A few weeks ago I finished the book Catastrophic Care: Why Everything We Think We Know about Health Care is Wrong by David Goldhill. In 400 pages he shed more light for me on our health care system than the hundreds of hours I've spent informing myself about health care policy. In fact, the book was so illuminating, after reading it I felt dumb for having previously wasted so much time. If nothing in our health care conversation today makes sense to you and you wish it did, you have to read this book.

One of Goldhill's key devices is to place the language and values of the health care industry on a metaphorical island. He constantly talks about life "on the island" and "on the mainland." For example, on the island, nobody ever talks about prices, they only talk about costs. This is not a subtle nuance. Prices, of course, are related to costs but, in a true competitive marketplace -- one where people, not a third party, actually pay directly for the goods and services they consume -- we never talk in terms of costs. Only prices.

Does it really matter to you how much it costs the grocery store to provide that twelve pack of your favorite beverage? Of course not. It's only matters to you -- someone living on the mainland -- what the price is to you. Price is how you determine your preferences among competing items. Profit is how the market receives feedback on those preferences. High prices invite substitution. High profits invite competitors. This is all basic and obvious to us on the mainland.

Which is why, on the healthcare island, the conversation is about costs. Your preferences don't matter, except where they are aligned with the objectives of those on the island. Substitution doesn't matter; there are no competing services. Obscene profit margins don't invite competitors; they invite consolidation. Justifying costs to third party payers, instead of prices to patrons, is the name of the game. It's a bizarre world that doesn't make any sense to people like Goldhill when they take a critical look at it.

Last week, Bloomberg's Noah Smith wrote an article titled "The U.S. Has Forgotten How To Do Infrastructure" that asked a lot of questions that would get us to a Goldhill like analysis of our infrastructure approach. Just like on Healthcare Island, on Infrastructure Island we have our own way of talking about things. And we never talk about prices, only about costs. And as Smith suggests, costs go up and nobody seems to understand why. 

He goes through and dismisses all of the usual suspects. Union wages drive up infrastructure costs (yet not true in countries paying equivalent wages). It's expensive to acquire land in the property-rights-obsessed United States (yet countries with weaker eminent domain laws have cheaper land acquisition costs). America's too spread out or our cities are too dense (arguments that cancel each other out). Our environmental review processes are too extensive (yet other advanced countries do extensive environmental reviews with far less delay). I concur with all these points, by the way.

Smith concludes with this:

That suggests that U.S. costs are high due to general inefficiency -- inefficient project management, an inefficient government contracting process, and inefficient regulation. It suggests that construction, like health care or asset management or education, is an area where Americans have simply ponied up more and more cash over the years while ignoring the fact that they were getting less and less for their money. To fix the problems choking U.S. construction, reformers are going to have to go through the system and rip out the inefficiencies root and branch.
Our infrastructure incentives are all wrong. Until we fix them — until we go through the system and rip out the inefficiencies root and branch — throwing more money at this system is simply pouring good money after bad.

Much like health care, our infrastructure incentives are all wrong. Until we fix them -- until we go through the system and rip out the inefficiencies root and branch -- throwing more money at this system is simply pouring good money after bad. Let me provide some examples.

The more lane miles a state has, the more federal transportation dollars that state qualifies for. What is the incentive? It is, of course, to build more lane miles. Add to this the fact that federal transportation programs generally pay 90%+ for new construction, but only ~50% for maintenance, and we have a system that encourages states to build more than they can ever maintain.

That's okay. When we put together our appropriation request, is it better to show a catastrophic level of need or is it better to prudently ask for only what is absolutely necessary? It's an altogether silly question; the more desperate we can make ourselves and the more miserable we can make taxpayers, the more they will demand that governments pay more for infrastructure.

In the United States, many engineering contracts -- and if not the contracts, at least the cost estimates -- are based on a percentage of construction costs. Imagine getting your car's oil changed and the industry-wide cost for the labor was a percentage of the oil cost. As you can well imagine, the price of oil for cars would skyrocket, one way or another (we can imagine a specialty line of oil exclusive to cars). The bigger the project, the more everyone involved gets paid. Thus: big, expensive projects.

In addition, the longer the project takes, the more everyone gets paid. Change orders -- because of weather, redesign, special requests, etc... -- often add to project costs and, even when they don't, take time ($$) to administer. Once a government commits to a project, they are committing to an open checkbook. That check will be written in a system where nearly everyone involved will be compensated more the longer the project takes and the more expensive it becomes.

That check will be written in a system where nearly everyone involved will be compensated more the longer the project takes and the more expensive it becomes.

Back when I did engineering work, I worked on two separate contracts for very similar projects at roughly the same time. Project A was for a city, while Project B was being paid for by a developer. For Project A, we signed a lump sum contract with the city to do the study and design and then an hourly billing schedule for inspection. For Project B, we had an hourly agreement with the developer to provide the same services. Guess who paid less in the end (and it wasn't even close).

At times, the developer was in my office twice a day getting updates, checking on progress and overseeing my work. My engineering was a huge expense for him. When he got my bill, he demanded hourly itemization and scrutinized the entire thing, refusing to pay when he thought things shouldn't have taken as long as they did. It was a pain and I remember being annoyed, but I also remember it got done quickly and for a tiny fraction -- my admittedly faulty memory is telling me 1/3 the cost -- of what a very similar project cost the public client.

In Minnesota where I live, public contracts are required to always take the lowest bid price. This creates incentives for all kinds of shenanigans. I worked on one state paving project where the low bidder bid most every item far below cost except for bituminous, where they were the highest price by many multiples. The strategy for executing the contract was then clear: Do the least amount necessary to fulfill the contract agreement and overrun the bituminous as much as possible. An extra 1/8 of one inch of pavement over a 40 mile project -- an amount hardly perceptible -- caused a massive cost overrun.

I could go on, but here's the crazy thing: On Infrastructure Island, this all makes sense. Nobody there is really unethical, it's just that the incentives have perverted what, in other realms, would be seen as normal and acceptable. Make the project big. Make it take a long time. Create a lot of overruns. Don't maintain it until it falls apart catastrophically. Few on Infrastructure Island set out to do these things, but they happen and nobody loses a lot of sleep over it. That's because, for the players involved, there is little negative feedback and lots of positive feedback associated with these perverse outcomes.

I think it would be easy to say at this point that the only way to deal with this is a purely libertarian approach; privatize it all and make people pay to use it. I don't think things are that easy and I would not recommend that approach for a variety of reasons. 

We need to find every opportunity to localize infrastructure spending and funding. Instead of giving cities money, we need to give them many more tools for raising their funds locally.

Here's what I do recommend. First, I think we need to find every opportunity to localize infrastructure spending and funding. Instead of giving cities money, we need to give them many more tools for raising their funds locally. I'd take little off the table. Cities have far more incentives than other levels of government to put money to work prudently, especially when they must confront their own constituents who are directly paying the bill. Cities should be spending more money on data analysis than on lobbyists, more money on figuring out what works than where they get more money. (Note: I'd reduce state and federal taxes along with this to make it, at least initially, revenue neutral.) Not to get political, but President Trump's infrastructure plan -- which is sure to have at least some bipartisan support -- is almost certain to be an epic disaster of bad incentives.

Second, the only tool I would take off the table -- or at least constrain -- is debt. Cities should have the ability to take on cash flow take and make strategic investments with debt, but they should not be able to live beyond their means today -- intentionally or not -- at the expense of future generations. I'd cap municipal debt service at 5% of locally-generated revenue with the ability to go up to 10% with approval of voters. No city should have the capacity to blow themselves up financially.

Third, I'd encourage all cities to adopt infrastructure funding mechanisms that provide the most direct feedback. A sales tax to pay for roads is popular for the same reasons it is destructive: because it's indirect and results in an unfocused slush fund. Tolls, maintenance districts and direct user fees are less popular but actually more empowering for people in that it allows them to speak their preferences more forcefully and clearly.

Finally, while I wouldn't privatize infrastructure, I would push for more contracts that are design/build/warranty instead of splitting those into two separate but colluding contracts -- design and build -- with the taxpayers getting struck with the long term warranty. If we can align the incentives of the players involved, we can build infrastructure that is actually necessary, and while doing it quicker and at lower prices than we do now.

(Top photo courtesy of the State of North Dakota.)


You may also be interested in...