Lecture 10: Investment in

Transportation Infrastructure

Lecture 8a
 References

• Abelson, P. (2015) “Financing Transport

Infrastructure” (mimeo)
• Nguyen, H. and Tongzon, J. (2010), “Causal
Nexus between Trade and the Transport and
Logistics Sector: Australia’s Trade with China
and the Implications”, Transport Policy, 17, pp.
135-146.
• Immers and Stada (2004), Basics of Transport
Economics, pp. 6-54.
 Outline
Introduction

1. What is investment in transportation infrastructure?

2. The link between investment in transportation infrastructure

and economic growth

3. The link between investment in transportation infrastructure

and market access and productivity

4. Different forms of investment in transportation infrastructure

and financing

Conclusion
 1. What is investment?

l
Investment means “allocation of money with
l
the expectation of generating financial and
l
economic benefits in the future”
l
Investment in transportation infrastructure
l Public investment in transportation infrastructure
l
Government expenditure on transportation
infrastructure
l Private investment in transportation infrastructure
l
Private sector's participation in transportation
investment
 1. Investment in
transportation infrastructure

l
Investment in transportation infrastructure covers
spending on new transport construction and the improvement of
the existing network. Infrastructure investment is a key determinant
of performance in the transport sector. Inland infrastructure includes
road, rail, inland waterways, maritime ports and airports and takes
account of all sources of financing.

l
Adequate and efficient transportation infrastructure provides economic
l
and social benefits by:
l
contributing to economic growth
l
improving market accessibility and productivity,
l
ensuring balanced regional economic development,
l
creating employment, promoting labour mobility and connecting
l
communities.

l
This indicator is measured as a share of GDP.
 2. Transport infrastructure investment and
economic growth
l
Transport infrastructure investment leads to:

Higher output via its direct effects (increase in production
and consumption)

Higher output via its multiplier effects and other externalities

l
Adequate and efficient transport infrastructure results in
less congestion and less delay and therefore lower transportation costs
and international competitiveness


Example: adequate and efficient port infrastructure reduces maritime
costs by avoiding port congestions and ship waiting time, by allowing
for quicker and safer freight movement and allowing the ships to achieve
the economies of scale


Adequate infrastructure in terms of having motivated workforce and high
Quality cargo handling equipment leads to higher productivity


Limited access to current information about shipping arrivals due to lack of
adequate IT will slow the documentation process and the port operations.
Dependent variable:
maritime transport costs per tonne of containerizable cargo

Port reform

Better port infrastructure

reduces maritime transport costs
Dependent variable:
maritime transport costs per tonne of containerizable cargo

Better (perceived) port efficiency

Port reform

reduces maritime transport costs

 Port efficiency and maritime
transport

l Transport as most important single element

l in logistics costs for most firms
l Freight movement has been observed to
l absorb between 1/3 and 2/3 of total logistics
l costs

l Previous studies (e.g. Sanchez et al., 2003)

l have shown that port efficiency is a
l significant determinant of maritime transport
l costs
 3. Investment in transport and market accessibility and
productivity

Adequate and efficient transport infrastructure results in more market

access and higher productivity:
l


Agglomeration benefits (the economic benefits that
firms will get by being close to each other or in clusters)
•
More connectivity leads to more efficient allocation of
l
resources
l
Efficient allocation of resources means that the scarce resources are utilized at
their best (i.e. P=MC)
Economies of agglomeration are cost savings arising from urban
agglomeration, a major topic of urban economics. One aspect of
agglomeration is that firms are often located near to each other.
This concept relates to the idea of economies of scale and network
effects.
As more firms in related fields of business cluster together, their
costs of production may decline significantly (firms have competing
multiple suppliers; greater specialization and division of
labor result). Even when competing firms in the same sector
cluster, there may be advantages because the cluster attracts more
suppliers and customers than a single firm could achieve
alone. Cities form and grow to exploit economies of agglomeration.
Diseconomies of agglomeration are the opposite. For
example, spatially concentrated growth in automobile-
oriented fields may create problems of crowding and traffic
congestion. It is the tension between economies and
diseconomies that allows cities to grow but keeps them from
becoming too large.

The basic concept of agglomeration economies is that

production is facilitated when there is a clustering of
economic activity. The existence of agglomeration
economies is central to the explanation of how cities
increase in size and population, which places the
phenomenon on a larger scale. The concentration of
economic activity in cities is one reason for their
development and growth.
Benefits arise from the spatial agglomeration of
physical capital, companies, consumers and
workers:[1]
•Low transport costs
•A great (local) market
•A large supply of labor and thus the increased
chance of supply and demand for labor,
particularly for specialists to compensate for fast
matching, lower search costs
•The accumulation of knowledge and human
capital leads to knowledge spillovers between
firms.
Dependent variable:
maritime transport costs per tonne of containerizable cargo

Better connectivity between ports/

Port reform

more competition among carriers

reduces maritime transport costs
4. Different forms of investment in transport infrastructure
in terms of
ownership and management

Public investment (government expenditure and
funded from taxes/loans)

Private sector participation (PPP):
 Lease (the government builds the infrastructure but the
ownership of infrastructure is retained with the government)
 BOT (the private sector builds, operates and transfers the
ownership to the government)

Joint venture

Full private ownership (privatization – sale of
assets to the private sector)
4. Different forms of financing investment in
transport infrastructure
 Financing refers to the raising of financial capital to fund
transport infrastructure investment
 Raising capital for transport infrastructure investment
cannot be separated from servicing/repaying capital
 The provision of capital often confers or should confer
ownership or property rights, which in turn have
implications for the management of assets
 It is assumed here that investment in transport
infrastructure represents an efficient use of resources as
determined by cost and benefit analysis (which we will
discuss in the following week)
 4. Instruments for raising and serving capital
Capital raising Capital servicing

Taxation  

Consolidated revenue (taxation) No servicing required

Infrastructure levies No servicing required

Public sector borrowing  

Borrowing – general bonds Taxation / user charges a

Sale of asset

Infrastructure funds Hypothecated tax revenue

Infrastructure revenue bonds Project revenue

Public trading enterprise borrowing User charges / taxation supplements

a 

Private sector financing  

Private debt  User charges

Private equity Government contributions (taxation)
Mixed private instruments Shadow tolls
Subsidies – community service payments
Guaranteed repayments
 Taxation
 Consolidated (general) tax revenue
 Part of general revenue (notably revenue from
fuel taxes) is hypothecated to fund transport
infrastructure)
 Infrastructure levies (development taxes
levied on either developers or households
or both)
 No servicing is required
 Public sector borrowing
 Borrowing – general bonds (long-term bonds)
 Interest bearing certificates of debt (payment of interest and
repayment of the principal at a nominated future date, 10 years or
more)
 Infrastructure funds and Infrastructure revenue funds
 Both are raised from the public via bonds
 But the former may not be project or revenue specific and the capital may be
serviced from general tax revenue or from a hypothecated tax source, such as fuel
levy. The latter is project based and is serviced from project revenues with
government guarantee backed by government’s tax powers.
 Tax advantage – bond holder receives a tax concession on the interest from the
bond

 Public trading enterprise (PTEs) borrowing (ex. Airport or seaport

corporations)
 Services and repays from user charges for the services provided
 If a PTE incurs a deficit, the government may be required to fund the deficit.
 Justification for government funded investment in
transport infrastructure
• Characteristics of the infrastructure
• Generally long-lived (durable)
• Capital intensive
• Significant externalities
• Part of a wider network
• Provides essential services whose disruption can impose
significant costs on the economy
 Private sector borrowing
 Private debt (issuing bonds)
 Equities
 Complex composition of financial instruments (e.g. PPP)
 Service most of the debt or equity from user payments for
the services provided by the infrastructure
 However, the government may contribute to the servicing
and repayment of capital
 By paying particular services or
 By paying shadow tolls (i.e. payments for services when no user
charge is levied)
 Subsidies (called community services payment)
 By providing unconditional guarantees for payments (bears the
risk of default)
 Capital raising and user charges
• If capital is due to be serviced by taxation
• Capital is usually raised by the public sector
• Ceteris paribus, this is appropriate since the government has the power
to collect taxes and ensure that the obligations are met
• If capital is due to be serviced by user charges or most of it
• Capital is raised by the private sector
• The gov’t may contribute to capital servicing and repayment costs
• Since there are different methods to service capital and the existence of user
charges has implications for methods of capital raising, it is important to
consider when user charges are feasible and appropriate
• When user charges are feasible and few externalities, there is a strong case for user charges
• Charges based on marginal costs to encourage an efficient allocation of resources since they
provide signals to the producers and consumers about the cost and value of services
provided
• If mc pricing is not sufficient to cover full costs, mark ups or 2-part tariffs can be applied
• If charges are inconsistent with the equity objective, the charges can be combined with
transparent public subsidies
 Capital raising and user charges
• Another advantage is that tax revenue required and the related excess
tax burden of taxation is minimized
• Excess burden is the cost associated with taxation that distorts
voluntary behavior (DWL)
• Ex. Income taxation that causes people to reduce work hours
• The total burden of taxation is the tax paid plus the excess burden
• Ex. E=.3; w=10; L=100M; t=.5

DWL=
½ EwLt2
•
• L
•
 Capital raising and user charges
• There are however situations in which user charges are
either not feasible or not appropriate
• In this case public financing is usually preferred
• Not feasible at a reasonable cost
• In congested urban areas with limited technology
• Not appropriate
• Excess capacity
• Low marginal cost
• Significant positive externality
• Safety or equity reasons
 Capital raising and risk
• Which one can handle risk better?
• Public sector?
• Public sector can handle risks better because it can pool risks
over a number of projects and spread risks over a large
number of taxpayers
• Thus the real cost of risk is lower for government borrowing
than private borrowing
• Private sector?
• Private capital market can and does diversify risk efficiently
• Some project specific risks are specific market risks (e.g.
relate to traffic forecasts, marketing, construction costs,
operating efficiencies)
• The private firms generally can handle these risks better than
the public sector, especially when there is competitive bidding
 Assessment of policy alternatives

• Arguments for/against:
• Efficiency?
• Economic policy results in the society achieving the
maximum economic benefits at a given cost
• Maximizing the total size of the economic pie
• Equity?
• “Fair” distribution of these economic benefits
across the entire population
• “Fair” portioning of the economic pie
 Efficiency
• Criteria are used to assess the efficiency of an economic
policy/measure
• The most common criterion is the concept of Pareto
efficiency
• Thee strict Pareto criterion states that there is an
improvement in efficiency if a policy/measure improves
the welfare of at least one individual without any other
individual welfare getting worse off (e.g. production
possibility frontier)
• A policy is Pareto efficient if improving the welfare of at
least one individual can only be achieved at the cost of
the welfare of at least another individual
• Pareto efficiency has nothing to do with distribution of
prosperity amongst individuals
 Efficiency
• In practice, the application of strict Pareto efficiency leads
to problems
• In everyday life, economic policies/measures always
have winners and losers
• To get around this problem, Hicks and Kaldor proposed
an alternative criterion – the potential Pareto criterion
• According to this criterion, economic efficiency is
increased when the policy/measure introduced leads to a
situation whereby the winners could in principle
compensate the losers and still retain a net advantage
• The application of the potential Pareto criterion does not
require or demand that actual compensation take place
 Efficiency in Taxation
• Policies that are efficient
• Fosters work effort, savings and investment
• No distortions in consumption and production
• Examples:
• Income tax versus indirect tax such as sales tax
• Subsidies versus no subsidies
• “Beneficiary pays” criterion/principle
 Equity
• Two criteria for equity
• “Ability to pay” criterion
• “Beneficiary pays” criterion
• Examples:
• Progressive income tax versus sales tax
• Toll user charge versus fuel charge
Transport infrastructure can be financed by current taxation, general or infrastructure-specific
public borrowing, or by privately organised finance. The preferred method of finance depends on
overall value for money, equity and efficiency considerations not just on the cheapest source of
finance. Thus the choice of method depends partly on the cost of finance but also on the role of
user charges and on the ownership and management of infrastructure assets associated with
each form of finance.

Table 2 summarises the main advantages and disadvantages of the main methods of financing
transport infrastructure.

Table 2: Advantages and Disadvantages of Instruments for Raising Capital

Capital raising Advantages Disadvantages

Taxation

Consolidated revenue Limited source of finance

Inequitable
Lacks efficiency incentives

Infrastructure levies Can be equitable Lacks efficiency incentives

Public sector borrowing

Borrowing – general bonds Low cost of finance Inappropriate if debt is high

Suitable for public projects

Infrastructure funds /bonds May attract private funds No cost advantage

Public enterprise borrowing May encourage efficiency May be a cost penalty

Private sector financing

Private debt /equity May encourage efficiency Often high cost option

Mixed private instruments Can combine advantages of Requires clear contracts and
public and private sectors efficiency allocation of risks

Current taxation measures are generally not effective, efficient or equitable methods of raising
finance for infrastructure. Current taxation can raise a limited amount of funds, imposes high tax
rates (with consequent economic distortions) on current households, and imposes a large burden
on the current generation of taxpayers.

General public borrowing is a low cost method of borrowing that spreads the burden of payment
equitably. It is appropriate when user charges are not feasible (and so private financing is
difficult) and when government carries a high proportion of project cost and risk. It may also be
appropriate when the market is not competitive. Specific infrastructure bonds have few
advantages, although revenue bonds may be useful in some situations.

Privately financed infrastructure is a high cost form of finance. However, when user charges are
feasible, private ownership and management may produce goods and services more efficiently
than does the public sector. These ownership and operational efficiencies may offset the
relatively high cost of finance.