the South
Bronx. Connecticut needs to be connected to Long Island by a bridge, and
connecting highways and another bridge need to be built linking Long Island to
New Jersey.
The principal purpose of such construction would be to allow traffic to move
from New England to the Mid-Atlantic states without having to drive 270 degrees
round New York, a city that is particularly awkwardly situated for modern road
traffic.
A bridge could be built west of New London to the tip of Long Island, crossing
19 kilometers of water, from East Haven, crossing 32km of water (but connecting
conveniently with Connecticut's meager north-south road network) or from
Fairfield to Moses' Sunken Meadow State Parkway, covering 22km of water. At the
New Jersey end of Long Island, a bridge from Rockaway Point to Sandy Hook would
cross only 13km of water. Short links would connect the Connecticut bridge
terminus to the Connecticut Turnpike, the New Jersey terminus to the Garden
State Parkway (or a longer link to the New Jersey Turnpike) and the Long Island
termini to the island�s extensive road network.
Constructing such bridges would not be particularly difficult or expensive -
the waters to be crossed are much shorter than that crossed by the Chesapeake
Bay Bridge-Tunnel, completed in 1965, let alone the Channel or Seikan tunnels.
As well as removing the 177km New York circuit for long distance north-south
travelers, the bridges would relieve the Connecticut Turnpike of most
long-distance traffic, allowing the remaining locals to enjoy their gridlock in
peace. They would also free Long Islanders from long-term imprisonment,
allowing them to visit the rest of the United States without driving through
New York.
Such a project would be dear to the heart of the Duke of Bridgewater. However
it is unlikely to proceed because it cuts across the jurisdictions of three
different states, would take a decade to build and would run into enormous
opposition from various local interests, as well as from environmentalists who
would have six different court systems and five appeals courts in which to
harass it.
Presumptive Democrat presidential candidate Senator Barack Obama has proposed a
US$60 billion infrastructure fund at the federal level. This project would be
an obvious candidate for such a fund, but is unlikely to fare well there
because of the diffuse nature of its beneficiaries - even at the federal level
it is easier to fund "pork" in a single district, so the local Congressman gets
the benefit.
The other and better way to fund infrastructure is through the private sector.
This only began to be squeezed out by public sector financing with the success
of the Erie Canal, financed by New York State guaranteed bonds in 1817-25. From
roughly 1930 to 1980, public sector financing was assumed for all major
infrastructure projects, since the state was able to borrow more cheaply than
the private sector. In addition, private sector finance, which had focused
largely on debt through the 19th century, from the 1920s onwards focused
increasingly on equity, a very expensive means of financing infrastructure
needs. However after 1980 the increasing popularity of the private sector and
budgetary constraints in the public sector swung the pendulum back towards
private finance.
The ideal infrastructure finance involves both debt and equity, with the equity
used as a cushion to provide assurance that the debt will be repaid. That
should be readily available in a universe that includes junk bonds. The problem
is that infrastructure brings only long term returns, which are generally
fairly low but very secure. In addition, political harassment can hugely
increase the cost of even the simplest infrastructure project, primarily by
delaying it.
The Eurotunnel project, which ran so far over its cost estimates it was
eventually forced to declare bankruptcy, is a prime example of an
infrastructure financing gone wrong. It required agreement on even small
details between two governments and two public sector rail operators. Its form,
a rail-only tunnel, was chosen for political reasons when a road bridge was
clearly economically preferable. Finally, it was selected through the kind of
public sector bidding process that almost always results in costs running
astronomically over the heavily massaged estimates that win the bid.
Even with the relevant governments lined up, private finance for infrastructure
today is questionable, because of the excessively short-term orientation of
most financiers. The infrastructure specialist Macquarie Bank's approach, in
which the project arranger extracts a high return quickly through financial
engineering, works only when the investor takes over existing infrastructure in
return for an up-front payment to the seller. The Macquarie structure can be
very attractive to local governments with aging infrastructure and urgent
budgetary needs; it is no solution when more than minimal new construction is
involved.
There is however a natural match between the long-term modest but fairly
certain returns of infrastructure projects and the long-term investment
requirements of life assurance companies and pension funds, which have a need
to diversify their assets beyond stock and bond markets.
Rather than investing fiduciary money in fly-by-night short-term operators in
hedge funds and private equity funds, such institutions should form consortia
to hire engineers and undertake infrastructure projects directly. As
representatives of thousands or even millions of life policyholders or
pensioners, they would have the political clout to deal with recalcitrant local
governments. For them, infrastructure projects would provide that ultimate
diversification: long-term returns that were inflation-protected and
independent of stock and bond markets, though not of the economy overall.
To build better infrastructure, we need superb engineers and sober, long-term
oriented, moderately paid fiduciaries. Not expensive fast-buck financiers and
not governments. The problem is one of US economic structure, and it urgently
needs to be solved.
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-07 David W Tice & Associates.)
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