Partnering with the Private Sector to Fill the Infrastructure Gap

By / 5.19.2010

The 2007 collapse of bridges in Minneapolis and Oakland, which resulted in significant injuries and massive traffic disruptions, vividly demonstrated the decline of our nation’s infrastructure. Decades of neglect are beginning to have very real consequences in the lives of citizens. Left unaddressed, the infrastructure gap will soon begin to have severe repercussions for our nation’s economic capacity.

These issues arise at a time when traditional methods for financing public projects — using general fund revenues, proceeds from the sale of bonds, grant monies from outside agencies to fund the improvements — are proving insufficient. Whether due to economic factors (public entities reaching the limits of their ability to float bonds) or political obstacles (the difficulty of raising taxes), governments are in need of additional ways to finance necessary public improvements.

Attesting to the dire situation was a recent report by a blue ribbon panel examining the inability of the national highway trust fund — a fund financed by the gasoline tax — to keep up with the nation’s highway needs. The current system has failed to keep up with inflation and, ironically, has been undermined by increased fuel economy, as lower tax revenue is brought in for the same number of vehicle miles traveled.

Although the bipartisan commission agreed that substantial additional investment in transportation infrastructure was needed over the next 50 years to support economic growth, it was unable to agree upon a method of financing. While a majority supported an increased fuel tax indexed to inflation, a minority called for using a variety of market-based approaches, including congestion pricing. Unfortunately, while it has authorized interim funding to keep the trust fund solvent, Congress has been unable to summon the political will to comprehensively address this problem.

But a proven financing alternative exists for our public infrastructure needs: the public-private partnership (PPP). PPP approaches have been used successfully in Europe, Canada and other countries. In the U.S., they have been used more sparingly, with a limited number of projects in Texas, Florida and Virginia, among other states. As PPPs have become better understood, more states have adopted laws to facilitate their use. This policy memo provides a brief description of how PPPs work, weighs their risks and benefits, and seeks to emphasize their growing utility in a period of retrenchment for public funding of infrastructure.

What Exactly Are PPPs?

The Federal Highway Administration defines public-private partnerships as “contractual arrangements between public and private sector entities pursuant to which the private sector is involved in multiple elements of public infrastructure projects.” There are many different PPP structures, under which the private role can involve various aspects of the design, construction and operation of a public facility. However, project finance is really the point of PPPs. Under many PPP arrangements, private investors supply the capital to get infrastructure projects built. In exchange for providing funding, those private partners obtain a stream of income from the completed public project to recoup their investment and make a profit.

One of the most attractive features of PPPs is the flexibility they allow in arranging financing. Some PPP projects begin with a valuable asset, like a bridge or toll road, that can be transferred to a private partner in order to raise the cash that is needed to undertake other projects. Some PPP projects allow private partners to take advantage of innovative financing vehicles, such as government credit programs or private activity bonds, which provide tax benefits to firms taking on public infrastructure projects.

Yet another type of PPP transaction involves shifting financial risk to the private entity and the payment obligation to the public users (again, as with toll roads). This approach can prove controversial, however, as the public may object to making payments to a private party for facilities that were previously operated by their government or to rates that are subject to the control of a private company. On the other hand, if the public holds rate-setting power, the private partner will want some assurance that there will be sufficient funds to enable it to meet its obligations.

Although there are no real limits to the type of enterprises that can be undertaken using the PPP model, certain kinds of projects seem like a better fit than others. Projects that produce a steady stream of income, such as toll bridges, toll roads, and water facilities, are particularly well-suited to PPPs, since the revenue stream can be relied upon by the private partner to recoup the costs of developing the project. Other successful PPP’s have included hospitals, schools, offices and penal facilities. (Many such projects are described by the Canadian agency promoting the use of PPP’s, while a list of American case studies is available from the National Council for Public-Private Partnerships.)

But PPPs are not limited to money-producing projects. Many public facilities, such as transit systems, customarily lose money and are supported by public funding. Such facilities can be operated through a PPP approach by means of subsidies, often termed “availability payments,” that provide a stream of income to the private partner for making the facility available for the intended use. These payments can be adjusted to provide incentives to the contractor to maintain the facilities in optimal condition.

The Risks and Rewards of PPPs

Because of PPPs’ potential to inject a stream of private capital into projects that otherwise would have to be deferred, infrastructure experts have become increasingly interested in turning to them. But despite their clear benefits, federal, state, and local governments have been slow to accelerate their use, as the risks of PPPs give government actors pause.

What are those risks? For one, PPP transactions typically involve more complexity than the traditional design-bid-build approach, given the added terms needed to address financing, operations and maintenance. Details that normally would be addressed throughout the course of a facility’s operation must be anticipated and addressed in the initial transaction. In order to handle the added complexity, agencies often turn to outside consulting and legal experts. The upfront cost of such help and the risk that a deal may not ultimately pan out may discourage some agencies from exploring PPP options.

Another risk is political. Sometimes PPP projects meet with opposition, often from public sector labor groups, who may view such projects as a threat to their jobs or bargaining power. Such is the case in California, where legislative initiatives to authorize PPP’s have been opposed by the Professional Engineers in California Government, a union that represents state-employed engineers.

A change in the political winds can also wreak havoc on a proposed PPP transaction. This occurred with the “Texas Trans-Corridor” project, an innovative proposal by Texas Gov. Rick Perry (R) to construct a series of combined infrastructure corridors in that state. While initially positively received, the proposal soon drew opposition from a vocal faction, leading to its demise. As one commentator noted: “It has been said that no single statewide issue in Texas had ever succeeded in unifying business, labor and agriculture interests plus small and large municipalities in a common effort since the Alamo fell.”

But while there are real risks in undertaking PPP transactions, the dilapidated state of our infrastructure leaves us with little choice but to consider them. Besides, the benefits far outstrip the risks – and even the risks are manageable provided agencies follow best practices. In cases where no alternative funding source is available, only PPPs can make public projects happen. One reason that agencies consider the PPP approach is to complete needed projects without increasing their debt load. In some circumstances, the agencies may prefer to shoulder long-term financial obligations (such as long-term leases) rather than bond obligations.

PPPs could lead to the prompt delivery of projects through more efficient contracting and the early initiation of a revenue stream. In some instances, the infrastructure project involves a highly technical facility, such as a desalinization plant, where a supplier can more accurately predict the timing and cost of project delivery. It can then contractually obligate itself to an accelerated delivery schedule with a fair degree of confidence.

PPPs also give public institutions the ability to selectively allocate risk between the public and private partners. Take the case of a toll road for which expected traffic counts might not materialize. Such a project might be unattractive to a private party, which might prefer a fixed payment rather than risk the uncertainty of traffic demands. A public entity in that instance might take such traffic variations in stride and be willing to bear that uncertainty, knowing it won’t face other risks that a private entity would, such as construction claims. The beauty of the PPP approach is that it allows a high degree of flexibility to the parties in intelligently allocating the various risks they face.

Conclusion

The success of PPP projects in Europe and Canada has sparked interest within the U.S., but only a few have been completed. A useful list of case studies of U.S projects highway and transit projects can be found in a report issued by the U.S. Department of Transportation, “Innovation Wave: An Update on the Burgeoning Private Sector Role in U.S. Highway and Transit Infrastructure.”

Examples of successfully completed American projects are the Las Vegas Monorail project and the South Bay Expressway, which links an active commercial port of entry at the Mexican border with the greater freeway network in San Diego County, California. Other American PPP projects under development include highway projects in Florida, Texas and Virginia. The Federal Highway Administration’s website contains useful descriptions of many domestic PPP projects, as well as others using the design-build contracting approach. In Canada, numerous projects have been completed, many of which are featured on the Canadian government’s PPP agency website. Just in time for he 2010 Winter Olympics, Vancouver, B.C. completed the “Canada Line,” a $2.054 Billion, 11.8-mile rapid transit line connecting downtown Vancouver with its international airport.

Although PPP transactions are both complicated and challenging, the prospect of developing significant infrastructure improvements without adding to public debt loads or diverting scarce general funds is a very attractive option. While some may distrust such solutions, a deal that is well-crafted and skillfully presented can engender public support. Given the growing shortfall in meeting our nation’s infrastructure needs, creative approaches like PPPs deserve thorough consideration as a means of delivering projects that might not otherwise come to fruition.