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Is Trump’s US Infrastructure Vision For Real?

IImage by Henry TeitelbaumBy Henry Teitelbaum, Editor, P3-Planet.com

Right up to election day, President-elect Donald Trump was frustratingly short on the details of his post-election plans. In hindsight, it seems that lack of specificity didn’t hurt his chances, and may have even helped his campaign.

Now that he’s elected, Trump’s public remarks point to the possibility that he really is committed to investing in rebuilding America’s infrastructure. If confirmed, such a program would go a long way towards redeeming an otherwise deeply misguided political agenda.

As of this writing, it’s too early to expect a detailed plan from the new administration, particularly one that is led by such an easily distracted personality. However, most political observers seem to agree that this is one domestic program that passes the smell test. It is potentially  a rich harvest of low hanging political fruit because behind all the angry rhetoric of the campaign, both candidates put infrastructure near the top of their domestic agendas.

Serious Commitment

An analysis written in October by Commerce Secretary nominee Wilbur Ross and and business professor Peter Navarro — both senior policy advisers to Trump — points to a serious level of political commitment to infrastructure investment. It also indicates a willingness to consider innovative approaches to private sector financing for infrastructure  alongside public sector and public private partnership investments.

The “Trump Private Sector Financing Plan” described in their analysis is designed to be a revenue-neutral option for financing up to $1 trillion of the nation’s infrastructure needs over 10 years. A key incentive for early stage private sector infrastructure construction would come from federal tax credits. These would be  equal to 82% of the amount of the estimated equity required to absorb long-term revenue-related risks on projects. Because the equity component of the required investment is tax credit-supported, it reduces the revenue needed to service the financing, thereby improving the project’s feasibility.

Tax Neutrality

By their calculation, $167 billion of private sector equity investments in infrastructure could then be sufficient to secure leverage financing of $1 trillion. All of this assumes interest rates of 4.5% and 5%, an assumption that the post-election jump in yields call into question.

To achieve tax neutrality, the plan calls for the repayment of the tax credits from incremental revenue generated from project construction. That would be mainly from taxes on additional wage income and taxes on additional contractor profits.

Trump’s proposed corporate tax reform plan is designed to incentivize private capital flows into redeveloping America’s infrastructure. It achieves this by using the tax credit on infrastructure equity investment to offset corporate tax liabilities on the repatriation of  untaxed profits from foreign operations – effectively turning a tax liability into an equity investment.

Trump has proposed to tax US companies’ accumulated offshore profits at 10%, down from the current top corporate income tax rate of 35% on a one time basis if they repatriate those monies. US companies currently hold an estimated $2.5 trillion in earnings overseas because current federal law allows them to indefinitely defer paying taxes on these profits until they return them to the US.

Trump, who has specified that as a businessman he has “always loved leverage”, has also indicated a desire to take advantage of the current historically low interest rates to borrow long term, likely for a sum exceeding $500 billion.

Clean Sweep of Congress Helps

It’s worth remembering that Trump has been a real estate developer for his entire career. It is where his main business interests lie. But  it also seems that creating impressive, modern, even garish physical structures really excites him on a personal level. During the campaign, Trump emotionally recounted his experiences visiting modern airports in China and Dubai and wondered why the US has allowed its own public infrastructure to fall into its current state of disrepair.

Another factor that supports a potential increase in borrowing for infrastructure investment is the Republican sweep of both houses of Congress. Historically, most of the increase in federal spending in the US in recent decades has occurred under Republican administrations, most notably under George W. Bush when both Houses were under Republican control.

There is also considerable bi-partisan support for large scale infrastructure investment. President Barack Obama’s first term featured the American Recovery and Reinvestment Act, which was passed in 2009. It has been widely criticized for being too small in scope, and too focused on shovel-ready projects and other short-term fixes to address the enormous backlog of under-investment in infrastructure. But many still consider it an important Keynesian boost to the economy that contributed to the US outperforming other developed countries over the past eight years. A significant part of Hillary Clinton’s plan would have involved extending this investment program by creating a federally funded infrastructure bank that Obama was blocked from creating in the early part of his term by congressional Republicans.

Sorry State of US Infrastructure

There’s no question that the US would benefit enormously from new investment in these essential assets of future prosperity. The nation has been under-investing in its economic and social infrastructure for many years under both political parties, with overall spending dropping by half over the past three decades.

The extent of the neglect is evident across the board, with the American Society of Civil Engineers giving the country’s infrastructure a ‘D+’ GPA score on its 2013 report card. This includes a ‘D’ (poor) for drinking water and wastewater and a near failing grade of ‘D-‘ for levees and inland waterways. Aviation, roads and schools infrastructure are also rated ‘poor’ in terms of their fitness as measured by their capacity, condition, funding, future need operation, maintenance and public safety.

According to the ASCE, the US has infrastructure needs of about $3.6 trillion through 2020, including $1.7 trillion for roads, bridges and transit alone.

The Trump analysis points out that the future attractiveness of the US as an investment destination, its competitiveness, and its productivity are all at risk from the poor condition of the country’s infrastructure. It noted that the US now ranks 12th on the Global Competitiveness Index in infrastructure, with traffic delays due to inadequate transportation infrastructure costing the economy more than $50 billion annually.

Public Safety Issues Emerging

Beyond this, America’s quality of life and increasingly public safety are compromised, as recent episodes of lead poisoning and bridge collapses have demonstrated. The Trump campaign’s analysis cited an investigation by USA Today identifying nearly 2,000 additional water systems spanning all 50 states where testing has shown excessive levels of lead contamination of the past four years, including 350 systems supplying drinking water to schools or daycare facilities.

Since the Great Depression in the early part of the 20th century, infrastructure investment has been used as a fiscal tool for generating economic growth.

Citing the Federal Reserve, The Trump campaign paper says that in the US every $200 billion in additional infrastructure spending creates $88 billion in wages and increases real GDP growth by more than a percentage point, with each GDP point creating 1.2 million additional jobs. Other estimates, suggest that this multiplier effect could be even higher. According to the Federal Reserve of San Francisco, over a 10-year horizon, the average multiplier effect of government spending on highways is about two, which means that for every dollar spent, two dollars of GDP activity is generated.

There is also a potentially huge pool of domestic investment demand for infrastructure projects from pension funds, insurers and other institutions with long-term liabilities. The long-term nature of infrastructure programs means these investments are structurally well matched to the revenue flows from the debt that finances their construction, operation and maintenance.

Inflation Protection, Diversification Benefits

This revenue is highly reliable due to its link to dedicated tax revenue streams (availability payments) or revenue collected from tolls (concessions), it can provide inflation protection to the investor. Investors also look to infrastructure for its portfolio diversification benefits.

There are several challenges that could derail, or at least limit the success of Trump’s infrastructure plans. Among these is that the US unemployment rate has now fallen below 5% and continues to decline. That leaves very little slack in the labor market to prevent cost-push inflation from being generated. Regardless of the fundamental economic case for investing in infrastructure, shortages of labor are bound to appear, driving up the cost for delivery of these assets and making his goal less attainable.

It seems, in fact, that Trump’s plans for rebuilding America’s infrastructure will almost certainly be at cross-purposes with other key elements in his domestic agenda. Most notably, this includes his outspoken pledge to deport some 11 million illegal aliens.

Debt Spiral Risks

Another consideration is that the scale of Trump’s other policy initiatives, including higher defense spending and a range of tax cuts, could create a debt spiral that is potentially unsustainable. Already, the bond curve has steepened significantly amid concern that interest rates could start to rise quickly to prevent inflation from running out of control. If this happens, it could quickly and dramatically raise the cost of any large infrastructure investment program.

My own view is that Trump, or his Congressional allies will sooner rather than later have to decide which of his campaign promises needs to be curtailed so he can pursue the priorities that he believes will restore America to some semblance of his definition of its historic ‘greatness’.

Brexit: What Happens When Governments Stop Investing

By Henry Teitelbaum, Editor, P3 Planet

The Brexit vote not only exposed how out of touch the government here is from British voters, it laid bare the extent to which its leaders have failed to address the twin issues of low growth and rising inequality that led to this fiasco.

More than anything else about the UK referendum decision to leave the European Union (EU), it was middle class economic insecurity and diminished hope for the future that allowed people to be influenced by mostly false propaganda about immigration, compromised independence and lost identity.

Assigning blame for the conditions that led to these misconceptions is the easy part. Prime Minster David Cameron and Chancellor  George Osborne had tough choices to make starting in 2010 as they tried to navigate the UK economy out of the worst recession in the modern era. They  consistently made the wrong ones, and it is fitting that they should now resign.

As Goes Britain…

The question for Britain and the many other western countries that face populist rebellions, is whether their leaders will have the courage to do things differently before they too feel the wrath of a despairing and disenfranchised electorate. It could well become the ultimate measure of success in post-globalization politics across Europe and the US.

I am of course referring to fiscal policy, or in the case of this Tory government, the absence of one. It always seemed counter-intuitive, to put it mildly, to expect that piling  austerity onto one of the worst hit economies of the 2007-2009 financial crisis would produce anything other than misery.

But that’s exactly what they did. Public spending has been cut by 8.3% since 2010, and there’s no end in sight,  with the Institute for Fiscal Studies (IFS) now estimating that it will be 2020 before the budget is balanced.  Benefits were cut without consideration for the massive workplace displacements that people were experiencing, and investment in  public infrastructure was drastically reduced after Osborne decided in 2011 to suspend Private Finance Initiatives. This is no different from the ruinous austerity that has prolonged recessions and hobbled growth across the EU for the past seven years.

Stoking A New Housing Bubble

But Cameron and Osborne have done even worse. Instead of using ultra-low borrowing rates to encourage productive investment in long-term growth, they reflated the housing bubble with questionable programs such as Funding for Lending. Near-term, this  generated some stamp duty revenue for the government, but not nearly enough to close the budget deficit.

It also did nothing to create jobs outside of the real estate business. In fact, it probably added to peoples’ sense of financial insecurity by putting the cost of home ownership even further out of reach.

The result of these policies has been one of the most uneven recoveries, and one of the world’s most persistently wide income gaps.

 

Historically, this level of income inequality would be resolved in one of three ways. Politically, it could happen through tax policies that re-distribute wealth. Economically, it could result in financial collapse, which causes massive bond defaults that disproportionately destroy the wealth of those with income to invest. Or it could happen by way of  Europe’s traditional equalizer: war.

Britain’s Infrastructure Deficit

But there is a much less painful way out of this mess. And all it requires to produce real results for people, their communities and the economy at large is some big picture thinking and the courage to grasp the opportunity.

Britain is sitting on a more than £60 billion deficit between what is needed and what is currently being spent on public infrastructure. This is not unlike other parts of Europe, where government spending has become a dirty word. What needs to happen here is to make infrastructure development a priority the way it was during the depression era, because this investment creates stable, well-paid jobs in precisely those sectors of the economy where middle-class incomes have eroded.

Investments in infrastructure, whether financed by the government or through partnerships with private sector delivery organizations, create enormous value for the economy in both the short- and long- term that fully justifies their cost. In the short-term, new jobs restore middle class incomes, and get money circulating in the real economy. This supplies a key ingredient that has been missing from this recovery, where  aggregate demand has been  too weak to prevent price deflation.

Longer-term, the essential assets that are delivered  – modern roads, railroads or better schools and hospitals – boost productivity and attract new investment at home and from abroad.

The Multiplier Bonus

There’s also a big bonus from the multiplier effect. This is the impact on GDP from the increased amount of money that people spend as a result of  job creation and the contribution that the new asset itself makes to economic activity. According to Standard & Poor’s Corp., the UK would benefit twice as much from this multiplier effect than would Germany or France. It also specified that an increase in infrastructure spending of 1% of GDP returns 2.5 times as much as the cost of that investment over a three-year period.

Government tax collections meanwhile typically increase dramatically due to  all of this additional consumer spending, eliminating the deficit far more quickly than any policy fix this government has tried.

The UK government’s updated National Infrastructure Plan (NIP), published at the end of 2014 and updated last year, contained 550 projects and programs with a combined capital value of £413bn. The pipeline of planned projects includes investments in the energy, transport, flood defense, waste water and communications sectors and features 40 major infrastructure projects termed as high priority.

It would be nice during his remaining time in office to see Mr. Cameron put an effort into mobilizing the nation around delivering  these projects before interest rates start to rise. It would go a long way towards giving people hope for a better future, as well as bringing a new sense of identity and purpose to the nation.

Can P3 Help Tackle Asia’s Corruption Problems?

By Henry Teitelbaum, P3 Planet

(A version of this story previously appeared on Aon One Brief)

The Big Picture

Economic growth, supported by huge flows of foreign capital, has expanded prosperity in many countries across the South and East Asian region, leading to declines both in poverty and political risk.

But now, as China’s growth engine for the region subsides, regional competition for capital is likely to increase. While economic challenges in the short term create uncertainty, a renewed focus on anti-corruption efforts in the region could help states remain preferred destinations for foreign investment over the long-term.

The impact of anti-corruption campaigns in China, India, Indonesia and Malaysia are already being felt, according to the 2016 findings of Aon’s annual Political Risk Map. Across the Asia-Pacific region, tackling corrupt practices in both public and private sectors could not only reduce political risk, but also economic inefficiency. This in turn should support resilience in individual Asian economies at a time when emerging economies remain under intense pressure, helping them to more effectively address their growing infrastructure needs.

The challenge is very real. Urbanization and population growth is driving huge demand for basic essentials such as water, sanitation, transportation and electricity. This will place a clear focus on inclusive, sustainable development, that will reduce the already significant impact of development projects on the environment. At the same time, public financial resources are stretched and existing multilateral bank funding is insufficient.

New multi-lateral lenders, including the Asia Infrastructure Investment Bank (AIIB) may help to attract private investment to meet the region’s infrastructure needs. But ensuring this foreign capital remains for the long-term may also depend on progress in anti-corruption efforts. Clearer legal and regulatory frameworks and more transparent procurement structures could become important ways to accomplish both goals.

Deep Dive

Developing countries in Asia – including India, China, Indonesia, Malaysia, South Korea, Taiwan, Thailand and the Philippines – have achieved great success in generating prosperity, alleviating poverty, and encouraging political stability over the past 20 years. Much of this has been due to their ability to attract foreign investment through skilled labor, low wages, pro-market policies and political stability.

Political and economic risks in many Asian countries have also declined as stable currencies, and in some countries the adoption of pro-market policies the spread of democracy have expanded prosperity and created middle classes. But now, the physical infrastructure that is needed to keep apace with the demands of growing and increasingly urbanized populations is proving inadequate to the task. Asia’s infrastructure market is set to grow to 60% of global demand by 2025, according to PwC’s Capital project and infrastructure spending: Outlook to 2025.

Balancing Reform, Growth and Uncertainty

Nevertheless, as the Political Risk Map reported, countries such as China may face uncertainties in economic policy as their governments try to strike a balance between implementing reform and managing growth. In China, President Xi Jinping continues to consolidate power through his anti-corruption campaign – the economic outcomes of which are likely to be positive – while in India, Indonesia and Malaysia measures to counter corruption are expected to improve political and economic resilience.

“Anti-corruption campaigns may rebalance concerns regarding a stalling Chinese economy, but improvements in political risk do not necessarily translate into economic gains,” says Karl Hennessy, President of Aon Broking and CEO of the Global Broking Centre in London.

“Macroeconomic drivers are behind the current slowdown in China,” Hennessy continues. “While a war on graft is likely to have a positive, long-term impact on China, it may also reflect efforts to stabilize an economy going through an unprecedented deceleration. Following stock market uncertainties earlier in the year and a slide in GDP, Beijing may be turning to additional levers to instill greater confidence in its future economic program.”

The Rise Of Institutional And Private Funding

Outside of China, public funding resources for investing in this infrastructure are largely not up to the task. This is especially the case in poorer countries, where scarce government funding is needed to care for poor, largely rural populations. In countries such as India, this leaves little discretionary public funding available to support investments that would allow public infrastructure to keep pace with growing demands for better schools, healthcare facilities, care for the elderly, water, waste, electricity, broadband and other basic requirements.

As long-term investors in developed countries seek ways to diversify globally, opportunities to attract private investment from abroad to help meet this demand are increasing. However, competition for capital from other countries in the region also means that foreign investors will be weighing the relative risks more carefully than ever.
Existing multi-lateral lenders such as the Asia Development Bank (ADB) are inadequately funded to meet expanding demand for infrastructure, bureaucratic and slow. New multi-lateral lenders, such as the Asia Infrastructure Investment Bank (AIIB) and possible increased in capital flows from regional trade agreements like the Trans-Pacific Partnership (TPP) may help to attract private investment to meet infrastructure needs.

The robustness of legal, regulatory and market structures are important factors for determining where this private capital will gravitate. But corruption, in addition being a drain on public finances, is a major risk factor for both public and private investors and is a key determinant in their choice of where to invest.

In China, where state-controlled enterprises, including infrastructure developers, absorb a huge proportion of the country’s financial resources, the government’s current anti-corruption drive is a central part of its goals to make the state more efficient, thereby freeing up capital in the more efficient private sector.

Some Asian countries, notably India, have significant Public-Private Partnership (P3) programs underway to help tackle their infrastructure needs. When they work well, the competitive bidding and need for transparency involved in P3 tendering can itself help to reduce or eliminate corrupt influences. At the same time, the contract forces greater accountability on to the private sector by specifying penalties for inadequate delivery or maintenance of the asset.

Partnership structures such as these can also bring stability to foreign investment flows into the country, create local jobs, encourage the development of a domestic investor base and even respect for the rule of law. At the same time, foreign institutional investors gain investment and currency diversification and the potential to earn strong returns on investment.

For Asian economies to overcome the potential ripple effect of China’s current economic slowdown and secure sustainable long-term growth, increasing political stability can play a key part. While much progress has been made in recent years, as seen in the findings of Aon’s Political Risk Map, there is still work to be done – and political stability is only part of the story.

Our Fragile Markets, or Why China’s Your Daddy

By Henry Teitelbaum, Editor, P3 Planet

There seems to be very little western investors, governments or central banks can do to stem the tide of contagion from China’s collapsing stock markets.

While it’s tempting to dismiss this selloff as merely a correction in equity markets after they hit sky-high valuations, it’s troubling to see how quickly the wealth of millions of people has evaporated. Of greater fundamental concern for markets is that as China’s export-driven juggernaut slows, there are no real economic growth engines in the world to replace it. The fact is that our economies remain weak and vulnerable, and for that we have ourselves to blame.

During the past 20 years, when China’s booming economy was busy exporting goods and importing western technology and capital, governments in the US and Europe did very little to mobilize investment in the essentials of future growth at home. In Europe, the focus was on futile efforts to rein-in social spending, reform labor markets and keep jobs from disappearing, while in the US little attention was paid to economic fundamentals. Instead, successive governments, Democratic and Republican alike, threw everything behind politically popular efforts to expand home ownership to the millions.

Critically, nothing much happened at either the federal or state level to develop the public infrastructure that would be needed to support a thriving and productive 21st century economy. Whether it was upgrading roads and bridges, rail networks and airports, or building schools and public healthcare facilities, investment utterly failed to keep up with society’s needs. What we got instead was the biggest housing bubble in US history.

US Labor Productivity

Wrong-Headed Crisis Response

Even after that bubble burst, western leaders ignored or were thwarted from making these investments. Across the Euro-zone, governments focused on a self-defeating exercise in fiscal austerity, while in the US, an initial investment in fixing public roads was followed by political gridlock. Despite the opportunity to borrow long-term at historically low cost,  governments in both the US and Europe continually failed to make these urgently needed growth-generating investments.

The private sector has also failed us. Businesses across the US and Europe — rather than make bold investments in their flat-lining economies — have been sitting on their expanding piles of cash for years. Dividends to investors reached record levels while companies waited for that elusive economic turnaround that never seemed to take hold. Predictably, when the investment-starved turnaround finally did come, it was weak and woefully inadequate.

So here we are. The US, Europe and Japan are all still drowning in debt, either outright, or as a percentage of GDP. And investment spending, such as it is, isn’t anywhere near where it needs to be to allow economies to grow their way out of debt. So western economies, markets and indeed their financial systems are all looking very fragile indeed.

Investment Opportunities Ignored

It didn’t have to come to this. Investments in infrastructure create enormous value for economies that fully justify their cost. In the short-term, they generate jobs, which helps to put money into circulation in the economy through increased spending on goods and services. Whether it is public money, or private sector investment through Public Private Partnerships, the multiplier effect that follows quickly generates economic activity and tax revenue for the government.

Longer term, the completed asset supports better services for both the public and private sectors, leading to a more productive economy and a more attractive investment destination for both domestic and foreign businesses. The debt generated from building these public assets can also make for a safe, long-term  investment that can contribute to the stability of domestic markets in the face of turbulence elsewhere in the world.

Studies have repeatedly shown that infrastructure investments, particularly during times of economic bust, generate a much higher fiscal multiplier than other types of government investment, (http://www.frbsf.org/economic-research/publications/economic-letter/2012/november/highway-grants/).

In effect, they provide a Keynesian lift to aggregate demand at precisely the time when it is most needed. Further out in time, according to the Federal Reserve Bank of San Francisco, there’s a medium term boost to the economy when the asset, in their example a public road, increases the economy’s productive capacity.

The SF Fed concludes that combining these multiplier effects can mean that every $1 of government spending produces “at least” $2 of economic output.

China’s Treasury Bond Option

The colossal failure of western developed economies to adopt growth-oriented investment policies means their markets will remain extremely vulnerable to exogenous shocks such as the one China has generated. And it’s not just equities. Treasury yields could be in for a similar shock if China, now the biggest holder of US Treasurys ($1.27 trillion as of June 2015), decides to start selling off its holdings to support its markets.

In the absence of western leadership, what’s likely to happen in our fragile markets going forward will depend on how quickly and successfully China re-positions its economy towards domestic consumption. Let’s hope they decide they don’t need to sell their Treasury holdings to get there.

This blog has appeared in Medium and Business Daily.

Henry is available for freelance commissions and long-term assignments and is reachable at hthq@hotmail.com.

GOP Should Put Infrastructure Back On US Agenda

By Henry Teitelbaum, Editor, P3 Planet

Over the past six years, Republicans have become very adept at blocking US President Barack Obama from achieving anything in Washington, often through tactics that could have done lasting damage to the nation’s credit standing in the world.

Now that the Republicans have control over both houses of Congress, it’s time for them to grow up. The 114th Congress  brings with it just about enough time before the  2016 Presidential election campaign for the Republicans to craft a meaningful federal agenda that will prove it is more than just the party that says “no”.

While there is already talk of working together on a tax reform or immigration agenda over the next six months, it’s hard to imagine a breakthrough on issues of such long-standing disagreement between the two parties.

Continue reading GOP Should Put Infrastructure Back On US Agenda