By: Dr. John Brown Miller
Miller was previously a professor of civil engineering at MIT, chairman of the American Bar Association Section of Public Contract Law and is an expert on infrastructure procurement. This is the first part of a three-part series on infrastructure.
Thanks to @TheHill for publishing a three-part series on infrastructure issues facing the United States. This allowed a more comprehensive, practical, treatment of these topics.
This post provides graphical illustrations of the points made in the series.
Figure 1 shows a typical expense cash flow on a Design Bid Build project.
A typical DBB cash flow, including OM&R, has the shape shown in Figure 2. The asset in Figure 2 is always in good condition, fully maintained. A substantial refit is completed mid-way. Life cycle costs of operation are ten (10) to twenty (20) times that of initial construction.
Figure 3 illustrates where many public owners have moved. OM&R expense is unaffordable. Regular maintenance and capital repairs are deferred. Facilities decay, driving replacement costs up. This is the source of our current difficulties.
The 2007 ABA Model Code for Public Infrastructure Procurement (MCPIP) is an example of a practical state legislative model to re-open procurement delivery methods across the life cycle.1 The MCPIP offers a full menu of delivery and finance methods, for governments to use in meeting the specific needs of their infrastructure portfolios.
Figures 2 and 3 show single assets, not the system-wide challenges governments actually face. Governments manage multiple infrastructure assets at the same time.
Figure 4 shows the shape of this portfolio challenge for a (hypothetical) town with 61 infrastructure assets – 30 of them in the past, one in the present, and 30 in the future. For simplicity, each project’s cash flow is the same. Initial delivery costs are shown in yellow, the costs typically subsidized by federal grant programs. The long tail of OM&R costs for each project is shown in red. These are the costs for which state and local governments are responsible under these same programs.
Figure 5 shows the same information, on a cumulative basis. The infrastructure financing challenge is NOT CYCLICAL.
The American economy – not the government – needs to spend more of its GDP on public infrastructure. China spent 8.6% of GDP on public infrastructure from 1992 to 2013. The USA spent 2.5% over the same period.2 American spending on infrastructure is insufficient. It’s that simple.
2. Bridging-Global-Infrastructure-Gaps-Full-report-June-2016, McKinsey.
Figures 6 and 7 show typical cash flows for a concession contract to design, build, operate, and maintain an infrastructure facility. Figure 7 adds a 3% financing premium across the concession. This illustrates the effect of private financing of infrastructure, at a rate 3% higher than the government rate. Both Figures show a substantial refit of the asset and a second (contract required) maintenance and repair effort just before turnover to the government.
There are substantial differences between the cash flows shown in Figure 2 and Figure 6. The cost of design and construction is reduced by 10%+/- when these activities are integrated in a single effort – known as “Design Build.” Whether this is a wise depends on the circumstances.
Our research also showed that the cost of OM&R is substantially reduced when Design-Build is further integrated across the life cycle. Figure 6 includes $950 for OM&R, instead of $1276 shown in Figure 2, a 25% reduction in OM&R. Table 1 summarizes these differences.
Project delivery and finance is a substantive professional field within civil engineering and construction management. The profession has addressed and answered many of the questions policy makers mistakenly find to be sticking points, like the following.
What is the “cost” of a Design Bid Build project?
Is it $110 (Figure 1)? Or, nearly $1400 (Figure 2)? The answer is easy for taxpayers, who pay for the entire life cycle, no matter how government chooses to deliver infrastructure.
Must governments pay a financing premium for life-cycle projects (Figure 6)?
No. Governments can raise and use their own funds to pay a competitively verified payment stream for these services (an “availability payment.”) As long as the services are being properly performed, the availability payment is due.
Why might a government choose to pay a financing premium for projects delivered as shown in Figure 7?
There are three frequent reasons. First, an infrastructure project has such a large, reliable revenue stream (or its promoters claim it does) that there is no reason to subject taxpayers to more debt. The Golden Gate Bridge is an example. Second, a government’s existing credit rating limits how much tax-exempt financing it can raise. The Chicago Skyway is an example. Third, the life cycle cost savings from delivering the project now on a concession basis (30-35%) overwhelm the additional cost of the “financing premium.”
Can governments compare: “public” (Fig. 2) to “private” delivery (Fig’s. 6 & 7)?
Yes. Canada does it regularly, by first building a business case for “public” delivery and using it as a benchmark for “private” competition.
Should all projects be delivered on a 25-35 year concession basis?
No. There will always be situations where design-bid-build or design-build (without OM&R) makes sense. But, for core infrastructure assets – i.e. facilities and networks that have been and will continue to be central components of public infrastructure portfolios for decades – competing on a life cycle cost basis, with specific commitments as to level of service to the public provides the path to a 30-40% savings in life cycle costs.
Avoiding 30-40% of life cycle costs on core infrastructure assets would allow trillions of dollars in taxpayer funds to be repurposed to non-core infrastructure assets, to other government programs, or back to taxpayers.