Wharton's Robert Inman discusses the role of federal, state and local governments in the critical task of fixing America's aging infrastructure.

Infrastructure is among health care, immigration, trade and other pressing topics on the American political agenda that need immediate attention. It’s also one of the most difficult problems to solve because it’s expensive, divisive and downright complicated. Nevertheless, Wharton finance professor Robert Inman makes a compelling argument for why government officials need to make infrastructure a priority. He was part of a recent Penn Wharton Public Policy Initiative seminar on Capitol Hill on the topic and joined the Knowledge at Wharton radio show, which airs on SiriusXM Channel 111, to discuss what it would take to finance improvements, and the role government should play.

An edited transcript of the conversation follows.

Knowledge at Wharton: The Penn Wharton Public Policy Initiative held a seminar on infrastructure because this issue deserves attention. Why is it so important?

Robert Inman: The seminar was with government folks, and the government is going to be a big part of the story. The issue for the seminar was, what is the role for the federal government in the financing and management of public infrastructure?

The motivation is obvious. Potholes are a part of everybody’s life. But, more dramatically, the [2007] collapse of the bridge between Minneapolis and Saint Paul, which killed many people and derailed travel between these two major cities, is a good example of what the problems are. The issue, while quite general, has some very specific and concrete consequences. I think that’s what put it on the top of the agenda. And the issue now is, how do we finance it, how do we manage it going forward?

Knowledge at Wharton: New bridges and roads can last for 50 or 75 years without having to be replaced, correct?

Inman: Exactly. I think one of the strong motivators for infrastructure is economic consequences. If you don’t have bridges, you don’t have roads, people can’t move, goods and services can’t move, and as a consequence the economy is going to suffer dramatically. In a very practical way, the impact of public infrastructure on economic growth is important. Maybe we don’t think about it much, but sewers, clean water and health are other examples of the importance of infrastructure. So, this is an issue that is easy to neglect but exceedingly important to solve.

Knowledge at Wharton: There has to be a list of specific bridges that are the most important in this country. I would think the George Washington Bridge in New York City is one of them.

Inman: One has to think about infrastructure as it relates to economic activity. Your example of the George Washington Bridge is a perfect example. If that bridge did not exist, you can just imagine the increase in the cost of moving goods and services and people, the implications for regional GDP, and the importance of New York in the national GDP.

The example I give my students, and why it’s important to be very specific when talking infrastructure, is Dodge City, Kansas. In 1870, Dodge City was an important hub for the movement of beef. The cattle came up from Texas, Colorado and Oklahoma, got on the train in Dodge City and moved to Chicago for beef processing.

Dodge City’s infrastructure was absolutely essential for the economic success of the West. But then the railroads built all the way down to Texas and Dodge City disappeared. You want to think of infrastructure as it is important in the immediate economic setting and not just assume that because we always had great infrastructure in Dodge City, we need great infrastructure in Dodge City today.

“In a very practical way, the impact of public infrastructure on economic growth is important.”

Knowledge at Wharton: What is the role of state and local governments in infrastructure?

Inman: One of the real beauties of our financing and service provisions structure in the United States is the federal structure. That is, the national government has a role to play, and states and cities have roles to play. What the states and cities bring to this agenda is expertise. They know where the needs are. Their representatives are there, looking at the economy daily. They know the needs in a way that a federal bureaucrat would not. The way I look at it, the important role for the federal government in this exercise is financing. But the delivery, the construction and the management are best done at the state and the city levels.

Knowledge at Wharton: How do we finance new infrastructure without significantly increasing debt?

Inman: I would argue that the role of the federal government is to provide the dollars necessary for services that impact wide regions, state interactions and the nation as a whole. The federal role is really looking at the interaction between the states and the cities. Debt is important, but the beauty of infrastructure is that it provides services over the long run at the same time that we’re repaying the debt. There is a matching of the benefits that the infrastructure provides with the taxes needed to repay the debt. It’s not that we should not use debt for the financing of infrastructure. It’s like mortgaging for your home. Your home is going to provide services for 20 years, so you borrow for 20 years. We definitely want to use debt for the financing of public infrastructure, but we want to use it in a way that’s efficient for the allocation of national resources.

Knowledge at Wharton: Many people would be concerned if they see tolls on roads going up significantly. Here in Pennsylvania, the cost of driving along the Pennsylvania turnpike has gone up markedly in the last decade or two.

“This is an issue that is easy to neglect but exceedingly important to solve.”

Inman: What you want to do is use prices to cover the daily costs, the marginal costs of driving on the road and repairing the road. The construction of the asset, the actual building of the road, the bridge, the sewer system, is best financed through debt and then repaid primarily through taxes over time. There’s a role both for taxes connected to debt and user fees or tolls connected to the marginal costs of providing the infrastructure on a daily basis.

Knowledge at Wharton: There are many examples of public/private partnerships that have been used to build infrastructure. Are we going to see more of that in the future?

Inman: I think there’s an important role for public/private partnerships in this exercise. What does the private sector bring to the table? It’s primarily management expertise. What you want to do is ask, when can I take advantage of that management expertise? Suppose I build a road, but I have to maintain it. Private firms typically are going to be much better at maintaining these kinds of infrastructures than might be public firms. Private firms can also have expertise in managing offices and labor costs, so you want to bring private-sector management to the story.

My concern is private-sector ownership. Anytime you sell an asset to a private firm, the private firm has to get its rate of return. Where is the rate of return going to come from? It’s not going to come from maintaining the road because that’s got to cover annual costs. It’s going to come from a price above that annual cost, mainly what economists call the difference between average cost and the variable cost. What is that? That’s the profit margin. To sell a road means the firm is going to have to charge a price that’s significantly higher than the marginal cost of maintaining that road.

You and I driving on that road might say, “Oh my goodness, the tolls have gone up by 30%, 40%, 50%. From the firm’s point of view, that’s necessary. They’ve got to get a return for their investors. From a citizen’s point of view, is that the best way for covering those fixed costs? I would argue taxes, in many cases, would be preferred to a toll increase.

“The beauty of infrastructure is that it provides services over the long run at the same time that we’re repaying the debt.”

Knowledge at Wharton: Do you expect how some of these roads are being managed is going to change significantly? I’m thinking specifically about commissions, such as the Pennsylvania Turnpike Commission, which oversees the turnpike and some of the other interstates that are here in the state.

Inman: This is a difficult question. Would I turn over the management of the road system to a private entity? Probably not. The road system is there to serve the public, so let’s have it managed by public officials. If we don’t like their performance, throw them out of office. I think that’s the role of politics. But have the government — officials whom we respect and trust and have given over the responsibility of managing these things — manage the private firm. Have the private firm get an acceptable rate of return, and then have the public sector choose the firms that look the most efficient in the actual maintenance and management of the service.

Knowledge at Wharton: In terms of infrastructure in the United States, is there a crisis?

Inman: Yes. The question is, where is the crisis? I think the civil engineers have done a very useful thing in going out and looking at our assets and asking the important question, “Is this thing going to fall down?” They’ve come up with a pretty depressing track record. I don’t know the full details of their grading system, but there are no As and Bs out there. The troubling thing about infrastructure is, unlike a corporate machine or a factory machine with squeaks, you go, “Ooh, this machine is squeaking, I need to put some oil on it.” Bridges and roads and sewer systems don’t squeak. They just exist and wear away and then in time collapse. What the engineers are looking at is the fundamental structural soundness of these things. We can put bandages on that. But the underlying fundamental structure, has anybody looked at that? And that’s where the issues are. I don’t know the details of the Minneapolis bridge, but literally it just fell into the water.

Knowledge at Wharton: You say that infrastructure needs to be a policy conversation at the federal, state and local levels.

Inman: Absolutely. Remember, we began our conversation by saying the role for federal government is financing and not managing these things. That is for the states and the localities. Here’s the dilemma: I’m a mayor. I’ve got a four-year term, I’ve got a lot of pressure to deliver on quality education and police safety. An easy thing to give up is going down and looking at the sewers, checking out my bridges and my roads. The last thing I want to know is that I’ve got to pony up $100 million to repair that when I’ve got 30 kids in a classroom. That’s the dilemma that local politicians face. The pressures are to deliver services today. What are you doing? You’re borrowing from the infrastructure, loosely speaking, and its maintenance for the future.

Knowledge at Wharton: We’ve seen that spending on infrastructure and elementary education has decreased over the years while spending on social benefit programs, for example, has gone up.

Inman: That’s right, and these are all choices to make. What is squeezing it out? We’re getting older, so there are going to be Medicare demands, Social Security demands. There are going to be demands of the elderly on state and local governments. This is going to create an obvious tension not only for the financing of education but the educational needs, and then you’ve left no money for the infrastructure.

“The road system is there to serve the public, so let’s have it managed by public officials. If we don’t like their performance, throw them out of office.”

Knowledge at Wharton: How has the inflation of construction costs for infrastructure affected the process?

Inman: We have looked at the rising construction costs. They’re pretty consistent with the CPI (Consumer Price Index) and in some ways do a little better than the CPI because we’ve become much more sophisticated in the use of capital and substitute away from labor. So, the cost issue is less and less a problem. I think the issue is more fundamentally the nature of the product itself and the political incentives to maintain it.

Knowledge at Wharton: Is there a best-case scenario or formula to address some of these issues?

Inman: I would hope that the federal government would step in on the financing of the important interstate activities. For you and me, that’s close to home here. It’s the movement of people and goods and services up and down the East Coast. It’s the big controversy over the train tunnel in New York City. Who’s the beneficiary of that? Well, it certainly is moving New Jerseyites into New York City. But it’s also moving Washington D.C. and Boston business executives up and down the East Coast. The benefits of that are clearly regional and arguably national, given the importance of the East Coast economy. There’s the role for the federal government in thinking about their contribution. It would be a shared role. You’d want New Jersey money, you’d want New York money, you’d want Pennsylvania money in that activity. But it would be a shared role. So, the federal government’s role is going to be primarily a financing role.

Knowledge at Wharton: It would be hard for the people of Massachusetts to say, “We’re going to chip in $5 billion to the New York tunnel project.” It’s just not going to happen.

Inman: No, and that’s where leadership comes in. The argument has to be made from the President’s point of view and from Congress’ point of view that we should cooperate on this. This is a national benefit that deserves national financing. But it is easily understandable as to why there are local biases.