There is general agreement among the public that much of the infrastructure of the country is in need of improvement. The nation feels the burden of overworked airports (before the coronavirus pandemic at least), crumbling and crowded highways, an outdated wireless network, an electrical grid exposed to foreign attacks and accidents risking massive outages, limited pipelines to transport gas and oil, and an outdated system of air-traffic control. All of these highlight the need for investment. Furthermore, we are in the middle of an economic crisis, with massive unemployment and a general reduction in investment and consumption. Under these circumstances, it is generally accepted that infrastructure investments, on top of any community benefits they may bring in themselves, would help with the economic recovery and create new employment opportunities.
With that in mind, one would think that it would be a no-brainer for politicians to reach a compromise and create the conditions for increased investments in infrastructure. A cynical soul, like me, would add that we are in an election year, when politicians in search of votes and campaign contributions tend to be even more sympathetic to pressure groups that would benefit from the government’s largesse and are willing to reciprocate. One would hope that at least the self-interested motivations of the politicians would contribute to accomplishing something on that front.
It is a testimony of how broken our political system is, however, that the political class sees in the potential for unified government of their party in 2021 a better way to advance their own interests than the ones offered by the inbuilt incentives for compromise, on an “infrastructure bill.” Perhaps, in a moment like this, instead of increasing the amount of pork to be shared in an attempt to satisfy everybody, the voters could demand a more rational, less dysfunctional way to get something done.
It is important for the citizenry to remember that not all infrastructure investments are the same. It is true that all have something in common in that they are capital investments. Since the resources invested in them could potentially be invested in other things, they can be evaluated by the returns they may generate. We should make sure that the projects pursued pass the “market test”—that is, that they are sufficiently good investments to encourage private investors to put their money on them. Or at the very least, we should make sure that there are compelling reasons, such as the national security considerations related to the backbone of the next-generation (5G) wireless network, that would justify a political decision to pour scarce resources that could be invested elsewhere into any given project. If such justification exists, the political leaders should make their case in front of the American public and transparently assess the costs and benefits of those decisions.
Bureaucracy and Its Discontents
We might wonder why, if there are projects that are likely to be profitable, they are not being built through the private sector without the need of subjecting them to the political process. The answer is simple: red tape, and lots of it. Once we realize that, we are forced to conclude that of all the capital investment in infrastructure (except for the ones necessary for national defense), only the profitable investments are worth pursuing, but that for those, money is not the problem. The problem is getting the legal authorization to move them forward—getting environmental licenses or having administrative regulations lifted or addressed, to the extent that they are reasonable. Those regulatory restrictions all add uncertainty, time to fruition, and direct costs to new projects, making them less profitable, and become the prime reason why they do not attract entrepreneurs and investors.
But wait. Accepted wisdom about the role of regulation says regulations add certainty, not uncertainty! Once you have the rubber stamps provided by the regulatory agencies, you are good to go. Let us put aside for a moment that the frequent recourse to courts in recent years by environmental groups questioning the licensing of construction of pipelines and many other projects, large and small, have changed the assumptions on which such accepted wisdom is based. One of the many problems with the conventional wisdom is that it takes into consideration only what remains profitable after all the costs imposed by regulation (such as the cost of applying for a license without a reasonable confidence that it would be approved, which is no minor consideration). All the projects that no one ever applied for, or applied once but abandoned before approval, or approved and never executed are not part of this picture.
Evidence of this sad truth that just in the last few days two major infrastructure investments, the Dakota Access Pipeline, and the Atlantic Coast Pipeline, have been shut down, the former being told by a judge to stop work, and the latter having canceled their investments citing regulatory uncertainty as the main reason. Let us allow that to sink in for a moment. At a time when the country desperately needs investments, private investors are being forbidden to operate and forced to suspend projects in which they have already invested billions with the consequent loss of production, employment, and income. Yet this is only true because we, as a country, cannot create a regulatory environment that is not subjective, conditioned to the whims of the moment, and open to political shenanigans. In the face of such uncertainty, there is no wonder that some projects only move forward if the government is willing to subsidize them.
However, if government wants to make certain opportunities more appealing to investors, there are several other ways to do so. The most obvious one is simply by subsidizing them. If the revenue generated by operating this or that new facility is not enough to make it profitable, the government can offer a handout covering some of the cost.
Subsidies and Risk
But governments often choose not to directly subsidize because the level of transparency can be politically damaging. (Public opinion tends to reject throwing taxpayers’ money away on bad investments.) Therefore, typically, the government decides to take the risk of the project itself—that is, it simply hires someone to build that piece of infrastructure to be managed by the government directly. Even if a given bus lane, rail service, or other project does not generate sufficient revenue to repay the bonds issued to fund it, requiring constant cash inflows from the treasury to pay its operational expenses, it does not look so bad as paying $100 million of taxpayer money to a contractor to build something that, once finished, only values at a fraction of its cost (which happens all the time with infrastructure projects).
If the Federal government decides to promote infrastructure investment in this way, though, it will need to borrow or create money out of the blue. That would be ugly under the current fiscal circumstances. Left-leaning economists would say that in a time of crisis, with construction equipment idled and people in need of work, the government must step in and spend if the private sector is not spending. That may be true as far as it goes. Nevertheless, if the government wants to do something to reduce unemployment and to use the full productive capacity of the country, the surest way is to create the conditions for profitable enterprises in an open and competitive market, not to subsidize them. In any case, we must not forget that if the government borrows in order to spend, it will need to repay the investors in the future. If the government creates money out of nothing, it is in essence taxing people for holding money (as it is always the case with inflation) and the net result, other than transferring income from some to others, is doubtful.
A better way that the government may help to induce capital investments is to reduce the regulatory cost by reducing discretion in the approval processes, streamlining the procedures, and reducing unreasonable restraints. That will help more people find investing to be in their interest, and it offers a model for how government may incentivize investment in other fields as well.
Investments Worth Making
This approach eliminates the barriers that prevent the private sector from spending and investing. When subsidies are given to particular projects, they create all sorts of moral hazards, cronyism, and plain corruption. Reducing the regulatory burden, on the other hand, allows a thousand flowers to blossom under the rule of law and the fair play of a competitive market, as long as the projects are profitable or likely to become profitable.
In Mr. Trump’s time as a real estate developer, he had significant profit motivations incentivizing him to make sound investments, and even so, he did not hit the mark every time. There is no reason to think that his administration would do any better than previous administrations in playing favorites. (Just think of Obama’s Solyndra debacle. There’s no reason to think Trump and his appointees would invest with any greater wisdom.) It would be much better for him to use his good instincts, and whatever political capital he may still possess, in order to advance a drive to reduce regulatory constraints, burdens, and uncertainties such as the Mercatus Center’s “Fresh Start Initiative.” That would allow the market to sort out which infrastructure investments are worth making.
A maverick like Trump may have the mettle to take bold action, like privatizing air traffic control or pushing for a new wave of cost-reducing deregulation, which would do better to boost innovation, capital formation, and ultimately employment. This should be preferred to shoving billions of dollars into trains to nowhere or similar forms of traditional government wealth destruction. We cannot spend ourselves out of this recession, and putting money into losing investments will make us neither wealthier nor more productive.