While other countries are exploring new approaches, America’s infrastructure strategy is in desperate need of an upgrade.
In addition to being a critical challenge, infrastructure represents an intriguing economic opportunity. Unleashing a wave of creative infrastructure investments in the U.S. will reduce shipping costs, help U.S. manufacturers, directly employ millions of Americans and reduce CO2 emissions from the transportation sector.
The trouble is the way we decide what to build. The decision should be based on the return on economic productivity generated from infrastructure projects, not simply the amount of dollars invested.
Here’s an example of what I mean.
One stretch of highway on the East Coast received hundreds of millions of dollars in federal earmarks. Unfortunately, the road handles less traffic in a year than most major urban highways handle in a week or less. Other examples are the public works whose budgets are set optimistically low but end up doubling or tripling in cost, effectively destroying most of the societal returns for the project.
The opportunity cost is enormous if we continue to allocate resources to major investments that systematically fall short of expectations due to biased estimates, or fund projects based on little more than the exercise of political power.
It is also clear that there are a wide variety of very high-return projects that are currently languishing without any identified funding.
We have to understand our investment alternatives, and to do that, we need a non-political prioritization mechanism—something that is badly lacking at all levels of government today.
The mechanism should help to prioritize projects objectively, mainly by force-rankings based on an assessment of economic returns.
One way to do it would be for the administration to create an independent panel to develop a prioritized list of critical national projects and seek authorization flexibility to deploy resources competitively and consistently with panel recommendations.
The critical prioritization lens should be applied not just to new investments but also to ongoing projects. We recommend conducting a rigorous review to prune current commitments to a core set of priorities that will provide major productivity boosts, “de-bottleneck” economic growth and generate appropriate returns on capital.
There are a couple of important ways to do this, and that is to employ user fees and private partnerships and capital as often as possible.
User fees are central to balancing supply and demand in virtually every sector of our economy, and infrastructure is no exception. Prices tied to the true cost of using infrastructure smooth demand by reallocating it to off-peak periods or under-used capacity, reducing overall capital needs.
We also need to create an environment that attracts private investment and partnership—that’s not happening now.
Besides providing needed capital to upgrade infrastructure, private partnerships can improve the discipline of the project selection process by injecting an analysis about the projected returns of a given project. These partnerships also can increase cost transparency, as the true life-cycle costs of infrastructure rehabilitation and maintenance are often underestimated for political reasons.
There are a variety of tools at the disposal of the federal government to advance the use of private capital and operational expertise into state- and locally owned infrastructure.
Among them are pilot programs that specifically award funds based on the level of taxpayer risk reduction; tax-code changes (expanding the use of private activity bonds and leveling the public versus private sector playing field for Build America Bonds); expanding Federal credit support for projects that are tied to the willingness of state and local governments to employ user fees; removing federal restrictions on user fees and reforming some preconstruction processes to elim inate investment uncertainty and expedite time frames for big-payoff projects.
Many lessons have already been learned in the U.K., Australia, Canada and other countries that have had developed public-private partnership programs for many years. While no program is perfect, it is clear other countries have struck a much better balance than the U.S. has uniting diverse political constituencies in infrastructure—unions, environmental groups, the construction industry itself and so on. These countries strike a balance without losing the various incentive benefits associated with transferring a variety of project risks to the private sector.
It is clear that, while healing credit markets continue to impact infrastructure project development around the world, private equity continues to be strongly interested in the space. Many of the largest financial institutions, public and private-sector pension funds, and private equity firms in the world have raised infrastructure funds and continue to target the space for its attractive medium-risk, medium-return profile. Due largely to a U.S. political and policy stalemate on this issue, however, much of that capital remains on the sidelines or has begun to explore alternative opportunities in Asia, Europe and South America.
A clearer national infrastructure strategy that is not hostile to the deployment of these resources would help improve credit, raise equity financing and speed the pace of transactions.
There’s more that needs to be done. We also must structure programs so that grantees are incentivized to innovate and think beyond the special interests that can dominate the infrastructure debate in the U.S.
An efficiency-based competitive scorecard for projects and for infrastructure quality could create positive incentives for states to emphasize performance.
To coordinate all this activity and direct federal resources, new or overhauled institutions are needed.
A national infrastructure fund administered separately from current programs would help create a large and efficient market for private investors, as well as help depoliticize investment decisions
All these ideas won’t ensure success nor miraculously convert our infrastructure from a 1976 Chevy to a 2010 Ferrari. But at least they’ll increase the likelihood that our national infrastructure will once again be a competitive advantage and a source of pride.
Benjamin Cheatham is a partner in consultant McKinsey & Co.’s Philadelphia office and leads the Americas Infrastructure Practice. Prior to joining McKinsey, he owned and operated a construction company in New York City. He can be reached at benjamin_cheatham@mckinsey .com or at 215-594-4217.