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 / Spring 2007 / Issue 46(originally published by Booz & Company)


Lights! Water! Motion!

Government, in short, is best positioned to lead the initial planning stages, but deftly and selectively, with a firm but light-handed oversight role that emphasizes goals instead of means. One prerequisite is to build the capacity for local governments to act more effectively. Federal governments, rather than making decisions or providing financing, should limit their role to setting standards and drawing together expertise in a discriminating fashion. Local governments, which typically have direct jurisdiction over infrastructure projects, need to learn to set up inclusive, fair, and rational decision-making forums, open to the public and business sectors. The project process should be set up with deliberate incentives for the private sector, not just so companies can position themselves as contractors, but so they can offer their ideas and insights early in ways that can influence the entire planning process.

Sustainable Financing
The private sector should take the lead, meanwhile, in financing, pricing, and ownership. This in itself will represent a significant change in the way many infrastructure projects are developed, particularly in water and transportation. In general, the state makes a poor owner over the long term. Its financing is inefficient; the cost of capital is artificially low, which skews decision making; and the short time horizons of government bonds create few incentives to minimize costs, to seek innovation, or to prioritize.

The answer lies in deploying a new set of incentives that take advantage of the best aspects of government and business. Currently, the incentives found in most major infrastructure programs around the world nearly guarantee the approval of poorly conceived projects and cost overruns, because of the way they are designed:

  • The people most affected by a water, power, or transportation system don’t have the authority to approve its construction.
  • The people who approve it are not those who use it most.
  • The customers who use it most don’t pay most of the costs, and thus have little reason to use infrastructure resources wisely.
  • The people who pay the costs (taxpayers, those who underwrite the capital, and those displaced by its construction) don’t necessarily benefit from it.
  • Those who benefit most from maximizing its costs (developers, contractors, and particular businesses) often have too much of a voice in determining how it is organized and developed.

To overcome these problems, the most appropriate government role in financing is explicit without direct oversight management: setting up a transparent, nonpreferential financing process and then allowing capital markets to bear the risk and reap the financial reward. Allocating and syndicating risks is one of the things that the private sector does best (and most creatively). Capital markets are also hungry for this type of relatively low-risk, long-lived investment. With the establishment of basic and tested legal and financial instruments (such as securitization), infrastructure has taken off as an investment in recent years. It is particularly attractive to institutional investors because it is largely uncorrelated with other classes of financial assets available to them. And it can be profitable: Booz Allen estimates suggest that in 2006, five-year returns included 11 to 13 percent for airports, 10 to 13 percent for toll roads, 8 to 10 percent for rail passenger lines, and 10 to 14 percent for wastewater plants.

Using fees to reflect underlying costs is another critical component of a financially sustainable infrastructure sector. One way to accomplish this is through marginal pricing: charging more for “peak” service, such as rush-hour transportation or residential electricity use during early evening, when or where demand is high. Although this type of pricing is often criticized as making poor people pay more, it turns out to be the most effective way to create the kinds of feedback loops that improve cost performance and quality. And cities already have a great deal of experience using tax policies and targeted subsidies to overcome any regressive implications. Those who can’t afford to pay for electricity or water can be guaranteed a minimum amount to maintain a decent quality of life.

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  1. Alan A. Altshuler and David E. Luberoff, Mega-Projects: The Changing Politics of Urban Public Investment (Brookings Institution, 2003): American political history from Robert Moses to Boston’s Big Dig, proposing new forms of multiple accountability.
  2. H. Spencer Banzhaf and Randall P. Walsh, “Do People Vote with Their Feet? An Empirical Test of Environmental Gentrification,” Resources for the Future discussion paper 06-10, March 2006: The answer to the title’s question is yes, when the quality of life declines. PDF download.
  3. Shaila Dewan, “Cities Compete in Hipness Battle to Attract Young,” New York Times, November 25, 2006: Atlanta and Portland, Ore., are magnets, whereas Philadelphia struggles.
  4. Bent Flyvbjerg, Nils Bruzelius, and Werner Rothengatter, Megaprojects and Risk: An Anatomy of Ambition (Cambridge University Press, 2003): Skeptics document how enthusiasts negligently green-light bad projects and explain how to build in better accountability, particularly in Europe.
  5. Daniel Gabaldon, Tom Hansson, Eric Spiegel, and Joseph Van den Berg, “The Next Wave of Generation Investment,” Booz Allen Hamilton white paper, May 2006: Strategy for electric power companies to invest presciently amid the risk of gas prices, regulations, and new technologies. Adapted as “Baseload in the Balance,” Electric Perspectives, May–June 2006, and as “Betting Big on Baseload,” Electricity Journal, August 2006. PDF download.
  6. Mark Gerencser, Reggie Van Lee, and Fernando Napolitano, “The Megacommunity Manifesto,” s+b, Summer 2006: How to bring together multiple organizations to develop solutions to complex problems. Click here.
  7. Joseph Giglio, Mobility: America’s Transportation Mess and How to Fix It (Hudson Institute, 2005): Impassioned, well-reasoned plea from a financier–academic for transportation infrastructure investment.
  8. International Energy Agency, “World Energy Outlook 2004,” OECD/IEA 2004: Comprehensive forecasts of energy demand and supply. PDF download.
  9. Bill Jackson and Vikas Sehgal, “One Billion New Automobiles,” s+b, Winter 2006: One billion new cars will need at least 1,000 new roadways. Click here.
  10. Jeffrey Rothfeder, Every Drop for Sale: Our Desperate Battle over Water in a World about to Run Out (Tarcher/Putnam, 2001): Journalist’s view of the pending global crisis in water infrastructure.
  11. Lord Andrew Turnbull, “Toward a Flexible Energy Future,” s+b, Winter 2006: How governments can promote better capital investments despite imperfect information. Click here.
  12. Eric M. Weiss, “Beltway Toll Plan May Need Virginia Funds; Rising Costs Strain Private Partners,” Washington Post, October 23, 2006: Private ownership is not a panacea for infrastructure projects.
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