Breaking municipal finance down to its basics
Quick: What’s the difference between financing and funding?
If you’re not sure, there’s a new resource for you. It’s the Handbook on Urban Infrastructure Finance, published this month by the New Cities Foundation. The handbook is a guide for city leaders, who increasingly find themselves at the center of complex transactions aimed at building new roads, transit lines, water systems and other urban necessities.
The handbook lays out the basics of public-sector and private-sector financing. It reviews the primary revenue streams available to local governments. And it covers some recent innovations in the field, such as “land value capture,” “crowdfunding” and the use of “green bonds.” The intended audience is leaders of mid-sized cities in the developing world.
I recently spoke with Julie Kim, the author of the handbook. Kim is a senior fellow at the New Cities Foundation and a program director at Stanford University’s Global Projects Center, where she researches business models around the use of public-private partnerships. This interview has been edited for length and clarity.
Christopher Swope: You say in the report that it’s written with the leaders of mid-sized cities in the developing world in mind. Why them?
Julie Kim: If you look at the statistics put out by McKinsey, the top 600 cities will generate 60 percent of global GDP in the next 10 years. That’s about $30 trillion. They say that 440 out of those 600, which we call the Emerging 440, come from the developing world, and most of those 440 are currently mid-sized cities.
In the past for these cities, most of the infrastructure financing has come from their national governments, or state or provincial governments. Or in the developing world, a lot of it came from international financial institutions like the World Bank. At the city level, the responsibility for taking care of financing has been fairly limited. But more and more, a lot of the financing part is getting decentralized. That’s happened in advanced economies and it is happening in the emerging world as well.
The idea was to provide some kind of guidebook so that we actually give some more knowledge and more expertise and help them to build their own capacity in terms of infrastructure financing.
I go to these conferences where infrastructure financing is a major issue. And I often find that people talk past each other. There are people from the investment community looking for investment opportunities, and there are public sector people from cities and state governments looking for funding. But they have a very different knowledge base and a different set of challenges.
Q: Why is that? Where does this disconnect come from?
A: There is an overabundance of capital right now in the marketplace, and a lot of investors are really interested in infrastructure assets. So that’s one side of the equation.
On the demand side, a lot of public sector people are very encouraged by this and come in thinking they’ll raise free money. But ultimately, somebody has to pay for all of this.
That’s when you get into financing versus funding. Typically, infrastructure requires very high upfront costs — that’s where the financing comes in. But over the long run, that financing has to be paid with revenue or a funding stream. And that’s the challenge: Where do they actually get those funding and revenue streams, beyond the grants and subsidies and transfers from central government?
Q: Could you clarify this point? It’s a major theme in the handbook — what’s the difference between financing and funding?
A: Let me give you an example. If you have a mortgage on your home, that’s financing. The banks, the lenders, all of that is the financing side.
But ultimately people are not going to lend you money unless you have some income stream plus some down payment. That’s the funding side. And you have to have a certain creditworthiness.
Q: You say in the handbook that there’s a global gap in infrastructure spending of $57 to $67 trillion. What kind of infrastructure are we talking about and why is that number so huge?
A: Infrastructure has many different sectors. There’s infrastructure the public sector is responsible for, like transportation — roads, bridges, tunnels, parking, public transit, airports and seaports. The public sector is also largely responsible for water supply and water treatment, sewage and solid-waste treatment.
Then there’s what we call social infrastructure. These are the things where there’s no way of actually charging users. They include things like schools, education facilities, public health care facilities, prisons, civic and cultural buildings and things like that.
Then there are areas where infrastructure is often privatized, such as the distribution of power and electricity, and telecommunications. And things like oil and gas — refineries, extraction, storage and distribution.
When I say that there’s a disconnect in the conversation, these definitions are part of it. How the investment community looks at infrastructure is very different from how the public sector looks at it because a lot of the investment community is really focused on power, electricity and telecommunications.
Q: And why is the need so high?
A: One part is that right now roughly 1 million people are moving from rural areas to cities every week. There’s a great deal of urbanization going on, and this urbanization cannot happen in vacuum.
To satisfy the new demand and growth, cities need to provide new infrastructure. In the $57 trillion, all of that new demand is included.
On top of that, if you look at the U. S. and other more advanced economies, often people focus on building new infrastructure, but they neglect the operations and maintenance. It’s just kicking the can down the road. There’s a tremendous amount of deferred maintenance that can no longer be deferred anymore.
Q: In the book, you go through a lot of different financial strategies, from bonds to public private partnerships to boosting local government sources of revenue. If I am the mayor or leader of one of these emerging mid-sized cities and I’m looking at this gap, what’s the first thing I should do?
A: There’s no simple answer there. If you look at the U. S., municipal governments are fairly self-sufficient. The reason is there’s this very large municipal bond market.
That market is not that developed in other parts of the world. You have to overcome some of the national-local dynamics there because sometimes there is a power struggle. In order to issue municipal bonds, the cities need a revenue source. They need to have some localized taxing authority that will enable them to collect revenues, and that’s something that has to be granted by the national government.
So they need to work very closely with their national government on the one hand. And then the national government has to understand that urbanization will happen. They have to have an integrated urbanization plan and really work together with the cities. One area to look at is creating property tax authority, and then perhaps using something like muni bonds.
Q: What are some innovations in local financing you’ve identified?
A: There is a concept called a local government financing authority or LGFA. This has been quite successful in Scandinavian countries. Oftentimes individual cities do not have the weight to go out in the global market to raise financing. In this particular area, multiple cities came together and they formed a special purpose vehicle so that they collectively go out to get the financing together and they establish credit ratings together.
That has worked quite well in Finland and Sweden and other places. This might work in the developing world, if multiple cities can come together, working together with their national government to perhaps establish a joint credit rating and a collective borrowing capacity.
If you look beyond the very large infrastructure projects, a lot of cities are looking at smaller projects such as bike lanes or urban parks. For something like this, more cities are looking at crowdfunding and “mini-bonds.” Denver did this successfully to build bike lanes.
On the investor side, another idea that I present in the paper is how do we engage institutional investors — pension funds, sovereign funds, insurance companies — more effectively. One of the problems is that if you involve too many layers of fund managers, it ends up really increasing the financing cost. If you can actually do a more direct deal with pension funds and other institutional investors, you can reduce the cost substantially. For example, in Australia, a lot of pension funds have been involved very integrally with major public infrastructure projects.
Q: In some countries, there’s a lot of political tension between the national and local governments around these issues. Is that an elephant in the room?
A: The smaller the country, the more the national-local dichotomy can become quite politically sensitive. Senegal is one example, [where the the city of Dakar last year tried to sell a municipal bond but was blocked from doing so by the national government.]
If you look at the Emerging 440, a lot of the cities are in China and India. China has a centralized economy and they actually work very closely with local governments in terms of long-term planning. India is too, more and more.
Oftentimes, countries have national infrastructure plans that include where all the urbanization will occur. There has to be very close coordination and integration between those national plans and the development occurring in the major cities.
Surprisingly, many cities and state and national governments, they define infrastructure needs on a project-by-project basis. They don’t have an integrated national plan or integrated regional plan. One thing that’s very important is that they need to sit down and really figure out what the demand level will be and what kind of infrastructure they will need and how you actually phase it and how do you finance it.
Q: Is there anything that came up in your research that surprised you?
A: Just focusing on the Emerging 440 was something. When you think about urbanization the first thing that comes to your mind is megacities. But when we got into this, it became clear that it was essentially the mid-sized cities in the developing world that need the most help.
Another thing that I realized is that there are plenty of policy papers from development banks and academia. But what the developing countries and cities need is not another major policy paper but getting down to the basics of understanding the concepts such as the difference between funding and financing. They need to worry about tax and revenue sources.
Also, a lot of people are talking about smart cities, and technology vendors are looking at upwards of a $3 trillion potential market for smart cities. But again, that has to come from somewhere. Somebody has to pay for it.