What is the right way for the Commonwealth to invest in infrastructure projects

What is the right way for the Commonwealth Government to invest in infrastructure projects?

The typical approach has been for the Commonwealth to make a grant to a state government – which in turn contracts with a private sector company to design and build the project.

For example, the Commonwealth is funding eighty per cent of the Toowoomba Second Range Crossing, a 41 kilometre long bypass, at a cost of $1.137 billion.  The Queensland Government has contracted with the Nexus consortium to build the project. 

But as last year’s budget papers laid out, there are two other ways in which the Commonwealth can make infrastructure investments.

It can spend directly to acquire physical assets – such as when the Commonwealth in the nineteen eighties bought the Badgerys Creek site on which Western Sydney Airport is to be built.

Or it can pay cash to acquire a financial asset – either debt or equity. For example, the Turnbull Government has made a $2 billion loan to Sydney Motorway Corporation (SMC), the NSW government owned company established to build and operate WestConnex. 

The three approaches have very different consequences for the Commonwealth’s balance sheet – and for Commonwealth taxpayers.

If the Commonwealth acquires a physical or financial asset, then this goes onto the asset side of the Commonwealth’s balance sheet. 

Assuming the Commonwealth borrowed the cash it used to acquire the asset, the consequence is that liabilities increase by a certain amount and assets increase by the same amount.

But if the Commonwealth makes a cash grant to a state government, it is an operating expense of the Commonwealth and included in the underlying cash balance for the year in which the payment is made.

Yet the Commonwealth gets no rights over the asset that the state government buys or builds with the cash it receives.  The state government gets an asset on its balance sheet; the Commonwealth gets nothing.

There will always be a place for capital grants to the states, particularly for infrastructure with more limited revenue-raising capacity. 

But the Turnbull Government is increasingly looking to make more use of debt or equity in structuring its infrastructure investments.

The 2017 budget saw equity injections of $5.3 billion into Western Sydney Airport, and $8.4 billion for Inland Rail. 

This change in approach has been questioned by some - including Labor State Governments which unsurprisingly regard it as a splendid idea that they get free money from Canberra, with virtually no strings attached, for infrastructure projects that they can claim the credit for.

Some commentators have questioned whether government, or the private sector, is better placed to bear the risk associated with investing in infrastructure projects. 

In fact, with many infrastructure projects government is better placed to handle that risk, at least during the construction or greenfields phase.

With Western Sydney Airport, for example, there is substantial regulatory risk related to flight paths, to the provision of ground transport connections to the airport, and other issues key to the airport’s prospects. 

This makes government a more logical party to handle the construction of the airport than the private sector – although there will certainly be a point in the future where it will make sense to transfer this valuable asset to the private sector and recoup the taxpayers’ capital invested in its construction.

Of course, funding infrastructure through a debt or equity injection is not costless.  Government – and in turn taxpayers – must pay the cost of capital on the funds invested.

But funding infrastructure in the traditional fashion - through the provision of a grant – is not costless either.  Every dollar the Commonwealth hands over is lost to taxpayers immediately – and yet the Commonwealth and taxpayers must pay the cost of capital on those funds too.

So the real issue is the return to be obtained on the capital the Commonwealth invests – and key to this is managing the investment in a businesslike fashion.

Some have argued that the NBN is an example of the risks of Commonwealth equity investment. 

It is certainly true that Labor gravely mismanaged the NBN.  Their mistakes included appointing a board and chief executive with little relevant commercial experience; choosing a needlessly expensive network architecture; and being incredibly slow with the rollout, in turn delaying cash coming into the business.

That is why Malcolm Turnbull’s focus when he became Communications Minister was to correct, as much as possible, for these mistakes. He appointed an experienced board and CEO; changed to a more cost effective mix of fibre to the premises, fibre to the node and HFC; and dramatically accelerated the rollout. 

But Labor’s mismanagement of one project is not an argument against the use of equity investment as a matter of principle; rather it serves to underline the importance of a businesslike approach and treating taxpayers’ capital carefully.

That is something the Coalition takes very seriously – and we aim to demonstrate this with our infrastructure investments.