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Common Assets on the Road to Privatization

Why some politicians are so eager to sell off the construction and maintenance of our public roads.

As never before, state governments are plunging ahead with new experiments in privatizing public roadways. The deals offer investors huge profits from the large toll increases they will charge on highways they control. But for the tax-paying public and drivers, it’s a bad bargain. Over the long term, the public will not receive the full value of the higher tolls that drivers pay. Private operators will manage major highways in ways that maximize tolls and minimize their costs rather than to serve the public interest. Many cash-strapped state politicians are eager to avoid responsibility for constructing or maintaining roads lest they be forced to raise taxes and tolls themselves. But a look at the economics and governance of road privatization sends a flashing warning of danger ahead.

cc license by amanky, nc, nd from Flickr http://www.flickr.com/photos/amanky/21541563/

The privatization of toll roads is a growing trend in the United States. During 2007, sixteen states had some privatized road project formally proposed or underway. In 2005, Chicago leased its 7.8 mile Skyway toll road to an international consortium that paid $1.8 billion for a 99-year concession. Indiana followed with a similar 75-year deal, selling off control of its 157-mile Indiana Toll Road for $3.8 billion.

Governors in New Jersey and Pennsylvania shortly thereafter began exploring privatization options for their own well-established turnpikes. And governors in major states such as California, Texas, and Florida have proposed long-term toll concessions to companies that build and operate new highways.

The trend is big and getting bigger. Between 1994 and early 2006, $21 billion was paid for 43 highway facilities in the United States using various “public-private partnership” models. Recent legislation enabling private companies to operate public roads has passed in a majority of states.

Explaining the Surge in Road Privatization
Why is interest in toll road privatization so widespread right now? On the government’s side, it has a lot to do with the budget squeeze for transportation and federal rules that promote privatization. Capital markets are also driving the trend. Investors are eager to reap low-risk profits from such a reliable source of revenue, road tolls.

Roads across the country are under great strain in terms of growing congestion and years of insufficient investment in maintenance. The American Society of Civil Engineers graded the overall condition of the nation’s infrastructure a “D.” Part of the problem is perverse rules which discourage investment in maintenance while encouraging construction of new roads. Regardless, states are having great difficulty finding the money to fund their transportation programs at accustomed levels. The costs they must pay for health, pension, energy and construction are rising, limiting their ability to use general revenue funds for transportation.

As a result of revenue shortfalls, states will soon be unable to sustain highway spending at traditional levels. The federal Transportation Trust Fund, used for state and local projects, is projected to run into shortfall during 2009 and will need to reduce payments by 42 percent the following year unless new revenues are obtained. Many state level transportation trust funds are also forecast to run into shortfall in coming years.

In the context of great investment needs and stagnant revenues, the huge upfront payouts of toll road privatization have obvious short-term appeal. Many elected officials find them especially attractive. In the short term, privatization promises a huge budget windfall, which creates budget slack and an ability to dedicate resources to favored projects. The long-term financial downside, particularly the loss of toll funds and rising toll rates paid by drivers, often is overshadowed by the short-term and initial windfall.

For its part, the U.S. Department of Transportation is encouraging the privatization of toll roads by offering secured (direct) loans, loan guarantees and standby lines of credit to attract private investment in surface transportation infrastructure. And investors are clamoring to strike deals with state governments because toll revenues are seen as a highly reliable and stable source of long-term revenues. According to a report by McKinsey, private infrastructure funds dedicated to investment in public infrastructure grew from $5 billion in 2004 to approximately $45 billion in 2007. At least ten such investment funds were launched in 2006, and more than a dozen large ones were expected in 2007.

The Dangers of Road Privatization
Governments have a long history of outsourcing service delivery on public thoroughfares. Private companies, for instance, operate gas stations and food service at public rest stops. But the public interest is best served by outsourcing only those functions where public capacity is lacking, and where continual competition exists for privately provided service.

The common characteristics of road privatization deals is that they enlist a private intermediary to borrow large sums of money backed by a schedule to collect multiple decades of steadily increasing toll rates. Private proposals should thus be judged according to the relative costs and benefits of enlisting this intermediary to borrow and to hike tolls.

By this standard, road privatization is highly problematic. Governments can borrow upfront sums at substantially lower cost than can private companies. A private entity will have higher capital borrowing costs and must divert some revenues to shareholder profits. So even at its most basic financial level, privatization is not advantageous to the public.

Perhaps even more than these fiscal problems, long term road contracts pose a variety of serious threats to the public interest. These include fragmentation and a loss of public control over transportation policy, and an inability to prescribe future needs in contracts signed decades earlier. These can have consequences.

For example, some privatization contracts explicitly limit the state’s ability to improve or expand nearby roads. Private investors fearing that improved free roads would compete with their paying traffic, have obtained non-compete clauses in California and Colorado, and to a lesser extent, in Indiana.

If private toll road operators raise their tolls, and this causes some trucks and cars to take alternative routes – causing new congestion and pollution in local communities – that’s too bad for the public. In its privatization contracts, the state has already surrendered its authority to manage overall traffic flows.

If a state government at some point decides it wants to modify an exit ramp or build mass transit line down the median of the highway, such normal policy decisions may require paying an extra fee to the investors of the private roads. The Indiana deal, for example, requires the state to pay investors for reduced toll revenue if and when the state performs disruptive construction that wasn’t anticipated in the original contract.

Because investors want to be protected against large increases in safety or maintenance costs, no state can improve its highways to include state-of-the-art features unless it pays for those features itself, and also pays the investors for any lost tolls during construction.

The Financial Loss to the Public
According to many financial experts who do “asset valuation,” the public is getting shortchanged on the value of its roads. They suggest that privatization deals fail to supply full value for the future tolls that private companies are expected to collect. Even though the Indiana deal stretches 75 years, investors are likely to recoup their investments in less than twenty years. One economist believes that it is more reasonable to value the $3.85 billion lease of the Indiana Toll Road at $11.38 billion.

But even these estimates are speculative because massive, unforeseeable changes will likely take place for transportation technology, networks, demographics and the distribution of populations over the course of privatization contracts. In the face of such uncertainties, governments cannot predict their transportation needs, nor the revenue potential of its toll roads, well enough to negotiate deals that fairly allocate risks, dictate future policy or set a fair price.

Beyond the uncertainties, there is a good-government issue: disenfranchisement of future voters. Private investors specifically seek out essential thoroughfares that lack attractive alternative routes. These highways are vital infrastructure, integral to the daily lives of residents. So long as the State, directly or through a turnpike authority, retains control over its toll roads, voters have the ability to hold decisionmakers accountable. Turning over control of the roads to private investors eliminates that accountability and binds future voters to present-day decisions. Doing so for several generations of voters is simply anti-democratic.

Perversely, the transfer of public control to private parties may be precisely what makes road privatization so appealing to some elected officials. It provides a way to avoid political responsibility for the toll hikes that will be necessary, and to avoid tax hikes or program cuts during times of tight budgets. Privatization of existing toll roads amounts to a short-term budget gimmick that actually aggravates long-term budget problems.

Moody’s bond rating agency concedes that state governments can borrow against future toll collections without privatization, and make necessary investments from such borrowing. But Moody’s points out that, “If they pursue the option [without privatization], governmental authorities must take responsibility for their own toll raising decisions, rather than distancing themselves from these decisions through a long-term concession to a private entity.” Privatization gives politicians political cover for making decisions that look only to the short term, and not to long-term budgetary issues.

New Jersey’s Governor Jon Corzine has learned this the hard way. After initial talk about privatizing some of the nation’s most trafficked toll roads, the former head of Goldman Sachs declared in June that private leases or concessions would be bad for the state. Instead, he proposed a “Public Benefit Corporation” organized to reassure Wall Street bond buyers into fronting $40 billion while ensuring that excess toll money would go to public infrastructure projects. He has taken the heat for proposing steady toll hikes. And hard questions are being asked about matters such as the composition of the governing board and the incentives for future turnpike managers. Critics want to protect the public by ensuring that roadways remain in the public commons and that all the details are on the table.
Protecting Against Bad Privatization Deals

Examining the details is crucial for any deal on existing or newly constructed roads. Private contractors may have a role to play in constructing new roads – such as to introduce new technology for bridges and tunneling – but the same set of seven basic principles should be used to safeguard the public.

  • Public control over decisions about transportation planning and management should be retained;
  • Fair value should be guaranteed so future toll revenues won’t be sold off at a discount;
  • No deal should last longer than thirty years because uncertainties over conditions and risks rise exponentially over time;
  • State-of-the-art maintenance and safety standards should be the goal, not just statewide minimums;
  • Complete transparency should be required to ensure proper processes;
  • Full accountability can only be had if the legislature is required to approve the terms of the final deal, and not just authorize that a deal be negotiated; and
  • No budget gimmicks should be accepted to privilege short-term over long-term budgetary goals.

Without these safeguards, the chances are much greater that the public will suffer financial loses, higher tolls and new limits on its ability to maintain and improve its highways. It is up to us to ensure that our legislators to protect our common assets, especially when the temptations are so great to do otherwise.