Where will the money come from?

Melbourne & Ballarat trams in the 60s (click)

According to Paul Austin in The Age (29/11/10), there’s little doubt that infrastructure inadequacies weighed heavily on voters’ minds in last Saturday’s election. His list of problems includes overcrowded trains, congested roads, the Myki debacle and long hospital waiting lists.

The pressure to “fix” these problems from voters in the eastern suburbs and sandbelt electorates that fell to the Coalition on Saturday will be immense.

The new Premier, Mr Baillieu, might therefore find it worthwhile to look at this report on public sector borrowing by Dr Nicholas Gruen (summary here).

Dr Gruen contends that governments in Australia have focussed on the cost of debt but have ignored the benefits. They’ve reduced the budget deficit to zero but exchanged it for an infrastructure deficit. Their constituents have saved on debt repayments, but:

they are paying inflated tolls on roads and heavy mortgage repayments that reflect the lack of land release and the loading of infrastructure charges onto the land that has been released. And they are paying with their time as they wait at peak hour in traffic that has slowed to a crawl or crowd into late trains and buses.

Thanks to the culture of strict fiscal rectitude that dominates modern government thinking, new debt has been kept off the government’s balance sheet by funding infrastructure in other ways – partly through asset sell-offs but mostly via Public Private Partnerships (PPPs).

However these mechanisms have their own problems. Dr Gruen says PPPs cost significantly more than funding infrastructure through debt because government can borrow at a significantly lower cost than private investors (in extremis, governments can always increase taxes).

Investors also demand a higher return for the extra risk that the asset might be ‘stranded’ in the future by a competing government investment e.g. another road. This tends to compromise the government’s own future plans for infrastructure.

Ross Gittins sums up the issues with PPPs in this pithy one-liner: “the public is paying dearly for the efforts of governments to hide the debt they’re responsible for”.

Dr Gruen is not advocating fiscal laxity. Australia’s ability to respond to the GFC showed the benefits of prudence. He says governments should only run deficits during economic downturns and with strengthened development of the institutions that provide prudential supervision. Major decisions should not be made, he says, except on the basis of public, independent, expert advice.

Government borrowing should not be a problem where it is undertaken to invest in infrastructure that produces a strong economic return (as distinct from borrowing to fund operating shortfalls). It is very desirable at a time when the economy slows.

Those with arcane knowledge of PPPs might tell me otherwise, but the only reason I can see why government would pay more for a private investor to provide a school would be to hide the cost on someone else’s balance sheet. There’s an argument about efficiency, but if government funds the school itself it still gets built by the private sector and even the project management can be out-sourced if wanted.

If the infrastructure deficit in Victoria is going to be addressed adequately, the new Victorian Government will have to build more. There’s an opportunity for the new Premier to lead the electorate toward the idea that prudent borrowing for sound projects is good for them. Given all the anti-deficit rhetoric of recent years, this won’t be easy.

But as Nicholas Gruen says:

If it means anything, fiscal conservatism should mean prudently building the net worth of the public sector and doing so in a measured way – that is, at an acceptable risk. In an environment in which some infrastructure assets typically enjoy a rate of commercial return well above the cost of borrowing (not to mention additional returns to society and improved environmental amenity), borrowing should be encouraged up to the point at which further borrowing would constitute an unacceptable risk. This is how public companies and many households are run.

No doubt the complex interactions of cost and risk need to be looked at on a case-by-case basis, but I think there’s still an argument in some instances for the private sector to provide infrastructure that generates an income stream. The experience with failed toll roads and (airport) rail lines in Sydney and Brisbane indicates these are risky projects. It would be better to minimise that risk.