Investing for the Future

Five Principles to Guide 21st Century Infrastructure Investment

 

In the forthcoming book Infrastructure Economics and Policy: International Perspectives (Cambridge, MA: Lincoln Institute of Land Policy 2021), edited by José Gómez-Ibáñez and Zhi Liu, some 20 international authors offer perspectives that can help us evaluate the infrastructure investment proposals currently being considered in Washington.

Here are the top five takeaways to consider in any infrastructure investment package, based on extensive research into the ingredients for success:

Think Long-Term Growth, Not Quick Stimulus

Infrastructure investment typically increases a country’s GDP, but contrary to the conventional wisdom, it’s not an effective way to provide a quick economic stimulus to cut short a recession. The pipeline of so-called “shovel ready” projects is usually relatively short, and it takes many years to secure the permissions and funding necessary to begin construction on a new project, by which time the recession is typically over. Moreover, the image of infrastructure providing opportunities for unskilled labor is also misleading. Modern construction projects often involve sophisticated equipment and require extensive training; they do not offer pathways to quick employment for large numbers of unemployed service-sector workers.

Shovel-Worthy Matters, Not Shovel-Ready

The returns on investment depend importantly on the quality of specific projects being funded. Economists have developed and refined methods for estimating the value individuals place on the various benefits and costs of a project. The resulting difference between the benefits and costs, or the net benefit, can be interpreted as the measure of how much society will gain or lose from implementing the project. Most federal infrastructure agencies are required to prepare benefit-cost analyses of the major projects or policies they are considering and of the relevant alternatives to those projects. However, the U.S. Congress seldom, if ever, requires the agencies to adopt the alternative with the highest net benefits because of political considerations, including the concern that benefit-cost analysis might not adequately reflect goals of fairness and equity. While cost-benefit analyses are not perfect, they are one of the best tools available for evaluating infrastructure proposals. Agencies should beware of departing significantly from the alternative with the highest net benefit without good reason.

Beware of Over-Confidence and Over-Optimism

One of the drawbacks of cost-benefit analyses is that they typically assume that the forecasts of the project’s usage, costs, and other dimensions of performance are accurate, when in fact they are biased. A landmark analysis of some 2,000 infrastructure projects found that actual costs were significantly higher than forecast, while usage was significantly lower, as Bent Flyvbjerg and Dirk W. Bester explore in a chapter of the forthcoming book. This pattern might arise if the agency executing the projects bore little liability for cost overruns and demand shortfalls. Such arrangements are rare, however; instead, the authors blame several well-known behavioral limitations, particularly overconfidence bias and optimism bias. Fighting against these biases is difficult because they are so deeply ingrained in human nature. Still, some measures suggested by the authors are worth considering, such as holding the forecasters legally accountable or using independent audits.

Take Equity Seriously

The benefits and costs of infrastructure projects are often distributed inequitably. On the one hand, major infrastructure facilities such as highways and power plants are often built in locations where the negative impacts are felt disproportionately by low-income residents and people of color. On the other hand, the lack of access to basic infrastructure, particularly in the developing world, impairs quality of life and contributes to inequality. Studies from the developing world show that access to an all-weather road or to the regional electricity grid can stimulate economic activity, narrow the gap between rural and urban incomes, and reduce the economic disparities between villages. In the United States, the Rural Electrification Administration, created during the Great Depression and now part of the U.S. Department of Agriculture’s Rural Utilities Service, is an example of a successful investment that raised living standards for many. The counterpart today is broadband internet, once considered something of a luxury but increasingly necessary to support electronic banking, remote learning, telemedicine, and other valued services in urban and rural areas alike.

Consider Governance Challenges

A final takeaway is to consider how a major investment program might require changes in how the infrastructure system is governed, including the roles of the public and private sectors but especially those of the national and state or local governments. State and local governments have historically been deeply involved in regulating both private and government-owned infrastructure for several reasons: The initial motivation was to protect against monopoly in sectors such as electricity. In addition, infrastructure’s importance to everyday life makes access an important concern for local government. Finally, the adverse impacts of facilities on their surroundings make siting controversial, leading state and local governments to intervene in order to manage competing interests. However, the advent of a major new infrastructure program—particularly one focused on decarbonizing the energy system to reduce climate change—will increase the national government’s role. First, national government is almost uniquely positioned to invest in future technologies for which there is not yet a sufficient market to fuel innovation, and to drive responses to large-scale problems that require collective action. In addition, decarbonization will likely require major new investment in renewable generation and longer transmission lines crossing more state borders, shifting disputes about siting new facilities to the national level. Further, national government will face pressure to mitigate the economic impact of its climate change policies—for example, compensating owners of fossil fuel plants and other assets that lose their value. These governance challenges may prove even more difficult than the financial challenges that current debates focus on.

In sum, the success of any infrastructure plan ultimately depends on the type and quality of the projects selected. The quality of the projects selected will depend on the quality of the supporting benefit-cost analyses, and on the ability of leaders to think strategically for the long run, commit to equitable outcomes, and sensibly balance national and local oversight.

 


 

Image: iStock.com/lavin photography

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