Privatizing public assets

The debate over privatization of Lambert International Airport, a public asset, is just beginning. This local debate will most likely foreshadow a forthcoming national debate over Donald Trump’s infrastructure plan; a topic which will likely play a role in the 2020 presidential campaign if not sooner in the midterm elections.

First, let me catch you up on the local debate: We have been accepted into the FAA’s Airport Privatization Pilot Program. This program allows the City of St. Louis to lease out Lambert International to a private company. While the city would maintain ownership of the airport, a private corporation would pay us a lot of money to take over control of the airport and the revenues earned by it.

Just how much money?

Puerto Rico leased out Luis Muñoz Marín International Airport to Aerostar Airport Holdings (owned 60% by a massive Mexican airport operations company called Grupo Aeroportuaria del Sureste). LMM is similar in size to Lambert, serving about 9 million passengers a year compared to Lambert’s 13 million per year.

In exchange, Puerto Rico was paid $615 million up front for a 40 year lease. The first 5 years of the deal, they received an additional $2.5 million annually. The next 25 years, they will receive 5% of gross revenues and, for the last 10 years, they will receive 10% of gross.

Aerostar also agreed to a $1.2 billion capital plan in remodeling and renovating the airport.

It seems too good to be true, but apparently Aerostar believes it can garner a profit despite the high initial investment.

Privately managed airports are arguably more efficient and more responsive to passenger needs than publicly managed airports. Theoretically, a private company would have greater access to capital than the city and would be in a better financial and managerial position to make improvements. The hope is that, in private hands, Lambert International might be transformed into a globally competitive airport. It could be a good deal for the city.

The opposing side views this as a cash grab by moneyed interests coming at a time when the Airport is already financially stable and steadily improving. The city is currently grandfathered into an agreement with the FAA which allows us to earn 5% of the airport’s gross revenues annually (normally, airport revenues have to be reinvested back into the airport, as per FAA regulations). This amounts to about $6.5 million per year. In addition, the city has recently refinanced some airport funding bonds for a better interest rate which will hopefully allow us to lower landing fees and increase Lambert’s competitiveness without needing to privatize.

The Board of Estimate and Apportionment (consisting of Lyda Krewson, Lewis Reed, and Darlene Green) has chosen a group of 3 companies to be their advisory team:  Moelis & Company, McKenna & Associates, and Grow Missouri. This team of advisors will only be paid if a deal is finalized, prompting concern that they are biased from the start due to a financial incentive to close a deal… any deal. Adding fuel to the fire, Grow Missouri is funded by Rex Sinquefield, a billionaire libertarian political donor distrusted by many progressive aldermen. Half of the BOA has called upon Krewson to fire Grow Missouri as an advisor. She probably won’t.

That’s pretty much where we stand as I write this article in early February 2018.

This is undoubtedly a big decision for the city, but let’s hold that thought for a few minutes and talk about the bigger picture.

The reason this is important nationally is because this potential airport deal is an example of a public-private partnership, or, a P3. Donald Trump’s infrastructure plan heavily subsidizes the “private” part of public-private partnerships over more traditional means of infrastructure funding. It will very likely trigger a shift of utilities and infrastructure from public control to private. If this is done haphazardly, it will have negative repercussions which could very well last for decades.

Typically, in order to fund infrastructure improvements, a municipality will issue tax exempt bonds. These are bonds on which investors, usually institutional investors like pension funds and mutual funds, do not have to pay taxes on interest. This allows them to make more money on bonds with lower interest rates, which ultimately saves money for the municipality. This is how the St. Louis region has partially or fully funded many of its utilities up until today such as the water division, the airport, MSD, and MODOT, just to name a few. These bonds are typically paid back through service fees charged by the utility or through other strategies such as the bonding authority directly paying them off with tax revenue.   This funding strategy allows the municipality to retain managerial control of the asset along with transparency of operations, finances, and the data collected on customers.

Private enterprises are at a distinct disadvantage when it comes to investing in public assets like roads, water divisions, or electrical grids because they typically cannot issue the same tax exempt bonds and are otherwise limited in their abilities to apply for grants. Infrastructure investments are long term and unpredictable which makes this sort of investment very risky.

Trump’s plan aims to change that. The Trump Infrastructure Plan wants to incentivize private companies to invest in the nation’s infrastructure. In order to make it worth their while, he will issue tax credits of 82%. These tax breaks will alleviate some of that risk and make infrastructure investment more profitable for private enterprises.

At first glance, it doesn’t seem unreasonable. Privatization has the benefit of market forces. We, as consumers, are better off when an organization is competing with other organizations over our business. A company is incentivized to innovate and reduce redundancies in order to keep prices and quality of service comparable or better than the competing entities. Japan’s fantastic rail system is private. 34 of the top 100 airports in the world are privately owned. Canada’s Air Traffic Control System is privatized. It can work.

But the problem with public utility privatization is that some services don’t function well as markets. Infrastructure such as underground plumbing or the electrical grid form natural monopolies. Building a competing network requires a massive investment whereas the cost of adding onto an existing network is relatively low. This imbalance presents a barrier to entry which drives out competition. Without competition, a company would have very little incentive to innovate or keep prices low. Natural monopolies are, by necessity, heavily regulated, typically by state or local public utility commissions (PUCs).

Due to the lack of competition, it is not surprising that private water utilities have NOT been shown to be any more efficient than public water utilitities. When a private company takes over a natural monopoly, the only barrier to increasing profits is the local PUC. Unfortunately, local government officials are often outgunned by savvy corporate negotiators with greater skill and expertise

Take, for example, the purchase of Coatesville, PA’s water utility by PAWC, a subsidiary of American Water. Oversight by Coatesville’s regulatory authority quickly broke down when the city naively chose a former PAWC employee as their city manager. PAWC was then able to convince Coatesville’s PUC to allow a rate increase of 216%. Rates topped $200 per month in some of the town’s poorest neighborhoods.

A similar situation occurred with Chicago’s Parking Meter Fund. Money earned through the deal was spent ineffectively while the private company jacked up parking prices.

It’s tempting to place blame on incompetent local governments rather than privatization. But take into consideration that privatizing a natural monopoly sets up a situation where extremely wealthy profit driven entities have an incentive to employ their best negotiators, financiers, lawyers, and businessmen to whittle away at the regulatory barriers upheld by public servants making $40k a year in small towns across America. You are inviting a fox into the hen house. It is a recipe for disaster.

When regulation breaks down, profit driven private companies are only motivated to improve infrastructure and customer service for customers who can afford to pay. This leads to situations where poor communities do not have the same access to water and electricity. There is also no incentive to conserve water or power. A community which uses more water means the company is selling more water.  And that means more profit for the company and its shareholders. Just ask California about how privately controlled water has worked out for them.

There are bad examples everywhere you look. The austerity wave in Europe during the financial crisis led to a wide scale movement towards the privatization of public utilities. This has ended up being a bad deal for most countries, leading to issues such as corruption, crony capitalism, and unfulfilled promises of efficiency. A similar case can be made for the United States.

Despite these realities, local governments often fall prey to short term thinking. If you are a politician in a poor city with a crumbling water infrastructure, it is far easier to convince your electorate to accept millions of dollars, CASH, in exchange for handing off the problem to a private company than it is to convince them to pay more in taxes to fix the problem themselves. It’s not hard for well-oiled corporate machines to make promises of cheaper labor, cheaper procurement of material, and better management when these assumptions cannot be proven true or false until many years later. Heavily outgunned public servants often fall prey to bad deals like non-compete clauses or renegotiations which heavily favor company shareholders over the good of the community.

In reality, privatization is often not the best financial decision. Any money a private enterprise invests into infrastructure improvement needs to be recuperated somehow. They just rely on fees and service charges instead of taxes. This source argues that any money made through the sale of a public utility, after taking into consideration the inevitable rate increases, is equivalent to taking out a loan at 11%. On top of it all, let’s not discount the possibility of incompetence on part of the private company. Take for example Texas State Highway 130. The company overestimated the amount of money it would make from a toll road and ended up going bankrupt and unable to uphold its end of the bargain, leaving Texas taxpayers holding the bag.

Not only is privatization a bad financial deal, but it requires that we give up public control of the utility. We are giving up transparency of operations, transparency of finances, and the right to know what data is being collected on us. We are also accepting less control over labor standards. My father was a Union Heavy Equipment Operator (Local 513) throughout the ’90s and ’00s. That job beat the hell out of his body. He recently had to undergo a spinal surgery (fusion of some of his cervical vertebrae), and as a kid I remember seeing him come home exhausted every day after work. Say what you will about unions, but if it wasn’t for collective bargaining he wouldn’t have made a living wage,  and would not have a pension to fall back on today. My family owes a lot to Local 513.

Is the community really saving any money if it comes at the expense of our workers? Is the discount labor worth a generation of broken down middle aged men with no savings, health insurance, or retirement funds? That’s a tragedy all on its own. The debate over unions is not clear cut, but if we’re going to be investing into our infrastructure, we should consider workers as part of that deal.

Believe it our not, I’m not entirely against privatization. Putting natural monopolies (our pipes, electrical grid, and sewage systems) into the hands of private companies is a recipe for disaster. But I do think it’s possible to utilize market forces for certain aspects of public utilities while maintaining equity, control, and transparency. Take for example electric utilities in Singapore, a thriving city-state which ranks number two on the Heritage Foundation’s Index of Economic Freedom.

In Singapore, electricity generation, transmission, distribution, and retail are all separate. Market forces allow multiple electricity companies to compete over the generation of electricity or retail services while a single, heavily regulated company handles the distribution (Singapore can get away with privatizing their electrical grid because they are a single wealthy city state rather than a poor Midwestern city).

Compare the model in Singapore to the vertically integrated Ameren MO which we have here in St. Louis. Ameren generates the electricity, distributes, and sells it to the consumers. They have a government granted monopoly which has its rates capped and regulated by the State.  As to be expected, the regulatory authority has to compete with Ameren’s profit motive. Some states have experimented with deregulating their electricity rates, allowing competition among retail suppliers to determine the prices. It appears that those states end up paying more for electricity than regulated states and many of them have converted back to regulated systems.

In fact, the US is taking advantage of market forces where applicable. A nationally regulated wholesale electricity market exists which allows electricity generators and transmission systems to compete for business. But local power grids are still regulated by local government. I’m not against experimenting with privatizing certain aspects of our electric utilities, but the grid is off limits.

Back to the airport. Should we privatize Lambert?

Lambert International Airport is not a natural monopoly. It has to compete with other airports over the business of airline companies. I mentioned at the beginning of this article that private airports have been shown to be more efficient and responsive to passenger needs, and that is thanks to competition. The FAA would regulate the process and put caps on how high fees may be raised, so that should protect us from the potential downside of a company hiking up fees and driving the airport into the ground for a profit.

At the same time, I am very skeptical of the team of advisors chosen to guide our city through this process. After seeing how easily the Kiel Group squirmed its way out of a previously agreed upon deal over the Scottrade Center I question whether our current government officials are capable of going toe to toe with the highly skilled and practiced negotiators of a multi-million dollar corporation.

The next couple of years promise to be interesting. As citizens, we should all be educating ourselves on the pros and cons of public private partnerships because there are going to be a lot more coming down the shoot. We cannot fall victim to short term thinking.  Our future is at stake.