Justin Trudeau’s big infrastructure mistake

November 14 was a big day for the Trudeau government’s infrastructure plans.

In the afternoon, Prime Minister Trudeau attended a “summit” for foreign investors focussing on investment in areas like infrastructure, technology, natural resources, and renewable energy.

The summit was hosted by Blackrock Capital Investment Corporation, the world’s largest asset management company with $5.1 trillion dollars under management. All told, BlackRock brought two dozen of its clients to Toronto from around the world to meet with Trudeau. Blackrock clients include many of the world’s largest pension funds, sovereign wealth funds and other institutional investors.

Cabinet ministers attending the event included Finance Minister Bill Morneau, Minister of International Trade Chrystia Freeland, Minister of Natural Resources Jim Carr, Minister of Innovation Navdeep Bains, Minister of Infrastructure Amarjeet Sohi, Minister of Canadian Heritage Melanie Joly, and Minister of Health Jane Philpott.

Earlier in the day, the Liberals met with Canadian institutional investors such as the CPP Investment Board, the Caisse de dépôt , Ontario Teachers’ Pension Plan, OMERS, and Brookfield.

The two meetings are a follow-up to the work of the Advisory Council on Economic Growth which on October 21, released three reports calling for a national infrastructure bank, a greater effort to attract foreign investment and a major boost to immigration. Finance Minister Bill Morneau announced that the government had decided to pursue the bank model proposed in the infrastructure report only a week later in his Fall Economic Update.

The Advisory Council is chaired by Dominic Barton, managing director of McKinsey & Co., an elite business consulting firm operating globally. Mark Wiseman, senior managing director at BlackRock, was an influential member of the Advisory Council.

While the Advisory Council’s reports focussed on immigration as well as direct foreign investment, it is the infrastructure bank proposal that is creating the most buzz in international finance circles and was the real focus of both the Blackrock summit and the morning meeting with large Canadian institutional investors.

Examples of potential infrastructure bank projects listed in the Council’s report include toll highways and bridges, high-speed rail, port and airport expansions, city infrastructure, national broadband infrastructure, power transmission and natural resource infrastructure.

At the heart of the Council’s proposal for an infrastructure bank is the belief that the bank could leverage project-specific private capital at a four-to-one ratio from pension funds, sovereign wealth funds, private equity, insurance companies and other institutional investors. What this really means is that because the federal, provincial and municipal levels of government traditionally split infrastructure funding equally, for every dollar the three levels of government collectively put into a specific project, the bank would attempt to leverage four dollars from private pools of capital for direct investment in that project. This is clearly spelled out on P. 29 (Chart 2.2) of the November 1, Economic Update.

Of course, whether the government can successfully leverage private equity at the four-to-one ratio is an open question. Ottawa’s previous efforts to attract private infrastructure investment – including through an agency focused on public-private partnerships called PPP Canada – have had limited success.

In addition to the government investment in the bank and the leveraging of private capital for specific projects, the Advisory Council’s report recommends that Ottawa should privatize – in full or in part – some of its existing assets as a way of raising money that could be spent on other infrastructure priorities.

That advice comes as the government recently hired Credit Suisse AG to analyze several privatization options for Canadian airports and Morgan Stanley to look at privatizing ports.

As a complementary measure to providing financing, the report also wants the new bank to act as a national “centre of expertise” on infrastructure.

In the Council’s view, the proposed bank’s three roles as: 1) a centre of infrastructure expertise; 2) a financing vehicle for Public-Private Partnerships (P3’s); and 3) a recipient of proceeds from the privatization of existing public assets, are tightly intertwined. In reality, the idea of creating a centre for expertise is a good idea that can stand completely on its own while the proposed financing model with its reliance on private equity partnerships, is deeply flawed and needs a fundamental re-think. The privatization of public assets such as ports and airports is an idea that should be abandoned immediately.

First, the centre for expertise.

According to Council members Mark Wise and Michael Sabia, the centre of expertise activities would include:

• assembling a national infrastructure gap inventory.
• working with federal, provincial and municipal governments to develop a national infrastructure plan.
• hiring experts in finance, engineering, project management and procurement to ensure that the two sides of the bargaining table are evenly balanced.
• negotiating the operating contracts that set the rules for service levels, capital requirements, pricing changes and so on.
• providing operational expertise – in procurement, in the management of tender processes and in the co-ordination of siting and permitting – that would be available to governments for large investments, even on projects that the bank does not finance.

These are sensible ideas and to the extent that government mis-management of large scale infrastructure projects is often given as the reason for involving the private sector in the first place, building up public sector infrastructure expertise is a legitimate government priority.

But the financing model proposed for the new bank’s projects is deeply problematic.

The problem with the private financing of infrastructure – higher costs

Put bluntly, the government’s case for involving private capital in the bank’s projects is bad policy because private investors in these schemes demand a much higher rate of return than the government borrowing rate.

Michael Sabia, who in addition to being a Council member is also CEO of Quebec’s Caisse de dépôt pension fund, let the cat out of the bag in a March 3 speech to the Toronto Region Board of Trade :

“For long term investors, infrastructure offers something that’s not easy to find today: stable, predictable returns in the 7 to 9 per cent range with a low risk of capital loss – exactly what we need to meet our clients’ long term needs”.

But while structuring infrastructure deals with a private equity component may be attractive to institutional investors, that doesn’t make it good public policy. That’s because there’s plenty of low-cost public financing available to the federal government to finance infrastructure directly. According to the Bank of Canada, the federal government can float a one-year bond at under 0.6 per and issue a thirty-year bond at around 2 per cent.

In fact, there has never been a better time for governments to borrow to finance infrastructure directly. It simply makes no sense for the federal government to guarantee private “partners” a seven to nine per cent return on infrastructure investments when the government can float long-term bonds at two per cent or less. CUPE economist Toby Sanger did the math and calculated “that financing at two per cent for a $100 million project amortized over 30 years adds $34 million to its cost, while eight per cent adds $165 million — almost five times as much in financing costs and doubling the total cost, including the principal”.

This is consistent with the 2014 findings of Ontario Auditor General Bonnie Lysyk who found that Ontario’s Public-Private Partnerships (P3’s) had cost Ontario taxpayers nearly $8-billion more on infrastructure over the preceding nine years than if the Ontario government had successfully built the projects itself. A full $6.5 billion of the overpayment of $8 billion came from the higher borrowing costs of P3’s relative to traditional government infrastructure financing.

Ms. Lysyk found that the province assumed that there was less risk of cost overruns and other problems with P3’s than with public sector financing and project management. But, she said, the province actually had no historically based evidence on public sector overruns to back up that assumption. Private partnerships, meanwhile, are more expensive because companies pay far more than the government does for financing, and receive a premium from taxpayers in exchange for taking on the project risks. In Ontario, the auditor found that this “risk premium” paid to private partners was often more than 50% over the project “base” costs!

In most cases, she said, the least expensive solution may simply be for government to get better at building infrastructure itself, rather than farming it out to the private sector and its much higher borrowing costs.

Put bluntly, Canadians will have to pay more for infrastructure if private investors in infrastructure projects are going to get the kind of returns that they will demand. And this means higher user fees for the average Canadian on top of their taxes paid to fund the government’s share of the projects.

Moreover, nowhere in the Advisory Council’s report does it acknowledge that if new revenue streams can be created to give private (and mainly foreign) capital the high rate of return that it wants, then those very same new revenue streams can be created to increase government returns for 100% publicly-owned infrastructure projects. In other words, if the government feels it can withstand the political heat from the imposition of user fees and other charges ultimately passed on to the public, why not pocket the new revenue itself?

The real need – greater government expertise in infrastructure

If creating new ways to allow private sector participation in financing public infrastructure doesn’t make economic sense and the real need is to develop greater expertise in government in delivering infrastructure, should the emphasis even be on a “bank” in the traditional sense?

University of Toronto professor Matti Siemiatycki doesn’t seem to think so. Siemiatycki has written two reports for the Residential and Civil Construction Alliance of Ontario outlining what he would like to see in a new infrastructure agency (not bank) and the emphasis is not on finance but on developing government expertise in infrastructure. In his reports, Siemiatycki proposes the formation of an arm’s length federal institution known as the Canadian Infrastructure Investment Agency (CIIA).

In Siemiatycki’s words, “the CIIA would be positioned as a national centre of excellence supporting rigorous project evaluation, procurement best practices and project financing under a single roof.”

Moreover, if there is to be a bank, Siemiatycki says it must be capitalized with funds that add to — not replace — existing federal funds budgeted for infrastructure. In his November 1, Fall Economic Statement, Finance Minister Morneau re-allocated $15 billion in existing infrastructure funds to the new bank much to the consternation of many infrastructure hungry municipalities.

Conclusion

As detailed above, there is a strong case for creating an arm’s length centre of expertise to improve the federal government’s infrastructure game in project management, financing and related areas. Council members Michael Sabia and Mark Wiseman have made some very useful suggestions on this front and Professor Siemiatycki has provided a number of other excellent recommendations in his two reports.

And ironically, there is even a strong argument for a public infrastructure bank along the lines envisioned in the 2015 Liberal election platform. In their platform, the Liberals pledged to “establish the Canadian Infrastructure Bank to provide low-cost financing for new infrastructure projects”. The platform goes on to say that the advantages of such a bank would be that:

• “The federal government can use its strong credit rating and lending authority to make it easier and more affordable for municipalities to build the projects their communities need”.
• “Where a lack of capital represents a barrier to projects, the Canada Infrastructure Bank will provide loan guarantees and small capital contributions to provinces and municipalities to ensure that the projects are built”.

The fact is that the central purpose of the bank as proposed in the Liberal election platform still makes perfect sense: namely to allow lower levels of government access to the low-cost financing that the federal government enjoys by virtue of its size and strong credit rating.

What doesn’t make sense is to invite private asset managers to invest in bank financed infrastructure projects expecting a return of seven to nine percent when the government can float long-term bonds to finance infrastructure at two per cent.

Yet that is precisely what last Monday’s meetings were all about.

Canadians can only hope that the Prime Minister and his key economic ministers will go back and read their 2015 election platform before implementing their deeply flawed proposal.

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