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Urban Infrastructure: Problems and Solutions RICHARD R. MUDGE and KENNETH I. RUBIN WHAT IS INFRASTRUCTURE, AND WHY IS IT IMPORTANT? Users of inadequate public works facilities bear significant costs. Every time a bridge is closed to traffic or subjected to weight restric- tions because of deterioration, users' time and money are lost. For example, operating costs for small automobiles are almost one-third higher on poor roads than on well-maintained roads (Congressional Budget Once, 1983~. In the worst cases, there may also be substan- tially increased safety risks. The deterioration of existing facilities and their insufficient ca- pacity to accommodate future growth will eventually constrain eco- nomic development. The nation's urban transportation network, water supply, and wastewater treatment facilities all provide vital services both for industries and individuals; where capacity is inad- equate, growth will be stunted. Similarly, a community with badly deteriorated roads, bridges, or other transportation facilities is in a weak position to attract new businesses. Although clifficult to quan- tify, the costs of lost opportunities are no less real. For example, This paper is based in part on a series of reports on public works in- frastructure prepared by Apogee Research for the National Council on Public Works Improvement. 308

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URBAN INFRASTRUCTURE: PROBLEMS AND SOLUTIONS 309 according to a 1983 Transportation Systems Center report, halting deterioration (but not eliminating all deficiencies) in the nation's highway network would improve economic growth for the economy as a whole: national income would be 3.2 percent higher by 1995, employment would be 2.2 percent higher, and inflation would be 8 percent lower than if road conditions had continued to deteriorate as in the late 1970s (Transportation Systems Center, 1983~. Why Is It Infiast~cture? and Infrastructure projects are not ends in themselves. Rather, their importance to the economy and to society as a whole derives from the services they offer: the opportunity to improve productivity or reduce costs. Although most easily thought of in a physical form a bridge, a wastewater treatment plant, a subway train the real output of infrastructure is service: the movement of people and goods, the provision of adequate clean water, and so forth (Apogee Research, 1986b). Infrastructure generates additional investment or economic ac- tivity through a multiplier effect on private firms or other public agencies. This process occurs in several ways: ~ by making better use of underutilized resources that previ- ously were very costly or difficult to obtain; ~ by enabling more efficient trade-offs among factors of produc- tion (for example, reduced transport costs versus a location closer to markets); by reducing costs and thus increasing economic efficiencies; by expanding markets as improved efficiency results in more effective competition with other countries or regions. In other words, infrastructure encompasses those activities without which there would be only limited economic activity. In particular, most public works infrastructure projects share several character- istics: (1) high fixed costs (they are capital intensive); (2) a long economic life; (3) the potential to dominate local markets; and (4) interaction with other infrastructure projects. Because of their long time horizons and high construction costs, major infrastructure investments usually involve higher risks than the more typical industrial investment project. As a result, some public sector involvement is often required. Also, most infrastruc- ture projects are part of a larger systemfor example, a national

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310 Richard R. Mudge arid Kenneth I. Rubin road network or a regional water supply system. The coordination required for projects of this type means that some public involvement is needed even if the projects are financed privately. Also, because of the high costs of market entry, many infrastructure projects have near monopoly power in their local markets. As a result, economic and safety regulations are often required. Facilities with these general characteristics strong links to eco- nomic development, high fixed costs, long economic life, interaction with other parts of a system, and strong traditional public sector involvement may be termed public works infrastructure. When applied to urban areas, this definition usually inclucles the follow- ing "modes": highways, public transit, wastewater treatment, water supply, solid waste, and airports.) Despite these special characteristics, infrastructure has much in common with other sectors of the economy, particularly those that involve capitalinvestments. By definition, allinvestments require deferring current consumption to achieve greater consumption in the future. As a result, infrastructure must compete for financial and human resources with other public and private activities. In this sense, even though they may generate important public benefits, proposed infrastructure projects require the same careful analysis as should be applied to other investment projects. Why Is It Public? Projects that can be characterized as infrastructure may be pro- vided either by the private or the public sectors. Indeed, the division of responsibility between public and private bodies varies consider- ably by infrastructure mode, by country, and by historical period. For example, freight railroads are now almost completely private even though in the nineteenth century they received large public contribu- tions. Also, telecommunications is a private sector responsibility in the United States, but in most other countries it is publicly owned. A number of straightforward rationales help determine the de- gree of public sector involvement in providing infrastructure services. Except for the lack of strong current public involvement, such areas as communications and electric utilities would fit the public works infrastructure characteristics set out in the text. Other observers might cite a broader list: government buildings, housing, prisons, hospitals, education, and so forth.

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URBAN INFRASTRUCTURE: PROBLEMS AND SOLUTIONS 311 The applicability of each rationale may change according to the Toca- tion of infrastructure ant] its developmental stage. These rationales include: . The public good nature of infrastructure. The benefits of certain public activities are received by society as a whole. In these cases, individuals cannot be assessed the costs of the activities (tliis is sometimes called the "nonappropriability" problem). National defense provides the classic example of a public good.2 Externalities. The full impact of some actions may not be borne directly by the individual or group responsible for the action. Because the benefits or costs are received or borne by others, there are incentives to under- or overinvest.3 Infant industries. The potential rewards from developing a new industry may be so uncertain or remover] in time that outside help is needed to share development risks.4 The major economic eject of public aid for infant industries is to bring forward the time when society benefits from a mature industry not to determine the industry's ultimate success or failure. The timing of such support is the key to its effectiveness and is not always obvious. Investments may be premature, as with Dulles Airport in suburban Washington, D.C. Regional development. Underutilized resources can justify public investment as a means to greater growth. In addition, infras- tructure spending and the growth such projects may generate are sometimes used as mechanisms to redistribute income.5 Further, 2Defense is also often closely linked with infrastructure development. Some examples include the development of ports and inland waterways by the Army Corps of Engineers in the last century, the construction of the interstate highway system over the past 30 years, and certain current port proposals. 3Examples of externalities include dirty water that affects downstream communities and extra peak-hour travel that increases the delay for all other travelers. Solutions to these problems usually involve regulatory or financial action by another level of government. 4The clearest examples concern interurban infrastructure; public support for railroads and canals in the nineteenth century and federal promotion of the aviation industry through mail contracts and the air traffic control system are two such instances. 5 Using infrastructure to redistribute income ignores the primary consider- ation that applies to decisions on infrastructure projects: how productive is the investment relative to the benefits from greater productivity? The Appalachian Regional Commission is a good example. Despite substantial expenditures to repair and revitalize the old and decayed infrastructure of Appalachia, there is no indication that the area developed more rapidly than it would have without

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312 Richard R. Muddle and Kenneth I. R?`bir~ regional competition for new development is a prime motivator for locally sponsored infrastructure projects. :[nfrastructure's Role ~ Fostering Economic Growth and Employment Functional View of Infrastructure Infrastructure problems may be considered in two different con- texts: (1) the physical (removing existing deficiencies, meeting re- curring problems, or adding capacity for expansion), and (2) the functional (considering population-based needs versus those required to produce goods and services). The physical view is the traditional approach to defining prob- lems and framing solutions. The functional or economic view of infrastructure has two components: one based on population and the other on production. The first or core component of infrastructure demand depends on individual needs that, in turn, are a function of personal tastes, income levels, and location. Examples might include local travel needs such as trips for work, shopping, anct recreation. These components change relatively slowly and depend on social and population makeup: for example, age distribution, family structure, disposable income, and residential location. The second component is oriented toward production; that is, what is needled to produce goods and services. Infrastructure needs under this portion change as the economic base shifts among agriculture, manufacturing ser- vices, government, and foreign trade. 07 The functional view serves three purposes: (1) as an aid to understanding the role of public works infrastructure in fostering economic growth; (2) as one explanation for the development of different public and private roles; and (3) as a possible explanation for recent trends in infrastructure spending. These latter two points are discussed in more detail in the next sections. the expenditures. The most successful infrastructure investments were not those linked to income redistribution but those designed to make resources more com- petitive and to lower costs. The Tennessee Valley Authority is a prime example of this kind of investment.

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URBAN INFRASTRUCTURE: PROBLEMS AND SOLUTIONS Caveats About Economic Growth 313 Although there is an obvious link between infrastructure in gen- eral and economic growth, this link generally must be taken on faith. There have been few attempts to measure the magnitude of the effect and how this link functions, except in the case of developing countries and for certain individual projects. As with every econorn~c sector, investing in projects with rel- atively low rates of return diverts resources from other potentially more productive economic investments. Investments of this kind may be made because of limited information on alternatives or because of financial incentives that distort investment decisions (e.g., overly generous matching grants); however, whatever the reason, if such a policy is pursued, overall economic growth will be smaller than would otherwise occur. This problem is not unique to the infrastruc- ture sector but can also occur in housing, steel, defense, and other industries. The effect of inefficient investment decisions can be seen in an economic simulation of the costs of removing all highway defi- ciencies that was carried out by the Transportation Systems Center (19833. This study found that the costs exceeded the expected eco- nomic gains from better roads. Thus, even if a particular infrastruc- ture program stimulates economic growth, the question that must be asked is whether there are other investment packages (public or pri- vate) that might bring about even higher rates of social and economic return. DIFFERENT PUBLIC ROLES The relative incidence of benefits and costs is the key link in determining the proper infrastructure role for the public and private sectors and for the various levels of government. There are strong equity and efficiency arguments that those sectors receiving great benefits from a particular infrastructure mode should bear an equally large share of the financing responsibility. When an imbalance ex- ists between benefits received ant! financial responsibility, there are strong incentives either to over- or underinvest. (For example, it is doubtful whether New York City would have pursued the develop- ment of the Westway highway project if the federal government had not been paying 90 percent of the costs.)

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314 Richard R. Mudge arid Kenneth I. Rubin Public Versus Private Combining the physical and functional definitions of infrastruc- ture helps provide a framework for considering what the public and private infrastructure roles should be and how they have evolved in the United States. Table 1 summarizes the interaction between these two views. Historically, the private sector in this country has been most actively involved in areas that increase capacity for production (see the lower right corner of Table 1~. These are also areas in which the beneficiaries have been able to pay for the benefits re- ceived, in part because they faced growing markets. Examples of this phenomenon vary by historical period, however. For in- stance, in the early nineteenth century, canals were privately owned in large part because they were seen as an efficient way to serve the nation's growing industrial capacity. Similarly, this combina- tion of growth and key economic ties explains why the communica- tion portions of infrastructure telephone, telegraph, and electronic communications have been dominated by private firms from their inception. Once a particular infrastructure mode receives public subsidies, it becomes more Biscuit for that mode to revert to an organization TABLE 1 Comparison of Functional and Physical Views of Infrastructure Functional (Economic) Roles Physical Core or Population Problems Based Economic or Production Based Maintain system Intraurban Increase capacity Public sector dominates Intraurban Sunbelt Public sector dominates Interurban "older" systems (canals, highways) Public sector dominates Interurban Communications, airlines Greater chance of profits Strong private role SOURCE: Apogee Research (1986b).

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URBAN INFRASTRUCTURE: PROBLEMS AND SOLUTIONS 315 having a strong private sector role. The larger the subsidies and the longer they are received, the more difficult this reversal becomes; witness the current efforts to restore a private role in urban mass transit. The line between public and private involvement is sometimes difficult to draw. Pennsylvania now permits the establishment of independent transportation districts that are funded in part by as- sessments on local developers. For example, Upper Merion (near Philadelphia) is financing some $66 million in highway improvements, with one-half the funds from assessments on new development the rate is $933 for each peak-hour auto trip generated, or one-half the estimated capital costs of $1,866 for each new peak-hour auto trip.6 Texas has a program whereby developers help defray the costs of new roads by contributing land for rights-of-way, thus speeding construc- tion. Over the past 2 years, some $400 million of donations have been received under this program. As a result, there appears to have been a shift in priorities in state highway projects. Many private infrastructure projects involve indirect public fi- nancial support. For example, tax-exempt industrial development bonds provide interest rates below those available to other corporate borrowers. As with other private capital investments, rapid depre- ciation schedules and investment tax credits are available as well, although this may change with the new tax bill. Private involvement in infrastructure projects depends on the level of risk or uncertainty. Risk increases according to the size of the investment required and the degree of market uncertainty. Even massive projects can be financed privately if market uncertainty is Tow enough; the Trans Alaska and Trans Canada pipelines were privately financed and built, based on long-term contracts and take- or-pay agreements. At the other extreme, if market uncertainty is high because there are no commitments from end users, some form of public support or guarantee may be required for even modest projects (public transit is an example) (TELESIS, 1986~. 6In some cases, developers find it less expensive to make their contribution in kind by contracting for the improvement work directly. Partly because of this, Upper Merion has volunteered to double its contribution for state-local highway projects to 50 percent if the state department of transportation will provide additional funds. For a discussion of other new approaches to financing urban infrastructure, see National League of Cities (1987~.

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316 Current Roles Richard R. Mudge and Kenneth I. Rubir; State and Local Versus Federal The existing division of responsibility among local, state, and federal governments derives largely from past history and political forces and only partly from a logical examination of the distribution of benefits and of financial and operational capabilities. Beyond those areas of clear, overriding national interest- inter- state highways, the network of inland waterways and canals, and the ear traffic control systems federal involvement depends on the importance of externalities and the strength of arguments to relieve local fiscal pressures.8 For example, some federal role is called for in water and air pollution, a recognition of which has resulted in the Environmental Protection Agency (EPA) construction grants program and federal regulations. On the other hand, the major rationale for the federal transit program is ~ desire to help solve local fiscal problems, and most federal aid for urban water supply systems is targeted at fiscally stressed areas. Yet any attempt to separate federal from other responsibilities does not mean that the condition of "local" infrastructure is not important to general econorn~c growth. Because these areas are vital to regional growth as well, however, adequate incentives for local support should already exist. Development Stages The current roles of each level of government vary considerably according to the stage of the infrastructure development process. Five separate but related stages can be identified: (1) nomination, or the identification of candidate projects, including major new capital investments as well as routine replacements and maintenance options; (2) evaluation, in which potential projects are analyzed and those to receive funds are selected (this process can range from highly techni- cal and formal to ad hoc procedures); (3) finance; (4) construction; and (5) operation. 7In fact, the federal government currently plans, finances, and operates both the inland wateray and air traffic control systems and provides 90 percent grants to construct interstate highways. bother traditional arguments for public roles are limited. Today, there are no new regions of underutilized resources, and infant industry arguments appear to be restricted largely to special cases such as space transport.

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URBAN INF~4STRUCTURE: PROBLEMS AND SOLUTIONS TABLE 2 Degree of Federal Involvement (percentage) by State in the Development of Public Works Mode Nominatea Evaluate Finance Construct Operate Highways Interstate 50 0 91 0 0 Other federal 0 0 50 0 0 State-local 0 0 10 0 0 Transit 20 40 70 0 0 Airports Large 0 20 20 0 0 Small 0 0 50 0 0 Wastewater 0 0 55 0 0 Water supply 0 0 15 0 0 Solid waste 0 0 0 0 0 NOTE: These percentages are overall averages; rankings for particular facilities will vary considerably. aFederal engineering standards often play a key role in identifying and evaluating projects. In addition, governmental economic, environmental, and safety regulations can influence any stage. SOURCE: Based on data from the Office of Management and Budget (1986) and the Bureau of the Census (1986~. 317 These stages are not of equal importance. Missed opportunities in the nomination and evaluation stages are costly to correct. Fur- ther, the steps are neither independent nor always sequential. Most importantly, the terms and availability of financing has a major ef- fect on the number and types of projects that agencies nominate, on the rigor with which they are evaluated, and on the trade-offs made between capital-intensive and operating proposals. For example, now that it is clear that a significant local contri- bution (50 percent or more for deep-draft ports) will be required for local port development, projects are being reevaluated. By changing its channel design, Baltimore will save about $100 million or one- third of the original cost projection. Similarly, Norfolk has cut the cost of its deep-draft development in half. Table 2 summarizes how the current federal role varies across the five development stages and each of the major urban public works infrastructure "modes." The federal government plays a significant role in financing almost every area of infrastructure except solid waste and water supply. State and local governments dominate the

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318 Richard R. Mudgc and Kenneth I. Rubir' nomination and evaluation stages of the process, including roughly 80 percent of the areas in which federal funds predominate. Except for a small (14 percent) proportion of mass transit, virtually all operating and maintenance funds for urban infrastructure are provided by state and local governments. While considerable attention is being given to encouraging a greater private sector effort in financing public works infrastructure, the present level of private involvement is quite limited. Currently, this effort is most significant in water supply projects, for which pri- vate firms supply about 20 percent of total funding (Congressional Budget Office, 1987~. Also, private firms make significant invest- ments in port development facilities. Private involvement in other public infrastructure sectors, such as wastewater treatment, airports, and transit, is limited to 2 or 3 percent of spending. Of course, with the exception of mass transit, corporations and individuals provide most transportation rolling stock- such as buses, trains, cars, and airplanes. Regulations Federal or state regulations form an important "overlay" to this "normal" five-stage development process, even when no funding is involved. Environmental rules provide the most important examples. Federal clean water and clean air rules have forced localities to modify their investment plans quite significantly. The costs of infrastructure projects are also influenced by federal labor rules. By setting minimum wage levels, the Davis-Bacon law increased the costs of virtually all construction projects that use federal monies. Similarly, because of the Urban Mass Transportation Administration's Section 13c rules, many transit operators do not use certain types of cost-effective service in order to avoid conflicts with labor unions. The Development of Current Public Roles Historical Background There is a long history of federal financial aid to the states beginning with the federal repayment of state debts from the Rev- olutionary War. This early financial takeover in particular made it feasible for the states to play a more active role in supporting public works (Break, 1981~.

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URBAN INFRASTRUCTURE: PROBLEMS AND SOLUTIONS 337 capital outlays over the period 1960-1984. Conventional wisdom generally notes the federal contribution to this public works mode as much smaller than its actual amount. ~ Federal grant contributions to total state and local capital outlays for airports have ranged widely but averaged about 30 per- cent. Federal capital grants contributed only 1~20 percent Off the total construction costs of major airports and 70-80 percent of the costs of small airports. Federal grants for all public works modes have remained sur- prisingly steady since 1960 at about $75 per person, more or less. The 1965 local peak in federal grants per capita was due chiefly to highway grants; a similar jump in 1977 was due to the combination of wastewater and transit grants. Trends In the Issuance of State and Local Debt According to the Bureau of the Census, new state and local long- term debt (maturities greater than 1 year) has grown from about $7 billion (in current dollars) in 1960 to $95 billion in 1984. Most of this growth, however, comes from uses that are not defined as public works for the purposes of this paper. For example, bonds for public housing, hospitals, and other "social welfare" purposes now account for about one-third of these new issues. Industrial pollution control bonds industrial development bonds issued publicly and used to fund private investments account for another 16 percent. Educational facilities claim another 8 percent. Public works, as defined in this paper, accounted for about 20 percent of all new debt issued in 1984, which was about the same percentage as in 1980 but roughly a third tower than the comparable percentage in the 1970s and 1960s. As a result of the Tax Reform Act of 1986, this percentage is likely to increase as noninfrastructure areas such as industrial development bonds face new restrictions. The data do not allow a detailed analysis of the role of debt within public works modes, but experience has shown that in recent years, debt accounted for about half of all state and local capital financing for public water supply systems, 10 to 20 percent of highway financing, about 20 percent of transit financing excluding New York or perhaps over 50 percent if New York is included, 90 to 95 percent of airport financing (100 percent for the major hub airports), and perhaps 60 to 70 percent of wastewater treatment facilities financing.

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338 Richard R. Mudge arid Kenneth I. Rubirz Trends in the Use of Own-Source Funds to Finance Public Works State and local own-source funds include tax receipts, user fees collected from government-owned or government-run enterprises, and other special charges assessed periodically. These sources generally fund current government operations, but in special cases they di- rectly fund public works construction through "enterprise funds." An enterprise fund is a capital management technique that is used to finance the capital expansion of a particular public works system out of fees paid by users of that system. Some airports finance capital expansion this way by setting up a so-called "sinking" fund to siphon off the excess of current revenues over current expenditures and hold the balance until needed for a future capital outlay. Similarly, some port authorities allocate a portion of their current revenues to en- terprise funds. The highway trust funds maintained by most states operate much the same way, with the exception that projects are built on a pay-as-you-go basis, with annual outlays equivalent to annual revenues. In a recent survey of 529 cities, common city enter- prise functions included water and sewer utilities (when supported by user fees), electric and gas utilities, airports, parking Tots, and local transit (Matz and Petersen, 1985~. Unfortunately, the use of own-source revenues to finance public works is not well documented historically. This is the case with the Census Bureau's and the Bureau of Economic Analysis' (BEA) series on sources of state and local receipts data; these series tabulate revenues by government and by type of revenue but not by use of those revenues. Some of the other data sets that are not centrally collected attempt to link sources of funds to uses, but most are limited in one way or another: they focus on one public works mode, data represent a small sample of all state and local governments, or data have been collected only over a short period of time. This section briefly reviews the trends in the composition of over- all state and local government receipts. It may not be appropriate to extend conclusions drawn from this section to the finance of strictly public works investments. Aggregate State and Local Own-Source Revenues Total state and local own-source revenues have tripled in real terms from some $150 billion in 1960 to $480 billion in 1984. This increase is equivalent to about 5 percent a year in real growth. The

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URBAN INFRASTRUCTURE: PROBLEMS AND SOLUTIONS 339 combined state contribution to this total roughly equals the combined local government contribution. Moreover, the rates of growth in each have been roughly comparable over the midyear period. Interestingly, this 5 percent annual rate of growth in own-source revenues compares closely with the 4 percent annual growth rate in state and local operating expenditures for public works (Apogee Research, 19866~. Trends by Source Between 1960-1984 user fees and other user-based revenue sources accounted for an increasingly larger share of total state and local own-source revenues. That the share of state and local own-source receipts claimed by property taxes fell by about the same amount during the study period suggests a substitution of user-based revenue for property taxes. California's Proposition 13, passed in 1978, provides the most dramatic example, but this trend appears to have caught on in other states and localities throughout the nation. Income and other taxes have also grown slightly as a proportion of total state own-source receipts; sales taxes, on the other hand, have remained relatively stable. The opposite is true at the local level, which has seen a small increase in relative sales taxes and steady property taxes. ALTERNATIVE MODELS FOR INFRASTRUCTURE SOLUTIONS The economic and financial costs of neglecting infrastructure problems can be substantial. These costs include higher long-term construction and repair costs for facilities that are not properly maintained, higher costs borne by users of inadequate facilities, and potential constraints on economic development. Three alternative but related "models" for analyzing and solving public works infrastructure problems are presented in this section: . a needs- or engineering-based approach that emphasizes the identification of facilities and services that do not meet engineering standards; ~ a private sector model that considers the rates of return from public works improvement projects and compares these rates with returns available elsewhere in the economy; and ;

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340 Richard R. Mudgc and Kenneth I. Retire ~ a capital management mode} that focuses on improving the incentives for productive public and private action contained in the way in which fecleral, state, and local funds are provided. Although distinctly different in philosophical approach, all three of these models are closely related. Thus, the needs-based approach can help define the physical problems of public works that are, in turn, a key input to estimating the economic returns from alterna- tive projects. And correctly setting public and private incentives as called for under the capital management view depends on informa- tion assembled using tools that properly belong in one of the other two models. Engineering-Based Mode} An engineering-based needs assessment is the typical first step in evaluating the adequacy of public works (Apogee Research, 1986a). After identifying the scope and efficiency of available capacity in light of present and projected demands, needs assessments highlight two types of specific project investments: (1) those that meet cur- rent demand and (2) those that provide additional capacity to meet projected demand. Removing bottlenecks to meet current demand and improving existing levels of efficiency are usually assigned the highest priorities. Many presentations of needs estimates amount to a picture of a technically possible optimum, an idealized goal measured without regard to economic feasibility and based principally on age, capacity utilization, or technical standards. Age alone ~ not a reliable indica- tor of the demand for repair or replacement; age-based estimates tend to ignore intensity of use, materials, and construction techniques- even the state of maintenance. Standards tend to be vague in the scope of their definitions and, in some cases, "gold-plated." Strong incentives to overestimate needs frequently offset the pressures for cost-effective solutions that budget limits tend to impose. Finally, the analysis is usually based on average standards instead of being site-specific. Priorate ln~restment Mode! If there were no limits on available resources (no budgetary constraints), the entire capital investment program identified by a needs assessment could be carried out without financing problems.

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URBAN INFRASTRUCTURE: PROBLEMS AND SOLUTIONS 341 Yet resources are limited and budgets are constrained, forcing society to make difficult choices among competing investment projects, as well as among competing economic sectors. In the private investment model, the basis for the choice is rooted in the extent to which the project contributes to the economy in effect, its economic efficiency. The private investment mode} applies the same economic criterion of efficiency to infrastructure investments as would be applied to any investment, public or private. In economic terms, the project's contribution to the economy is measured by its return on capital investment. Rate-of-return analysis measures the rate at which current investments will be converted into future consumption Value. As such, it is a key toot used by many private firms to help choose among competing investments. It has seen only limited use, however, as a too! for ranking and then selecting among alternative government investments. A positive rate of return is not enough to justify the selection of a project, however; rather, the return should exceed the rate available on the last project to be invested in the marginal rate of return. The most widespread use of rate-of-return techniques has been by private corporations in which the future strewn of benefits is simply expected profits (or perhaps expected cash flow). The use of these techniques by the public sector obviously requires a broader definition of benefits. This simple description begs a number of serious technical prob- lems with the use of rate of return for government-sponsored projects. Some problems are largely technical and concern the availability of adequate data and estimating techniques: most importantly, what is the proper discount rate? Other problems are conceptual and con- cern the degree to which a technique designed for private, financial returns can be applied to public investments in which intangible out- puts (income redistribution, for example) and returns to the public at large (national defense, for example) are often a key rationale for government involvement. to Rate of return is closely related to a number of other techniques and concepts, including some in regular use by the public sector. These include benefit-cost analysis, in which the ratio of benefits to costs is used to rank projects; net benefits, which calculates the total dollar value of benefits minus the total costs; and the first-year benefit. Other cost-effectiveness approaches might use measurer of physical output instead of financial return, calculating, for example, the number of new passengers per dollar spent on different transit strategies.

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342 Richard R. Mudge arid Kenneth I. Rubir; When applied to public rather than private projects, benefit-cost analysis attempts to quantify the economic returns to the commu- nity as a whole rather than merely the financial returns. This kind of emphasis represents a significant difference from the application of the same techniques to private sector investment decisions. More specifically, a project could generate great public benefits but still show up as ineffective in terms of its financial returns. This difference between public and private costs and benefits is a major justifica- tion for public investment in public works. For example, because a new or upgraded highway provides improved operating conditions, it thus generates savings in user time, operating costs, and reduced accidents. These savings eventually result in greater productivity and lower transport costs and could justify the project even if public financial support were required. Capita] Management Mode] The capital management approach attempts to combine eco- nomic techniques from the private sector model, local data available through the engineering model, and the recognition that an attempt to apply either of these models in their pure form would be likely to run into impossible technical and political problems. A key assump- tion is that decision makers act in their own best interests. Thus, the goal is to find those financial and organizational incentives that, along with adequate data, will encourage actions that support an effective infrastructure. Many of the options presented in the next section might be characterized as capital management, even though they have been debated for years (Congressional Budget Office, 1986~. SOLUTIONS There are two general solutions to public works infrastructure problems: (1) increase funding, and (2) make more effective use of ex- isting resources. These solutions are not mutually exclusive because no matter what the level of funding, there is a natural interest in seeing it used effectively. Given the fact that all levels of government will probably be faced with budgetary pressures for the foreseeable future, a significant increase in general funding for infrastructure is improbable. Infrastructure revolving funds may be one way to es- tablish a new financing mechanism despite such budget pressures.

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URBAN INFRASTRUCTURE: PROBLEMS AND SOLUTIONS 343 Revolving funds are currently used in several states, and at the fed- eral level, they will probably replace the existing EPA wastewater treatment grant program during the 1990s (Congressional Budget Office, 1985b). Thus, the most promising policy alternatives are likely to involve ways to improve the effectiveness of existing as well as any new resources devoted to infrastructure. Managing Demand: [ow-Capital Solutions The purpose of infrastructure is to provide productive services. As such, there is no inherent reason why infrastructure solutions must be dominated by capital-intensive projects. In fact, ways of en- couraging more productive use of existing capital often show greater rates of return than do new investments. For example, the 1968 decision by the Port Authority of New York and New Jersey to quin- tuple peak-hour minimum landing fees for general aviation (from $5 to $25) brought about an immediate decline in aircraft delays of 30 minutes or more (Federal Aviation Administration, 19763. A comparable improvement could have been achieved by adding new airport capacity but not without also incurring massive capital and operating costs. The productivity of Tow-capital options has long been recog- nized. In the early 1970s, Congress even earmarked funding for Tow-capital urban highway improvements (this program was called TOPICS and included traffic signal coordination and high-occupancy vehicle lanes). Indeed, an analysis of recent state and local spending trends for public works infrastructure shows a shift away from capital spending and toward what the data classify as operations. Better Incentives The U.S. economy is governed by free market precepts, under which individuals, acting in their own best interests, increase the productivity of the economy as a whole. The parallel principle for the public works economy may be called "rational parochialism." Most of this nation's infrastructure has been built using one or both of these principles as the rationale for its construction. Thus, it is important that infrastructure programs contain incentives to channel this parochialism along productive lines. The interstate highway trade-in program provides a good exam- ple of the influence of financial incentives. For more than 10 years,

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344 Richard R. Mudgc and Kenneth I. R?~bir' states have been allowed to "transfer" local interstate highway seg- ments back to the federal government and to use the released funds either for transit improvements or alternative highway projects. Since 1980 projects worth some $3.7 billion have been withdrawn. Fully 71 percent of these projects turned out to have had low (often negative) rates of return (Congressional Budget Office, 1986; Skrotzki, 1983~. Thus, when 90 percent funding was available only for new highways, states acted quite rationally in trying to maximize the number of segments that qualified for this level of funding. When trade-ins per- mitted states to keep these funds for other local purposes, they also acted quite rationally in dropping road segments with low economic returns. At present, the federal government provides quite generous matching rates for those programs in which it is active: 70 to 90 percent for highways, 75 to 85 percent for transit, 55 to 75 percent for wastewater treatment plants, up to 90 percent for airports, and, of course, close to 100 percent for most water resources prograrrts. These high ratios of federal to nonfederal dollars have a history of encouraging capital-intensive projects. For example, a statistical analysis of wastewater treatment plants found that dropping the ba- sic federal matching rate from 75 percent to 55 percent would reduce the overall costs of secondary treatment plants by some 30 percent (Congressional Budget Office, 1985a). The Shifting of Current Roles There is always considerable inertia favoring the current division of infrastructure responsibility, whatever it may be. At present, the federal government dominates the funding of infrastructure capital despite the fact that most of the direct benefits accrue to lower levels of government. A realignment of responsibilities could be made based on one of two different principles. First, financial responsibilities could be adjusted to bring them closer to the incidence of benefits shown in Table 1. This adjust- ment would be likely to shift considerable financial burdens to state and local governments (and probably to the private sector as well). Arguments against such a move have usually centered on the heavy new financial responsibilities that would be imposed on state and local governments. Given the significant level of federal user fee fi- nancing of public works infrastructure, however, there may be ways

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URBAN INFRASTRUCTURE: PROBLEMS AND SOLUTIONS 345 to soften the transition (Advisory Commission on Intergovernmental Relations, 1986~. Second, the degree of responsibility for each of the major stages in the infrastructure development process could be realigned more equitably. Because the federal government is the dominant source of funding, this realignment might imply an increased federal role, particularly in the key nomination and evaluation stages (see Table 3~. There would probably be increased costs as the decision process became further removed from the local level. Better Information and Techniques Good information is needed at several stages of the infrastructure development process: engineering and socioeconomic trend data are needed to help develop long-term plans for federal as well as state and local agencies; inventory-type data are required both to help formulate gen- eral policy options and to help identify and evaluate specific local project proposals; and ~ performance measures are needed to help develop and evalu- ate a range of alternatives that includes low-capital options as well as more traditional approaches. System performance measures could also play a valuable role in ex post facto evaluations of program effectiveness, but they are usu- ally ignored. Such a use of performance measures would help greatly in the design of new infrastructure programs and in improvements to existing ones. RlD~lDRENClDS Advisory Commission on Intergovernmental Relations 1986 Dcvol~nng Federal Program Rcapon~bilitic~ arid Revenue Sources to State arid Local Gonc~r~mcut~. Report A-108. Washington, D.C.: Advisory Commission on Intergovernmental Relations. Apogee Research, Inc. 1986a A Review of the Uses and Misuses of Infrastructure Needs Surveys and Inventories. Paper prepared for the National Council on Public Works Improvement. Apogee Research, Inc., Bethesda, Md. 1986b Infrastructure: Issues, Problems, and General Solutions. Paper prepared for the National Council on Public Works Improvement. Apogee Research, Inc., Bethesda, Md. 1986c Trends in Financing Public Works, 196~1984. Paper prepared for the National Council on Public Works Improvement. Apogee Research, Inc., Bethesda, Md.

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346 Richard R. Mudge and Kenneth I. Rubies 1986d Trends in Public Works Expenditures, 1960-1984. Paper prepared for the National Council on Public Works Improvement. Apogee Research, Inc., Bethesda, Md. Break, George F. 1981 1983 1986 Fiscal federalism in the United States: The first 200 years, evolution and outlook. Pp. 39-65 in Advisory Commission on Intergovernmen- tal Relations, The Future of Federalism in the 1980's. Report M-126. Washington, D.C.: Advisory Commission on Intergovernmental Re- lations. Broude, Henry 1959 The role of the state in American economic development, 1820-1840. Pp. 4-28 in Hugh G. J. Aitken, ea., The State and Economic Growth. New York: Social Science Research Council. Congressional Budget Office 1978 Highway Assistance Programs: A Historical Perspective. Washington, D.C.: U.S. Government Printing Office. Public Works Infrastructure: Policy Considerations for the 19808. Wash- ington, D.C.: U.S. Government Printing Office. 1985a Efficient Investments in Wa~tewater lkeatment Plants. Washington, D.C.: U.S. Government Printing Office. 1985b Infrastructure Revolving Funds: A First Review. Washington, D.C.: U.S. Government Printing Office. 1985c The Federal Budget for Public Works Infrastructure. Washington, D.C.: U.S. Government Printing Office. Federal Policies for Infrastructure Management. Washington, D.C.: U.S. Government Printing Office. 1987 Financing Municipal Water Supply Systems. Washington, D.C.: U.S. Government Printing Office. Federal Aviation Administration 1976 Airport Quotas ar~dPeak-HourPrscing: Theory and Practice. Washington, D.C.: U.S. Department of Transportation. Hilton, George W. 1974 Federal Transit Subsidies. Washington, D.C.: American Enterprise Institute. Matz, Deborah, and John E. Petersen 1985 Trends in the Fiscal Condition of Cities: 1983-1985. Report prepared by the Government Finance Research Center for the Joint Economic Committee of the U.S. Congress. National Council on Public Works Improvement 1987a Airports and Airways. Report prepared by Apogee Research, Inc. Washington, D.C.: National Council on Public Works Improvement. 1987b Wastewater Treatment. Report prepared by Apogee Research, Inc. Washington, D.C.: National Council on Public Works Improvement. National League of Cities 1987 Financing Infrastructure: Innovations at the Local Level. Prepared by Apogee Research, Inc. Washington, D.C.: National League of Cities. Office of Management and Budget 1986 Budget of the United States, ~987. Historical Appendices. Washington, D.C.: U.S. Government Printing Office. Peterson, George E. 1984 Financing the nation's infrastructure requirements. Pp. 110-142 in

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URBAN INFRASTRUCTURE: PROBLEMS AND SOLUTIONS 347 Royce Hanson, ea., Per~pectiocs on Urban Infrastructure. Washington, D.C.: National Academy Press. Skrotski Associates 1983 Economics of Completing the Interstate Highway System. Cor~gres- ~iorzal Record, 98th Congress, First Session, 1983, Vol. 129, No. 5, pp. 53533-53537. Tarr, Joel A. 1984 The evolution of the urban infrastructure in the nineteenth and twentieth centuries. Pp. 4-60 in Royce Hanson, ea., Perspectives or' Urban Infrastructure. Washington, D.C.: National Academy Press. TELESIS 1986 Promoting and Financing Large Scale Infrastructure Pro; ects in Europe. Report prepared for the Commission of the European Communities and the Roundtable of European Industrialists. Transportation Systems Center 1983 Highways and the Economy. Report FHWA/PL/33/014, DOT-TSC- FHWA-83-1. Cambridge, Mass.: U.S. Department of Transportation. U.S. Department of Commerce 1980 A Study of Public Works Investment in the United States. Report prepared by CONSAD Research Corporation. Washington, D.C.: U.S. Department of Commerce.