Republished with permission from Knowledge@Wharton, the online research and business analysis journal of the Wharton School of the University of Pennsylvania.
The use of public-private partnerships to build everything from airports to parking garages is an increasingly popular finance mechanism for governments that are strapped for cash. But private companies are increasingly less interested in investing in these types of ventures. Wharton finance professor Joao Gomes recently presented a seminar on Capitol Hill for the Penn Wharton Public Policy Initiative exploring the reasons why corporate investment in the public sector, which predictably declined during the Great Recession, has not rebounded as much as expected. An edited transcript of the conversation follows.
Knowledge@Wharton: When did the decline in private-sector investments in the public sector begin in the United States?
Joao Gomes: The 2008 Recession was damaging in a lot of dimensions for the U.S. economy — output and GDP, income and employment. Everything suffered, but investment perhaps more than anything else. While maybe 15% of average Americans are worse off relative to some sort of hypothetical alternative world that would have taken place if the crisis didn’t exist, corporate investments may be 25% or 30% below what they would have been in that alternative universe. So, it’s quite significant.
This is more significant in a world in which we keep talking about U.S. corporations having enormous profits and paying out enormous dividends and returning capital to investors. So, there’s this puzzle, this question mark, about what exactly is the U.S. corporate sector doing. Why are U.S. corporations not investing in the United States? This feeds into a number of other things like, what’s the future of the country? Are we investing enough, or are we investing abroad? Are we damaging our workers?
We started to be intrigued by this a few years ago, when we started looking at the numbers and at everybody’s focus on the income of the average American, the employment opportunities, and so on. But the U.S. corporate sector seemed to be more striking and more puzzling to us. It seemed like the question mattered more and more as we got into the 2016 election and afterwards, when we start talking about whether the government should replace the private sector [in funding public infrastructure projects]. Maybe we should do public investment instead?
That was the trigger for us to think more deeply about the reasons why the private sector was not investing. Is it because they don’t want to, or because they can’t? That’s the central question when you think about policies. Should the government take over and do public infrastructure because that’s really going to trigger the private sector? Investments are going to follow it, pretty much like the rationale of the highway system of the 1950s or the 1960s, or the technology boom after the 1970s and the 1980s. Is this really a good reason to spend a lot of money on public infrastructure? Or maybe not. Maybe the reason we don’t see this is because the private sector collectively is coming to the conclusion that the 21st century is just a different economy where we just don’t need these kinds of heavy assets or capital-intensive technologies.
Knowledge@Wharton: Does that mean we stop adding new infrastructure? Or think about it differently?
Gomes: Maintenance and repairing — keeping the existing capital — is unquestionably something we should continue to do by and large. I think the real questions are, do we need a high-speed line in California? Do we need a new airport in New York? Do we need a high-speed line on the East Coast? Those are the big money-grabbing initiatives, and we should think about them carefully as we go forward. Of course, repairing bridges, our water supply system — there are a lot of things that absolutely need upgrading, so we’re not talking about zero spending on infrastructure.
“The private sector collectively has the resources to do a lot of things. Why are they not doing it?”
Not to get sidetracked too much out of corporate investment, but one of the things that motivated me to think about this is that a lot of the fiscal problems of countries in Southern Europe came because of the spending they devoted to infrastructure in the last decade. We always think of infrastructure the way we think of China. Infrastructure has been crucial for China’s development experience, but infrastructure has really not been very helpful for Spain. Spain has built highways that nobody uses. It has built airports that are literally abandoned. We should think carefully about our role model. Maybe China was successful because it was growing, and that’s why the infrastructure ended up generating the revenues for the governments to pay for the infrastructure. Spain had no growth. The infrastructure cost a lot of money. The government did not have the tax revenues to pay back those debts.
I don’t know where we fall. I honestly don’t. But I think we should ask the question: Does it make sense to spend $1 trillion on infrastructure? Part of answering that question has to do with why the private sector is not investing on its own, in a world in which it has the resources. We look at a huge amount of profits. We look at the payouts they’re making to shareholders. It might have been in 2008, 2009, but it’s no longer a question of financial capability. The private sector collectively has the resources to do a lot of things. Why are they not doing it?
Knowledge@Wharton: Are we going to move more to public-private partnerships in infrastructure?
Gomes: Public-private partnerships are the solution that most of the Southern European countries adopted. It’s extremely complicated to negotiate these things, and fundamentally they have worked in Europe as a transfer of risk. The basic reason you do a public-private partnership is that the government doesn’t have the resources to build whatever it is you want to build. Do you want to build a new airport in New York City? We just don’t have the resources in the state of New York, and the federal government is not willing to do it. So, the private sector will build it and pay for it. In exchange for that, you give them the rights to exploit the airport and extract revenues. The question then is, what if the revenues don’t show up? If so, who pays the bill?
In Southern Europe, the governments got stuck with the bill. In the case of railroads, the governments have basically guaranteed a stream of revenues to these private agents to build these railroads. Now, they are struggling to make those payments. In some cases, they had to renegotiate those contracts. In some cases, they just defaulted.
The question always comes down to the same [answer]: The private sector will want a revenue compensation for this investment up front. It makes it more of a market-driven decision. A government can just walk into something like building a road and not worry too much about the economic benefits. A private agent will not want to do that. They’ll want to know if they’re going to make a big profit out of it because the risk is large. So, it makes the economics more difficult, in my opinion. It makes the funding upfront easier on the federal, state and local government. But it brings the economic consideration much more to the forefront than, say, a purely public-funded investment.
Knowledge@Wharton: What drives corporate investment these days?
Gomes: One of the things we wanted to do was exclude what we would call residential investment. We set aside the whole housing sector because we have this episode that we might classify as a bubble of construction and then a crash afterwards. We’re looking just at plants, machines, computers, even intellectual capital and software, trucks, for example — tangible assets, long-lived assets that we would use to manufacture something. Undoubtedly, investment is tied to manufacturing. I think that’s essentially the component that we’re looking at, and that’s really where we’ve seen the largest decline.
The year 2008 was our starting point. We saw something bad happen in 2008. We saw a structural shift in the U.S. economy. When we looked at the data, we started to see that maybe this happened way earlier and maybe we were deceived by this big boom of upgrading of technology in the late 1990s, when everybody was worried about Y2K. We saw massive upgrading of technology at that point, and that distorted the numbers. If you take that out, it seems like for the last 35 years or so, you see a steady decline in corporate investment that really accelerated post-2008. Explaining that has been something that has fascinated us for a little while.
“People who believe in public infrastructure should really take a close look at Southern Europe and why they got into trouble.”
Knowledge@Wharton: What’s the role of technology in these findings?
Gomes: What the data speaks to is that U.S. corporations are concluding that they need to invest more in people, in human capital, and maybe more on intangible creations that those people manage to achieve and less on the physical part of it. Looking at it over the last 30, 35 years, you see the strain where corporations just have concluded that we do not need these tangible assets. We need the intangible part — the human capital part — to be more important and to play a bigger role in the production of goods and services in the whole nature of the U.S. economy going forward.
I think it’s an important conclusion when you think about evaluating public infrastructure. What is the U.S. economy in the 21st century? If you want to build an airport, it’s going to be around for 50 years. Does that make sense in a world in which maybe we will just do a lot more videoconferencing? I don’t know. It’s just not obvious when you think about something 50 years out. Are you that certain about the future of the U.S. economy that you want to reorganize the interstate highway system for the 21st century? I don’t know what that looks like. I don’t know if high-speed rail is a good bet or not, and the U.S. corporate sector clearly is not that certain anymore.
Knowledge@Wharton: There was a lot of difficulty in raising the capital during the recession. Conditions are significantly different now – so why hasn’t investment followed?
Gomes: One of the things that really deceived us for a number of years [was] generally a sense of uncertainty about the world. There was heightened uncertainty about what was happening. Where is the U.S. economy going? Is this a new Great Depression? All those things masked for a while what was really driving investment.
…One possibility, which a lot of people have pointed out … [is that] this is just an increase in concentration. Consolidation in the airline industry would be the typical example. Airlines consolidate. They just shut down capacity, and that’s why we see less investment. I think that’s an explanation for some sectors, for sure. I don’t see that as an overall explanation of what’s going on in the U.S. If you believe that’s true, then you move towards an explanation in which the U.S. corporate sector does not want to invest. Airlines do not want to increase capacity. They’re consolidating.
[The] more weight you give to this explanation, the more you feel like we should do something on the policy side. Maybe it makes sense for the government to intervene more aggressively and to compensate for a lack of private investment. I think it’s possible. I don’t think it’s the most likely explanation. The only evidence for an increase in consolidation is the enormous level of corporate profits that we see. I think that is masked by the fact that so much of corporate profits come from abroad.
So, I don’t see the evidence as [being] very clear to cite that as an explanation…. I prefer to think of it as a technology explanation and, to be honest, just a structural decline in the U.S. economy. The demographics look terrible going forward…. We don’t see the productivity.
Knowledge@Wharton: Technology is transitioning faster than it used to. Because of that, are companies worried about making an investment in an airport now when an airport may not be needed in 20 years?
Gomes: I think that’s exactly the way we should be thinking about it — particularly when an airport is a 50- or 60-year project. I’m always very reluctant to extrapolate from anecdotes, but you can argue in a world of Airbnb, do we need lots more hotels? I think that’s the question for this particular part of the economy because it involves such a long lead period. You’re going to put a road in place. It’s going to be there for 30 years. You need to think very carefully about the benefits and the costs of this, whether it’s on the public side or the private side. On the private side, we don’t see businesses jumping the gun the going out and doing massive amounts of investment. There’s one exception, which is the whole intangible software creation. But I think fundamental to technological transformation is … [that] we are moving to an economy that just needs less capital goods as assets.
Knowledge@Wharton: Do you think there is going to be a shift moving forward because of that?
Gomes: No doubt about it. I think corporations are going to look very different. What does it even mean to be wealthy? There’s just going to be less physical things to own. I’m a little worried about speculating about what it will look like. I’m sure it will look very different.
Knowledge@Wharton: Are policymakers playing catch-up rather than planning ahead? And how potentially costly is that?
Gomes: I don’t think there’s anything costlier than this particular problem, because we are talking about spending hundreds of billions of dollars. Even if it’s a public-private partnership, we would spend $100 billion or $200 billion of new taxes on things that are going be around for 50 years that we very likely will not need.
“The jealousy argument is the argument that got us into trouble with the housing market.”
There’s no more damaging decision than this one. This is a long-lived thing, and we’re going to do it only for the reason that we want to spend money, we want to give people jobs for a few years. But we’re going to put in place things that literally, the private sector is telling us, we do not need right now.
I always go back to the basics. You see people who are making business decisions, who are looking at the dollars and cents, telling us, “We don’t want this. We don’t want to do this. We have the money. We don’t want to do it.” How comfortable do I feel spending tax-payers’ money on this? … If I have money, I can spend it on saving health care. I can spend it on retirement benefits. The question is, is this the best use for public money? …
Knowledge@Wharton: What reaction have you received to all of these ideas?
Gomes: Intrigue. I think that it does challenge the perceived wisdom about public infrastructure. I think people who believe in public infrastructure should really take a close look at Southern Europe and why they got into trouble. We keep looking at China, and the argument for public infrastructure has been, “Look at these beautiful, shiny things in China. We should have the same.” To me, that’s the same as saying, “You have an iPhone 10. I should have the same. I can’t stand having an 8.” That’s a bad argument. That’s the argument that my daughter would have. That’s just not a serious economic argument.
The right argument is, “Does this make sense for us? Can we generate the growth going forward that pays for itself, that improves our lifestyle and makes our citizens better off?” The jealousy argument is the argument that got us into trouble with the housing market. “I want a McMansion, too.” It’s the kind of argument we used to make fun of, but somehow with infrastructure it doesn’t apply.
When you look at corporate investment, it’s hard to avoid the conclusion that the private sector is telling us, “We who collectively operate in the U.S. economy do not see the need for these assets, for these capital goods.” Does the government feel comfortable that all of them, collectively, are substantively wrong? I don’t.
The views expressed in this article are those of the author alone and not of Zinqular Investment Partners (Zinqular Group).