President Joe Biden is working hard to pass a massive infrastructure package of roughly US$2.2 trillion through the United States Congress. Regardless of the political motivation behind this initiative, this move highlights the need for infrastructure development in the US. It can also be seen as a response to the narrative that the US has lacked recent funding for infrastructure relative to other developed and developing countries.
In particular, China has been very aggressive on the infrastructure front. While the joint high-speed rail (HSR) project between Singapore and Malaysia had recently fallen through, China has developed the world’s largest HSR network over the last two decades, accounting for more than half of the world’s total length of HSR tracks. This transportation network has grown by over 25,000 km over just the last decade, with ambitious plans to increase the coverage by more than 50 per cent over the next decade.
Who benefits, and who pays?
Funding this and other types of infrastructure developments is typically done by the government, as infrastructure works are typically seen as public goods, which benefit a large portion of the society and yet are not economically viable for private sector funding.
Indeed, President Biden’s plan largely hinges on increasing the US government’s balance sheet via a substantial increase in corporate taxation rates. Increasing taxes is always difficult with voters, and the opposition to his plan partially hinges on this important consideration.
With the pandemic-induced economic shrinkage, paying for infrastructure expenditures whose benefits will be enjoyed by future generations is unlikely to be popular with the current generation of voters and politicians.
But this opposition is not limited to downturns. Even during good times – the US economy has grown almost uninterruptedly since World War II – politicians and voters tend to allocate less than what is necessary to maintain and improve existing infrastructure network and facilities.
Infrastructure bonds bridge the transfer
In response to this reluctance to inter-generational transfer, governments and other public entities have actively participated in infrastructure bonds. In so doing, the balance sheet of the public sector can be increased without the commensurate, immediate increase in taxpayers’ burden. We can view Singapore’s recently announced SGS (Infrastructure) bonds from this lens.
Infrastructure bonds are particularly useful for infrastructure projects whose cash flows will be quite stable, to support the interest payments in the future. In this context, infrastructure bonds can be seen as an efficient way to perform inter-generational transfers, where future users of infrastructure projects provide the guarantee for future payments to bondholders.
If the cash flows fall short of the required interest payments, the issuing government may have to increase the tax rates for future taxpayers to pay for the shortfall.
Choosing the projects to fund
Asking future taxpayers to shoulder the additional burden seems reasonable to the extent that they benefit from the infrastructure project. However, situations where the infrastructure project’s cash flows are insufficient for interest payments may coincide with the project having low benefit for its intended users.
If the proposed MRT projects funded using SGS (Infrastructure) bonds end up with low ridership figures after completion, the projects would produce insufficient cash flows to pay the interests and provide minimal benefits to the intended users: future generations of Singaporeans. This potential negative scenario highlights the importance of choosing carefully which projects to fund with infrastructure bonds.
Having an efficient bond capital market is useful in reducing potential government waste in this context. Potential bondholders pay close attention to this type of issues and may shun bond issuances that are likely to run into potential shortfalls.
Of course, governments issuing domestic-denominated infrastructure bonds can also print more money to pay the interests accrued to bondholders, eliminating the possibility of technical default. However, this will still hurt bondholders since the resulting payments will be less valuable due to the corresponding inflation and currency reduction.
Potential bondholders will shun the albatrosses
This issue will be exacerbated for foreign-denominated infrastructure bonds. As a result, potential bondholders will be very sensitive to the likelihood of infrastructure projects becoming albatrosses hanging around the issuing government’s neck.
It is therefore plausible that bond market participants, driven by their concerns regarding future payoffs, are more sensitive to potential albatrosses than politicians who want to gain voters’ adulations. This framework will force governments to be more disciplined in choosing which infrastructure projects to fund.
The bond market will be particularly sensitive to risky, strategic infrastructure projects. Since bondholders do not benefit from the potential upside of these projects, they may be reticent to finance infrastructure bonds issued with these objectives.
Relying solely on infrastructure bonds will result in under-investment in such projects. Governments therefore will have to make the difficult decision of identifying strategic – but risky – projects that must be funded by taxation, either directly by increasing tax rates or indirectly by introducing or increasing usage fees.
If these strategic projects end up being successful, future generations will benefit from lower tax rates, higher quality of life, or both.