How do our roads, bridges, and highways actually get built? If we want a new prison, a new power plant, a new tunnel, or a new dam, how do those things actually happen? Well, the short version is that someone pays some money for some stuff and some workers and then the workers go build that stuff into other stuff, but because very few cities, states, or countries actually have the cash on hand to pay for incredibly expensive projects, what we don’t see when we see a new stretch of highway being built can actually tell us a lot about how the world works and the forces at work behind, well, everything.
The ironclad rule of all property development comes down to three little letters: OPM. Other people’s money. If you’re going to build something really big, get investors, help reduce the risk on yourself by risking a lot of their money too. The same is true when we talk about infrastructure spending, and the world of infrastructure financing is incredibly important.
To make all of this make more sense, let’s use a long complicated metaphor (this will go well) Think about when you buy a car: most people don’t have the cash on hand to just buy a car, so you make monthly payments – you finance the car. Now, let’s think about that car for a second. Someone built the car, meaning that someone had the get the raw materials, design the car, buy the machines and hire the workers to build the car, and do all of the safety tests and paperwork associated with selling a new car, and advertise the car so people know about it. That whole process obviously costs a lot of money. By the time you enter the process, a lot of money has changed hands already, and the dealership likely bought the car from the manufacturer to pay their costs, so now the dealership is ostensibly “out” the cost of buying that car from the manufacturer. Now, obviously if the dealership sells you a car, they’re going to make a profit, but if you are paying off that car a little bit at a time (say over 3 years), it will take the dealership a long time to actually make their profit on that car. In the meantime, they still are at a loss from buying the car from the manufacturer in the first place, so in the end, the dealership would spend a lot of time in debt. That’s where financing comes in. Basically, someone with a lot of money (a bank), doesn’t mind waiting for a long time for you to pay off your car, because the bank has a shitload of money already and doesn’t mind taking that slow payment for a big payoff (interest), whereas your car dealership has a lot of money too, but significantly less than the bank, so they’d much rather have the bank pay them right away, and then let the bank service your car loan and take a little bit off the top so they don’t have to wait for their money.
This, in a nutshell, is financing. Someone with enough money to be able to take the “slow” profit fronts the cash for someone else to buy/build something. When we’re talking about infrastructure projects the world over, we’re talking about vast, vast sums of money floating around out there. In fact, according to a recent article from The Economist, consulting company McKinsey estimates that simply to maintain the current infrastructure we have in the world through 2030 will cost approximate $57 trillion (yes, with a “t”), or about $3.7 trillion per year. Current world expenditures on infrastructure are at about $2.7 trillion per year (about 4% of all world economic output). In other words, we’re already not spending enough world wide to build the subways, power stations, bridges, and tunnels that we need, let alone to create a new, green, sustainable infrastructure we all dream of. Part of the problem is that many of the traditional financiers of these major projects are still reeling from the 2008 financial crisis or the austerity measures implemented since and don’t have the patience to make the long investments required for infrastructure projects (typically over 20 years before you get paid back on your billions of dollars). New sources of money other than banks, such as private equity firms, insurers, and sovereign wealth funds (basically, the reserve money that a country has) are beginning to invest in these projects. So the money is coming from somewhere: does it really matter? The Economist estimates that there is some $50 trillion of wealth out there in the world from sources like the ones I just mentioned that makes a lot of sense to match up with infrastructure projects, but simply isn’t at the moment, or is doing so slowly. This could be avenue for investment in the future, sure, but what difference does it make to you and me?
Infrastructure projects are important for a few reasons: first of all, having infrastructure that works lets us do everything else we want to do. If we have good power, roads, bridges, sewers, and fiber optic lines, we can start businesses and universities and day care centers and whatever else you can dream up. Secondly, infrastructure projects represent something important in this finance-based economy: a major investment in an actual, real asset. So many investments are so derivative these days, we essentially just have giant companies trading money for other money in the form of complicated financial instruments barely connected to any assets of real value. In infrastructure spending, we have investment into something real that actually exists.
So again: what’s the big problem and what impact does it have on you and me. Well, let’s think about how money is actually made in infrastructure spending and we’ll start to see what’s going on here. First, in general, when a bank or other large investor invests in an infrastructure project, they are giving up short term money for long term profit, but who is “making the payments” on those long term projects? Well, the governments that ordered up the projects of course, and where do those governments get money? They get it from your taxes. So, no matter who is financing infrastructure, you and are eventually paying the bill and paying it with interest over a very long period of time.
Second, with these new investors now interested in funding infrastructure projects, many are deviating from the course of banks in years past that simply invested the money, collected their payments, and then went away. Many of these new investors are interested in ownership and fee generation. Take the case of three prisons recently built in France which were financed by a private investment firm called Blackstone. Blackstone paid the money but can’t start collecting their payments until the prisons are up and running, so now there’s a lot of pressure on builders and governments to be on time and efficient, and to start getting prisoners into the prison. Are we starting to see the problem? The Economist praises this type of process because it brings private sector efficiency to public infrastructure building, but in cases like building new prisons, do we really want efficiency of getting people into jail to be the top priority?
Think of the implications here: we the taxpayers owe some giant company a shitload of money for building us something – let’s say a toll bridge. Okay, so we’ve got this toll bridge and we owe a bunch of money, so now the government knows that it needs people to use this toll bridge to generate the money to pay back the financier. Well, that’s all fine as long as we like people driving over the bridge, but what if what the people really want is a subway system, a green infrastructure and sustainable public transport system that doesn’t really use toll bridges? Now we’ve created something called moral hazard where the government knows it must drive traffic to the bridge to pay public debts, but also knows public demand is asking for a project that drives people away from the toll bridge. Multiply this by thousands of infrastructure projects the world over and we start to see the essential moral hazard of private sector involvement and financing in public infrastructure projects, especially when private sector firms don’t just want to get the money from your car loan, but also want to own a piece of the car so you suddenly have to get a job delivering pizzas instead of being a software engineer so your investment starts generating income for your financiers.
TL;DR Private sector financing of public infrastructure projects has long been the way of things and inherently can lead to moral hazard, but a shift in the types of funds investing in infrastructure actually has the potential to increase this effect. Money. Rules. Everything. Vomit.