Highways; J. Semmens

John Semmens Highways: Public Problems Private Solutions EARLY in 1984 an article in The Wall Street Journal was headlined: "In terstate-Highway Building Projects Are Threatened by Political Stale mate." The gist of the story was that House Speaker Tip O'Neill was hold ing a highway appropriations bill hostage in an attempt to get more money for a project in Boston. The struggle over appropriations is a political struggle over the divi sion of tax receipts. This type of struggle is both a manifestation of the "infrastructure crisis" and a contributing factor in perpetuating infrastructure problems. The "infrastructure crisis" can be roughly defined as the observed or anticipated deterioration of public facilities like highways, bridges, Mr. Semmens is an economist for the Arizona De partment of Transportation. The views expressed here are those of the author and do not necessarily reflect Departmental policy.

172 dams, and the like. The phenomenon becomes a "crisis" because the cost to repair or forestall the deteriora tion is projected to exceed the avail able tax revenues. A middle range estimate of the tax revenue shortfall in the case of highways alone has been pegged at $60 billion per year. The magnitude of the forecast of needs easily dwarfs the recent in crease in revenues of about $5 bil lion per year generated by the 1983 5-cent-per-gallon Federal gas tax hike. The implication of such a huge gap between revenue and cost is that huge tax increases are necessary, perhaps even inevitable. However, before we get swept away in a stampede to throw money at the problem, it might be worthwhile to examine the situation more closely. If the infrastructure problem is truly as large as some of the figures indicate, it is clear that mere tax hikes within the existing opera tional structure would be an inade quate answer. In the instance of highway finance, substantial effort was required to pass a 5-cent-per gallon gas tax increase. Yet, this tax hike generates only $5 billion per year. Raising $60 billion would ne cessitate another tax increase of 55 cents (or more, allowing for some de cline in fuel consumption under higher taxes). Such a large tax in crease must be considered highly unlikely.

HIGHWAYS:PUBLIC PROBLEMS,PRIVATESOLUTIONS 173 Since it is unlikely that such huge estimated highway needs can be met from tax revenues, the task of mak ing do with less is of critical impor tance. Obviously, we cannot accom plish all that some think we "need" to accomplish. Choices will have to be made. Scarce resources devoted to some projects will unavoidably be denied to other projects. How these choices are made will deter mine whether the "infrastructure crisis" becomes the "infrastructure disaster." ChangesRequired One point that should be crystal clear is that "business as usual" cannot be maintained. A premise be hind the $60 billion annual gap be tween highway needs and revenues is that all existing facilities must be preserved. Since there won't be a $60 billion tax hike, this premise be comes infeasible and no longer valid. The notion that a highway, once built, must be preserved in perpe tuity is both impractical and illogi cal. There is no way that a society can progress if it is to be constrained to carryon the upkeep of every in vestment it ever made. Roads, be cause of their long, useful lives, give the impression of permanence. How ever, there is a crucial difference be tween longevity and immortality.

Times change, and the economic needs of a society change. The in vestments that were suited to an earlier era are not necessarily suited to the present or future eras. No vital industry in a dynamic economy attempts to perpetuate every capital facility it ever built. Factories, offices, stores, machines all wear out, become obsolete, or are replaced by other uses for resources. In fact, failure to anticipate the ob solescence of old facilities is a major drain on an industry's ability to cope with changing economic conditions. For example, the U.S. steel industry is plagued by aged facilities that threaten the survival of many firms. Failure to deal with the fact of ob solescence in highways is a definite threat to the public infrastructure. Funds poured into the maintenance and preservation of obsolete road ways are funds that cannot be used to provide new roads. Highway seg ments that may have had substan tial economic justifications when originally built may evolve into eco nomic dinosaurs that consume dis proportionate amounts of scarce re sources. This endangers the viability of the entire system. Dealing with this situation poses a serious prob lem for public highway agencies.

While the phenomenon of obso lescence poses difficulties in both public and private sectors of the economy, institutional factors make it much harder for the public sector to cope with these difficulties. The common perception is that govern ment is better situated to deal with 174 THE FREEMAN March problems like the infrastructure cri sis. After all, the federal govern ment has more revenue than any other entity in our economy. It has sovereign power to tax. It can borrow more money more cheaply. The fed eral government can even print money, if necessary. Despite this seemingly unlimited claim on re sources, government is severely handicapped in dealing with eco nomic problems. Unlike government, private firms are forced to rely upon resources voluntarily obtained. Customers cannot be taxed. They must be per suaded to buy. Investors must be in duced to provide capital. Resources are harder to come by and more costly than they are for the govern ment. Yet, it is these constraints faced by the private firm that pro vide the institutional incentives for better economic performance.

Market Discipline Restricted to only voluntarily ob tained resources, private firms must respond to market demands. Their products must fulfill genuinely felt needs or they won't make any sales. Their operations must be efficient or their competitors will undersell them. Their investments must pro duce profits or their capital will be depleted. The market provides strict discipline. Resources are channeled to those firms that make the best use of them. The importance of this market discipline can hardly be overempha sized. The absence of this discipline in the public sector makes it impos sible for even the most well-inten tioned public official to efficiently employ resources. The products and services government provides are not really marketed to willing cus tomers, so public officials have no feedback on real demand. True com petition doesn't exist, so there is lit tle pressure to improve efficiency or demonstration of how to do it. There is no requirement to operate-profit ably, so capital is depleted on in vestments with negative rates of return.

The private sector transaction be tween seller and buyer is clear-cut. The customer is not expected to pay for products or services he doesn't re ceive. Likewise, businesses are not expected to provide products or ser vices to those who don't pay for them. The public sector transaction is not so clear-cut. Customers or even non customers are taxed to pay for ser vices they mayor may not receive. Even in the case of public roads in which the user tax approach is em ployed, these types of inequities exist. To begin with, nonusers have been paying a growing share of the total revenues devoted to highway pur poses. A 1983 U.S. DOT study indi cated that by 1980, nonusers were providing nearly 40 per cent of the 1985 HIGHWAYS: PUBLIC PROBLEMS, PRIVATE SOLUTIONS 175 funds spent on highways at all levels of government. The nonuser per centage has nearly doubled since 1960. The trend is clearly away from the strict user charge principle.

InequitableUser Charges Even among highway users, the charges vary widely from the esti mated cost of service for each type of vehicle. Imbalances between the cost to provide service and the revenues earned imbed inequities and ineffi ciencies into the user tax structure. For example, the current Federal tax structure charges heavy trucks less than the cost of service. A report by the Federal Highway Administra tion estimated that this year the heaviest trucks will pay 71 cents in taxes for each dollar's worth of ser vice. At the same time, smaller trucks would be paying up to $1.31 for each dollar's worth of service. While this discrepancy may give the appearance of balancing out, the reality is that such a tax structure encourages an expansion of con sumption by the heaviest vehicles. Since heavier vehicles are paying less than a compensatory use charge, the highway trust fund takes a loss on the transaction. These losses will tend to grow over time as more users are encouraged to consume these under-priced highway services.

Despite the fact that the charges for the heaviest vehicles do not re cover the cost of highway services, intense lobbying to reduce these charges has occurred. This lobbying was successful in altering the tax structure to shift more of the tax to ward smaller trucks. Thus, even though highway officials might like to charge compensatory rates, they will not be allowed to do so. In effect, Congress is mandating that the heaviest vehicles be served at a loss. Congressional intervention in the pricing of publicly provided services presents some economic problems. The rates selected by Congress may make political sense, but be econom ically destructive. A private firm faced with such intervention by gov ernment would sustain serious losses. Government regulation of railroad rates helped make it a sick industry. Political control of high way user charges is having these same effects on the health of the highway system.

This is not to say that the highway agency will go bankrupt. These losses have been, and probably will continue to be, made up from non user subsidies and deferred main tenance. While the agency will not go bankrupt, the evidence does in dicate that existing investments in highways are not yielding a positive return. The importance of obtaining a positive return is that capital is regenerated and increased. If the economy is to grow, regeneration of capital is necessary. Failure to re generate capital leads inevitably to 176 THE FREEMAN March decline. The decline in one area could be forestalled by subsidies from other sources. This will, though, involve an opportunity cost in some other economic activity. Some other area would have to forego growth or suf fer decline in order for highways to receive a subsidy. Some will argue that highways provide much more in benefits than they consume in resources. Unfor tunately, this is merely an assertion.

The evidence indicates that the cost exceeds the value as represented by user charges paid for the service. Granted, the current user tax sched ule may not adequately assess the users for services rendered, but it is the only quantifiable measure that we have. It is only by observing the actual paid-for use that we can begin to get an idea of the value of the ser vice rendered by the highway system. Improved Accounting So-called cost/benefit studies that presume to sum up consumer sur plus and indirect benefits that then exceed the costs of highway invest ment are not adequate substitutes for positive financial returns. The reason for this inadequacy is that values are subjective. An analyst's estimate of what he thinks the in vestment conveys in terms of bene fits is only an opinion. Every form of economic activity produces con sumer surpluses and indirect benefits. However, none of these benefits are included in the financial returns reported for various investments. To include them only for highway in vestments or only public sector in vestments is a distortion that sys tematically biases the results.

Namely, it makes the public sector use of funds appear more productive than it actually is. To help put the concept of cost/ben efit in perspective, if such an ap proach were used for all prospective uses of capital, the policy implica tion would be that every undertak ing deserved to be subsidized by every other undertaking. Obviously, this is not possible. Consequently, attempting to economically ration alize investments with cost/benefit calculations cannot provide valid guidance for the allocation of scarce resources. Cost/benefit analysis can reveal how alternatives among a strictly limited list compare to each other. Such analysis cannot deter mine whether an investment is a productive use of resources. The only valid means of determin ing whether an investment is a pro ductive use of resources is to observe whether the revenues obtained from sales cover the cost of providing the services. Private sector enterprises get this sort of feedback on a regular basis. Unsurprisingly, the private sector has evidenced an accumula tion of capital and growth of re sources over time. In contrast, the 1985 HIGHWAYS: PUBLIC PROBLEMS, PRIVATE SOLUTIONS 177 public sector exhibits a propensity to consume capital. Public sector high ways, rather than accumulating capital to meet future growth, seem to require constant infusions of re sources from nonusers.

Competitive Pricing There is the prospect of increasing user taxes to cover full costs of pub licly provided services. While this has its positive aspects, it does pre sent some problems. We could prob ably hike user taxes substantially and thereby generate a positive re turn on the highway agency finan cial statements. This would be due, in part, to the fact that the services provided by highways are more val uable than the cost under the higher tax structure. However, the im proved financial returns would also be due, in part, to the monopoly po sition enjoyed by the public agency. In the private sector, competition limits the ability of individual firms to charge excessive prices. The fact that customers could resort to com peting suppliers gives the customers a strong bargaining position. The lack of competing suppliers in the provision of highway facilities elim inates the possibility of effective bar gaining power for the driving public.

Consumers cannot easily demon strate their preferences in the public sector monopoly environment. That these preferences are significant can be discerned from the wide variations in earnings generated on dif ferent road segments. Even though the existing tax structure for highway user charges leaves a lot to be desired in terms of pricing strategy, observing how these taxes translate into earnings on a segment-by-segment basis is in structive. For example, some high way segments yield returns far in excess oftheir cost. Others earn mere pennies on each dollar invested. In Arizona, State Route 181 is projected to lose 95 cents out of every dollar put into it. In contrast, urban por tions of U.S. Route 60 are likely to produce substantial surpluses over cost. The implication of these discrep ancies in yields on various segments owes much to erroneous pricing of the services. Urban highway users are stuck with high prices for rela tively poor service. At the same time, many rural segment users are pay ing far less than the cost of the ser vice. The monopoly position of the public highway system promotes this cross subsidy of rural facilities. In a competitive market, urban consum ers would be less vulnerable to this type of exploitation. Profit seeking entrepreneurs would be encouraged to offer attractive alternatives in the urban areas.

In addition to inefficient and ex ploitive pricing structures, the pub lic sector monopoly over highways reduces incentives to control oper178 THE FREEMAN March ating costs. In the private sector, competition prompts firms to re strain overhead costs. Lean opera tions allow for a better service/price offering to the consumer. Firms that allow overhead to get out of control will be unable to offer as good a deal and still maintain profitability. Mo nopoly removes the pressure to con trol internal costs. The effect of pub lic sector highway monopoly on overhead cost is as would be pre dicted. In the early 1960s, the ratio of overhead expense to actual con struction was about 7 per cent. By the early 1970s overhead expense was up to 12 percent of construction outlays. By the 1980s, overhead had reached 17 per cent of construction outlays. With no competitive pres sure to encourage restraint, the pub lic sector high way monopoly has allowed greater proportions of re sources to be consumed in adminis tering programs. This means less is available to provide usable facilities and services.

The Privatization Option Examination of the status and per formance of the public highway sys tem reveals an operation plagued with problems. Operational ineffi ciency, an inequitable tax structure, inability to discern and serve con sumer demand, and malinvestment of scarce resources are pervasive characteristics of public sector own ership and control. In fact, Federal law goes out of the way to mandate practices that unnecessarily impede efficiency. A classic example is the Davis-Bacon Act. The Congressional Budget Office estimates that the procedures required by the Act add 4 per cent to the cost of highway con struction. While 4 percent may not sound like much, on a multibillion dollar construction budget it is sub stantial. The annual cost of road con struction in the United States is probably around $1 billion higher than it has to be as a result of Davis Bacon. Bad as the record of public sector ownership and control is, the alter native of privatization is usually portrayed as impractical. Critics of privatization plausibly ask: "Who would be willing to buy and operate roads?" Although the "obvious" an swer to such a question is supposed to be "no one," there are other possibilities.

To begin with, if the real answer is that no one would under any circumstances be interested in acquiring and operating any road segment, the facilities must have no economic value. Such a conclusion is patently false. Roads do provide im portant services having definite eco nomic value. The existence of self sustaining toll roads and bridges would seem to indicate that at least some properties could be operated profitably. From a historical per spective, it could be pointed out that 1985 HIGHWAYS: PUBLIC PROBLEMS, PRIVATE SOLUTIONS 179 privately owned and operated toll roads were common in the United States in the early 1800s. So, the no tion that privately owned highways are infeasible is unfounded. There are many existing highways that could be effectively adapted to a toll operation. The key advantage of a toll facility is the strong link beween revenue and need. Only those who use the highway are re quired to pay. Service need not be provided at less than cost. The strong link between revenue and need pro vides the wherewithal and the in centive for better maintenance of the roadway. As a result, toll roads are almost always better maintained than nontoll roads serving similar traffic. Interestingly, Federal law explicitly prohibits the charging of tolls on highways that have received any Federal aid.

Tolls and Access Charges It seems likely that privately op era ted toll roads could be an ap pealing option in some instances. In other instances, toll roads might ap pear unattractive. Opponents of the toll road concept lampoon the idea by conjuring up a vision of congested urban traffic brought to a standstill by toll booths at every intersection. Obviously, such a method of opera tion would be insane. Fortunately, there are some prospective reme dies. First, access to urban road sys tems could be sold in larger units than one block of travel at a time. For example, the city of Singapore sells access to the central business district road system on a monthly basis. Many private sector busi nesses operate on this type of a mar keting system. Access to health club facilities is a prime example of this method of charging for services ren dered. Customers usually pay a monthly, quarterly, or annual access charge, not for each dip in the pool, weight lifted, or yard jogged. Fi nancing some road services via ac cess charges would seem a feasible option.

Second, payment for road use could be automated, with traffic electron ically recorded and billed periodi cally. The technology has already been developed for individualized vehicle identification, travel mea surement, and billing. A test of equipment in an urban setting is al ready underway in Hong Kong. The private sector makes use of a related approach in automated scanning of uni versal product codes to speed traffic flow at retail cash register lines. Third, highway facilities could be financed by indirect user charges. A frequent argument against the idea of privately owned roads is the prob lem ofthe "free rider." Some contend that roadways must be public goods because of the difficulty of excluding nonpayers. On the one hand, this dif ficulty is exaggerated. Public agen180 THE FREEMAN March cies already exclude would -be users who don't pay assorted charges like vehicle registration and driver's li cense fees. On the other hand, even assuming that collecting directly from the user is difficult, there is an other way.

In the twentieth century, the broadcasting industry grew from nothing to a pervasive part of mod ern life. Television and radio are multibillion dollar industries. Yet, their services are consumed for "free." Viewers and listeners pay no money to broadcasters. Anyone with a receiver can consume the broad casts without paying a dime. The in dustry is able to thrive by selling ac cess to the audience of free broadcasts. The millions of viewers and listeners are of interest to advertisers. Highways have millions of drivers and passengers on them every day. This provides the opportunity to sell space for communications. Bill boards are one means of communi cating. Though billboards can be seen from roads right now, they have been neglected as a source of reve nue for sustaining the highway facility. Tapping Real Estate Values Another variation of the indirect means of finance would be similar to the method in which shopping cen ter owners charge for lease space.

High volumes of traffic improve retail sales and, consequently, lease rentals. Highway facilities could link up with real estate developers to improve the traffic flow to and from a location and receive compen sation from the property owners based on the traffic· volume. As it now stands, public sector highway construction creates improved real estate values, but receives no reve nues based on these values. Windfall gains are created for the lucky or the well-connected real 'estate holders, while the highways end up losing money. The above suggestions are meant to show how privately owned high ways could conceivably succeed. Af ter so long a period of public sector monopoly, there is no immediate, universally obvious alternative method of operation. Because we cannot now specify exactly how pri vatization would work for all situa tions does not mean that privatiza tion is not a viable option. The whole point of privatization is that it will expose the problems of highway transportation to the initiative ofen trepreneurs. The creativity of entre preneurs in a market environment is the key advantage of privatiza tion. That we cannot precisely pre dict what they will create is but fur ther evidence of the shortcomings of centralized planning.

A transition period of experimen tation and gradual change would seem advisable. A potential starting 1985 HIGHWAYS: PUBLIC PROBLEMS, PRIVATE SOLUTIONS 181 point for a transition to privatiza tion could begin with the public sec tor's divestiture of poorly yielding facilities. Why would a private firm want to acquire such facilities? Many business ventures are money losers. Yet, in the private sector, purchasers can usually be found for the dispo sition of the "assets" of failed ven tures. Just because the government loses money in the operation of a fa cility does not necessarily mean that a subsequent owner won't be able to earn a profit. New management, combining old assets in new ways, can often turn losses into gains. Sellingthe Losers A program of divestiture would need to take a realistic approach. For one thing, public officials should not expect to recover the sunk costs of money-losing facilities. Assets of this kind can only be disposed of at a dis count. In fact, for road segments that don't even generate enough cash to cover out-of-pocket costs, the public highway agency would actually im prove its financial condition by giv ing such segments to whomever will take them.

In addition to discounted prices for divested facilities, the public sector agency will have to avoid the temp tation to heap debilitating restric tions on the operation of the priva tized facility. Since the very reason for divestiture is the fact that the public agency cannot operate the facility in a cost effective manner, it would be unreasonable for the agency to impose restrictions on the new owner. Besides, the fewer the re strictions, the more salable the· as sets. The public sector will get better prices for divested properties if they are less encumbered. As divestitures proceed, both pub lic and private sector participants and observers can learn from expe rience. Successful techniques for transferring ownership and for op erating the privatized assets can be imitated and improved upon. Un successful examples can be analyzed to provide guidance for reducing negative outcomes in the future.

Over time, the highway transpor tation system should show marked improvement. The public agency's financial condition will benefit from unloading deficit-ridden highway segments. Both savings in operating costs and revenue from the sale of assets will serve to relieve some of the financial strain. As facilities pass into different hands the prospects for service innovation and experimen tation will increase. Highways could begin to be integrated into the more dynamic private sector economy. The successful highway entrepreneurs will make their investments grow. This will enable them to buy or build more segments. The infrastructure, instead of facing a future of deteri oration and decay, would have an op portunity to grow and flourish. :!J Edmund A. Opitz Battlefor the Mind THE term Weltanschauung is noth ing more than a highfalutin label for "world view." Everyone has a world view, although not everyone is fully conscious of it or aware of its impli cations. In other words, everyone conducts his life on the basis of some fundamental premises he takes for granted. The premises may not be explicitly stated, in which case they can be deduced from observations of the way a person habitually acts.