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The Value of Value Capture

Today we spend money on infrastructure in the hopes of creating growth. That's backwards. Infrastructure should not be a catalyst for growth but something that emerges in support of productive patterns of development. There has to be a relationship between the infrastructure we build and the value that is created.

Thanks to everyone who sent us such positive feedback regarding my appearance on Minnesota Public Radio last Friday. If you missed it, the audio from the entire show is available on the MPR website. I want to thank everyone that has supported us financially this year. Your contributions have given me the time to be able to take on more and more opportunities like that where we can spread our message to a huge audience. We're working on ways to do even more. In the meantime, I promise to keep at it as much as I can. Thank you.

Late last month I wrote about the return on investment of our highway projects (Paved with good intentions, April 30). I pointed out what is obvious to anyone who thinks it through: Even if modern transportation improvements really did create a lot of wealth, we capture too little of it to be able to continue this system as we have built it.

The example I used was a diverging diamond in Colorado, a high return investment by today's standards. The official numbers were that this $7.2 million investment would generate $157 million in wealth and prosperity. Instead of debating that -- demonstrating the fiction of such numbers is old hat for us -- we simply pointed out that $157 million in GDP growth would only return $260,000 to the federal coffers for highway projects.  Since $260,000 is substantially less than $7.2 million, repeating this great wealth generation trick, not to mention maintaining this diverging diamond, is going to be difficult.

I was really disappointed that nobody took me up on my challenge to defend the value of the overall system. I did receive a second hand rebuttal that essentially argued that my analysis was too simplistic, that I'm overlooking all of the (unidentified) second order and third order growth effects. This is what I call the "it's the system, dude" argument. Sure, we may lose money on each project that you measure, but the overall effect of the system generates more than enough wealth to keep it all going.

This is what I call the Infrastructure Cult. We have no proof for our belief that highway spending creates prosperity, we just believe it to be true. We believe it so strongly that we can easily dismiss evidence to the contrary.

I'm going to repeat my challenge: Someone demonstrate how highway funding, and American post WW II development in general, is not simply a large Ponzi scheme, where spending generates the near term illusion of wealth in exchange for massive, unfunded, long term obligations. Show us how it is making the country financially stronger. I'm dying for someone to make this case as opposed to simply spout the belief.

Today we spend money on infrastructure in the hopes of creating growth. That's backwards. Infrastructure should not be a catalyst for growth but something that emerges in support of productive patterns of development. There has to be a relationship between the infrastructure built and the value created.

Let's examine the way the railroads were constructed. Nobody is arguing that there wasn't government subsidy of the railroads. There was. The land for the tracks and the towns along it were largely given to the railroad companies. Examine that investment, however. Land the government owned was given away. (I realize we can debate whether they owned it -- they didn't -- but that is another conversation.) There was no long term taxpayer commitment. There was no ongoing expense the government incurred.

The railroad then built the tracks. Did they build them and then charge a fee (the equivalent of today's gas tax) to pay for the construction? Absolutely not. That would have been far too speculative. In order to pay for the tracks they did something simple and obvious: they developed the towns along the way. The railroads owned the land, created the railroad stop, subdivided the land around it, sold it to speculators and others looking to develop and then used that money (minus some profit margin, for sure) to build the line. In other words, they used a value capture mechanism to pay for the infrastructure.

The railroads were land developers first, railroad operators second. Once the line was built and the land at the towns sold off, they were free of the need to pay off capital expenses. That meant that the fares that the railroad collected could go directly to covering operations and maintenance (and some profit, for sure). That's a viable model.

It is also a model with direct feedback. What happened when things didn't work out, when a town failed to develop properly or when the development of new towns got out ahead of the demand. If the railroads operated like today's highway departments, if the growth slowed down, we would simply build more railroads and towns. After all, the new infrastructure creates growth, right?

Of course, that is not what happened. Many railroads went out of business, and nearly all lost money, in the Long Depression of 1870, which was at least partially caused by over speculation along the railroad lines. That is what happens in a real market system when there is malinvestment and supply runs too far ahead of demand.

What happens today is that we get an infrastructure cult, where new spending on highways is justified because of a belief that it creates growth and jobs. Add to that a perverse tax like the gas tax -- where the system gets more revenue the more inefficient and wasteful people are with their use of resources -- and the ability to deficit spend at artificially low rates, and you have a system that is long divorced from financial reality.

One other thing to note about railroads and highways... When a railroad is built, it lasts a long time without needing to be replaced and without a ton of maintenance. In financial terms, you can amortize the maintenance charges over a long, long period of time. In contrast, highways require an enormous amount of maintenance, especially up north where I live. And even with good maintenance, a highway will last about a third as long as a railroad.

So understand what we have done with the Suburban Experiment. We took an affordable, efficient and long-lasting mode of transport that was funded privately by direct value capture and direct user fees and replaced it with an expensive, inefficient and maintenance-intensive system that is funded by politicians with deficit spending and a non-correlated fee.

See why we're broke?

So how would we shift from a gimmick system to one of value capture? I don't know in total, but I would start tomorrow with the assessment process. If I ran a DOT and a local government wanted a new improvement, I would assess them and their property owners for the value that is created by that improvement. That won't cover the second and third life cycles, but it would stop a lot of stupid projects from happening. In fact, it would probably stop every project from happening, and understand why.

When you are assessing someone, you are capturing the value created by the project. Highway enhancement projects wouldn't happen today because either (a) there is not enough value created to capture, or (b) the property owners won't be willing speculate that they can recoup the cost of the assessment.

The only reason this system feels normal to us is because it is the system we know. Step back and look at it through the prism of value capture and you will see just how bizarre it is. The Infrastructure Cult is driving us into bankruptcy. It is time we adopted a Strong Towns strategy.


Starting tomorrow, we are going to run a three day series by Barett Steenrod, a graduate student at the University of Minesota's Humphrey Institute, who wrote his master's thesis on my home town of Brainerd, MN. I am a graduate of the Humphrey Institute and they had asked me to mentor Steenrod this year. I really enjoy him and have been impressed with his work, to the point where I asked him if he would share it with you. Check back tomorrow for the first of three posts. 

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Reader Comments (5)

This feels more value-added to me (than more highways)--and far more investment oriented:


May 21, 2012 | Unregistered CommenterSophia Katt

Whenever I see the "it's the system, dude" line I always hear it in James Howard Kunstler's voice, which I find very funny. It just seems like something he'd say with plenty of his trademark snarkiness.

Anyhow, the railroad example is similar to what happened with streetcars in many cities. The building or extension of many streetcar lines into what were then the suburbs, was funded in a large part by land speculators hoping to open up their land to development. It's interesting because they had to fund the initial construction of the line and usually underwrite losses for a while until the development was built out. Some small local suburban railroads were similar, whether narrow gauge steam systems or sometimes experimental steam dummy lines made to look like streetcars.

Anyway, what's interesting about this is how the transit system very quickly became decoupled from land development. In many cases those streetcar lines or commuter railroads were never even expected to make a profit, as the density of the development wouldn't be sufficient to support it. Once the developer was finished they jumped ship and left the line to flounder and die or maybe be absorbed into the larger city system. With flat fares in the city systems, the long haul suburban service was the least profitable and some of the first to be abandoned.

I guess I don't really have a point here, but it's just an interesting comparison. There seems to be elements of the more "pure" railroad model of development and the hyper-subsidized road and highway model of today mixed together, especially the privately built but then publicly maintained infrastructure. There are good examples of transit and value capture in other countries though. Some of Japan's and I think maybe also Hong Kong's biggest land developers are their railroad and subway companies. To maximize their ridership they built very large buildings at each station. I don't know if they sell off the developments after they're finished or not, but it's a very resilient, not to mention lucrative model.

May 21, 2012 | Unregistered CommenterJeffrey Jakucyk

It seems like it's been since Roman times that we've considered roads to be public services that didn't necessarily have to serve as 'value capture' devices. There have been value-capture railroads, streetcar lines, transit companies, canals, and turnpikes, but these all were arguably products of 19th century 'laissez faire' capitalism, an era in which all new innovations (including electricity generation, phone and telegraph service, and other infrastructure) were expected to start themselves up, run themselves, and pay for themselves as private or quasi-private ventures.

Since road infrastructure easily predates all that (still relatively-new) 19th century infrastructure, there's a lot of really old cultural baggage associated with them, especially the notion that roads didn't really have to sustain themselves. There was always an abstract "them" (the municipality, the state, the kingdom, etc.) that was expected to provide and maintain the roads without much regard to economic reality. Sure, in the last few years a lot of fantasies about roads have cropped up (like the notion that gas taxes pay for all of them), but I would argue that underneath all this there is still the notion that roads are a special "other" that don't have to follow the rules that all our other infrastructure traditionally had to follow to sustain itself.

May 21, 2012 | Unregistered CommenterMarc

You make a good point Marc, and I think the "emotional baggage" of sorts is definitely a big problem. There's nothing wrong with setting aside the space for roads and streets and such, though you can certainly argue that here in the US we set aside WAY too much space for them, even as far back as the 18th century. The real problem comes with the amount of extra money that has to be spent to maintain the roads for motor vehicles. Back when it was just dirt or even bricks for people and carriages, it didn't cost much in either time or materials to build and maintain. That's definitely not the case anymore.

May 21, 2012 | Unregistered CommenterJeffrey Jakucyk

Marc--I am in agreement you make a good point.

Interestingly enough, some of the first transportation-infrastructure investments in this country were "turnpikes" which were, whaddya know, PRIVATE ROADS. In many places along the east coast, through-roads still bear the name "pike", a derivation from and reminder of what was once an extensive privately-owned turnpike system.

Another major issue is that roads are culturally associated with basic access. Higher-order transportation--first turnpikes, then canals, and then railroads--was allowed to be private, but streets and roads (here I will clarify I am thinking primarily of farm roads when I say "roads" in this pre-20th-century context) actually served houses* whereas higher-order roads served intercity markets.

When you think about it, our conflation of streets and roads may well begin in this period.

The Better Roads movement of the early 20th century, too, generally promoted better access; the major early highways were really just a series of Main Streets linked up with farm roads and former turnpikes and designated as through routes with what would be considered today rather modest investment; for real intercity transportation, the railroads were far faster. The Pennsylvania Railroad, for example, maintained a 90 mph mainline west of Pittsburgh; the Milwaukee Road's Hiawathas traversed Chicago-Milwaukee-Minneapolis at 100 mph+. Railroads at that time were highly competitive on speed, and the highest-speed systems generally got the most traffic. As an example: In 1940 the 20th Century Limited did New York-Chicago in 16 hours, when a fanatic driver could expect to make the trip in, at best, a day.

Eastern states began experimenting with limited-access highways primarily during the 1930s. These roads were built to be through roads that bought travel speeds up to what engine technology allowed, but they were also supposed to be self-financing through the use of tolls. By 1955 a toll highway network linked New York and Chicago, and drive time had dropped down to 20 hours (although an overnight layover was still advisable).

It was with the onset of the Interstate and Defense Highway Act that limited-access roads suddenly became "free" and the ultimately-regressive gas-tax formula came to be how they were financed. It was also during this period that the art of safe designing for highway speeds was mastered, and also first began to be misapplied to local streets; unsurprisingly, American accident rates jumped through the roof and have remained some of the highest in the developed world for a half-century or more.
*Technically, so did turnpikes, but it does not seem anybody really cared.

May 21, 2012 | Unregistered CommenterSteve
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