The battle over the future of infrastructure is fully joined in Washington. But neither the Biden administration's original $2.25 trillion plan, its revised $1.7 trillion plan, nor the Republicans' recently announced $928 billion proposal is up to the task. In various ways, the plans all seek to rebuild our infrastructure. But all the proposals are entirely reliant on conventional public funding. The administration calls for a corporate tax. The GOP has not so far specified funding mechanisms, but their plan will reportedly rely on redirected coronavirus relief funds and existing tax revenues, such as the federal gasoline tax. None of these mechanisms is even remotely adequate.
Make no mistake: There is nothing wrong with taxation as a means of funding public expenditures. But taxes are politically challenging, as is the other public funding mechanism, deficit financing. If we are truly going to create a 21st century infrastructure and revitalize American productivity for decades to come, then alternatives need to be on the table — from the private sector in particular. And pension funds should be at the top of the list.
Why turn to pension funds? The proposed expenditures — even the GOP's $928 billion, which is the smallest of the lot — sound enormous. But they are not. To put the infrastructure challenge in perspective — the American Society of Civil Engineers has called for $2.59 trillion in infrastructure spending just to bring our existing infrastructure into a state of adequate repair — without starting new projects. The ASCE's 2021 Infrastructure Report Card quantifies the consequences of this investment shortfall — a cost of $10 trillion in GDP and more than 3 million jobs by 2039, and $2.24 trillion in exports over the next 20 years. ASCE recommends an infrastructure funding increase of 1 percentage point from 2.5% to 3.5% of U.S. GDP from all sources by 2025.
Where are those funds to come from? Public and private-sector pension funds are a ready source of capital. U.S. pension funds had more than $18 trillion in assets under management at the end of 2019, according to the Organization for Economic Cooperation and Development. While pension funds do currently invest some of those assets in infrastructure, what the situation demands is large-scale direct investment in infrastructure projects, perhaps with the support of a newly created infrastructure bank. This approach promises to bring hundreds of billions of dollars to bear on infrastructure development — including in such areas as renewable energy infrastructure, which promises robust job creation and high growth. The Biden plan includes a major push toward such renewable energy projects as solar and wind power, where pension funds can play a leading role. In addition, pension funds can invest in energy transition, which will also help accelerate the U.S. toward sustainable economic growth.
Direct exposure to these opportunities — and to infrastructure in general — will greatly benefit pension funds and the retirees they serve. Infrastructure projects are highly predictable — power transmission and distribution grids, toll roads, bridges and airports have stable, well-studied cash flows that are maintained over the decades-long life of the investment.
Direct investments will also help address pension fund shortfalls. The Equable Institute, a bipartisan nonprofit that provides data and analysis on public pension funds, reported in August 2020 that the national funding shortfall for state retirement systems was $1.35 trillion at the end of 2019 and projected it would rise to $1.6 trillion by the end of 2020. Near-zero interest rates on fixed-income securities compound the problem. As long as these types of direct infrastructure investments generate returns that are 3% to 4% over inflation, they can provide attractive risk-adjusted returns over a long period for those pension funds that need to match their long-term liabilities and help bridge the deficit gap.
But U.S. pension funds are under-allocating to infrastructure compared with their Canadian or Australian peers, for example. According to Preqin, total investments allocated to infrastructure by U.S. pension funds that disclose their allocation were $68 billion, which represented 1.1% of their total AUM. In contrast, Australian superannuation funds allocate 7% and Canadian pension funds allocate the highest percentage to infrastructure, 8.4% of AUM.
Why are U.S. pension funds so far behind in deploying infrastructure investments? The paradox is that most U.S. pension funds would love to invest in infrastructure, but there are too few projects. How is our infrastructure crumbling, yet we have no projects? The challenge is that U.S. infrastructure projects are managed by a complex set of federal and state entities. For example, 95% of public highways and bridges are owned by local and states governments. There are 50 states and more than 80,000 local authorities that manage these assets. A pension fund cannot practically approach each of these entities to identify attractive projects.
To overcome this, we need to introduce not just "public-private partnerships" but also "public-public partnership" between state and local authorities and U.S. pension funds, similar to what Canadian pension funds did with many cities in Canada. These partnerships will allow funds to invest directly in these projects under long-term concession agreements that benefit all parties. States and municipalities benefit because infrastructure projects require long-term planning as well as assessment of economic, environmental and social concerns. Public-public partnerships provide state and local authorities with steady, long-term funding, in contrast to federal or state funding that is subject to appropriation cycles and generally focuses only on shovel-ready projects.
To make this possible, innovation is needed. A proposal would be to create a public infrastructure bank — an infrastructure trust or "infratrust" for short — established under the same statutes as government-sponsored enterprises, such as the Federal Mortgage National Association, know as Fannie Mae, that could act as a major clearinghouse for infrastructure projects. It can provide all the support needed to devise infrastructure projects as well as participate in the funding of these projects alongside pension funds. The infrastructure bank could also invest funds from other public-public and public-private sources, including from overseas pension funds, overseas sovereign wealth funds and perhaps even such novel instruments as dedicated infrastructure IRAs. Innovation must also be brought to bear on behalf of state and local authorities, which may need technical assistance to develop and devise appropriate funding mechanisms and then offer those projects to U.S. pension funds. The infrastructure bank could provide this type of technical assistance in developing criteria for public-public partnership projects.
The fundamental point is this: With the right vehicles, U.S. pension funds can invest directly in infrastructure and allocate a greater percentage than the 1.1% currently allocated. If they increased their allocation to 5% for example, thanks to the approaches described, the amount of available investment could increase to $300 billion. And this is a win for everyone: state pension funds gain needed exposure to strong long-term returns, while bringing scrutiny and discipline to the infrastructure planning process. Retirees gain enhanced retirement security and take pride in knowing that their contributions are rebuilding our infrastructure — underwriting modern roads, airports and power systems. State and local authorities have the certainty of long-term funding and the support of a reliable partner. The result is an infrastructure funding system that works. Our infrastructure needs all the investment help it can get. Pension funds — a largely untapped resource — are a logical place to start.
Sadek Wahba is a senior fellow at the Development Research Institute at New York University. He is also chairman and managing partner of I Squared Capital, a global infrastructure investment company. He is based in Miami. This content represents the views of the author. It was submitted and edited under P&I guidelines but is not a product of P&I's editorial team.
