Download A2 PRIVATE INVESTMENTS IN NEW INFRASTRUCTURES

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PRIVATE INVESTMENTS IN NEW INFRASTRUCTURES
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PRIVATE INVESTMENTS IN NEW INFRASTRUCTURES
Abstract
The Lisbon Strategy demands large investments in transport projects, broadband networks and energy infrastructure.
Despite the widely-acknowledged need for investments in new infrastructures, European and national public funds are
scarce in the current economic climate. Moreover, both policy-makers and economists largely agree that the public financing of such investments should no longer be the standard, as it may have been some decades ago. As a result, private investors become increasingly important when it comes to investments in infrastructure. Yet, such investments are generally
high, they involve political risks, and they often have uncertain returns and long payback times, which implies that private
parties may also be reluctant to invest. Departing from these drawbacks for private initiatives, we address the question
as to what policy-makers can do to improve the climate for private investment in new and innovative infrastructures in the
fields of energy supply, telecom and transport. This paper formulates seven imperatives to stimulate private investment in
innovative infrastructures:
1.
Allow private companies to earn a decent profit
2.
Create political stability and certainty for companies
3.
Stimulate innovative financing structures
4.
Allow money to flow
5.
Refrain from making technological choices
6.
Allow contractual freedom
7.
Reduce the administrative burden
Author(s):
Barbara Baarsma, Joost Poort, Coen Teulings, Michiel de Nooij
SEO Amsterdam Economics, Roetersstraat 29, 1018 WB Amsterdam, www.seo.nl
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1 INTRODUCTION:
INVESTMENT AND RELIABILITY
An important way to increase the reliability of infrastructures is by building new and innovative ones. New
infrastructures generally increase overall capacity and
incorporate state-of-the-art technologies that meet higher
reliability standards. What is more, new infrastructures
that compete with existing infrastructures constitute a
redundancy that enhances overall reliability. For example,
the chance of fixed and mobile telephony breaking down
simultaneously is almost negligible. From the point of view
of reliability, competition between infrastructures is therefore preferable to competition on infrastructures, regardless of the other economic aspects involved.
In the years to come, substantial investments in new infrastructures will be required throughout Europe. In order to
reach the goals set in the Lisbon Strategy – to make the
EU the world’s most dynamic and competitive economy
by 2010 – large investments in transport projects, broadband networks and energy infrastructure are considered
to be indispensable. In addition, several EU Member
States have formulated their own ambitious investment
plans. Many of these investments are necessary to fight
a lack of capacity on existing infrastructures, but there are
also other grounds for investments in new infrastructures
(see Box 1).
Box 1: When investments in new infrastructures are economically feasible
From an economic point of view, duplicating infrastructures is often inefficient and pointless.
Particularly network infrastructures such as water
pipes, electricity grids, and natural gas pipes, have
high fixed costs and low variable costs, making a (regional or national) monopoly the most efficient market
structure possible.
Economists refer to this situation as a natural monopoly. Yet, there are four circumstances in which new
infrastructures can be desirable:
1. Congestion on the existing infrastructure
Alternative or new infrastructures may be desirable
when economies of scale or density on the existing infrastructure run out, most notably resulting
in congestion. For example, population growth or
increased commuting in an area can require an upgrade of existing infrastructure, or the construction
of a bypass motorway.
2. Superior technology
New infrastructures can also be feasible if the technology or business model employed makes the new
infrastructure superior to the existing one in terms of
production costs, service quality or product variety.
High-speed trains, decentralized electricity production, and broadband Internet access are examples
of these types of new infrastructures.
3. New products and services
New infrastructures may introduce entirely new
products and services. The introduction of mobile
telephony is the obvious example here; some twenty
years ago no-one knew how widespread and indispensable it would become to make phone calls on
the way.
4. Enhance competition
Investments in new infrastructures may enhance
competition and as such improve choices for the
customer, reduce prices and improve cost efficiency.
An example is the Euro tunnel, the UK-based operator of the high-speed, cross-channel transport
system that links the UK and France by rail. Before
the tunnel existed, the crossing could be made by
air or by sea. The key market, however, is that for
accompanied vehicles and lorries. Euro tunnel and
the two principal ferry operators (P&O and Sealink)
expected prices to drop by at least 20% on the route
between Folkestone and Calais because of the increased competition between infrastructures.
As always, the boundaries between these four
categories are blurred. For example, investments
in innovative and superior infrastructures are often
triggered by congestion on or dissatisfaction with
existing infrastructures. As such, the roll-out of
broadband networks was spurred by the explosive
growth of bandwidth usage, which the existing dialup connections could no longer facilitate. Broadband
Internet connections in their turn can sustain entirely
new services such as teleconferencing and gaming
over the Internet. Similarly, mobile telephony is an
entirely new communication service for travellers,
but at the same time it is a substitute for fixed telephony, as is shown by the recent decrease in the
penetration level of fixed lines in the Netherlands.
Despite the widely-acknowledged need for investments in
new infrastructures, European and national public funds
are scarce in the current economic climate. The Stability
and Growth Pact, which requires EU Members to keep
their budget deficit below 3% of GDP, does not distinguish
between public expenditures and investments. In periods
of economic downturn, this makes it hard for governments
to find public money for new infrastructure, or to contribute to an increase in European funding. Moreover, both
policy-makers and economists largely agree that the public financing of such investments should no longer be the
standard, as it may have been some decades ago.
Instead, society looks to private parties to act when it
comes to investments in infrastructure. Yet, such investments are generally high, they involve political risks, and
they often have uncertain returns and long payback times,
which implies that private parties may also be reluctant to
invest.
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Taking these drawbacks for private initiatives into account,
the central policy question of this paper is:
What can policy-makers do to improve the climate for
private investment in new and innovative infrastructures in
the fields of energy supply, telecom and transport?
The paper is organized as follows. Section 2 briefly discusses when, from an economic point of view, public
(co)funding of investments in new infrastructure may be
inevitable, and when private initiatives should prevail,
given the proper conditions. Boxes emphasize the main
lessons in this section pertaining to private investment in
infrastructure. Section 3 returns to the central policy question and focuses on what those proper conditions are.
Section 4 concludes with some final remarks.
2 WHY PRIVATE PARTIES MAY UNDERINVEST IN NEW INFRASTRUCTURES
Considering the infrastructures for energy supply, telecom
and transport in all their diversity, an initial observation
is that private parties are willing to invest extensively in
some types of infra-structure, but are reluctant to invest in
others. Most networks for mobile telephony, for example,
were privately financed by companies that subsequently
laid out vast amounts of money for licenses to build and
operate UMTS networks. Private companies have constructed broadband connections between major economic
centres within and outside the EU in such an abundance
that prices have dropped to the point of bankruptcy for
some. In the airline industry, new private airline companies – particularly low-cost-carriers – have mushroomed
since the deregulation of European air traffic.
Many other infrastructures that were state monopolies
throughout most of the twentieth century, have been
successfully privatized over the past twenty-odd years.
Interestingly, also those infrastructures that most countries have not ventured to privatize, generally originated
from purely private initiatives made back in the nineteenth
century. What (if anything) has changed since then? Here
below, from an economic theoretical point of view, we
explain why private parties may under-invest in new infrastructures, and when governments have economic justification for intervention.
When public investment is indispensable
Every standard work on micro-economics puts it so neatly: “In a market with perfect competition, a Pareto-optimal
allocation is realized automatically”. In plain English, this
means that “free market forces lead to the best pricequality ratio and the highest welfare levels for consumers”.
In practice, however, perfect competition hardly ever occurs. Particularly in the case of infrastructures, various
imperfections of markets are at play. Depending on the
severity of these “market failures”, it may sometimes be
necessary for a government to intervene. In some cases
this can be done by imposing regulation, but in certain
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circumstances public investment is indispensable for new
infrastructures. Yet in all cases, it is important to realize
that a need for public intervention or investment should
not be equated with a need for public supply. A host of
empirical research has shown that for most of the time
private or privatized firms are more efficient, more profitable, financially healthier, and more willing to invest than
otherwise comparable state-owned firms.
External effects
The market failure of external effects occurs in many if not
all infrastructures. External effects occur when not all welfare effects of the production and consumption of a product or service have a price. External effects can be either
negative – i.e. incurring costs and reducing welfare – or
positive, i.e. enhancing welfare by means of additional
benefits. In their investment decisions, governments differ
from private parties in that they are supposed to take both
internal and external effects into account. To illustrate
this: a private party will invest in a road only if the costs of
building and operating it are lower than the fees they can
collect. Governments generally invest if the social benefits
(including private benefits like travel-time gains) exceed
the total social costs (the costs of construction, noise, pollution, etc.).
Goods with negative external effects have a tendency to
be over-produced by private parties. In aviation, for example, “excessive” noise pollution occurs because there
is no charge for it, or because its price is too low. Such
external effects call for government intervention, such as
a noise-tax to make the social costs incurred part of the
private investment decisions. Hence, negative external effects of infrastructure require intervention to bridle private
investment – quite the reverse of the main issue of this
paper.
In the case of positive external effects or spill-overs, too
little is produced. Innovation represents an example. If the
benefits of an innovation can leak away to others, companies will invest less in innovation and development than
is socially desirable. Intellectual property law (patent law,
copyright law, etc.) is a way of enabling innovators to (partially) internalize the benefits of innovations.
Positive external effects are often a crucial part of infrastructure investments, in particular in innovative infrastructures (types 2 and 3 in Box 1). Investment in a
high-speed-railway, for example, can improve the competitiveness of a region by enhancing accessibility and connecting markets. A new underground line will raise property prices in the vicinity of the stations. Since private
investors cannot capture such spill-overs, they may not
be able to earn a decent rate of return, even though from
a social point of view the project may benefit welfare. In
such cases, (financial) government intervention is called
for to spur private investment. A special kind of spill-overs
are strategic interests in certain infrastructures. A good
example here is the Galileo positioning system
(see Box 2).
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Box 2: Galileo positioning system
The Galileo positioning system is a public-private initiative of the European Union. Its total costs are estimated
at € 3 billion, two thirds of which to be invested by private parties. In September of 2003, China also decided
to invest € 230 million in Galileo. The Galileo project
consists of a network of 30 satellites allowing one to
determine one’s global position with great accuracy.
The signal used for positioning up to a certain accuracy
is an “open service”, without encryption. More refined
positioning will be available at a price. To a large extent, Galileo will be a close substitute for the American
Global positioning system (GPS), which has become a
commodity among sailors and mountaineers and which
is also used in car navigation systems. Nevertheless,
the project has a strategic value as the GPS signal can
be “switched off” at the liberty of the US government. In
the light of the fast adoption of positioning technology,
this implies a technological dependency of European
countries that may justify investment.
Public goods
Public goods can be seen as an extreme case of positive
external effects. They are another source of market failure. The two distinguishing features of public goods are
“non-exclusiveness” and “non-rivalry”. Non-rivalry means
that use by one consumer is not at the expense of the use
by another. In other words, the marginal costs of an extra
user are zero, which introduces a strong natural monopoly
tendency. Non-exclusiveness of public goods means that
it is impossible to exclude people from its use and hence
to recover investment costs by charging a user fee. Classic examples of public goods are defence and dikes.
Technological innovations have increasingly enabled the
exclusion or charging of users on infrastructures, where
this was once thought impossible. Ten years ago, for example, local and urban roads were considered practically
non-exclusive for practical reasons. In 2003, the introduction of a £ 5 toll for cars entering the city of London (enforced by a network of some 800 cameras) did away with
this dogma. Political and social ambitions can still make
charging for such infrastructures undesirable, however, as
will be discussed below.
Positive external effects and public goods lead to under-investment in infrastructure by private parties. For
example, because a private investor himself does not
earn any money by reducing congestion, he will be less
inclined to invest in road infrastructure.
Other grounds for public intervention
In the case of positive external effects and public goods,
public funding for part of new infrastructures may be required. On top op that, there are a number of fundamental
justifications for governments to intervene, albeit not by
investing. We will mention them briefly.
A lack of competition
Government intervention may be required when competition is seriously threatened. In infrastructures this is
usually the case in (natural) monopolies such as the electricity grid and railway lines. Profit maximization under a
monopoly implies under-provision - and over-charging - of
goods. On the other hand, competition also has a price,
as free market forces may focus too much on efficiency
gains, thereby leading to under-investment in quality. Specific regulation may be needed to ensure that efficiency
improvements are not made at the expense of network
reliability.
A lack of competition generally leads to under-provision
- and over-charging - of goods. Still mo-nopolies may
be necessary to obtain the rents needed for private
investments in infrastructure.
Coordination problems
Coordination problems concerning the construction of
new infrastructure are another justification for government
intervention. Coordination problems stem from a lack of
perfect and costless information (also referred to as lack
of information transparency or information asymmetry).
Government action could be justified in such cases, if the
regulatory body is better able to collect and process the
necessary information. Coordination may also involve
allowing the interest of society prevail over that of individuals. The construction of a high-speed railway line,
for example, requires permanent expropriation of land
and publicly authorized planning decisions. Coordination
may also relate to standardization of technology (i.e., the
GSM-standard).
A lack of perfect and costless information leads to coordination problems, and thus to under-investment in
infrastructure by private parties because they are unable to process all the relevant information.
Non-economic motivations for government
intervention
In practice, we see that governments intervene not only
to correct the aforementioned market failures, but also
for other reasons. The issue is then to achieve objectives
in areas involving justice, legal security, distribution of
income and wealth, ethics and morality. These are all areas in which no univocal statements can be made on the
basis of economic theory. The non-economic motives for
government intervention can be roughly divided into three
situations: inequality, paternalism and social imbalances.
When the market outcome is regarded as unjust, intervention is aimed at achieving a more equitable outcome.
Regulation in order to prevent monopoly profits is an
example common to many infrastructures. “Universal
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service obligations” are another instance of government
involvement aimed at improving equality. The accessibility
of an infrastructure such as electricity, telephony, and public transportation for every individual can be desirable for
social or moral reasons. If this is considered to be the case,
it usually requires interference with the construction plans
or pricing strategies for that infrastructure. For example, the
Dutch and other governments require that every household
is connected to fixed telephony at the same costs. Likewise, a government may decide that it is not fair to charge
people for using motorways, and partly for similar reasons,
the “open service” Galileo positioning signal is given away
unencrypted. The downside of such intervention to eliminate inequality is that it often has a negative impact on
competition and private investment.
Intervention may also be introduced for paternalistic reasons. This applies to the discouragement of production and
consumption of products that the government believes are
bad for citizens (e.g. tobacco or drugs), as well as to the
stimulation or production and consumption of products that
the government believes are good for citizens (e.g. education, theatre visits and wearing seatbelts). Thus, the construction of a broadband network in a poor neighbourhood
can be advocated from an emancipatory perspective.
Finally, intervention may be motivated by macro economic policy objectives such as creating full employment
or reducing inflationary pressure, or to combat regional
inequalities. For example, the majority of the public funds
that are available for a high-speed railway line to the
Northern Netherlands stem from the “Langman-agreements”, aimed at improving the economic performance of
the Northern provinces. The EU regional structural funds
are another example of such objectives.
A lack of perfect and costless information leads to coordination problems, and thus to under-investment in
infrastructure by private parties, because they are unable to process all the relevant information.
Non-economic motives for government action also affect private investment behaviour. For example, a ban on
monopoly rents to protect small consumers, or a strict
universal service obligation to improve equality, may shut
the door to private initiatives. Paternalistic motives (like
broadband Internet for everyone) may also thwart private
plans. State subsidies to overcome regional inequalities,
or to help loss-making sectors, also affect private investment behaviour.
Pitfalls of government regulation
For a long time, it was assumed that the government had
a corrective role to play in the event of market failure or
in one of the politically undesirable situations described
above. Nowadays, reservations about this concept prevail: government intervention can itself lead to undesirable
welfare effects that may outweigh the effects of market
failure: the remedy may be worse than the disease.
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Such “government failure” or “regulatory failure” is related
to the complexity of regulation and to what is called the
“information asymmetry” between the regulator and the
regulated sector(s). Market parties have more and better
information about their business than the regulator (the
government), which gives them an opportunity to manipulate the latter. This leads to sub-optimal regulation, as was
first pointed out by Baron and Myerson. It may, however,
even lead to what has been coined “regulatory capture”.
Economic Nobel Prize Laureate Stigler is famous for
pointing out how a regulator may end up protecting the
interests of the regulated party. For example, a regulated
infrastructure owner may be able to convince the public
authorities (by lobbying fiercely) that to preserve universal
service obligations, no other parties should be allowed to
build competing infrastructures.
But information asymmetry works both ways. Private parties do not know what the government is up to and thus
they endure regulatory risk. The risk that the government
regulates profits away after several years, or that it breaks
earlier promises under political pressure, will make private
parties reluctant to invest in new infrastructures (Box 3
gives an example related to cable networks). The abovementioned non-economic motives for intervention may
also cause regulatory risks. For example, worried politicians may plead for a maximum for electricity prices, in an
attempt to protect residential consumers, but at the same
time thwart private investments in new capacity.
Box 3: Regulatory risk
Cable networks
In the early 1980s, the Dutch national authorities encouraged the construction of cable networks by local
governments. By doing so, substantial economies of
scale could be realized, negative external effects of
ubiquitous antennas would be diminished, and TV pirates would be ousted. As a result of this policy, Dutch
cable networks now have a penetration rate of about
90% of households, which is very high by international
standards.
In the late 1990s, most Dutch local governments sold
their cable television networks to private parties, who
subsequently invested large sums of money in these
networks in order to upgrade them for delivering broadband Internet services and telephony. As a result, the
cable sector enjoyed a temporary first mover advantage and (transient) monopoly power in the broadband
market. In response to this, pressure groups called for
public intervention to mandate third party access to this
infrastructure, even though no such arrangements had
been stipulated in the sales conditions.
Now, a few years later, several local governments
consider subsidizing fibre-to-the-home broadband
networks, which will be a direct competitor to the cable
networks that were sold less than a decade ago.
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Apart from the negative effects of regulatory uncertainty,
government intervention can give rise to transaction costs
that are higher than the efficiency gains of the regulation.
In addition, when government intervention involves public
funding, these investments are paid from tax revenues.
Taxation brings about welfare losses since it changes the
way in which people behave. An increase in income tax,
for example, makes working less profitable and generally
reduces labour supply. Similarly, a sales tax on houses
discourages people from moving. Because taxation
changes the choices of people, efficiency is no longer realized and a welfare loss occurs. In addition to this, taxation also incurs administration and compliance costs.
Government intervention as a remedy to market failure can be worse than the disease. Uncertainty about
future regulation hampers private investment in infrastructure, while existing regulation can be an effective
means of discouraging competitors to enter a market.
Why would private parties under-invest in new
infrastructures?
Let us now return to the central question of this section:
Why do private companies invest abundantly in some
types of infrastructure and not in others? Reviewing our
exposition of market and government failure, we sum up
the fundamental and practical reasons for a lack of private
enthusiasm to invest in infrastructures:
- A lack of exclusiveness:
Private investment will only occur if it is possible to exclude others from using the infrastructure and hence to
recover investment costs by charging a price.
Addressing these issues adequately will spur private investments. Before turning to the question how to do this,
we summarize our theoretical framework in Box 4.
Box 4:
Situations in which government intervention
can be desirable and reasons why private parties may under-invest in new infrastructures
General justifications for government
intervention
Market failure
Non-economic
motivations
- A lack of competition
- Positive and negative
external effects
- Public goods
- Coordination problems
- Unequal distribution of
welfare (universal
service obligations)
- Paternalistic motives
- Social and regional
imbalances
Why private parties may under-invest in new
infrastructures
- A lack of exclusiveness
(related to market failure of public goods)
- The existence of positive external effects
- High regulatory risks
(these may be due to political considerations)
- (The perceived higher interest rate for private
companies when compared to the government)
- Positive external effects which cannot be
internalized:
The social benefits of an infrastructure that do not directly accrue to its investors and users, generally lead to
under-investment by private parties.
- High regulatory risks:
The risk that the government regulates profits away after
several years or that the government will change the ex
ante regulatory framework, will make private parties reluctant to invest.
This is especially true for investments in new infrastructures that have long pay-back periods.
A more practical reason can be added to this list:
- The perceived higher interest rate for companies
when compared to the government. Government debt
has a very low risk and, hence, a low interest rate. However, this is largely due to the lack of a project-related
risk premium, which means that a government may go
ahead with a project because the discount rate used is
too low. Also, the economic distortions (costs) of raising
taxes are usually disregarded.
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3 POLICY ISSUES: IMPROVING THE
INVESTMENT CLIMATE
In this section we discuss the proper conditions for private investment in new infrastructure. Taking the barriers
described in the previous section as a starting point, the
following success factors for private initiatives can be determined.
1. Allow private companies to earn
a decentprofit
According to the traditional dogma of welfare economics, monopoly rents have to be avoided, since they occur
when a monopolist exploits his market power by reducing
supply and raising prices. The reduced supply constitutes
a welfare loss and monopoly rents raise distributional concerns. Moreover, monopolies are traditionally considered
as inefficient and not inclined to innovate. Such observations seem to be the guiding principle for many governments and regulators in their attitude towards monopolies.
However, modern research shows that this position needs
some serious qualifications, especially in a rapidly innovating environment. Not all profits that a monopolist
makes, constitute a welfare loss. Without some prospect
of a considerable rate of return, private investments in
infrastructure will be discouraged. Large profits, which
the public will easily perceive as “monopoly rents”, are
required to cover both the high fixed cost of investments
in infrastructures and the risks, which can be particularly
high for investments in innovative infrastructures. Moreover, a monopoly or market leader has a greater incentive
than any other firm to carry out a lot of research, to keep
innovating and thus stay on top.
Drug patents and copyright protection, although not
entirely undisputed, tend to protect a monopolist for decades, whereas in infrastructures, particularly those for
telecom, politicians can hardly bear the idea of a monopolist making large profits for more than one year.
In order to show the need for “monopoly profits” in some
cases, we will now present a finer breakdown into Ricardian rents and Schumpetarian rents. Ricardian rents play
a role when dealing with scarcity issues (we will come
back to these when discussing the fourth success factor). Schumpeterian (entrepreneurial) rents come about
because imitation does not occur instantaneously, even
though imitators may well “swarm” around the innovators’
key technologies and products. Both are benign sources
of rent from an antitrust perspective, as they encourage
investment in valuable knowledge assets and in innovation. Therefore, Schumpeterian (and Ricardian) rents
should not be regulated away.
What is the lesson to be drawn from all this? Monopolies
(and monopolistic competition) are not always bad when it
comes to investing large amounts of money in new infrastructure. There is a clear difference between protecting
the public from monopoly rents of individual companies
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on the one hand, and stimulating private investment by
allowing companies a sufficiently long pay-back period on
the other hand. In addition, monopolies themselves face
contradicting incentives as a result of their market power.
Both empirical and theoretical analyses indicate that the
incentives for innovation follow an inverted u-shaped
curve with respect to market power. In other words: a
moderate instead of a maximum level of competition gives
a private company the largest incentives to invest in innovation.
Regulating away what is perceived by the public as “monopoly profits” tends to increase effi-ciency in the short
run, but particularly in a dynamic environment it may take
away the incentives for both the monopolist and possible
contestants to invest in new infrastructures. Hence, longterm innovation and infrastructure competition may suffer
from over-regulation. This may be the major dilemma for
unleashing private investments in infrastructure.
2. Create political stability and certainty for
companies
It is often argued that private companies will not invest
in projects with large pay-back times. This argument is
flawed, however. An example showing that private parties
can indeed be interested in projects with long pay-back
periods are the French motorways. Some of these roads
are privately built, maintained and financed, despite the
fact that the pay-back period for these projects through
toll collection is 30 years or more. The crucial condition
for private investment here is not the pay-back period, but
the reliance on the government throughout those years
to keep its word not to tamper with the agreements about
the toll-setting or to build a free alternative.
Given the proper circumstances, private companies have
no problem with long pay-back times. What matters is that
policy-makers provide stability of two kinds:
Regulatory stability (i.e., no unexpected access regulation
or expropriation, commitment to non-intervention).
Stability in planning (i.e., no building of publicly-financed
alternatives that compete head-on with private initiatives).
Box 5 gives two examples of regulatory risks that may
hamper private incentives to invest (also see Box 3 for an
example related to cable networks).
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Box 5:
Regulatory distortion of a private innovation
Digital hourly metering systems in the
electricity sector
Market power plays a very important role in the electricity sector. For example, a main issue in electricity
market design is how to control the ability of powergenerating firms to raise prices. One possibility is to
increase the price responsiveness of demand by implementing digital hourly metering for (residential) customers. On the one hand, digital hourly metering brings
about benefits for the network operators (a longer
lifespan, no necessity to drive around and take meter
readings, illegal consumers can be detected more easily and switched off, consumption by defaulters can
be limited to a minimum). There are social benefits as
well. The meters send real-time user data digitally via
de network. In times of scarcity, the operator could
influence power consumption – following government
rules – by limiting the use by some parties in favour of
other parties (such as hospitals).
The costs to the network operators consist of investing
in and placing the new meters (€ 100 ~ 175 per meter,
depending on the number of power points). The benefits for users are obvious: consumers can respond,
for example, by switching to interval metering. At the
moment most residential and small business consumers receive a final payment only once a year and larger
business consumers are invoiced every month. In both
cases, the relation between demand and price does
not play an important role. Digital hourly metering has
drawbacks for the power generators, as they will lose
part of their market power: all suppliers are faced with
a more elastic residual demand curve and, therefore,
competition will intensify.
Italy is the leader when it comes to actually implementing the digital hourly meters. The Italian power company Enel has already replaced two-thirds of the total
of 30 million meters. Enel, the former state monopolist,
was privatized in 1999 and cooperates with IBM in this
large-scale project. The Scandinavian countries will be
next. In some countries, like the Netherlands, electricity companies are considering implementation but are
weary of new government rules stating that each consumer may choose his own meter. Since the digital meters have a higher purchase price than the traditional
mechanical meters, and the companies expect consumers to focus on this short term expenditure instead
A related aspect is that it is important for the government
to manage possible expectations of private parties concerning the future role of the government. Under these
conditions, private companies will have no problems deal-
ing with long pay-back times and will use lower discount
rates for their investments, thus enhancing the financial
viability of projects. The risks that do remain are of a more
fundamental nature, such as the risk Motorola took when
investing in the Iridium satellite network (Box 6).
Box 6: A private company accepting
astronomical risks
Motorola came upon the idea of combining the two
technologies of cellular phones and small satellite
communications systems. In this project, later to be
named “Iridium”, the company proposed launching 77
small communications satellites, and to route cellular
telephone traffic over them. (The atomic number for the
element iridium is 77, hence the name of the project.)
Ground users would communicate directly with the
satellites, instead of with a local transmitter, which
would later pipe the communications through existing
land-line systems. The project turned out to be a commercial mistake, however, because of the faster-thanexpected uptake of mobile telephony, even in emerging
economies that were the target area for Iridium. A
mere 50,000 Iridium phones were sold, instead of the
hundreds of thousands that had been expected. This
example proves that private companies are willing to
accept astronomical risks, as long as there is a prospect of huge profits to justify the risk.
Such stability may be harder to provide than it would
seem, in particular as a newly elected gov-ernment may
strongly disagree with the policies of its predecessor.
However, long-term continuity with respect to agreements
reached with private infrastructure investors is critical. Enhanced accountability for policy changes that violate such
agreements could improve the investment climate.
3. Stimulate innovative financing structures
In some cases, allowing companies to capture social
rents (positive external effects), for example by allowing
real estate development, is a way of making a project’s
ends meet. Traditionally, governments prefer to grant a
subsidy when positive external effects occur, for fear of
losing control if a private party manages to capture social rents by itself. This may, however, lead to a loss of
synergy: the infrastructure investor loses the incentive to
maximize these rents.
In Japan, for example the high-speed rail connections are
privately financed. Losses on these lines are compensated for by the exploitation of the buildings around the
stations, which are in the hands of the railway investor.
Another example was the Dutch Maglev proposal, by a
private consortium of ABN Amro, Ballast Nedam, HBG
and Siemens, to invest a large amount of money in exchange for real estate developments and ownership of the
railways. Apart from this private funding, the Dutch government would be willing to invest € 2,73 billion.
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The consortium was abolished due to the long and insecure waiting period before the government cut the Gordian knot.
By opting for subsidy instead of synergy, governments
can enhance the incentive to create spillovers through
a voucher system giving purchasing power to the target
customer group. This could very well be a more direct way
of reaching the social target group than through public
service obligations.
Another example of innovative subsidies to private parties
are shadow tolls. Shadow tolls are paid not by the users
but by a third party (such as a sponsoring governmental body) to the facility operator. Like regular tolls, they
can be based on the type of vehicle and the distance
travelled. Shadow tolls can be an element of a highway
finance approach whereby a public or private sector developer/operator accepts certain obligations and risks and
in return receives periodic shadow toll payments instead
of, or in addition to, real or explicit tolls paid by users.
4. Allow money to flow
Sometimes, political ambitions follow country borders that
economic efficiency is inclined to ignore. Targets for pollution, CO2 emissions and renewable energy, for example,
serve an international or global purpose but are often
translated into national targets. However, a 10% renewable energy target may be harder and more expensive
to achieve in some countries than in others. This may be
due to external effects (e.g. horizon pollution) that are
larger in densely populated countries, or to natural resources such as sufficient wind or flowing water.
Private investors will look at the overall internal rate of return, and the result may be that private investment will be
viable in some countries only. Making such policy targets
tradable at a European scale, as has been done with CO2
emissions, will allow the Euros to flow to where they can
earn the highest rate of return. This will serve both the
economy and the environment well.
Allowing money to flow means allowing Ricardian rents to
be reaped, even though it may not be within the national
borders (when discussing the first success factor we already stated that Schumpeterian or entrepreneurial rents
should not be regulated away). In the context of innovation, Ricardian rents reflect a scarcity of a unique input
(e.g., a unique engineering skill). If the input is necessary
to produce the output, the firm could be a (transitory)
“monopolist” in the output market. While the firm could be
thought of as a monopolist, its profits are scarcity rents,
properly attributed to the scarce input. Note that it is precisely the existence of scarcity rents that engenders the
expansion of output through replication of the underlying
skills.
rents may be looked upon with jealousy, but should be
accepted for the fact that the overall outcome will be more
efficient.
5. Refrain from making technological choices
Governments can be useful by playing a coordinating
role in the process of reaching industry standards. Such
standards can be efficient in maximizing the network
effects that users experi-ence. For example, the EU-involvement in the adoption of the GSM standard allows
EU citizens to roam all over Europe while using the same
mobile phone handset. But, standardization can have
negative effects as well. A widely accepted standard
tends to create lock-in, which means that a shift to a new
and superior technology or standard will be made too late
or not at all.
Moreover, prescribing a sub-optimal standard or dictating a standard too early in the life-cycle of a product may
frustrate private entrepreneurship or the natural selection of standards. In the case of GSM, the bureaucrats
have operated wisely. In the case of UMTS, however,
their choice for the W-CDMA standard seems to have
been less fortunate. At this moment, operators in Japan,
Korea and the United States have been more successful
at launching 3G mobile networks using a rival technology
(CDMA2000). In technological choices, governments
should generally not try to lead the way.
6. Allow contractual freedom
Governments often try to protect consumers by prohibiting certain arrangements in contracts offered by suppliers. For example, a contract that binds a household to an
energy supplier for more than a year may be deemed illegitimate. Such government action may serve the purpose
of short-term competition but it can reduce incentives for
suppliers to invest in customers or in new technology.
Consider, for example, the investment in digital metering
systems discussed in Box 5, or innova-tive battery systems that may enable households to use cheap night-time
energy during the day. The costs of such new technologies are often so high that households are not interested,
even though the investments may be profitable in the long
run. Electricity suppliers have a scale advantage to take
the lead in such innovations and, hence, they may want
to speed up the adoption of such technology by renting it
to households. A policy aimed at reducing switching costs
for households by prohibiting long-term contracts can be
a serious threat to such investments, however, just as
health insurers have few incentives to invest in prevention
(like losing weight, or quitting smoking) when people can
easily switch between insurers.
7. Reduce the administrative burden
Returning to the example of investment in renewable
energy, one can envisage that tradable policy targets
lead to Ricardian rents for countries that have a natural
advantage because of mountains, fjords, or wind. These
62
Finally, governments can stimulate private investment by
reducing administrative burdens that cause companies
serious loss of time and money. Excessive administrative
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burdens and “red tape” are generally considered to be a
negative determinant of a country’s investment climate.
In Denmark, investments in wind power are larger than in
the other European countries; Spain and Germany take
second and third place, respectively. The better Danish
investment climate may be interesting for other countries
to learn from (the Danes may well have Ricardian rents).
Differences are also likely to be found in the legal and administrative procedures.
4 CONCLUSIONS
The Lisbon Strategy touches upon almost all of the EU’s
economic, social, and environmental activities. The European Union has been implementing the Strategy for four
years now, and progress has been considerable. One
of the reasons for the low growth in overall productivity in Europe is the inadequate level of investment. For
example, the contribution of information technologies to
productivity growth is less than half of that found in the
United States. This situation works to the detriment of the
priority areas identified by the Lisbon Strategy. In this respect, the European Growth Initiative and the Quick Start
Programme, adopted by the European Council in December of 2003, are a major source of leverage to unlock
investments in the infrastructure and knowledge sectors.
The focus should be on investment, thereby strengthening both the demand and the supply side of the economy,
and with particular emphasis on the introduction of new
environmental-friendly technologies, enhanced funding of
research and development, and the completion of the enlarged EU’s trans-European infrastructure networks.
However, European and national public funds for the required investments in infrastructure are scarce in the current economic climate. In addition, there is an increasing
awareness that governments should not always be held
responsible for infrastructure investment.
This paper has formulated seven imperatives to stimulate
private investment in innovative infra-structures. They
are summarized in Box 7. Although these recommendations should be borne in mind by policy-makers wanting
their private sectors to take the risk neck and invest in
innovative infrastructures, many of them also contain dilemmas for which there are no one-size-fits-all solutions.
Allowing or regulating away monopoly profits may be the
most important of them all. In general, it seems justified
in this respect to argue that the more innovative a new
infrastructure, and the more it creates its own market, the
larger the risks involved for private investors. This warrants transient monopoly profits in case of success, and
it requires policy-makers not to yield to public and media
pressure to keep monopolies on too tight a reign for the
sake of short-term benefits.
Box 7: Improving the investment climate
1. Allow private companies to earn a decent
profit
Without some prospect of large profits, private
investment in infrastructure will be discouraged.
Regulating away those profits tends to increase efficiency in the short run, but particularly in a dynamic
environment it may take away the incentives of both
the monopolist and other firms to invest in new infrastructures.
2. Create political stability and certainty
for companies
Investments in infrastructures have long pay-back
times. Contrary to popular belief, this in itself is not a
problem for private parties, so long as the regulatory
and political environment is sufficiently stable. To
provide such stability may be harder than it seems,
in particular as a newly-elected government may
strongly disagree with the policies of its predecessor. Enhanced accountability for policy changes that
violate such agreements could improve the investment climate.
3. Stimulate innovative financing structures
Allowing companies to capture social rents, for example by allowing real-estate development, is a way
of making a project’s ends meet. Traditionally, governments prefer to grant a subsidy instead, for fear
of losing control if a private party tries to capture
social rents by itself. This may, however, lead to a
loss of synergy: the infrastructure investor loses the
incentive to maximize these rents.
4. Allow money to flow
Making policy targets, e.g. with respect to renewable energy production, “tradable” across internal
borders will improve overall efficiency, even though
this allows fortunate companies to earn (Ricardian)
monopoly profits from their resources.
5. Refrain from making technological choices
Governments have a role to play in standardization. In technological choices, however, they should
not aim to lead the way. Prescribing a sub-optimal
standard may frustrate private entrepreneurship and
hamper investments.
6. Allow contractual freedom
Governments often try to protect consumers by prohibiting certain arrangements in supplier contracts.
Such government action may serve the purpose of
short-term competition but can reduce incentives for
suppliers to invest in customers or in new
technology.
7. Reduce the administrative burden
Procedures and “red tape” that are aimed at good
governance and careful decision-making, may impose administrative burdens that discourage private
parties from investing in infrastructure.
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NOTES
I
Commission of the European Communities (2004),
Delivering Lisbon. Reforms for the Enlarged Union,
COM (2004), 29.
II
Take, for example, the Irish plans. The 2007-2013
National Development Plan aims to provide worldclass public and private transport, energy, telecommunications, and waste infrastructure, in order to
retain existing - and attract new - inward investment.
III
The GSM technology itself has also generated innovative spin-offs for other infrastructures. GSM-R, for
example, is a GSM-based communications platform
currently introduced as the European standard for
railway communication.
It enables a single international communication
standard for railways and it also improves interoperability between the various railway companies at an
international level.
IV
John Kay (1996), Pricing the tunnel, in: The business of economics, Oxford University Press.
V
William L. Megginson and Jeffry M. Netter (2001),
From State to Market: A Survey of Empirical Studies
on Privatization, Journal of Economic Literature, Vol.
XXXIX (June), pp. 321–389.
VI
G. Debrezion, E. Pels & P. Rietveld (2003), The
Impact of Railway Stations on Residential and Commercial Property Value: A Meta Analysis, Tinbergen
Institute, discussion paper 04-023/3, Amsterdam.
VII
World Bank, World Development Report 1994. Infrastructure for development, p. 115.
VIII Baron, D.P. & R.B. Myerson (1982), Regulating a
monopolist with unknown costs, in: Econo-metrica,
50, pp. 911-930.
IX
Stigler, G.J. (1971), The theory of economic regulation, in: The Bell Journal of Economics and Management Science, 2, (1), pp. 3-21.
X
Federico Etro (2004), Innovation by leaders, The
Economic Journal, 114 (April), pp. 281–303.
XI
This paragraph draws on: Teece, D.J., Coleman,
M. The meaning of monopoly: Antitrust analysis in
high-technology industries, in: Antitrust Bulletin, Volume 43 (Fall-Winter 1998), issue 3-4, pp. 801-57.
XII
Aghion, P. et al. (2003), Competition and Innovation:
An inverted U relationship, Ministry of Economic Affairs, The Hague; and: De Bijl, P.W.J., (2 May 2004),
Competition, innovation and future-proof policy.
64
XIII Economists think of profits in terms of Ricardian
and Schumpeterian profits, which they sum-marize
in the term normal profits. In plain English “normal
profit” means that companies make enough profit
to reward the invested capital. Economists also
distinguish surplus profits, which are realized due to
lack of competition. A monopolist can set really high
prices and earn profit exceeding a normal profit. The
line between normal and surplus profit is sometimes
thin, especially in dynamic markets where innovation
creates new markets and (transient) monopolists.
XIV This does not mean that tolls on these roads should
be left to the discretion of the private investor. Complete private provision without governmental control
is only rarely considered. The French government
has implemented a financial regulation, i.e., a maximum toll rate indexed to inflation, but apparently this
is predictable enough not to hinder investment. See
G. Fisher & S. Babbar (1996), Private financing of
toll roads, RMC Discussion paper series 117, World
Bank, Washington DC. The risk of welfare-reducing
profit maximization can be mitigated by a proper
design of auctions for concessions of private roads.
See B. Ubbels & E. Verhoef (2004), Auctioning
concessions for private roads, Tinbergen Institute,
discussion paper 2004-008/3, Amsterdam.