As a follow-on to my post the other day, here’s some further thoughts on risk and uncertainty, applied to revenue volatility:

• If long-term secular trends reflect low risk levels, fiscal volatility should revert to a mean where essential spending is almost certainly accomplished in the long run – that is, there is a low risk that the public sector will default on its fundamental obligations. This is true of most US state and local governments. But the path to get there is highly uncertain.

• Non-wealthy taxpayers and especially beneficiaries live in the short run, so for them a high level of uncertainty results in a high risk that something bad will happen. Contractual recourse for certain redress in future is not available to them – the ballot box is not at all precise or responsive. So allocating uncertainty to these parties is effectively allocating risk (in the sense of a “predictably bad outcome”).

• In contrast, infrastructure commitments are intrinsically long-term, which sets the stage for institutional investors to take a long-run view and incorporate the state’s low risk profile in their agreements. With detailed long-term contracts, the outcome of short term uncertainty (e.g. low payment this year) can be precisely and certainly addressed in future (e.g. a higher payment at some point). In effect, the state can allocate a high level of uncertainty – but not risk – to the investor.

• More specifically, cost-effective flexible debt capitalization can deal with the uncertainty of cash flow timing as long as the risk of ultimate repayment is low. Over the course of a 30-year infrastructure financing, a AAA-rated state is well-positioned to provide that assurance.

So overall, a P3 solution can allocate short-term fiscal uncertainty to the private sector (which is able to deal with this efficiently) but long-term risk would be retained by the state (which is well-positioned to keep it). This will reduce the harm of uncertainty when it results in a high risk of a bad outcome – directly for the infrastructure (planning, deferred maintenance) and indirectly for other “crowded out” spending programs (especially social services).

A minor additional point: one objective of a traditional-type P3 is “risk transfer” – it is useful to make it clear at outset that next-generation P3 is different, focused on “uncertainty transfer”