Let's Privatize Our Roadways

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The good news for environmentalists and those who want to wean the U.S. off foreign oil is that the rising cost of gasoline has sparked a sharp downturn in driving, with Americans driving 3.7 percent fewer miles in May than they did in May, 2007, according to a new report by the Department of Transportation.

The bad news is that the decline has also caused a steep drop in revenues from gasoline taxes used to build and maintain our vital transportation infrastructure, raising the specter that our federal transportation fund will have a $5 billion deficit by next year, after years of surpluses. The states, which collect their own gas taxes, are likely to get hit even harder because all but six states have fuel taxes which are higher than the 18.4 cents a gallon charged by the feds, including a whopping 74.9 cents a gallon in California, 70.8 cents in Connecticut, and 66.6 cents in Illinois.

With America already underspending on infrastructure by about $130 billion a year, the country will require new financing sources in the era of high gas prices, especially when one-quarter of our bridges are deemed in poor shape, and one out of every seven miles of road pavement is considered “unacceptable.”

Here’s an area where the U.S. can learn from the many other countries around the world which for years now have been tapping huge pools of private capital to help build, maintain and operate roads, bridges, tunnels and mass transit systems. Some 3,400 miles of toll highways linking cities in France have been built with money from private investors. The United Kingdom has used so-called build-to-operate agreements with private companies and capital for 20 years to finance new roads, tunnels and bridges. Developing countries as different as Mexico, Thailand, Malaysia, and Indonesia have followed suit to one degree or another. China is using private capital for a massive road building effort which involves linking its major cities with super highways.

One reason such efforts have been successful is that there is plenty of capital out there looking for the kind of solid, predictable long-term returns that this investing brings. Huge global pension funds with very long investing horizons have targeted this area, which is considerably less volatile than investing in equities (or mortgage-backed securities, it seems). In a typical deal, a bank or investment house managing pension money partners with a company that is experienced in operating roads or bridges, and the pair either build or take over an existing road with tolls on it, then contract to operate it for many years in exchange for the toll revenues. In return, government typically gets an upfront payment, which in the case of existing roads that don’t have to be constructed, can be enormous. Government can use that money to provide further transportation building, especially of roads or bridges that can’t pay for themselves by being tolled.

The technique is so widespread and attractive that a few places in the U.S. have already tried it with surprising results. In Indiana, Gov. Mitch Daniels, facing a $3 billion transportation funding shortfall (even before the current spike in oil prices), put the operation of his state’s tollway up for bid. A state analysis estimated that road was worth some $1.8 billion, but the winning bid astounded officials: $3.8 billion from an international consortium to maintain and operate the road for 75 years.

The deal was no fluke. Chicago Mayor Richard Daley did the same with the city’s Skyway, which investment bankers estimated was worth $900 million. Instead, it fetched $1.8 billion from an international group that will run and maintain it for 99 years. Both deals include extensive operating agreements, stretching to hundreds of pages, which place limits on toll increases, and set out maintenance and operating standards that essentially require the companies over the life of the contracts to virtually rebuild the roads as they age. If the private operators fail to live up to the contracts, they risk losing their right to manage the roads and, in the process, their huge upfront payments.

How can the private bidders afford to pay so much? For one thing, the bidders are confident they can increase the efficiency of operating these roads, thereby generating more revenues and lower costs than when the roads operate under government supervision. In some cases that results from doing simple things that government managers aren’t incentivized to do, like adding electronic toll collection where it doesn't exist or buying automated coin counting machines to free toll collectors from laborious accounting jobs, and bidding out snow plowing and other contracts without the burdens of bureaucratic and rigid government bidding processes.

Some of the private operators who run these roads are also far more experienced than your typical local, state or city highway department, which can be a hotbed of patronage appointments. Proponents of a plan to privatize the Pennsylvania Turnpike note the steep costs and patronage legacy of the state’s Turnpike Commission, which employs 2,000 people, including more than 500 in administrative positions, to operate a 537-mile road. An analysis of the turnpike’s operation by the Reason Foundation determined that the authority spends 62.4 percent of its toll revenues on operations and maintenance, while the average among private operators is 27.6 percent.

The moves by Chicago and Indiana have certainly sparked more interest in this financing and operating technique, especially in places where population is growing rapidly and the need to build new roads outstrips government’s ability to pay for them. Texas, for instance, has looked at using build-to-operate agreements to construct some of the massive Trans-Texas highway. About half of states now have legislation which allows these sorts of transactions.

Still, opposition has arisen from a variety of places, including public sector unions who don’t want to see these assets in the hands of private operators, state pols who relish the rich patronage opportunities provided by government control of transportation agencies, and proponents of “economic nationalism” who don’t want to see our essential assets auctioned off to foreign bidders (although, of course, the investors can’t actually take these assets overseas).

In Pennsylvania, Gov. Ed Rendell’s plan to lease the Turnpike has met with tough opposition, even though a private group has offered an astounding $12.8 billion to operate the road for 75 years. Opponents have presented an alternate plan that would keep the road in the hands of the bloated Turnpike Commission and use bond offerings secured by future toll revenues to raise capital now, but that plan doesn’t provide enough money to meet the state’s needs, some argue, and would require new tolls along U.S. Route 80 in Pennsylvania, which is now free. In Texas, meanwhile, opponents of private deals in the state legislature are threatening to rescind the state department of transportation’s ability to contract with private operators for building the Trans-Texas highway.

Of course, this opposition arose before the sharp slump in driving that began in April and accelerated in May. Considering the shape of our roads and bridges, and the fact that even during flush tax-times we’ve consistently underinvested in infrastructure, it is going to get harder and harder to ignore the huge pools of private capital that would welcome a chance to invest in the transportation future of the world’s biggest economy.

Steven Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute

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