The Weaknesses of Sweeping Privatization

The most important question is not whether private investment in roads and other public infrastructure will revive, but the degree to which it should.
by | October 2009

Two years ago, I could walk out of a bank with a home loan for a half-million dollars with no money down, even if I didn't have a job, hadn't owned a home before and had lousy credit. Banks were eager, insistent, that I take their money.

As all of us know, it's different now. Banks sometimes require 30 or 40 percent down, when they are willing to lend at all for real estate. They are insistent about credit reports and job history.

And as Brendan Schlauch reported in Governing last month, something similar has happened in the realm of infrastructure finance. Two years ago, private equity funds and multi-national companies were urging cities and states to allow them to build, buy and operate new or existing highways. A private consortium bought the Chicago Skyway; another was trying to buy the New Jersey Turnpike. Still another was planning a privately owned highway across Texas.

But just as banks aren't so eager to make mortgage loans now, private equity firms aren't very much interested in buying highways, certainly not for the amounts they once offered. Some states managed to beat the recession. Indiana, which sold a 75-year toll-road lease for $3.85 billion, did well by selling overpriced infrastructure at the top of the market. But this was a high-water mark in a short-term speculative bubble, just like the one in home mortgages.

William Reinhardt, editor of Public Works Financing magazine, says he's sure private investment in roads will revive because states and localities will need it, given its potential for stretching scarce public dollars for vital projects. For the immediate future, though, he admits that the prospects do not look good. "Private capital and expertise will be priced at premium rates to reflect the high risk associated with government partnerships," Reinhardt says. "But smart deals will get done and the fruits derived from them will become more apparent."

The devil, of course, is in the details. There are some public-private partnerships going forward right now. Even the private highway project across Texas is still alive. But while it's interesting to speculate about trends, the most important question is not whether private investment in public infrastructure will revive, but the degree to which it should. What best protects the public interest?

As I wrote in this column nearly three years ago, history shows that private investors often have lost money on transportation projects and that public purposes often have been thwarted by the involvement of private capital. In the past, transportation systems have worked best when they are largely planned, designed and funded by the public. That's the only way to achieve a comprehensive transportation system that creates the highest public benefit, as opposed to a fractured system used by a few.

Historian Charles Perrow, in his book Organizing America, noted how the United States was virtually alone among industrializing countries in the 19th century in allowing private railroad companies, armed with government powers and subsidies, to control the expansion of railroad infrastructure, which everyone saw as crucial to the transportation system of the future. The results were not good.

"The lack of regulation and enforcement by government authorities meant substantial inefficiencies," Perrow wrote. "Communities poured money into schemes [through subsidies of private companies] that never produced (trains never ran, ties were untreated and rotted, wooden rather than iron tracks were laid and were useless within a year and bridges collapsed). There was overbuilding to destroy rivals and gain market control, or for sheer fraud. Innovations to promote safety were resisted. Without regulation, competing lines chose different track sizes, resulting in gross inefficiencies. There was wasteful duplication of lines for speculative and monopoly purposes, routes zigzagged as towns put up capital, and then the lines were abandoned."

And for the private companies, well, despite the popular image of railroads as the preeminent 19th-century cash cows, things often went badly for them as well, notwithstanding all the government gifts of land, powers and money. Although a few titans became fabulously rich, the majority of railroad companies competed with each other ferociously over key routes, and they died by the hundreds.

As Michael Perelman points out in his recent book, Railroading Economics, the demise of so many railroad companies in the 19th century prompted many economists to revise their view that open competition automatically leads to efficiency and success. When it comes to railroads, they concluded, some sort of regulated cartels were necessary, because the small companies seldom made money and the big companies became monopolies that exploited citizens.

Change the labels and it sounds like some of the current debates in municipal halls and legislative chambers over cable television, cell-phone service and Internet access. It's a lesson we should not need to relearn so many times.

There will always be some role for private capital in the creation of infrastructure. But a clear rule should be paramount and not forgotten: The public should be in control.

Alex Marshall
Alex Marshall  |  columnist
alex@rpa.org  | 

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