More states privatizing their infrastructure. Are they making a mistake?

at 09:00 AM ET, 04/01/2012

Is this the future of transportation? (Joe Raymond/Associated Press)
Say you’re a state politician. Your local roads, bridges, and transit systems are all in dire need of upgrades. But there’s not much money left. Budgets are crunched. No one wants to raise taxes. And Congress is throttling back on transportation funding. So what’s left? Privatization, of course.

Maryland is the latest state looking to join the fray. At the moment, its legislature is mulling a bill that would encourage the government to seek out private companies to build, operate, and maintain the state’s roads, bridges, and public buildings. Virginia adopted this approach nearly a decade ago. And a growing number of states — from California to Florida — have been bringing in private capital to bankroll their transportation needs. But is privatizing infrastructure really such a good idea?

There are two main ways for a state to bring in private money for transportation. The first is to sell off assets that have already been built. This is what Indiana did in 2006, under Governor Mitch Daniels, when it leased its 157-mile Indiana East-West Toll Road to an international consortium of investors for $3.8 billion. The private companies have agreed to operate and maintain the roads for 75 years. In return, they get to hike the road’s tolls each year — by either 2 percent, the inflation rate, or the increase in GDP, whichever is higher.

While advocates claim that the private sector can operate these toll roads more efficiently, the major appeal of these moves is to solve short-term budget crunches. Essentially, state officials are giving up a source of revenue that’s spread out over a number of years — in Indiana’s case, tolls — and receiving a lump of cash upfront. “You might get less money overall, but you get it upfront, so that officials can go build the things they want to build,” explains Joshua Schank, the president of the Eno Center for Transportation. What’s more, the private firms are the ones that take the heat for raising fees and tolls, instead of nervous politicians.

Yet these sales can be controversial. The deals are frequently complicated and it can be difficult to assess how good a bargain the states are actually getting. Daniels has called the Indiana Toll Road transaction “the best deal since Manhattan was sold for beads.” Yet residents are still discovering surprises in the 600-page agreement — as when Indiana had to reimburse the operators for lost revenue after waiving tolls for safety reasons during a 2008 flood.

The other way to privatize infrastructure is to have a private firm take charge of building a road, bridge, or transit system from the start. From a global perspective, this isn’t a radical idea. Countries like France, Spain, and Australia have long harnessed these public-private partnerships to build their highways and rail lines. “Compared to other countries, we’re way behind on this,” says Schank. (Indeed, that’s why the large firms that handle these public-private contracts are often European — foreign companies have all the expertise.)

Here’s how this setup would work. Say a state wants to build or upgrade a highway. Various private companies will bid for the project, and the winning bidder has to raise enough money from outside investors to design, operate, build, and maintain the highway for a fixed number of years. The firm is allowed to recoup its costs through tolls and the like over that span. Because the private company is on the hook for the whole thing, it has an incentive to keep costs as low as possible and finish the road on time.

“The idea here,” says Robert Poole of the Reason Foundation, “is that the government is only commissioning projects where the private sector is willing to put its skin in the game.”

There’s some evidence that privately operated infrastructure projects can get built more quickly — and for less money — than projects wholly overseen by the government. One 2007 study (pdf) from Allen Consulting and the University of Melbourne looked at 54 large infrastructure projects in Australia and found that the privately financed ones had smaller cost overruns and were more likely to be finished on schedule than those financed through traditional public-sector methods.

Virginia, for one, has found that such partnerships can offer a way to get around funding logjams. For years, the Virginia Department of Transportation has wanted to relieve congestion on the I-495 Capital Beltway. But the state’s preferred plan involved adding two carpools in each direction on the most congested portions — at an unpalatable cost of $3 billion. Then, in 2004, the state was approached (pdf) by two companies, Fluor and TransUrban, that offered to raise private funds to add two high-occupancy toll lanes in each direction, and do it in a sleeker way that wouldn’t require as much widening of the Beltway. In the end, Fluor-TransUrban is planning to do it for a mere $1.4 billion, and the electronic toll system is set to begin later this year.

“No bureaucratic provision was a problem for them,” Ron Kirby, transportation director for the Washington Area Council of Governments, noted of Fluor in a recent issue of Public Works Financing. “It was ‘Tell me the issue and I’ll figure out a way to solve it.’”

But before getting too excited about the magical powers of private firms, experts warn that there are potential pitfalls to these arrangements. For one, as Robert Puentes of Brookings noted in a recent paper (pdf), these are complicated multi-decade financial arrangements. And “many states,” he notes, “lack the technical capacity and expertise to consider such deals and fully protect the public interest.” For another, the deals need to be structured wisely — in Maryland, for instance, Republicans have warned that certain provisions in the pending Senate bill could allow the government to circumvent the competitive bidding process. (The bill itself does, however, create several layers of review.)

Moreover, a road that’s privately owned for 75 years has the potential to conflict with other public-policy goals. For instance, as a recent GAO report (pdf) found, four of the five privately-funded toll road projects in the last 15 years included non-compete clauses that prevented the government from building nearby roads. As Tim Lee notes, “real-world privatization schemes are often explicitly protectionist.” So what if a state, say, later decides that it wants to build a rail network that competes with the private road? All sorts of complications could arise.

Plus, privatization can’t work everywhere. “It’s not a universal tool,” says Jonathan Peters, a professor of finance at the College of State Island who has studied these partnerships. There are plenty of roads in states like Montana, for starters, that don’t pay for themselves and would be unappealing to private investors. There are ways around this — Madrid, for one, built its subway system by offering formula-based subsidies to private firms, which still bore the risk of a shortfall in rider demand — but it’s trickier. Few transportation experts think we can fill our multi-trillion-dollar infrastructure shortfall with private money alone.

Still, as many states find themselves scrounging under sofas for cash, privatization may prove increasingly appealing. And drivers, at least, sometimes appear more receptive to paying for roads via tolls, where it’s obvious what the money’s going toward, than via gas taxes. “The lack of revenue,” says Peters, “is really forcing people to consider these options more seriously.”

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