All that is solid melts into air
My piece in Thursday’s Fin caused a modest stir by quoting Karl Marx, offset to some extent by an allusion to Schumpeter. It’s mainly about how to finance infrastructure investment, given that the PPP model looks to be off the table for some years to come.
â€˜All that is solid melts into airâ€™. At times like the present, it is hard to go past this description of the creative and destructive power of capitalism, written by Karl Marx in 1848 and later amplified by the great Austrian economist Joseph Schumpeter.Â
In the financial boom that preceded the current crisis seemingly solidÂ and local institutions like home mortgages were transformed into gossamer webs of financial obligations that spanned the globe many times over. Mortgage-backed securities were sliced into collateralised deposit obligations (CDOs) which in their turn gave rise to CDO-squareds and then to synthetic CDOs based on portfolios of credit default swaps (CDS), with no underlying assets at all.
Now all this is melting away like fairy floss, bringing households, financial institutions and governments face to face with some harsh realities and difficult choices. On the one hand, we must navigate a way through the current crisis. On the other hand, we must prepare for the future, without relying on the assumption that things will soon return to â€˜normalâ€™.Â
Nowhere is this challenge more difficult than in relation to infrastructure. The need for substantial investment in physical, and, even more importantly, human and social infrastructure has never been greater. New ways of meeting these needs are required in the light of the crisis. But, given the speed with which markets have unravelled, policies based on outdated assumptions continue to move forward.
The decision of the Council of Australian Governments last week to bring forward the $20 billion Building Australia Fund appears as a necessary response to the crisis and, in particular, the likely slowdown in construction activity.Â
On the other hand, the same meeting proposed a new push for Public Private Partnerships, based on a report from ABN AMRO estimating a potential contribution of $80 billion from this source over the next decade. Only a few days later at the Australian Davos Connection Infrastructure 21 Summit in Brisbane on Tuesdays, this projection was greeted with scepticism, to say the least.
The pace at which events are rendering past projections irrelevant was underlined by the news that, in the few days between these meetings, ABN AMRO had itself been swept up in the crisis. Following the failure of part-owner Fortis, its Dutch operations were nationalised over the weekend. With co-owner Royal Bank of Scotland also on the brink of failure, the future of ABN AMRO is decidedly cloudy.
With news of the crisis unfolding almost hourly, the task of the Finance group at Infrastructure 21 (of which I was a member) was challenging in the extreme. There was general agreement that government would have to take a more direct role in infrastructure funding for the next few years at least, along with a desire to ensure that the benefits of improvements in contract design, realised in recent years, should not be foregone. Beyond that, a range of ideas were put forward, though with an awareness that any plan made today is likely to need substantial revision in the near future.
The problem of financing new infrastructure is complicated by the need for radical changes in pricing to respond to climate change, water shortages and the need for congestion pricing in urban transport. Such changes will undermine many of the pricing models used in past projects.
The standard PPP model involves assumption of demand risk for individual projects by private owners, but this makes little sense when, in most cases, governments are responsible for managing the risk of the system as a whole.Â The problem was obscured in the past, when risk transfer was largely spurious. But genuine risk transfer inevitably entails large losses for some asset owners.Â
As a result, the appetite of private investors for taking on the demand risk associated with greenfields PPP projects was declining even before the credit crisis. To respond to this challenge, some members of the Finance group suggested a model in which State governments might take on demand risk in the early stages of a project, then selling assets when income flows stabilised. The buyers might be superannuation funds or a new Australian government business enterprise, run along lines broadly similar to those of the old Australian Industry Development Corporation.
In the midst of the current conflagration, it is hard to discern the outlines of the new system of financing infrastructure investment that will emerge from the crisis. Almost certainly it will entail a substantial rebalancing of the roles of the state and financial markets. Meanwhile, the infrastructure challenge will not go away.
John Quiggin is an ARC Federation Fellow in Economics and Political Science at the University of Queensland.