Asset Recycling in America
Asset Recycling in America
The Hon Joe Hockey
Australian Ambassador to the United States
Federal P3 Conference – Washington DC
27 November 2018
Australia and Americans like things that are big.
We have big countries and when it comes to infrastructure projects we have big ambitions.
In 1956, Eisenhower facilitated construction of the revolutionary and world renowned US Interstate Highway System. In 1949, Australia embarked on the largest engineering project in our history, the Snowy Mountains Hydroelectricity Scheme.
While these projects took place in decades past, they are remembered today, not only as great nation building exercises, but for their continued utility in the modern era.
However, in recent years Australia and the US have taken divergent approaches to infrastructure development even though we have the same federal structure, and states and territories own the infrastructure while the federal government is responsible for funding it. Australia has sought to leverage the capital of the private sector to develop this important public good and stimulate the economy. Our infrastructure is now experiencing an unprecedented boom, fuelled by common desire of governments and the private sector to get things built.
There is some irony that the very first private sector transport service in Australia was started by an American, Mr Freeman Cobb. The famous Cobb and Co used American stagecoaches to deliver exclusive transport services by stagecoach from Melbourne to the goldfields from 1853.
Pay as you go is a crucial part of the Australian infrastructure story. In fact, the famous Sydney Harbour Bridge could only be built as a toll road in 1932 and, like most of America’s toll roads, it was Government owned. That was until the seal was broken on P3s in 1992 when a consortium of an Australian engineering company and a Japanese construction company took over the Harbour Bridge Toll and at the same time build a new toll tunnel under the Harbour tunnel. Both tolls paid for the new, much needed Sydney Harbour crossing and the public only noticed the much needed new access.
Money and necessity forced the Government to work with the private sector. It worked. As DJ Gribben just remarked, “infrastructure is not screamingly urgent.”
It usually takes some form of economic crisis to get real economic reform as I saw during my time as Treasurer and as Chair of the G20. Extraordinarily the United States has fallen a long way behind the rest of the developed world on leasing, privatisation and P3s.
It’s not that you haven’t had crises or recessions. You seem to have those in cycles. It’s just that there is a lack of political will to engage with the private sector on infrastructure in the same way that many other countries have engaged.
From Korea to the United Kingdom and from Brazil to Germany, the need for big expensive infrastructure has led to the development of many new public/private partnerships.
In the 1990s, Australia privatised significant volumes of federal and state assets, including airports, electricity and gas facilities. The decade saw both Australia’s biggest bank, the Commonwealth Bank, and Australia’s national airline, Qantas, with a kangaroo on its tail, privatised by a centre-left government.
The policies were damned hard. I know because I was there.
In many cases, it was the choice between proactively seeking the best value for these assets and reinvesting the proceeds for the public good, or waiting their likely fire-sale in a bad debt environment.
The economic benefit was obvious. Many of your Congressmen and Senators that I have spoken with, and many of your Governors and Mayors that I have spoken with, can see the obvious need for more public/private partnerships but they can’t see a way through the politics.
Well, I can tell you, that the politics of these deals is no different in the United States to that of Korea, Brazil, Japan, the United Kingdom or any other country. The politics here are not unique.
In economic terms the United States will have to move far more urgently on public/private infrastructure partnerships than it may realize.
The United States
The American Society of Civil Engineers has estimated that an additional $4.5 trillion is needed over the next 7 years just to bring existing US infrastructure up to acceptable standards. That means your potential economic growth will fall if you do not spend $4.5 trillion just to maintain existing infrastructure.
To put that in perspective the US Administration has been promoting a potential $1 trillion on new infrastructure as a starting point. But if you don’t spend a new additional $4.5 trillion on fixing existing infrastructure, like water treatment plants, electricity supply, transport and roads, then the negative impact on the US economy will be enormous. If you don’t spend this $4.5 trillion, you will lose $3.9 trillion in GDP, 2.5 million American jobs will be lost and the modeling from the American Society of Civil Engineers says that there will be an average $3,400 reduction in disposable income per worker each year.
Even if the numbers are wobbly, can you risk anything like these numbers hitting your economy?
So where will this money come from?
US Government Debt
Well Governments haven’t got the money. And it’s going to get a lot harder here in the United States.
The Federal Government owns about 8 per cent of all US infrastructure but funds 14 per cent of it. The Federal Government’s ability to fund additional infrastructure is constrained by its own growing debt.
According to the IMF, over the next 5 years, the US is the only developed country which will see its debt to GDP ratio increase, with a forecast increase of nearly 9 per cent. Every other developed country in the world is trying to reduce its government debt during this period of economic growth. The US is the only country in the world to increase its debt.
As you are aware, state and local governments own the vast majority of US infrastructure assets – same as in Australia. But like the US Federal Government, the states’ ability to finance future infrastructure is constrained. While a number of states run a budget surplus - many do not. Five states ran a budget deficit of over 5 per cent in 2016.
Additionally, 43 states have some kind of restriction on the amount of debt they can issue.
In addition most US states have large underfunded pension liabilities that now total over $6 trillion.
Yet these same states and cities of America have trillions and trillions of dollars of underutilized and underperforming assets. Interestingly I have found that many states and cities don’t know all the assets they own let alone what they are worth, and how much they could be worth if they maximized their potential.
In addition there are many administrations that inadvertently run down valuable assets in transport, roads and even schools and hospitals because they can’t afford the maintenance programs.
But while government’s ability to finance and maintain infrastructure is highly constrained, the private sector as it so often does is stepping up to the plate.
The last three years have seen the private sector raise record levels of money for infrastructure investment. In the third quarter of this year alone, infrastructure funds raised almost $37 billion, with three quarters of that allocated to transactions in North America. However, utilizing these funds has been more of a challenge.
There are plenty of good news stories. For example the recent announcement of Carlyle’s $13 billion modernisation and expansion of Terminal 1 at JFK airport is a good story. But there is still too much money sitting idle.
There is some $173 billion of “dry powder” sitting in infrastructure funds, ready and waiting to be invested – an increase of 173 per cent since 2000.
Navigating regulations, local politics and competition with cheap public sector funding makes private investment in US infrastructure hard work. But it is not impossible.
Australia’s Asset Recycling Initiative
As the Treasurer of Australia in 2014, I sought to spur significant new infrastructure investment. We came to the view that we had to earn economic growth by improving productivity. Throwing money at the economy was not going to work. The easiest way to improve productivity was to build new improved infrastructure.
At the time, like every other Government, I didn’t have the money.
We had to be innovative and we used a number of tools.
I used our AAA credit rating to guarantee some private sector asset backed debt. We provided mezzanine finance for some projects and we provided some debt facilities for other projects.
For greenfields infrastructure we would provide seed funding as either a grant or a loan. We had to find some way to take political risk out of greenfields infrastructure. In my view, that was the biggest handbrake on infrastructure investment.
But the federal Government doesn’t really build infrastructure. It funds infrastructure.
It’s State and local governments that have much of the planning, environmental and regulatory controls although Washington still has its permitting process. They know what the local priorities are and they know how to handle the local politics.
If anything was going to be built I needed local administrations to have skin in each and every project.
But they didn’t have the money. They were asset rich and cash poor. The private sector is cash rich and asset poor.
This is why I launched the Asset Recycling Initiative.
The Asset Recycling Initiative provided Australian state and territory governments with a financial incentive to sell or lease government assets and redeploy the proceeds into new infrastructure. Effectively I gave them a bonus. I said I would give them a 15 per cent bonus to sell and invest in new infrastructure. Where did I get the money for this bonus? It came from the proceeds from selling the Federal Health Commission. State and territory governments had a pool of assets that did not pay tax. I needed them to be more efficient and to pay tax. If they paid tax, the assets would become taxpayers in perpetuity. The Federal Government in turn would get a return back in ten years, as I advised the Congressional Budget Office.
In order to create a sense of urgency, the Asset Recycling Initiative was open for a limited period of two years and operated on a first come, first serve basis. As it was time limited, the bonus was contingent upon the states and territories selling and building at the same time.
The Initiative was only available for agreed transactions with the Federal Government. Here is the political catch. I did not tell the states or territories what to sell or lease or what to build with the proceeds. They had to own the politics. If I told the states and territories what to sell or what to build then they wouldn’t have any buy in.
Overall, three of Australia’s eight states and territories participated in the scheme. Another state sought to participate but missed the two year deadline. Roughly $3 billion in incentive payments were paid to participating states and territories over the life of the scheme. This helped to unlock over $17 billion in new infrastructure development across Australia. And that was just the direct benefit.
There are now more cranes and tunnel boring machines in Sydney than in any other city in the world. And the ACT government is building a new light rail system for Canberra, paid for out of the proceeds from selling its lottery office and public housing. This was endorsement by a centre-left Government. And they are building what they wanted.
Australia is now spending more public money on new transportation infrastructure than any other major developed economy in the world. And the sale or lease of assets has spurned this growth. Government owned ports, electricity generators, transport and roads have been leased or sold. Even land titles offices, lotteries offices and dilapidated public housing have been sold or leased with governments redeploying the money into new infrastructure in partnership with the private sector.
And this has been embraced by all sides of politics. Last Saturday, the centre left government of Victoria, which boasts Australia’s largest city of Melbourne, was just reelected on the back of the biggest new infrastructure plan in Victoria’s history. Part of that is funded by recycling the proceeds of the lease of the Port of Melbourne into new infrastructure.
Australia is the world’s 13th largest economy with a population of just 25 million. It is the same size as the continental US. But we are investing more in transportation infrastructure than the likes of Germany, the UK, France or the United States.
Australia is spending more on infrastructure now than at any time in the past 30 years, since the Sydney Olympics. Last year alone, local, state and federal governments invested almost $100 billion in infrastructure development. Times have changed.
The number and value of Private-Public Partnerships has also broken records. In 2015, nine P3 transactions were completed in Australia – a record high - with a combined value of about $15 billion. In the state of NSW alone, there are currently over 36 active P3s. And of course, other states are engaging in this activity as well.
This new wave of infrastructure investment across Australia is one and a half times the size of the mining boom, which contributed to our 27 years of unbroken economic growth – a record among developed economies.
The benefits of infrastructure investment are obvious. Construction jobs now account for one in 10 jobs in the Australian economy – their largest ever share.
That’s not to say Australia’s infrastructure sector isn’t experiencing problems. But these aren’t the problems you typically hear about in the industry. The Chief Executive of our largest construction materials and building projects supplier lamented that he was “stretched” in meeting soaring demand for concrete and asphalt. From a business perspective, that isn’t a bad problem to have.
But bear in mind, the politics are never easy. Today critics are even complaining about too much construction work in our cities. A decade ago those same critics complained that there wasn’t enough infrastructure being built.
Progress in the United States
The US is making headway. I am more optimistic.
The Trump Administration’s “One Federal Decision” MOU is an example of a small but important step towards making US infrastructure investment opportunities easier to navigate. At a local level, the Australian Government has been proud to partner with the District of Columbia and the Bipartisan Policy Center on an “Asset Recycling Pilot” program. Launched last month, the Pilot links DC together with the Canberra in the Australian Capital Territory and Sydney in New South Wales – two Australian governments who are sharing their experience in asset recycling.
The DC Government is getting it right. The first thing every administration should do is have a public list of all its assets. Secondly it should have a real cost of maintenance associated with the list. Thirdly some assets that generate revenue should have an acceptable level of debt that provides some outside accountability for running the asset beyond the Government shareholder. And, finally, where appropriate the asset should have an independent board of management with an independent executive. All should have fiduciary obligations to act in the best interests of the business.
The District of Columbia to its credit is well on the way. It has the most comprehensive asset register in the US, down to the level of sidewalks and streetlights, along with a comprehensive asset maintenance program.
You live in the most innovative nation on earth. The United States is a pioneer in so many fields from Cobb and Co to the Hoover Dam you’ve always been able to do new and innovative projects. No country in the world does it bigger, and rarely, better than when the US puts its mind to it.
Australia’s experience is not unique, but when it comes to asset recycling we have taken the lead.
I want to emphasize that it is not a hard and fast formula. It is a concept that wins on the economics and the politics.
Variations on Asset Recycling that are good politics include giving workers some equity in the sale. Partnering with unions and pension funds in each state or city is also a good idea.
And every time an asset is leased or sold it becomes a new federal and state and city taxpayer – that is how it pays for itself.
There is however one big gap here in the US. There are very few obvious, respected and experienced sell side advisors to provide vendor advice to first time administration vendors. Much of the expertise is on the buy side for obvious reasons. But you need to work together to provide an entity that can provide trustworthy advice to administrations entering into these transactions for the first time. In Australia it took decades to develop this experience.
Asset Recycling will come to the United States in one form or another in the future. How it all works depends on all of you.