Economic infrastructure provides fundamental services to economies. Typically, this type of infrastructure provides electricity, water and gas to industry, businesses and large institutions, community organisations and households. It also assists in providing transport, freight and logistics services. In the information age, access to low-cost, high-speed broadband facilitates a range of e-services.
The quality, cost, and access to these services affect the productivity of an economy, the efficiency with which goods and services are both produced and consumed, and the equity between different sections of society.
The physical aspects that underpin these services have a range of characteristics that separate these services from everyday goods and services delivered through competitive markets. Service provision can be characterized by a large, up-front capital investment. Installation of an asset can create a local demand response and establish a natural monopoly. Economic arguments for duplication of the asset to stimulate competition are usually weak.
Also, there is usually a long-term stream of benefits that are generally small relative to the capital investment. In some cases, user benefits alone are insufficient to justify the construction and operation of economic infrastructure. Wider benefits can accrue to society, and some societal costs can be avoided.
These assets contain a high level of optionality. Unlike purchasing a retail good, it is possible to develop the asset in phases or stages, with options to scale up or down or abandon operations. In other cases, once the decision to build has been made and construction started, it is tough to change the project scale or scope.
These factors contribute to determining how these assets can be funded as well as who should potentially own and control them.
The classic argument for government provision of infrastructure assets, and consequently related services, concerns market failure. That is, the operation of the private market leads to under or over provision of services from these assets. As a result, mismatch of supply and demand reduces economic value in the economy. In the case of under provision, supply is constrained and the level of inputs is less than required to meet the demand. As infrastructure services are critical inputs into other sectors of the economy, economic efficiency is impeded. The productive potential of the economy is not fully realized and potential economic growth is stymied.
Where there are significant externalities, these are not captured in the price mechanism, where price signals between buyers and sellers determine the optimal level of production and consumption.
This affects the funding and revenue models for infrastructure assets. Consequently, asset transactions can become very complicated.
Where benefits largely accrue to users, and use of infrastructure services can be individually identified, it is possible to develop cost reflective charging regimes. The funding model, without recourse to other sources than user charges, is only limited by extant economic regulation where this is imposed on assets with strong monopolistic characteristics. This river of user revenue forms the basis of the transaction value, and also the initial assessment of feasibility.
It is not without significant risk because of the long period evaluation, accompanied by the risk around maintaining fixed parameter assumptions over that timeframe. Construction cost blow outs, poor demand forecasts, changes in consumer preferences, shifts in relative related prices for products and services that are substitutes or complements can all combine to turn a positive investment into a financial fiasco.
This is before considering the situations where direct asset-related revenue streams cannot support the creation and operation of economic infrastructure.
An infrastructure asset that cannot be funded from its future stream of user revenues requires additional funding contributions. The private sector will not fund infrastructure without a financial return. It is important to distinguish from an economic return.
Economic infrastructure may produce a return to an economy but will not be provided by the private sector if the private sector cannot get a return on its investment. In other words, the return to the economy is contrasted with the return to the balance sheet of a private investor.
Given the extraordinary imbalance in costs and benefits in any particular period over the life of an infrastructure asset, some form of financial intermediation is necessary. It is important to see this as a financial service rather than a private sector investment. This ensures that the cash flows needed to build, operate and maintain the economic infrastructure asset are provided as and when they are required.
Similarly, change of economic control of an infrastructure asset occurs at a specific point in time – a transaction date. The control is exchanged for a specific valuation of the asset.
As an example, early stage infrastructure development is heavily exposed to construction risk and unproven demand. In contrasts, mid-life infrastructure assets have mature demand profiles and risks associated with construction are better known. Late life assets face potential increases in maintenance and rehabilitation costs, as well as changes in user demand and the impact of technology.
Having a very clear perspective on the inherent economic and financial values of an economic infrastructure asset is very important. These valuations are combinations of knowledge at a point in time. It is where a very strong risk assessment is needed as well as an understanding of the relevance of that point in time.