Land-use and Transportation Policy Analyst Marc Scribner talks about his new CEI Issue Analysis, “The Limitations of Public-Private Partnerships.” Marc argues that PPPs are an improvement over the status quo in surface transportation because they introduce at least an element of competition into a sector where there is usually none. But PPPs are harmful in real estate developments because they tend to favor politicians’ preferences over those of consumers.
public-private partnerships
In our half-political, half-private world, there are a growing number of public-private partnerships. Almost nothing in the current world can be done without implicit or explicit permission by local, state, federal or (increasingly) global regulators. But the term, public-private is normally used to denote the joint funding and, sometimes, joint management of some “public” facility — streets, water systems, and so forth.
The rationale for “public” investments is that they are “public” goods, whose benefits are not adequately captured by the provider. There are many problems with this concept – in practice, it means that someone wants something and nobody seems to be providing it. Note, from a Coasian/Schumpeterian free market perspective, these are exactly the “lures” that lead mankind to pursue the unexplored entrepreneurial paths to the future. Rushing in with government assistance distorts and preempts those creative forces.
Sometimes, public-private partnerships can be a transitional step toward privatization. The concept of “corporatization” that is, reorganizing an activity now performed by some political agency so that its inherent economic realities become more understandable and transparent, may be a useful step in privatizing the activity.
In most cases, however, public-private partnerships are simply a means of using tax breaks, regulatory easing, taxpayer support and so forth to subsidize some private activity: stadia, light and heavy rail — mass transit generally, sometimes (for God’s sake) hotels and malls, downtown development districts. Where I live in Washington, D.C., businesses are allowed to add a “special tax” to pay for services the city supposedly pays for with normal tax revenues. Such public-private partnerships suffer from the full array of government failures:
- Log-rolling and pork-barrel politics: I’ll vote for your PPP if you vote for my PPP.
- Weakened market tests: resources are devoted to a project not because it benefits the citizenry but rather because it benefits a powerful interest group and/or because a creative referendum entices a majority of voters to support their special interests.
- Weaker Management: Absent market tests, managers are less motivated to find that mix of services and creative array of financing tools to ensure that it proves “profitable” (that is, a rational allocation of capital). Roads, even charter schools, etc all have suffered here immensely.
- Lack of innovation: No institution in the private world can allow itself to stagnate – the creative forces of destruction will soon make it obsolete. PPP managers face much weaker innovative forces – if things go wrong, they can always appeal to their “public” nature for taxpayer bailouts.
- Corruption: Crony capitalism abounds in the PPP world.
- Faddism: Markets sometimes go on kicks – the tech boom, for example – but these soon collapse. Governments go on kicks for many decades – “renewable energy” and “mass transit” being perhaps the best examples but “magnet” investments in downtown malls, stadia and convention centers are perhaps even more persistent ones. Before Walmart became a PPP, it did more for consumers than all the PPP malls in the world.
- Crowding Out: Capitalism plays a critical role in allocating capital – planting the seeds for our future. That is a very difficult task, one made much more difficult by the existence of PPPs. Government already seizes a disproportionate amount of our wealth and the PPP concept allows it to further distort the allocation by market forces. I’ve argued that the genius of the Progressives in the late 19th century was to preempt or push large sectors of the emerging future (the environment, schools, electromagnetic spectrum, infrastructure, welfare, the medical world) into the political world. The PPP concept simply exacerbates this tendency.
Our challenge is to find ways to expand the private sector and only very rarely does the PPP concept do that. It allows people to be sloppy — “That would never pay for itself but it obviously has value, thus, we need some government help. Let’s not make it an honest government function, let’s make it a Public-Private partnership and get the best of all possible outcomes!!”
This Mixed Economy model is less honest than true socialism (government acting directly) for many reasons. If as is often the case, things go wrong, it will be capitalism — not government — that will be blamed. PPP activities are less subject to consumer sovereignty (look at airports or schools). The true costs of the activity don’t appear on government budgets — making it appear that PPP arrangements are “bargains.”
The retail and entertainment development formerly known as Xanadu Meadowlands—recently renamed The Meadowlands—has been plagued with problems since the planning stage. The East Rutherford megamall is located on the site of the Meadowlands Sports Complex, about seven miles west of Midtown Manhattan in Bergen County, and would be the largest retail and entertainment complex in the United States. In addition to the shopping mall, Xanadu was to include an indoor ski jump, a basketball arena, a ballpark, a luxury hotel, and office towers. When the project was announced, it was hailed as the most innovative and expansive economic development public-private partnership ever to be undertaken in the United States.
The 4.8 million square foot project was expected to cost $1.3 billion when developers Mills Corporation—which had originally proposed the mall in 1998—and Mack-Cali Realty Corporation won the winning bid in February 2003. In March 2003, losing developers Hartz Mountain and Westfield America Trust both sued the New Jersey Sports and Exposition Authority (NJSEA), the state agency that owns the Meadowlands property, in an attempt to halt the deal. These lawsuits were ultimately unsuccessful, but the initial optimism over the project was already waning.
The NJSEA and Mills/Mack-Cali originally estimated an opening two years after groundbreaking, which occurred after the development consortium secured a 175-year lease from NJSEA in 2004. In 2005, the New York Giants, a Meadowlands Sports Complex tenant, filed suit in New Jersey Superior Court in an attempt to halt construction of Xanadu. The Giants claimed the project violated their lease agreement by obstructing views from the stadium, among other reasons. This lawsuit was also unsuccessful, but Mills was already in deep financial trouble. In the spring of 2006, Mills laid-off 15 percent of its staff, shareholders had filed suit, and the company was being investigated by several state attorneys general and the Securities and Exchange Commission. The company soon announced it was looking for buyers.
Mills was eventually sold to Indianapolis’ Simon Property Group, which abandoned the project after major lender Lehman Brothers collapsed and other lenders pulled out of what they viewed was a doomed development. Xanadu was then taken over by a new consortium led by Colony Capital, a California real estate investment firm. The project continued to suffer from financing difficulties, which led to ongoing work stoppages. By this time, the budget had ballooned to $2.3 billion. Dan Fasulo, managing director of real estate analysis firm Real Capital Analytics, described the Xanadu project as “too big to fail,” citing massive sunk costs and public liabilities.
In February 2010, it was announced that billionaire Bob Ross’ Related Companies, a major Manhattan developer, was taking over the project. This followed the release of a report authored by the transition team of Governor Chris Christie (R), which attacked Xanadu for its “failed business model” and which called on the state of New Jersey to tell the developers to “open or surrender the property” back to NJSEA. The report concluded:
There is no leasing plan making material on-site progress. The physical activities of construction are at a standstill, if not abandonment. The construction loan is out of balance. There are no monies readily available to finish construction of public areas or tenant improvements. Most, if not all, of announced major tenants have an ‘escape clause’ solely dependent on leasing—or lack thereof.
Officials were confident that Ross would be able to secure $500 million to $700 million in new financing and that an opening date could be expected as soon as mid-2011. However, in early July 2010, the role of Related Companies was still unclear, and the state was mulling the option of providing $180 million in emergency financing in a last-ditch attempt to save the project. Officials are considering tax increment financing (TIF), a method of public financing in which construction debt is financed by expected future tax revenue increases (the increment) that occur as a result of the property included in the TIF district becoming presumably more productive in the future. This, however, carries significant risk—public services may be over-provided, development investment may never materialize, and the likely possibility of harmful real estate market distortions, such as real property malinvestment, should concern local policy makers. A lot.
Regardless of whether or not Xanadu–sorry, The Meadowlands–is ever completed, New Jersey taxpayers will still be on the hook for the stupid mistakes of their unaccountable and shameless public officials. In the future, when “public-private partnership” and “economic development” are uttered in the same breath by some official or developer, New Jerseyites should run the other way. Fast.
Private sector involvement in surface transportation infrastructure is not new. Public and private turnpikes—roads that require the payment of a toll for passage—have existed for hundreds, if not thousands, of years. In the United States, turnpikes enjoyed limited success in the 18th century into the 19th century, before being virtually eliminated at the beginning of the 20th century. Renewed interest in tolls occurred just prior to the Second World War and continued until the passage of the National Interstate and Defense Highways Act in 1956. Only in the last couple decades have toll roads again become politically palatable, with many taxpayers now preferring tolls to increases in fuel taxes as means to fund road construction and upkeep. This is important not only in terms of getting road financing right, but also because tolls are the most efficient cost recovery mechanism for private firms.
Private roads serving residential areas have also enjoyed limited historical and contemporary success in the U.S. These are typically financed and managed by local property developers and owners’ associations, many of which allow public traffic. The advantage of these private roads is that investment and use decisions are made in close consult with the affected stakeholders (i.e., adjacent property owners). Roads controlled by private developers and owners’ associations can accommodate owners’ preferences which may be at odds with one-size-fits-all government regulation, such as preferences for narrower roads and smaller building setbacks.
During the 19th century, private streets were famously constructed in St. Louis. The so-called “private-place model” was successful for several decades, until new city ordinances granted the city the exclusive right to install and maintain “sewers, sewer inlets, water mains, gas mains, underground conduits for electric wires, fire plugs, lamp posts and other conveniences.” Essentially, owners of private streets lost the ability to control their properties, and many gave up and lobbied the city to take over ownership and management. But with the recent rise of common interest housing developments (often referred to as “gated communities” or “private communities”), private streets have been making a slow comeback as an important component of the overall transportation system.
Private involvement in surface transportation was not limited to roads. Prior to the middle of the 20th century, passenger rail infrastructure in the United States—including track used for intercity service, commuter service, and urban mass transit—had been privately built, owned, and operated. New York City’s subway and commuter rail systems, Chicago’s El, and the nation’s cross-country intercity rail network were all owned and managed by private firms.
The poor state of private mass rail transit following World War II was in part a consequence of the massive economic distortions and dislocations caused by the federal government’s annexation of industry to support its war economy. However, rail transit had been losing its market share for years following the first auto-driven suburban expansion after World War I. The street car industry, for example, was in a financial death spiral long before the outbreak of World War II. Unfortunately, these inefficient and unpopular (at least in terms of ridership) transit networks were put on government-funded life support for decades—or worse, continue to limp along to this day.
Around the world and in the United States, private sector involvement in transit infrastructure has increased dramatically in recent years. While not all public-private partnerships are created equal—and those which promote private ownership of infrastructure in the long-run should certainly be preferred over those which merely lease public infrastructure to private managers—they should be seen as a step in the right direction.
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