California’s Infrastructure Deficit

Public Works Management Policy, 1/2008.

There is a gap between the needs of California’s economy, the services required for its citizens and the capacity of its existing infrastructure. Our transportation systems, water systems, courts, fire and police stations, prisons and other forms of infrastructure were built for 25 million people, but we have a population of 37 million now and are projected to grow to 60 million by 2050.  Looked at another way, we have an infrastructure that was built for a $500 billion economy but we are generating more than three times that amount every year and that figure is growing 3-4% per year.

At one point, mostly in the 1950’s and 1960’s, California was the most farsighted state in the country, making important infrastructure investments well in excess of its then-current needs in order to set the table for the tremendous prosperity and high quality of life that followed in succeeding decades.  However, the pace of infrastructure investment declined thereafter, leaving the state with a huge unfunded need as its population and economy grew. According to the California Infrastructure Coalition, in the 1960s public works and infrastructure projects constituted almost 20 percent of State spending; today, that statistic is closer to 3 percent.

“Infrastructure” broadly refers to assets and operations that provide basic services to individuals.  Traditionally, the categories include transportation (e.g., roads, rail, ports, bridges, airports), education (e.g., schools, colleges, universities and related housing and other buildings), natural resources (e.g., water, recreation) and public buildings (e.g., courts, government buildings, prisons, fire and police stations).  Less traditional but of increasing importance are infrastructure investments that make us more efficient, such as “demand management” infrastructure that meets growing demand without expanding capacity or requiring new capital equipment. Examples include water metering, water-efficient fixtures, and perhaps most illustrative, California’s landmark electricity efficiency rules that made it profitable for utilities to help customers become more efficient and thereby demand less energy.  As a result of those and other policies, California has been able to triple its gross state product per kilowatt-hour of electricity over the past 30 years, a massive gain in productivity that has allowed the state to grow and citizens to prosper while avoiding the need for 24 power plants costing more than $55 billion.

Most recently we are facing a statewide drought potentially requiring more and different types of water storage, we have levees in immediate need of repair, and we have a troubled water conveyance system through the Delta that has just become even more problematic as a result of a federal court ruling that limits our ability to move water to the highly-populated southern portion of the state.  We have a prison capacity crisis that has us sending prisoners out of state while a bond to finance more prisons has been held up in federal court.  We have goods movement congestion and related environmental pollution at three ports through which more than 40% of all US trade travels.  We have crowded airports and freeways, new communities sprouting up all over the state, and increased calls for high-speed rail, light rail and other forms of transportation systems.

Furthermore, with a market of more than 37 million people and more than 1 million employers, 17 million employees and a gross state product nearing the $2 trillion mark, we have one of the largest and most dynamic economies on earth.  As one of the most innovative economies in the world, it also changes rapidly and accordingly imposes additional demands on our infrastructure.  To enable Californians to successfully compete in the global economy and earn higher incomes, we need a highly efficient and workable infrastructure that allows them to create, produce and distribute competitive goods and services. At the same time, that 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.

By some measures our infrastructure deficit amounts to $500 billion.  After years of under-investment, California finally started to address these needs in 2006 when Governor Schwarzenegger proposed a $222 billion Strategic Growth Plan for infrastructure improvement over 10 years. Voters approved the first portion of that plan when they authorized $42.7 billion of bonds.  Proceeds from those bonds are now starting to result in new infrastructure around the state but that’s just a down payment on our needs. For the benefit of both the current generation and future Californians, we must ramp up our infrastructure investment at a rapid pace.

Earlier in the 20th century, California’s infrastructure was largely financed with current revenues. Later, general obligation bonds become the preferred option.  More recently governments have turned to local sales taxes to pay for transportation improvements. Given our infrastructure deficit, it’s clear that California needs to consider these and all other reasonable forms of financing.

One of those forms is public-private partnership (P3) financing. Starting with the United Kingdom in the 1990s, countries and provinces around the world have been increasing their use of this technique in order to boost infrastructure financing, determine properly its full cost by including not just its upfront cost but also its lifetime maintenance and operation expenses, deliver it on time and on budget, procure and manage it at lower cost, and lower risk to taxpayers.

Two Canadian provinces, British Columbia (BC) and Ontario, provide some insight into the value conferrable by the employment of P3 financing.

Since the 2002 creation of PartnershipsBC, an independent oversight organization owned by the BC government, that province has boosted infrastructure financing approximately 20 percent and on average has obtained an overall project savings of 6.5 percent.  Among its recent successes are a water treatment plant at an environmentally-challenged mine, a 300-bed hospital and cancer treatment center, a highway improvement project, and a 19.5 kilometer rapid transit line.

Since the 2005 creation of Infrastructure Ontario, a crown corporation operated by a private board of directors but with the Ontario government as the single shareholder, over 45 major infrastructure projects have been assigned to the corporation and evaluated according to an alternative financing and procurement model that leverages the strengths of the public and private sectors.  According to Infrastructure Ontario, over 100,000 jobs are expected to be generated by those projects, and thus far more than two dozen projects, worth more than $5 billion, have been brought to market, including courthouses, hospitals and highway service centers.

PartnershipsBC and Infrastructure Ontario specialize in determining the full cost of proposed infrastructure and the best way to construct, finance, manage and maintain that infrastructure.  They examine project feasibility and viability, incorporate into all analyses the cost of operating and maintaining capital assets, identify beneficial opportunities to leverage non-government-sector resources, manage risk and competitive bids, and oversee construction and ongoing operations.  When involving the private sector in infrastructure projects, they negotiate between public sector priorities and private sector capabilities while ensuring that the private sector receives no more than a reasonable rate of return and that taxpayers get value for their money from the application of P3 in each case.  The process is transparent, with requests for qualifications, proposal requests, final contracts and value-for-money reports are all posted on-line.

In those cases where P3 makes sense, the benefits are usually some combination of more competitive procurement, lower project and completion risk, on-time and on-budget delivery with the risk of overages and delays placed on others, proper estimation and comparison of full project costs, including maintenance and operational costs, and lower lifecycle costs.

P3 doesn’t always provide an advantage. The cost of private capital tends to be higher than the cost of public capital, so the other advantages conferred by P3 must outweigh that higher cost of capital.  Absent other considerations, when that is not the case P3 is usually not the best option.

British Columbia and Ontario have found that creating an independent organization such as PartnershipsBC or Infrastructure Ontario to advise governments about infrastructure financing removes the responsibility of project allocation from the government, placing it in the hands of specialized staff able to provide due diligence, manage procurement and risk, assess the degree to which public sector projects can benefit from private sector involvement, oversee construction and monitor operation and maintenance.

Of course, California has entered into some types of public-private partnerships for many years.  These take the form of using private contractors to provide services under the direction of a state agency, such as when the California Transportation Department utilized the services of contractor CC Myers to urgently repair a Bay Area highway interconnection in 2007.  Also, many government agencies are tenants of buildings owned and managed by private enterprise.  But we have not fully explored the full potential associated with P3s. As always the key will be to ensure that the government only uses P3 when it gets additional value by taking that step.

In closing, California needs to aggressively attack its infrastructure deficit.  As the State Treasurer reported in his 2007 Debt Affordability Report, the result of years of under-investment “is a decaying infrastructure increasingly ill-equipped to serve our families, children and communities.”  To address this need we should provide governments tools with which to evaluate and, where appropriate, employ alternatives forms of infrastructure financing.