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CHAPTER 1
An Introduction to Infrastructure Finance
The business of infrastructure will always be vibrant because without basic systems such as transportation, energy, and water, neither the economy nor society can function. No matter how you define it, infrastructure is a large and important business sector. When defined broadly, the infrastructure business includes buildings, transportation, energy, water, telecommunications, and waste management as well as the cross-cutting construction and environmental businesses. When it is defined narrowly, it focuses on the construction industry, which is a vital and important sector of the economy.
Two compelling issues drive the need to finance infrastructure systems. The first is that the systems provide the physical basis for life, whether safe drinking water, energy to stay warm, or other essential services. The second issue is the business of infrastructure, or the functioning of the private sector and government organizations that provide and sustain the essential structures, equipment, and services of infrastructure.
This chapter introduces infrastructure as a business and identifies its main issues. Chapter 2 explains how infrastructure is a composite sector and introduces its subsectors. After a chapter about each of the subsubsectors, a summary chapter presents a range of investment opportunities. The remaining chapters in the book explain the capital and operating finances of infrastructure and identify the driving forces and trends that will shape its sectors in the future.
WHAT IS INFRASTRUCTURE BUSINESS?
Having a clear definition is the key to analyzing the “infrastructure business.” As the reader will see, people define infrastructure in different ways. To view it as a business, you must focus on its financials. The definition can be fuzzy, so it is even more important to specify what infrastructure includes.
Much of the interest in infrastructure is focused on the construction industry, but infrastructure involves more than construction. One business letter, the Infrastructure Investor (2009), wrote that infrastructure “covers the man-made facilities that ensure any economy can operate” and that it includes transportation (railways, roads, and airports), utilities (energy generation and distribution, water, and waste processing, and telecommunications), and social infrastructure (schools, hospitals, and state housing).
Our definition varies from this, but the idea is the same. Investments in infrastructure target basic facilities that meet the needs of society and the economy. One variation is the attention we give to the built environment itself, with its emphasis on residential and commercial buildings. If these are not included in the infrastructure sector, then a major share of construction spending is missed. Another important part of our approach is that we distinguish between infrastructure and operation of infrastructure-related services, which is important in analyzing the sector.
In the chapters that follow, the reader will see that infrastructure is a composite of sectors such as construction, transportation, energy, and water, among others. Why should anyone be interested in this composite sector when its parts, such as transportation or electric utilities, can be analyzed separately? Surely these parts are large and complex enough to deserve their own analysis. The answer is, of course, they are large and deserve their own analysis, but they have common attributes that lend themselves to analysis of the composite sector for the purposes of investors, public sector managers, and policy makers.
Investors are now being presented with new infrastructure stock funds and are told that infrastructure is an attractive sector because it is essential and solid at a time when other sectors are changing rapidly. This can seem like a new investment opportunity, and it does have new facets. However, much of what is offered comprises systems that have been around a long time.
Public sector managers are confronted with complex decisions, such as how to solve traffic congestion or when and how to renew aging infrastructure systems. Facing these issues, policy makers—such as local government elected leaders—face funding decisions that may dwarf their other financial decisions.
The general purpose of the book is to pose and answer questions that will help these three groups: investors, public sector managers, and policy makers. For the policy makers, the book opens a discussion of new forms of public-private cooperation and mechanisms to make government more efficient and responsive to public needs. For the public sector managers, it explains the financial structures and performances of the distinct infrastructure sectors. It ranges across public and private sector systems to explain how they obtain operating and capital revenues and how the balance between demand and supply is achieved. For investors, the book explains the structures of the industries that are in the infrastructure arena, how they obtain their capital and operating revenues, and how opportunities for private sector involvement arise in the capital markets, in equities of listed companies, and in private business start-ups.
INFRASTRUCTURE THEN AND NOW
Whereas the public side of infrastructure has a high profile, the fact is that infrastructure has always had a high level of private sector involvement. Just 100 years ago, the infrastructure business was strong in the United States, railroad stocks were hot on Wall Street, the electric utility industry was new, and the public demanded more roads for its new Model T automobiles. Go back 100 years earlier, and you see that change from a rural to an urban society gave birth to the technological age that drove the need for infrastructure.
This industrialization and urbanization that led to infrastructure development started around 1800, when a private banking venture led by Aaron Burr built a new water system for New York City. At that time and for another century, bankers were important players in financing infrastructure systems as well as other high-stakes national issues, even wars.
The steam engine had been invented, and it powered the Industrial Revolution. The privately owned Erie Canal created a boom for the Northeast, and people could see the close links between transportation and economic development. The growing nation required more and more politically charged internal improvements, and infrastructure issues moved to center stage in politics as well as business.
Now we live in a different world, but the infrastructure business remains important because the public still needs rail, electricity, roads, and many other infrastructure-related public services. If you include the Internet as part of infrastructure, then it rises even higher on the agenda. In any case, we are reminded of infrastructure constantly by the media. Time magazine, in its March 23, 2009, cover story, reported on 2 its top 10 national trends as related to infrastructure (Lacayo, 2009). One was the evolution of smart highways that serve to organize economic activity (see Chapter 4), and the other was recycling the suburbs with updated land uses (see Chapter 3).
Not only is the role of infrastructure in the economy large, it is growing in importance. This role was high on the agenda of many economists during the 1980s and 1990s, and they explained how infrastructure is essential to economic development, productivity, and employment (Gramlich, 2001). They also showed that infrastructure investments encourage innovation, competitiveness, and is the basis for a high standard of living (Infrastructure Australia, 2008).
During the recent financial crises, infrastructure figured prominently in national stimulus packages and the U.S. budget. Having learned from past recessions, cities have been competing to show how many “shovel-ready” projects they have on their books. Much of the response to the financial crisis has been about housing, public projects, and transportation systems, all of which are central to infrastructure policy.
America is under criticism for how it invests in infrastructure. Along with other policy questions, we as a society face decisions about how much to invest in infrastructure, even while we are confronted with tremendous “needs estimates” to rebuild highways and fix aging sewers. Some say that if the nation does not invest more, it risks having the infrastructure of a third-world country. Experts look back at past nation building and grand projects like the Interstate Highway System and ask, “Where is that vision today?” Investment analysts compare America’s infrastructure investment of 2.4 percent of gross domestic product (GDP) to Europe’s 5 percent and China’s 9 percent and point to dysfunctional transportation, choked ports and airports, road congestion, and inadequate rail track systems.
One way to view this lack of investment is as a “third deficit,” to go along with our national debt and social security deficit. On a more positive note, it is apparent that we are entering a period of massive investment to rebuild and reinvent our infrastructure, almost like the 1930s New Deal or 1950s Interstate Highway eras. In any case, the overall view among experts interviewed by the Economist (2008) was “It’s time to think big again.”
As we explain in the book, an important dimension of infrastructure finance is how it can be used to manage demand and raise efficiency of critical public systems and services. This challenge is aimed directly at a central question about infrastructure: Should it emphasize public or private purposes? Public purposes focus on the core needs of society, such as clean air and water and access to education and healthcare. Private purposes relate to more discretionary needs, such as housing choices and entertainment.
Infrastructure finance addresses the central questions of public versus private purposes and is thus in the crossfire of political debates about a fair society. Chapter 14 discusses how decisions about infrastructure finance align public and private purposes. It answers questions about the roles of government and the private sector and how to meet basic human needs, such as safe water, disposal of wastes, energy, and transportation to work.
Infrastructure is at the center of debates about the global problem of poverty. When basic needs are not met, why are they not met? Whose job is it to provide them? Should the poor pay the same for basic services as affluent people? If basic services are not provided, who should intervene?
On a broader scale, what are society’s obligations to provide infrastructure for the many displaced and disenfranchised people around the world? Hundreds of millions of people displaced by war, climate change, or lack of opportunity do not have the basic support systems provided by infrastructure.
In more affluent societies, the more urgent problem is to find ways to sustain current levels of infrastructure-related services in the face of resource and environmental limits. Doing this requires more attention to managing demand rather than constantly ratcheting up supply. Closely related to demand management and efficiency of infrastructure is the subtle but important issue of trade-offs. You will read over and over in the book about how society and individuals can make choices about using public services, and the closer we can align these choices with the obligation to pay, the better our management will be.
The other focus in the book is on the attractiveness of infrastructure businesses, whether as an investment, such as purchase of municipal bonds or stocks of listed companies or direct equity stakes, or as a business line for entrepreneurs. The controversy over privatization and use of public-private partnerships is addressed with this topic. Chapter 10 provides examples of investment opportunities, including privatization.
While people have a general idea about infrastructure, measuring its financial performance is difficult because it is hard to define and classify and it has broad public purposes as well as well-defined private purposes. Infrastructure is not one unified system but a composite of systems involving utilities, transportation systems, and environmental services, among others. Also, reports about infrastructure tend to confuse the condition of government-owned physical assets and operating performance of the organizations that provide public services.
The definition of infrastructure can seem abstract and apply to different types of systems. To avoid a fuzzy definition, the book focuses on the constructed assets in six systems: the built environment itself, transportation, communications, energy, water, and waste management systems. This definition leaves out nonphysical categories, such as economic and social infrastructure systems. It emphasizes that infrastructure services are required for people and the economy, and they are not simply based on consumer choice.
To formalize this definition, we can say that infrastructure comprises the structural assets of the built environment and its physical support networks, and it includes a great deal of equipment, such as generators, motors, and actuators. In most cases, when accounting for infrastructure, we include both structures and equipment, which are the two types of fixed assets tracked by the U.S. Bureau of Economic Affairs.
Our definition of infrastructure distinguishes between the structures of infrastructure systems and the equipment of the organizations using the infrastructure to deliver public services, such as private motor vehicles and aircraft. In the case of rail companies, infrastructure includes structures and railcars. In the case of airlines, equipment is not considered part of infrastructure in our analysis but is part of the fixed assets of private companies using public infrastructure. You could, of course, make a case to include privately owned aircraft as infrastructure, but the definition of it would require adjustment.
The concept of public and private infrastructure systems can be confusing. There are many possibilities, but our main focus in the book is on infrastructure systems that provide public services, as distinguished from those that meet only private needs, such as the infrastructure that serves a manufacturing site. In some cases, the infrastructure that provides public services also serves broad public purposes that fall outside of the direct service. For example, a privately owned toll bridge could provide the public service of access across a river, but it might be required to remain open in c...
