Infrastructure: Things fall apart

Putting them back together may require creative financing.

When residents of Windsor, Ont., opened their July water bill, they were surprised to find a notice informing them the price of water would rise 36% at the beginning of August. That surprise quickly turned to anger, however, when homeowners realized the quoted annual increase was actually for only five months. When the “real” rate increase was calculated for a full year, it was found to be a stunning 86%.

“People are mad,” says Peter Angermann, a local resident and blogger. “They feel like the city tried to misrepresent the amount of the increase, and they’re pissed off about the increase. There wasn’t really any warning.”

Not content to sit idly by, the aptly named Angermann organized what must be one of the first instances of civil disobedience to ever involve residential plumbing. In August, he, along with a couple of other local bloggers, entreated the citizens of Windsor to send a message to city hall by flushing their toilet three times between the hours of noon and 1 p.m. on Aug. 7.

It was a democratic, if vaguely threatening, display. Citizens harnessed the power of a network to register their displeasure with the ruling elite, but took a chance they might overwhelm the sewage system. That question — would a co-ordinated flush damage the system itself? — was considered and discarded. Something had to be done. Says Angermann: “We’re in recession here. Times are tough. The auto industry is getting killed. People here can’t handle this now. It’s obvious someone screwed up big-time, and we want to know what happened. It was important to send a message.”

Not even the recent appearance of a pro-Hezbollah billboard in the city’s downtown captured the attention of locals like Watermaingate. It’s clear: People don’t take kindly to unexpected, sudden changes in the price of basic commodities such as water. But what to do? The political drama playing out in Windsor is just the latest scene in a new movie, The Collapse of Infrastructure, now showing across North America.

For over a decade now, we’ve heard of an impending crisis in infrastructure. The problem kicked up a notch this summer. In July, a woman walking on a sidewalk in Manhattan died when an 83-year-old steam pipe burst beneath her feet and sent a massive geyser into the air. In August, 13 people in Minneapolis were killed and 100 injured when a bridge collapsed, plunging them into the Mississippi River. Here in Canada a year ago, we watched in horror as an overpass in Laval, Que., collapsed on five people engaged in that most mundane activity, driving down an expressway. It was a brutally stark reminder — the cars were flattened to knee height — that, although Canada has an image of being an advanced western country, it doesn’t take long for the veneer of civilization to fade and peel away.

“I’ve been talking about this for a decade,” says Saeed Mirza, a professor of civil engineering at McGill University in Montreal. A specialist in infrastructure renewal, he suggests there is a new moral imperative to deal with the issue in the wake of the recent deaths. “This is the basic stuff of society,” says Mirza. “We have an obligation to take care of it and pass it on to our grandchildren.” In a speech at a September conference in Toronto, Mirza called on Ottawa to come up with a national infrastructure policy. “In light of what has happened in Canada and around the world, there is a need for this issue to be dealt with,” he said. “We need to do this now.”

The big question is: Can we do this? Much of our existing infrastructure was built in the postwar era, the ’50s, ’60s and ’70s. When high interest rates showed up in the ’80s, spending on infrastructure — traditionally financed through municipal debt issues — dried up, and it’s never come back. The Windsor Utilities Commission first suggested the city begin replacing its aging water infrastructure back in 1988. But successive administrations didn’t respond, or spent the money elsewhere. Since then, the city’s system of water mains — more than half cast iron, some soldered with lead, 29% of them over 80 years old — has continued to decay, and the whole thing now leaks at a rate far above the provincial average. “We had a chance in the late ’90s to do something about crumbling infrastructure,” says Mirza. “We had surplus budgets. We should have done it then.” We didn’t, and the bill has continued to grow. The last straw was all of the downloading of services from federal and provincial governments to municipal governments, which further tightened budgets.

Today, the American Society of Civil Engineers estimates US$1.6 trillion will have to be spent over five years to get all of the country’s bridges, airports, canals, seaports, roads, rail corridors, hospitals, water systems, electrical systems and waste-water treatment plants back in order. In Canada, estimates start at $44 billion and range up to $200 billion for a similar reconstruction. A study from Infrastructure Canada found the problem too complex to even attach a price tag.

But while the numbers may be frightening from a budget perspective, they also represent a great amount of economic activity. And to no one’s surprise, the issue has attracted the attention of international engineering concerns, global construction companies, water service corporations, design firms and the army of professional services such as law, accounting and consulting that follow the herd. The smell of opportunity hangs heavy here. Tim Philpotts, leader of Ernst & Young Canada’s public-private partnership (P3) practice, expects infrastructure to become the world’s next great asset class by the year 2020. “The next 10 years is likely to experience the same explosive growth in infrastructure as an asset class that real estate has experienced in the last decade,” he wrote in a recent report. Big pension funds and insurance funds, both of which see the steady, safe, long-term returns on infrastructure as perfect matches for their liabilities, are also lining up. Governments have already turned on the taps.

In Canada, the feds recently announced $33 billion in funding, including $1 billion for the Asia-Pacific Gateway and Corridor shipping initiative. Alberta is spending billions on its own infrastructure; Calgary Mayor Dave “Bronco” Bronconnier recently stared down new premier Ed Stelmach over funding for an extension to the city’s light rail line. The most populous province has gone ahead with its ReNew Ontario program that will spend $30 billion on infrastructure between 2005 and 2010. The Ontario Power Authority also just released a 4,000-page proposal on electrical needs, which will see loads of cash flow to the refurbishment of nuclear power plants and the construction of renewable energy sources.

To facilitate all of this, Queen’s Park created a new Crown corporation, Infrastructure Ontario, in November 2005. The corporation is responsible for overseeing so-called Alternative Financing and Procurement (AFP), a new name for public-private partnerships. That was smart marketing. The Canadian public has been wary of P3s since a couple of early examples — a controversial deal on the Highway 407 express toll route in Ontario and building schools in Nova Scotia — generated reams of negative press.

A recent OECD report lists as its two main recommendations for global infrastructure the use of alternative funding methods and the tapping of the world’s pension and insurance funds for financing capital. The reason, according to the OECD, is simple: budget pressures demand it. Government spending on gross fixed capital formation as a share of total government outlays (the amount spent on new capital infrastructure projects) has fallen to 7% in 2005 from 9.5% in 1990. But between 1980 and 2003, spending on social programs increased to 21% of GDP from 16%. The pressure to increase social spending will continue to grow as the population ages. The only way out, goes the thinking, is through P3s and private capital, which, the OECD report claims, leads to reductions in construction costs, faster delivery and lower operating costs.

So, how will all the magic happen? According to Ernst & Young’s Philpotts, it’s in the way that incentives change under P3s. “The way government construction got done in the past was that governments would hand companies a blueprint and then tell them to build,” says Philpotts. “But the construction company would often bid low to get the project and then make up their money in cost overruns charged when changes were made to the original plan.” Under P3, the government simply specifies its needs and gives the builder responsibility for designing, building and (depending on the contract) operating the asset. That gives the “owner” incentive to make sure the project comes in on schedule and budget. “The government waits until the conditions are fulfilled and then hands over the money,” says Philpotts. “They pass along these risks to the company.”

If the company has a so-called design, build and operate (DBO) contract — like the recent contracts to Plenary Health and Carillion Canada for a couple of new hospitals in Ontario — then there is a competitive environment to keep costs down and put pressure on sub-contractors to stay within budget over the project’s lifespan. As well, there are incentives for the builder to use quality materials during the original construction so that the asset will last a life cycle and not need to be rebuilt every 10 years (as has happened in the past).

Better yet, as contracts and agreements become standardized, efficiencies of scale can be harvested, professional fees reduced and the construction cycle sped up at low cost. This efficiency may be even more fully realized in Ontario, now that all the P3 contracts will come out of one Crown corporation. That’s an improvement over the past, where each hospital would come up with its own plan. “That’s so inefficient,” says Mary Lowe, vice-president of communications for Infrastructure Ontario. “Hospital administrators should be running hospitals, not constructing buildings.”

She echoes Philpotts’s arguments about increased efficiency and optimized incentives. “The private sector has always been involved,” says Lowe. “The difference now is that we negotiate the costs upfront and the project is financed by the developer. We don’t hand over money until it’s done according to the terms of the contract.” Adds Lowe: “We’re pushing the risks of construction onto the builder. I think it brings a new level of accountability to the process that didn’t used to be there.”

Philpotts points to the recent construction of several privately financed hospitals in British Columbia as a perfect example. “Compare Abbotsford with the [non-P3] convention centre in downtown Vancouver. It’s hard to argue that a project $400 million over budget is better than two projects that came in on time and at cost.”

That may be so, say critics, but lower costs might come from using non-union labour. And not everyone is convinced the risk is being shifted as efficiently as claimed. Blair Redlin, a research representative with the Canadian Union of Public Employees, points to the example of Metronet Rail in the U.K., a P3 involving Bombardier Inc. that was supposed to make much-needed improvements to the London Underground. When costs escalated higher than expected, the program collapsed and the costs flipped back to the public. “One of the things supporters of P3s always claim is that risk is shifted off the government,” says Redlin. “I don’t want to sound ideological and say that no risk is being transferred, but I’m asking whether risk is really meaningfully being transferred.”

Redlin’s criticism raises a legitimate question for the taxpayer and the public commodity consumer: Do governments have the savvy and legal talent to negotiate with large for-profit corporations that do this for a living? “If you do this, you need really diligent, sophisticated public officials,” Redlin warns.

Proponents of P3s don’t deny that some of the first ones were problematic. “If you look at some of the early projects, they weren’t structured as well as they could have been,” concedes Philpotts. “Some of the protections [for the government] weren’t what they should have been.”

But lessons have been learned. Philpotts points to the Abbotsford hospital project, where the contract included terms to ensure that if refinancing is needed, half of the gains of that refinancing go to the government. He also points to contracts around road projects that have been rewritten so that government gets money if toll revenue is higher than expected. “It’s common now to put in a band,” he explains. “If traffic is higher than anyone expected, then some of that money goes back to the government. That wasn’t in the [Ontario] 407 contracts. But we see that in most projects now.”

Addressing the concern that governments may be out of their depth when it comes to negotiating contracts, Lowe points out that Infrastructure Ontario employs a third-party review system to look over contracts, all of which are made public and posted online. “I’d argue there is more accountability and transparency than we’ve ever had.”

Experts also point out that maintenance occurs on a more regular schedule under a DBO model than under traditional funding models, where governments, looking for ways to cut spending, are tempted to defer regular maintenance.

Setting up P3s, experts say, would help us rebalance the tax system away from income taxes (which are a disincentive to working) toward user fees (tolls), which lead to less waste (a key consideration for greens). But the problem from the public’s perspective — and this is especially true in Windsor — is that disposable income will decline at a time residents are suffering from the loss of manufacturing jobs.

At a major P3 conference held in Toronto in October 2006, John Wright, senior vice-president of market- and opinion-research firm Ipsos Reid, gave a speech in which he claimed the public was just now hashing out its opinions on P3s. “I can tell you that the public is at a stage of deliberation…that stands in stark contrast to where they were 15 years ago, or indeed, even five years ago,” said Wright. He wenton to detail the breakdown in public opinion: 30% of Canadians are deeply committed to the notion of completely publicly owned infrastructure, another 30% are at the other end of the spectrum (supportive of privatization), and the remaining 40% are somewhere in the middle.

Which way will we go? Claude Lamoureux, the president and CEO of the Ontario Teachers’ Pension Plan, suggests a perfect decision is impossible. “If there were a silver bullet, we would have used it already,” he says. Mark Wiseman, who is responsible for private equity investing and infrastructure at the Canada Pension Plan Investment Board, is of a similar mind. “Each of these ways [government financing or P3s] has policy benefits and policy drawbacks,” he says. “At the end of the day, it’s a policy decision. If the government wants to concede some long-term control, then they can get this money off their balance sheet and have it financed by a third party. But we need to see the terms and conditions favourable to a long-term steady investment in place before we’ll invest.”

Wright did mention that Canadians preferred to see governments retain the final and upper hand in the process. That is, many don’t mind private money brought into the equation; they just want infrastructure fixed and the government to be responsible for whatever happens. And in that, perhaps, there’s hope. Whatever decision comes to pass, be it more private capital or not, those at the top will be held to account by the world’s most effective governance regime: citizen rage.

In Windsor, water-rate protestor Angermann points out that our latest bit of infrastructure, the Internet, has facilitated a new level of civic communication and activism in the city. “It’s amazing,” he says. “This is the first time the Net has played a key role in an issue here.” Citizens have connected online, signed petitions and organized. Angermann mentions a new citizens’ action committee had formed and is demanding to be included in determining the terms of reference about whatever audit of Windsor’s water utility gets carried out.

The majority of city council has agreed to an audit by the Ministry of Municipal Affairs and Housing. But the citizens’ group, letter writers to the editor and a single breakaway councillor are demanding that a wider, deeper audit be performed by the auditor general of Ontario. The citizens want to know who spent money earmarked for capital replacement on operating and administrative costs, when that decision was made, and what exactly are the links between the Windsor Utilities Commission and the city’s private utility company, EnWin Utilities Ltd. (which handles administration for the WUC). “If we get an audit-lite, the people here are going to go nuts,” says Angermann. “Local politicians and now our provincial representatives are under the gun. People are still very angry. They’r e not going to forget this the next time they go to the polls.” Politicians and corporations: You’ve been warned.