5
May
2014

Why more infrastructure money is not the road to a stronger economy

by John Daley


Published by The Australian Financial Review, Monday 5 May

Premiers should beware a prime minister bearing gifts. On Friday Tony Abbott signed a deal to give states an extra 15 per cent towards the cost of new infrastructure if they also sold an existing asset.

The funding offer fits with the prime minister’s belief that spending on roads, in particular, needs to rise. He plans to be “an infrastructure prime minister” who addresses Australia’s “massive infrastructure gap” by putting “bulldozers on the ground and cranes into our skies”.

There is just one problem with this analysis: states and territories are already spending unprecedented amounts on infrastructure. For the past six years, these governments have spent more each year on infrastructure – mainly roads and rail – than at any time since the Bureau of Statistics first collected infrastructure spending data in the 1980s. Even when stimulus funding during the Global Financial Crisis is excluded, state infrastructure spending in real terms in 2013-14 was four times higher than it was in 2002-03.

To give just a few examples, in the past decade NSW opened a desalination plant, finished the Cross City Tunnel and built a railway from Epping to Chatswood. Victoria embarked on the Regional Rail Link, the EastLink Road and the Royal Women’s and Royal Children’s Hospital redevelopments. Western Australia completed the New MetroRail project, the largest public transport infrastructure project in the state’s history.

Big dollars were allocated to recovery projects in Queensland after cyclones and floods, on top of spending on the Gold Coast light rail and several major hospital redevelopments.

This spending has come at a cost, as Grattan Institute’s new report, the 2014 edition of Budget pressures on Australian governments, reveals. In 2006, the states and territories had $37 billion in the bank. Today, having funded infrastructure out of cash reserves and borrowings, they are $69 billion in the red, a deterioration of $106 billion in seven years.

The impact on their annual budgets is severe. Relative to 2006, state and territory governments are spending 3 per cent more of their budgets on interest and depreciation. Services are being cut to pay for past infrastructure decisions.

Even if states simply hold their contribution to infrastructure spending at current levels, more things will have to be cut in future to pay for it.

THE BUDGETS WILL BE NO PICNIC

This month’s Commonwealth budget will be tough, and state budgets are also unlikely to be a picnic. The Commonwealth government has rightly made it clear that Australia’s worsening budget position must be addressed. Yet it seems infrastructure spending will be spared the axe.

The belief that infrastructure is special rests on the argument that it increases productivity. Future prosperity justifies the increased charge on future budgets. And productivity does go up, provided that governments build the right infrastructure, in the right place, at the right time, for the right price. Unfortunately, as the Productivity Commission noted recently in its characteristically understated fashion, “there are many examples in Australia of poor project selection”. The Prime Minister and premiers have agreed to only fund projects backed by solid cost-benefit analysis and rigorous prioritisation.

These promises would be comforting if they hadn’t been made so often in the past, and so often broken.

There is no guarantee that more infrastructure spending will lift productivity by more than its cost. But even if it did, could we afford it?

The idea behind the latest Commonwealth-state agreement is “asset recycling”: selling assets and using the proceeds to fund new infrastructure. Superficially it’s attractive. The problem is that when states sell infrastructure, they save on interest payments, but they also give up future revenues from those assets. Although NSW is seen to have negotiated good prices for recent long-term leases of three ports, the interest saved will be about the same as the revenue given up.

Though asset recycling may make banks more relaxed about lending, it doesn’t help make ends meet. If states spend the proceeds of asset sales on new infrastructure, as the Prime Minister wants them to do, the interest and depreciation on these new assets will further strain their annual budgets.

Of course everything will be fine if new assets generate new revenues greater than the costs of building them. But it’s a while since any public infrastructure project in Australia did so – just ask the investors in the Clem 7 and Cross City Tunnel.

Premiers have welcomed the Prime Minister’s offer of more infrastructure money. But states may find it a doubtful gift. They will still have to pay much of the cost. Faced with tough budget pressures, and acknowledging their patchy record of project selection and execution, states should ask whether infrastructure really deserves a special exemption in tough budgetary times.