Innovation happens when new resources become available to meet a defined need.

There’s an awful lot of institutional (and very smart) money interested in US infrastructure — there’s clearly no lack of new resources.  I think the problem for infrastructure financing innovation has been the absence of clarity about public-sector needs.  Everybody knows local governments need something to help pay for infrastructure under difficult fiscal conditions — but what exactly?  Much of the current discussion focuses on privatization or P3s as alternatives to traditional or simple lease-type forms of financing, a binary characterization that is roughly accurate for currently available options — but only marginally useful for developing new ones.

In reality, all current and potential financing alternatives exist on a spectrum of increasing benefits and costs (click on picture to enlarge):

Looking at this way does a few things.  First, it reminds us that there’s no free lunch when smart money invests capital — increasing benefits inevitably mean increasing costs.  So if you’re looking for a solid net benefit, you’ll need to carefully define exactly what benefits are most valuable to you.  Risk transfer on an infrastructure asset is always nice-to-have, but unless you really need it, it’s not likely worth transferring to a sophisticated investor who knows how to price it.  Cost efficiency is obviously a good thing, but efficiency might come at a political price that is not worth paying.  The end result is a focus on identifying real needs, not pre-packaged solutions, which is where we need to start for innovation.

Second, once you start identifying needs, it’s clear that measuring the specific benefit of addressing a specific need (and its concomitant cost) is crucial for designing an alternative that has a compelling case to do it.  This naturally leads to a customized, unbundled approach, which I think dramatically increases the chances that a proposed alternative will work.

Third, and most importantly, thinking about infrastructure financing alternatives on a spectrum provides some real guidance as to where innovation should be focused.  There’s not much scope for innovation in the traditional end of the spectrum (which is inflexible by definition, and perhaps properly so).  On the other end, full privatization and demand-charge P3s are very powerful tools, with lots of potential benefit and cost, but they’re only applicable for a few asset classes and public-sector financial situations.  The middle of the spectrum — on a sliding scale of asset size and complexity, and public sector fiscal constraints — covers a lot of real-world situations in the US right now.  This is where I think the action should be.