Private infrastructure finance and secular stagnation (crosspost from Crooked Timber)

For most of my academic career, I’ve been working on (more precisely, trying to demolish) the idea of private investment in public infrastructure, exemplified by the Private Finance Initiative in the UK and the Public Private Partnerships program in Australia. Here’s my first published article on the subject, from 1996. I conclude that

The current enthusiasm for private infrastructure, like the enthusiasm for public ownership which it replaced, has been based more on ideological beliefs in the virtues of one sector and the vices of the other than on any systematic economic analysis …Analysis of the relative performance of the private and public sector in different phases of infrastructure provision suggests that, in most cases, the private sector will be most efficient in the construction phase but the public sector will be best equipped to handle the risks associated with ownership.

Twenty years later, this analysis seems finally to have been validated. The UK Auditor-General recently reported that

Analysis of the 2012-13 Whole of Government Accounts (WGA) implies that the effective interest rate of all private finance deals (7%–8%) is double that of all government borrowing (3%–4%)

As a result of the excess costs, and some spectacular failures, bipartisan enthusiasm for the PFI has finally turned to disillusionment. Here’s the Telegraph, correctly putting much of the blame on New Labour. And, for balance, here’s the Guardian. There hasn’t been a similar admission of failure in Australia, but the flow of PPP projects has greatly diminished, and most new ones rely on a substantial component of public capital.

Unfortunately, the failure of private finance hasn’t led governments to resume the high levels of public investment that prevailed in the Keynesian era of the 1950s and 1960s. So, even with central bank lending rates at zero, there has been no real recovery in infrastructure investment. Apart from the direct effect of lower investment, there’s a strong case that infrastructure investment increases the returns from private investment in general and therefore stimulates growth.

I think this analysis applies more broadly. The financialization of the global economy has produced a hugely costly financial sector, extracting returns that must, in the end, be taken out of the returns to investment of all kinds. The costs were hidden during the pre-crisis bubble era, but are now evident to everyone, including potential investors. So, even massively expansionary monetary policy doesn’t produce much in the way of new private investment.

This raises the question of how the hypertrophied financial sector we observe has succeeded in displacing less costly alternatives. I plan another post on this but my short answer rests on regulatory and tax arbitrage. These, and not the efficient allocation of capital, are the key functions of Wall Street, the City of London and their various counterparts around the world.

36 thoughts on “Private infrastructure finance and secular stagnation (crosspost from Crooked Timber)

  1. I agree with all that analysis. I have followed and read a fair number of your articles since about the time you mentioned (1996). I supported your analysis then (as a more or less silent but voting member of the public) and I support it now. How could one not support a pretty clearly theoretically sound position which is subsequently proven by real (empirical outcomes)?

    All this privatisation and financialisation nonsense was pursued purely as a wealth transfer mechanism.

  2. As Paul Samuelson once said, if the government can borrow at interest rates of zero, it would pay to have a government project that levels the Rocky Mountains so traversing trucks can save on fuel costs.

    There might be an environmental objection or two to that particular idea these days, but the principal is still correct.

  3. There’s an interesting paper out of the Bank of International Settlements (of all places) from earlier this year called Why does financial sector growth crowd out real economic growth?

    The abstract (extremely wonkish, as Paul Krugman would say, so reader beware) is

    In this paper we examine the negative relationship between the rate of growth of the financial sector and the rate of growth of total factor productivity. We begin by showing that by disproportionately benefiting high collateral/low productivity projects, an exogenous increase in finance reduces total factor productivity growth. Then, in a model with skilled workers and endogenous financial sector growth, we establish the possibility of multiple equilibria. In the equilibrium where skilled labour works in finance, the financial sector grows more quickly at the expense of the real economy. We go on to show that consistent with this theory, financial growth disproportionately harms financially dependent and R&D-intensive industries.

  4. @Uncle Milton
    IMHO, that’s the real elephant in the room. I just find it sad that our big 4 banks take up such a large chunk of our economy. Successive governments here in Australia have bent over backwards to support our large banks. It’s a bit like the Victorian State Governments bending over backwards to support the Crown Casino.

  5. @Uncle Milton

    Am I right in thinking that part of that translates this way into plain English: the economy works better when money is hard to get hold of than it does when money is easy to get hold of?

  6. Getting finance is, from the perspective of someone who has something they want to do that costs money, an imperfect substitute for Real Cash Money.

    The finance sector grows because governments don’t run big enough deficits to provide the liquidity needed in the private sector, so the liquidity there is has to be pooled and sliced and jullienned with the private bankers taking their slice. Hard-money is the same as the opposition to single-payer health insurance: the government can provide cash better than the private sector, and private bankers are determined to ensure that it doesn’t.

  7. “Analysis of the relative performance of the private and public sector in different phases of infrastructure provision suggests that, in most cases, the private sector will be most efficient in the construction phase but the public sector will be best equipped to handle the risks associated with ownership

    Or as John Kay puts it more simply, “Private firms are better at building things but governments are better at raising cash. So why not get each to do what they’re better at?”.

    Commonsense really, but I have come as I age to disagree with Keynes’ famous lines about the power of ideas versus vested interests. Vested interests rule because they ensure which ideas get implemented and which don’t. We live in a world ruled by what Labor, in its long-lost radical past, used to call “the money power”.

  8. @derrida derider

    The investment banks have been paid staggering amounts for making these PPP deals highly complex, which complexity then justifies the staggering amounts. Quite a nice earner. It would have been a lot easier if government had just issued bonds. But this is what happens when there are political constraints to public debt and you want to appease the ratings agencies. Of course the ratings agencies look right through these off-balance sheet tricks and load the government anyway with the liability. It’s just stupid.

  9. J.Q.’s post doesn’t say much directly about secular stagnation, so far as I can see. It does say, I guess, that excessive financialisation could be a cause of secular stagnation. By the way, I assume “secular stagnation” means long-run or persistent stagnation.

    For the Triad Economies (USA, EU and Japan) could there not be several other reasons too for secular stagnation? I will list possible causes I can think of including financialisation. For each country of the Triad, remembering the EU is 28 countries, any mix of these could apply individually.

    Possible causes of secular stagnation in no particular order;

    Resource Shortages;
    Labour Shortages;
    End of Demographic Growth;
    Wage Arbitrage (manufacturing and growth go to low wage countries like China);
    Poor Macroeconomic policy;
    Poor currency policy in particular;
    Structural economic problems.

    Larry Summers said (and there might be some overlap);

    1) Greater concentration of wealth and income means lower spending propensities and more incipient saving;
    (2) A desire on the part of emerging markets to accumulate large amounts of reserves, and in particular by running current account surpluses, and in particular to hold those reserves in highly liquid instruments like U.S. bonds, tending to depress yields

    are two major factors on the savings side.

    On the investment demand side,

    (3) Slower population growth and labour force growth

    and possibly also

    (4) Slower technological change — though that can be very much debated — operates to reduce investment demand.”

    I wonder what J.Q. thinks on the specific topic of secular stagnation (for the Triad or developed world mainly, including places like Canada and Australia)?

  10. I think you are right on the money with this post.

    I think there might also be another unintended outcome from the trend towards private participation in financing public infrastructure. That is the selection on uneconomic projects in the first place. Perhaps someone smarter than me might have a more informed opinion.

    Prior to the private financing, the project selection decision (based on the CBA) was made prior and separate to how the project would be financed. Only economically viable projects should ever get up (excluding pork barrelling projects).

    Under private funding model, the finance availability from the private sector is driving the choice of project. Providing the private sector gets a return on their actual proportion of the capital invested they will play ball. It doesn’t really matter if an economic analysis of the whole projects stacks up or not.

    And the public sector are basing their investment decisions on a metric of how they can reduce the actual debt that appears on their books, while the underlying economics of the project does’t really matter to them either.

    The consequence has been a string of excessively expensive and uneconomic projects.

  11. I have a friend that works for one of the major merchant banks financing major projects. I was once asked at a dinner party to explain to his partner what he actually did for a living as she didn’t quite understand it. I said something like “Mr A organises funding for inherently risky big projects, then slices up the risk and sells it off as smaller complicated investments to people who don’t understand the underlying project risk.” His partner then said “So you are a financial bastard then.” His reply. “Yes, but a very rich one”.
    @Uncle Milton

  12. @John Quiggin

    I am sure you are a busy man but I still await with interest your full discussion of modern era secular stagnation. Please refer if you can to the possibilities mentioned in my post number 11 and anything else you consider relevant. They are not my original ideas of course. I am sure I have taken every idea or possibility from the general noosphere or what ever we want to call it.

    I suspect secular stagnation, if it exists, is not neatly or evenly distributed and not neatly or uniformly caused. I will be interested if you can address these issues. I mean, I think there are problems. There is something or rather some set or complex of things holding us back. I guess by “us” I mean the developed world but there might even be some case that secular stagnation is becoming a global phenomenon.

  13. This sort of stuff I enjoy here and the comments from others leads me to beleive that even I can grasp the salient points after a while.

    After all, it is only saying what we know anyway, that the system is not only “captured”and being leeched off by the financial sector, but is no longer permitted to do its job of rational allocation for poleconomic reasons driven by greed that blinds rationality and logic and might crash the whole lot for everyone, as it almost did in 2008-9.

  14. @paul walter

    Agreed. Certain problems (high unemployment, high inequality) are not being substantially resolved because a rich and powerful minority (the 1%) don’t want them resolved. The will isn’t there. A motive to act out of more than self-interest isn’t there. I believe there is more than a lack of interest from the 1% in solutions. There is active, albeit mostly covert, opposition to any solutions. The maintenance of their wealth and power status requires that there be no solution to these problems at least in the short to mid term. And I would assert they do not care about the long term at all.

    This is all in my opinion. I want to emphasise that.

  15. “there’s a strong case that infrastructure investment increases the returns from private investment in general and therefore stimulates growth.” Surely it depends.

  16. Ikon, we are just apes not long down for the trees, insecure and easily spooked and not much happy with anything that doesn’t register as a jungle where we may try to feel comfortable within. Even a symbolic jungle seems better than no jungle at all to us.

    I agree wholeheartedly that hopes of a system that acccomodates humanity are premature; that that the system will ontinue to operate in the (imagined) interests of one group at the expense of all others because we have not advanced very far as a species and historically.

    Rational stuff along the lines of private versus public as to certain activities as to efficency is a rightful move from Prof.Quiggin. but no one wants to ponder that there could be a better way for fear of losing out. Also you suspect, few today can imagine some thing better, similar to the peasants of the Middle Ages peasants.

    We are creative at finding ways of making others suffer, but haven’t grasped that it is better to end the suffering and derive satisfaction from that- I have the feeling things could be sorted but won’t be, also. Not in this generation, anyway.

  17. @Ikonoclast
    I don’t even think it is the 1% of the world. It is very likely the 0.01%. I read somewhere that anyone with a net worth of over 1 million AUD is in the 1% world wide. So we are talking of the 1% in the OECD countries or thereabouts, and therefore the 0.01% world wide. The actual percentage of the rich and powerful in the world may be even smaller. Quite disgraceful really, and almost as bad as in the days of feudalism.

  18. Top 0.01% or top 1%? Isn’t it all being done in our name? So that we pay less taxes. So that we can buy cheaper fruit at the supermarket. So that t-shirts only cost $10.

    Remember Peter Costello saying that no one was complaining to him about the value of their house going up? Well no one whinges to me that the stuff they buy is too cheap.

    Its being done in our name. And like the frog in the pot of water getting gradually hotter, we aren’t noticing enough yet.

  19. @paul walter
    A great book that discusses the rent seeking of the financial class is, “Killing the Host” by Michael Hudson. It is truly a revelation (to me at least) and explains the torpor in most economies.

  20. @Kel Young

    There was an excellent 30 min. program on Brisbane TV yesterday (forget the station). It was by DW (Deutsche Welle) and about ISDS (Investor-state dispute settlement). The reality of ISDS is truly massive and frightening and it is growing exponentially. It is totally parasitic, unproductive and undemocratic. It is truly astonishing that states are letting corporations, lawyers and the finance industry get away with these criminal boondoggles which rob the public blind. Not only do corporations pay little in the way of taxes, they now have a mechanism to rob billions in taxes that the 99% pay.

    Our world economic system is headed for dreadful trouble if democratically elected governments cannot stamp out all the this major financial theft going on and the very rapid shift towards corporations ruling our economy.

  21. I don’t see the moves towards corporatism continuing forever. Right now it’s not that democratically elected governments can’t stamp out corporatism, it’s that democratically elected governments are /pushing/ corporatism, mostly because they’ve been bought by the corporations, or they’ve been captured by neoliberal ideology that’s owned by the corporations. The problem for the 0.01% (who are the real beneficiaries) is that a change in government can completely change the willingness of a nation state to go along with the corporatist movement – any democratic country is an election away from collectively saying “nope” to the whole thing, tossing the whole corporate friendly legal framework out the window and telling the corporations to go jump.

    A decisive win by Bernie Sanders would result in the whole TPP agreement going out the window; a win by Sanders that included control of congress and the senate would result in a /massive/ shift away from corporate friendly government in the US. A win by Jeremy Corbyn in the next UK elections might be as big an earthquake there. And that’s all /without/ any actual revolt, just the normal democratic processes. I don’t see a way for that to happen in Australia without some significant shifts in voting patterns, or a big shift in the core ideology of the Labor party, but even here half a dozen lower house seats going to the Greens and coinciding with a hung parliament might mark a major shift away from corporate power.

    For all it faults, democracy /does/ allow for revolutions in a country’s way of thinking and acting without needing bloodshed. Given the right impetus a majority can vote for real change, and even create real change if the ‘traditional’ political systems aren’t offering it (I recommend looking at some of the grassroots movements in the US to introduce constitutional change, particularly the ones targeting the Citizen’s United rulings –, for example)

    If it ever /does/ comes down to a real revolution, the military in most western democracies aren’t likely to participate in forcefully putting down a widespread push to (peacefully) overthrow the government, not even in the US. People are (barring a small number of idiots) invested in the /nation/, not the government of the day. But I just don’t see it coming to that.

  22. @Simon Fowler

    I wonder if any near-absolute monarch said, “I don’t see this move to democracy continuing.”

    It’s hard to say at this point if the move to corporate control of our society will continue or not. It is certainly still progressing in that direction. I don’t see enough hopeful signs to convince me it will stop worsening any time soon. In any case, capitalism naturally tends to oligarchic dictatorship. This is going to take more than a change in government(s). It’s going to take a change in economic system. This too could happen peacefully if it is handled correctly. I haven’t given up in a peaceful domestic evolution towards worker-managed democratic socialism.

  23. PPP are supposed to work by transferring risk from gov’t to the private sector – who are supposed to be more efficient. The problem is that the logic requires gov’ts (i.e. politicians) to have the strength of will to enforce this transfer when things go bad. Any expectation of weakness in enforcement leads to adverse behaviour and opportunism by the private sector. Hence with PPPs, the private sector always wins no matter which side of the coin comes up.

  24. @Sean Leaver
    Indeed. The “opportunism” starts at the political level. If things turn bad and a government goes in hard to protect their exposure to liabilities, all sorts of vested interests (including at the political level) start crying foul about this and that and how the government is ruining the incentive for private investment in large future capital intensive projects.
    Classic example was the scrapping of the East-West link in Melbourne which has now blown out by >$600M. Most of these back-downs are probably legally unavoidable which doesn’t help mitigate the pain for others chasing a slice of the government expenditure pie.

  25. @Ikonoclast
    Totally agree and although he is reviled by neo liberals, I saw Yanis Varoufakis, on Q&A tonight, who said Australia’s politicians had underperformed for many years. Hard to disagree when you realise how our elected have sold us out on every publicly owned entity.

  26. I have never understood the ratiionale for PPPs. It is a bit like private companies shelving assets/liabilities off balance sheet through put and sell deals so as to give the appearance of a stronger balance sheet and better performnce than they really have. British Leyland used to do this by selling inventory to the banks, taking it off balance sheet and then buying the inventory back later. It is slight of hand accounting.

    As fo private companies being better at building things, I am not convinced. On this view, I guess the Desalination Plant at Wonthaggi was an aberration.

  27. @Kel Young

    If he said they have ‘underperformed’, I wonder whether he meant they have performed less well than they could have, or less well than they should have, or less well than politicians in other countries have done; and if it was the last of those, I wonder which other countries’ politicians he was comparing them with.

  28. @J-D

    Invoking Tu quoque is perfectly good way to excuse our politicians’ performance.

    By the way, working conditions and wage in developing countries are bad so why should Australian workers be provided with good working conditions and high wages?

  29. @Tom

    I’m not excusing anything. The statement has more than one possible interpretation; I wondered which one Yanis Varoufakis had in mind, and I still do. Maybe you don’t care what he meant; that’s no reason why I shouldn’t.

    If he was making a criterion-referenced evaluation, meaning that Australian politicians have performed less well than they could have, or less well than they should have, then comparisons with politicians in other countries would have no value as excuses.

    If he was making a norm-referenced evaluation, meaning that Australian politicians have performed less well than politicians in other countries, that would have no value as an excuse either for politicians in Australia or for politicians in other countries; neither the better (if that’s what he meant) norm-referenced performance of politicians in other countries nor the worse (if that’s what he meant) norm-referenced performance of Australian politicians tells us anything about their criterion-referenced performance.

    However, if he was making a norm-referenced evaluation, it would be useful to know which other countries’ politicians he was using as comparators, since there might possibly be some ideas there for how Australian politicians’ performance could be improved; whereas if he was making a criterion-referenced evaluation it’s the criteria which contain the ideas for improvement.

  30. @J-D

    I don’t care who made statements that Australian politicians have been underperforming for quite some time and I would agree to such statement without the need to invoke whataboutery. This is because when someone says politicians of x country have been underperforming, I would only think of how the politicians could have done better on the issues which I would rate them to be underperforming, and not invoke “look over there, their politicians done worse on the same issue and therefore ours is ok”.

    It is false to assume that trying to invoke such comparison have no meaning of excuse for politicians of either country/ies in comparison, as there was no mention of agreement in the statement beforehand. Had your comment to be something like “I agree our politicians were and have been underperforming, but I wonder how does he (or other country’s politicans) compare to those he rate as underperforming“; then it would not give the false sense of invoking Tu quoque as an excuse for our politicians.

    Giving no agreement whilst invoking Tu quoque gives the sense of “I don’t agree with what he said because look how bad he (or other country’s politicans) performs!“; therefore gives a sense of trying to excuse our politician. Then again, it could just be that I’m bad at English.

  31. @Tom

    Maybe you are bad at English. Maybe I’m bad at English. Maybe we’re both bad at English.

    The meaning you derived from my statement was not a meaning I intended. I don’t know whether that’s your fault, or my fault, or both, or neither.

    I shall reflect on what lessons I may be able to learn about how to express myself more clearly in future.

    I hope the meaning I originally intended is clearer to you now.

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