Can infrastructure pay for itself?

In a difficult economic environment, many investors – government and private sector alike – are looking to ensure that their infrastructure investments are financially viable.

Borrowing, through government debt or via the private sector, comes at a cost that needs to be paid back.

The New Zealand Infrastructure Commission – Te Waihanga (NZIC) recently published its latest report Paying it back: An examination of the fiscal returns of public infrastructure investment.

NZIC looked at the likelihood of infrastructure projects paying for themselves, and the factors that make that more or less likely.

The commission finds that there are a few key drivers to consider.

Project quality will determine revenue

Project quality is the most important factor in influencing whether a new infrastructure investment can earn enough revenue to pay for itself.

Cost effective projects, which serve a lot of people, are more likely to create a positive financial return.

On the other hand, expensive projects that serve relatively few, struggle to pay back the initial investment.

Projects offering better value for money are likely to have higher returns

Projects with higher benefit-cost ratios (BCR) (an indicator of the value for money a project might provide) are likely to have better returns.

But the bar is high for projects to pay for themselves in full.

The commission suggests that for projects to provide positive financial returns, benefit-cost ratios would need to be anywhere between 5 and 9 (which is high for an infrastructure project).

Revenue tools are an important piece of the puzzle

When quality projects serve demand cost-effectively, revenue tools can play an important role in determining how much new income can be brought in.

Water charges, tolls and value capture levies (a way of monetising the increase in land value that comes from infrastructure investment) are all options councils and central governments could consider.

Attaching a revenue stream to an asset ensures the infrastructure provider will have the money available to recover up-front construction costs and fund long-term maintenance and renewals.

Likewise, when local government investment is matched with private sector development, financial returns are higher.

Bigger isn’t always better

Spending a lot of money up-front doesn’t necessarily mean larger returns.

A better approach may be to invest little by little, expanding infrastructure networks gradually over time in response to proven demand.

Major projects are not expected to pay for themselves because of their size.

Not all projects are created equal

Importantly, the commission recognises that not every infrastructure project is meant to make money.

Social infrastructure like libraries and leisure centres are unlikely to generate significant economic growth or return very much on the initial investment. Often, admission fees don’t cover the full cost of the project either.

But not all benefits are monetisable – quality of life or aesthetic value are often some of the key benefits of these projects.

What matters is the mix of these kinds of investments, and those projects that generate a return, in the network.

The public ultimately must pay for infrastructure. So, the more that is invested in projects that don’t deliver returns, the greater the share of taxpayer money that will go to paying for it.

Getting the settings right to ensure that projects are affordable, cost-effective, and pay for themselves where possible is an important part of the infrastructure prioritisation process.