California: A state growing beyond its infrastructure means

THINK Magazine, 2/2008.

California is facing an increasing gap between the needs of its economy, the services required for its citizens and the capacity of its existing infrastructure. Our current infrastructure, including transportation systems, water systems, courts, fire and police stations, and prisons, were built for 25 million people, but with a population of 37 million that is projected to grow to 60 million by 2050, the significance of the need is becoming increasingly clear.  Looked at another way, California has an infrastructure that was built for a $500 billion economy but this figure has more than tripled and is continuing to grow each year.

Consider for a moment some of California’s most substantial infrastructure needs:
The state’s water system is in need of a major overhaul, requiring alternative types of water storage to protect against future droughts and a revamp of the troubled conveyance system through the Delta; additionally, many of the state’s levees are in immediate need of repair.  Our prisons do not have the capacity to handle the current number of prisoners, and so we are forced to send prisoners out of state.  While California’s ports handle more than 40% of U.S. trade, increasing goods movement congestion and related environmental pollution is threatening to undermine California’s prominent position as a major trade portal.  The state’s crowded airports and freeways are increasingly unable to handle the growing volume of traffic, and with new communities sprouting up in previously unpopulated areas, there is an even greater need for public transportation such as high-speed rail and light rail.

Furthermore, as one of the most innovative and dynamic economies in the world, California requires an infrastructure that can support the rapid changes and increased growth that accompany such economic vitality.   Such an infrastructure must be highly efficient, one that encourages Californians to successfully compete in the global economy by producing and distributing competitive goods and services.  At the same time, this infrastructure must enhance our environment and our quality of life, or the human capital on which our prosperity depends will not wish to live here.

Some have estimated that California’s infrastructure deficit amounts to $500 billion.  To begin to address this massive need, Governor Schwarzenegger proposed a $222 billion Strategic Growth Plan over 10 years.  Thus far, voters approved the first portion of that plan when they authorized $42.7 billion of bonds in 2006.  Moreover, the Governor signed the Public Safety and Offender Rehabilitation Services Act of 2007 to begin to address California’s prison overcrowding.  Proceeds from these actions are now starting to result in new infrastructure around the state, but these actions are just a down payment on our infrastructure needs.  This year, in order to facilitate further improvement and expansion of California’s infrastructure, the Governor is proposing an additional $48.1 billion in bonds to improve California’s water system, education facilities, courthouses and high speed rail.

When all is said and done, current state revenues and general obligation bonds can only go so far in improving and expanding California’s infrastructure.  Given the significant investment required, we must do all we can to look to other innovative financing options to supplement the limited funding provided by state revenues and bonds.  That is why in January Governor Schwarzenegger joined Pennsylvania Governor Ed Rendell and New York City Mayor Michael Bloomberg to form Building America’s Future (BAF), a non-partisan coalition to call on the federal government to invest more and to invest more wisely in the nation’s infrastructure.  The short-term goal of BAF is to gain a commitment from the presidential candidates to renew federal investment in infrastructure.

In addition, this past January during his State of the State address the Governor detailed one possible innovative funding option, which we’ve chosen to term performance-based infrastructure, or PBI. Whether referred to as public-private partnerships, alternative finance and procurement arrangements, private finance initiative, or performance-based infrastructure, we employ the UN’s definition, which says that these types of agreements:

“ . . . are a form of contractual arrangement in which government and private companies assume co-responsibilities for the delivery of infrastructure services.  Through these partnerships, it is anticipated that the advantages of the private sector—dynamism, access to finance, knowledge of technologies, management efficiency, and entrepreneurial spirit—will be enhanced by competition and combined with the social responsibility, environmental awareness, local knowledge and job generation concerns of the public sector.”

The UN definition goes on to add that these types of arrangements “must not be confused with privatization.  While privatization means transferring a public service or facility to the private sector, P3s constitute a way of introducing private management into public service.”

Public-private arrangements are already widespread throughout California governments.  For example, billions of dollars of the state’s health and human services budget are paid to private doctors and hospitals, for the purpose of providing medical services to Californians, and the same is true of all 19 centers providing services to the developmentally disabled.

Likewise, CalPERS and CalSTRS, two public agencies who together manage nearly ½ trillion dollars contributed by taxpayers and public employees and dedicated to the payment of pensions for public employees, hire private money management firms to manage that capital in order to boost yields. In fact, CalPERS recently announced that it would even buy a stake in one of those private managers, and last year announced it would be investing a few billion dollars into public-private partnership transactions elsewhere.

Yet another example involves the public goods charge established for the purpose of promoting one million solar homes in California that channels money to private providers of solar panel installation and other services.  And, of course, government offices often hire outside lawyers and financial consultants, regularly lease cars and other assets from private suppliers, and much more.

In none of these cases is there a prohibition on partnering with private firms to deliver public services.  And presumably in each such case the decision to team with private firms rather than use in-house personnel is based on some value being obtained when compared to doing everything in-house.

However, when it comes to infrastructure in California, this is not the case. In California, even if a public-private arrangement could build and maintain the world’s finest mass transit system and do so for a fraction of the cost when compared to the traditional delivery method, state and local governments are currently prohibited from entering into these types of deals. The current law is the equivalent of the government not being permitted to lease cars from third parties, or team up with private companies to deliver medical or social services, or hire, much less purchase an interest in, those investment specialists.  If treated like infrastructure, all of that would have to be done by the government, even if there is less value achieved by the government conducting these activities.

In the meantime, while operating with one hand tied behind its back, California enviously views nearly ½ trillion dollars of high quality infrastructure around the world being provided under this performance-based infrastructure approach, and much of it in ways that greatly improve sustainability, mobility, transportation and the environment.  For example, as a result of performance-based infrastructure arrangements, France was able to add three more high-speed rail lines, British Columbia was able to build a state-of-the-art mass transit system in Vancouver, and Glasgow, Scotland was able to renovate or construct 89 schools within the Glasgow school district.  These are only a few of the examples of successful PBI-type projects from around the world.

In calling for California to fully enable state and local government use of performance-based infrastructure, all Governor Schwarzenegger seeks is to add this same tool to California’s toolbox.  It is important to note that PBI is just an optional tool – it is not mandatory. Governments should use it only when it adds value, and ignore it when it doesn’t.  It is also important to note that no other laws or rules change when performance-based infrastructure is allowed as an option.  The very same environmental, safety, labor and other rules apply whether a project is built the traditional way or the alternative way.

Moreover, the Governor’s PBI proposal does not mean that California favors private providers of infrastructure services.  The end goal is to secure better infrastructure services for citizens or lower costs or risks for taxpayers.  If the traditional method of infrastructure delivery provides the best value, that is the method that should be adopted in that case.  In fact, in countries that already use PBI-type arrangements, most projects are still funded in the traditional way; on average, only 15-20% of new infrastructure is provided under PBI-type arrangements.  The overwhelming majority of public infrastructure in these countries is still delivered in the traditional way because in each case the route providing the best value is chosen.

Looked at another way, this tool that we seek to make available to governments in California is simply what is available to every corporation, non-profit organization, partnership, sole proprietorship or household in California.  When a manufacturer or distributor or homeowner wants a new capital asset, they have the freedom to choose from a variety of options for providing, operating and maintaining that asset, including buying, leasing, renting, joint venturing and more. The decision is made on the merits, not because one is required to go a particular way.

In establishing PBI as a widely available infrastructure financing option, it will be important to ensure that California state and local governments arrange only the best financing, procurement, risk allocation, delivery, operation, maintenance and other contractual provisions.  Thus, in addition to calling for broad authorization for California governments to enter into these sorts of partnerships, the Governor also called for the creation of PBI California.  This institution would function as a center for excellence for performance-based infrastructure arrangements, providing state and local governments with expertise in negotiating, managing and implementing contractual arrangements with the private sector and assessing which projects would obtain the most value from PBI-type deals.  Similar centers of excellence in the UK, Ontario and British Columbia have proven to be effective in enabling governments to achieve the best outcomes for taxpayers and citizens.

In short, California desperately needs high quality, convenient, well-operated and well-maintained infrastructure, and it is only through creative methods of financing and procuring such infrastructure that the state will be able to secure the systems necessary to meet its future needs.  Broadly enabling state and local governments to utilize PBI where it makes sense is one such tool that will help California to begin to address its massive infrastructure deficit, improving the quality of life of its citizens and encouraging further economic growth.