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.

‘All that is solid melts into air’. 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. 

In the financial boom that preceded the current crisis seemingly solid  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 ‘normal’. 

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 But, given the speed with which markets have unravelled, policies based on outdated assumptions continue to move forward.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. 

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.  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. 

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.

10 thoughts on “All that is solid melts into air

  1. I’m an environmental economist who is interested in learning more about infrastructure investment issues. Do you have some good starting places where I can learn more?

  2. Hate to be picky John, but this line stuck in my craw.

    “The need for substantial investment in physical, and, even more importantly, human and social infrastructure has never been greater.”


    On a more substantial note, this seems like a softer line on PPPs than you’ve taken previously.

  3. Finally, it would appear that Marx, as an analyst of capitalism, is coming back in from the cold. I have said for a long time that his diagnoses and prognoses were correct but his prescriptions for reform were wrong.

    The capitalism of Blake’s “dark satanic mills” and Engel’s “Condition of the Working Class in Enland” was reformed by social democracy at work by the ballot, in the parliament, through the chuches and through the unions of working people rahter than by violent revolution. Strikes sometimes led to violence (usually perpetuated by the conservative state) but a violence not to be compared with revolution. Outright revolution unleashes too many negative forces and becomes a conflagration which cannot be controlled.

    Capitalism, like fire, is useful tool; a good servant and bad master. Capitalism must be properly regulated by a social-democratic system. Otherwise, as John Ralston Saul said, “Why have elections if you are going to let the market decide everything by default?”

  4. Nicholas, I do think it is a bit picky. Of course, it’s true that the need was greater, relative to GDP in, say, 1945. But in 1945, and for some decades subsequently, there was no doubt about the willingness of governments to do the job. So, if you like to spell it out “the needed for an expanded public commitment to meet accumulated shortfalls has never been greater”.

    On the soft line, it’s partly that I was reporting the discussions of a group with a range of opinions, and partly that I think in the current crisis, shifting assets and debt from state to national balance sheets might have some real benefits.

  5. Re 5 last paragraph. One of the obvious benefits would be that the government, as representative of the public, would get to see all financial contracts, not only those which fit into the balance sheet. Not sure whether complete transfer of ownership (equity) would be required or only a ‘sufficient’ percentage.

    There are calls for international cooperation, in particular from the US government. It seems to me taxation belongs onto the agenda. For example, one could discuss an agreement on increasing the degree of progressiveness in income tax rates if the extent of the mess (hidden debt due to off-balance sheet items) exceeds the reported mess or if the reported mess has increased ‘significantly’ since the preceding reporting period or both.

    There is also the HIH financing example of a public bail-out. The industry had to pay a levy and the shareholders were told how much it is. (This is a bit like an ex-post Tobin tax).

    All of this is, I believe, broadly consistent with your paper on the government’s role in risk management.

  6. A Tobin tax of 10% on financial derivatives would be just the ticket. Been saying it for 20 years.

  7. Anti-intellectualism was not epidemic in 1945. Human capital needs serious work.

    The need for mindboggling investments in R&D and infrastructure for alternatives to oil did not exist in 1945.

    The need to get off carbon has never been more acute.

    We’re just now beginning to understand we’re depleting the world even faster than the current financial crisis is evaporating imaginary value.

    I like the original sentence as written.

  8. John

    I used the same quote as a letter to the Age recently. I had it in quotation marks, but the Age for some reason took them out.

    Marx used the term to describe the catastrophic results of the tendency of the rate of profit to fall. Schumpeter talks about creative destruction, so the two are essentially opposed.

    I have been arguing that the financial crisis is, as Marx predicted, a result of the crisis of profitability in the real economy.

    For that reason I doubt more regulation, or less regulation, or pumping in trillions to save financial institutions, will work. Without pooh poohing infrastructure spending (eg more on nurses, teachers etc) and recognising the revolutionaries make the best reformists, I doubt that this will world. Certainly in my view the New Deal did not rescue the world from the depression – massive arms spending (slowing the decline in the rate of profit) followed by a war which physically destroyed capital – did.

    Keynesian economics doesn’t address the falling rate of profit. AT best it is an udnerconsumptionist apprach. At worst it is an apologia for attacking workers’ living standards.

    I also doubt that revolutions unleash too much that is negative (as one of the posters argues.) Certainly the English revolution, the French Revolution, the American revolution all helped unleash the bourgeoisie onto the world. The Russian revolution was a working class revolution defeated for a variety of reasons (not least Russian backwardness and the destruction of the working class as a class) but if the German revolution between 1918 and 1923 had been successful then the Russian revolution would have been the spark for socialism but not its guide. The German revolution was close run.

    Certainly too I think the revolutions that overthrew Stalinism were a step forward politically for humanity, and that Tienanmen Sq, a dress rehearsal for the future, was also a positive,despite the butchers of Beijing killing thousands.

  9. Could you elaborate on the PPPs point pls John – this one:

    “I think in the current crisis, shifting assets and debt from state to national balance sheets might have some real benefits.”

    And sorry for being picky 😉

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