Mark Beyer’s online opinion article ‘Is this prudent use of taxpayers’ money?’ (Business News, March 16 2022) asks a critical question about the relationship between the public and private sector economies.
In essence, how can we justify public funding of projects in the mining sector, or any large-scale infrastructure projects, when there are substantial pools of private capital ready and willing to be deployed?
After all, Australia’s superannuation savings pool stood at $3.4 trillion (Association of Superannuation Funds of Australia).
And as Beyer notes, several of the projects supported by federal government funding are backed by individuals who are very wealthy.
As someone who has always conceived of a smaller, rather than larger, role for government, this is an issue I considered seriously before joining the inaugural board of the Northern Australian Infrastructure Facility (NAIF) in 2016; at the time a $5 billion concessional loan financier for the development of regional infrastructure.
Government spending to achieve public benefit outcomes is, of course, not unusual. Indeed, it is a foundational principle of representative government.
Likewise, government investment in the development of large-scale infrastructure is commonplace, albeit in recent decades the trend has been away from direct funding and towards implementation of policy settings designed to limit merchant or market risks and thereby ‘crowd in’ private sector investment.
What drew me to NAIF, then, was the idea of leveraging the federal government’s balance sheet (rather than its profit and loss) to ‘crowd in’ private sector investment to projects that created public benefit outcomes in the north – a neglected but strategically important region of Australia – including employment growth and enhanced opportunities for the indigenous population.
In effect, NAIF was designed to de-risk the investment thesis for private capital by adopting a first-loss position in the debt structure or offering interest rate concessions (admittedly not a huge benefit in a low-rate environment) or tenor that private markets would not entertain.
A core element of the NAIF design was that the funded project be of ‘public benefit’.
Unlike private financiers, who are restricted to the cash flows of the project or its sponsor, NAIF is effectively able to bring the value of public benefit generated by a project outside the proponent into its assessment of the risk-return equation: in effect, a forward-looking, notional application of value capture in the development of large-scale infrastructure projects.
If the value of the public benefit exceeds the cost of concessional financing (whether in the form of interest rate, ranking or tenor), a net gain arises, and the taxpayer receives value for money.
Of course, this thesis rests on the twin propositions that: the project would not proceed in the absence of government assistance (i.e. there is market failure in the funding of these projects); and that the project proceeds successfully, and the forecast benefits are actually realised.
Neither of these things can be determined with certainty even after the event, let alone before it.
The same ‘net benefit’ rationale can be seen to underpin the Commonwealth’s $1.3 billion Modern Manufacturing Initiative (MMI), of which $243 million was recently allocated to the three battery metals projects in Western Australia considered in Beyer’s article.
While there is a sovereign capability overlay to these investments, Beyer’s question still deserves serious consideration.
So, I wanted to outline two examples of potential market failure, even in the heavily banked resources sector, where I have observed the potential for government funding, either though NAIF-style concessional financing or direct grant programs such as the MMI, to play a constructive role.
First, despite the widespread knowledge and understanding the Black-Scholes option pricing model, and others like it, markets still tend to undervalue long-dated options.
As Nassim Taleb noted in the seminal Black Swan: The Impact of the Highly Improbable, private investors either will not, or perhaps cannot, consider the sort of unpredictable events that give long-dated options their very considerable value.
Government funding can therefore have a role to play in projects with common user elements or embedded optionality to support future development.
I was reminded of this during a recent visit to Sydney, at the time celebrating the 90th anniversary of the Sydney Harbour Bridge. One of the several notable facts about this infrastructure project from the 1920s is its capacity relative to demand.
Despite only about 23,000 vehicles being registered in NSW at the time construction began, the bridge was designed to handle 20,000 vehicle movements every hour. It is almost inconceivable in the modern era that a privately funded infrastructure project would be built with such excess capacity.
Yet the bridge has proved to be one of the most foundational and valuable infrastructure projects since federation, not only linking two sides of the nation’s largest city, but also providing one of the most immediately recognisable vistas of Australia in the world.
To take another example: the ‘option value’ of the National Broadband Network arguably revealed itself only when large swaths of the population were required to work remotely during the pandemic.
Of course, history does not permit of counter-factuals.
Perhaps the NBN crowded out nascent investment in wireless services. Perhaps, if the harbour bridge was never built or built later or on a small scale, tunnels would have been built earlier or made larger (the technology for their construction did not exist at the time).
And one can easily point to public works projects, including the Sydney Opera House, with a far more ignominious outcome from a public spending perspective.
Now, this is not to suggest that government has any greater foresight of Black Swan events than the market, and there are in fact plausible arguments to the contrary.
But government can draw upon a disparate array of policy thought and forward-looking data across a range of fields in identifying latent option value in infrastructure projects that may not be immediately apparent to the market. And arguably, at least, it has incentive structures that extend over a longer time horizon than the market.
Second, the availability of private capital, even in the resources sector, does not seem to be uniform at all phases of development or for all kinds of development.
While there is ample capital available to support exploration, scoping, and pre-feasibility work, some choke points seem to exist at the feasibility stage, particularly if large-scale piloting is required.
This is particularly problematic in the critical minerals space, where, unlike say an iron ore, nickel or gold mine, substantial work is required to establish market acceptance of the end product.
Many critical minerals projects are in truth only one part mine and five parts chemical plant.
Private capital markets may simply be at an early stage of maturation in assessing these projects and, if so, government funding may have a role to play in catalysing investment and overcoming the first-mover disadvantage that often accompanies them.
The decision to invest in these kinds of projects should not, of course, be the end of the matter.
Government also needs to be attuned to the possibility to recycle funds when the investment proposition has been sufficiently de-risked to be attractive to private capital. In this respect, debt or equity funding may be seen as superior to grants, but each form of support has advantages and disadvantages.
While we all (especially those who grew up in WA in the 1980s) know governments have a mixed record when picking winners, perhaps most encouragingly, within the modern public service there appears to a willingness to acknowledge the limitations of government decision-making and to engage in meaningful dialogue with the private sector on the design and implementation of public spending programs.
This augurs well for Australia. While politics will always be politics, we should certainly not give up on the hope that, through a process of continued innovation and improvement, direct, targeted government support of industry can yield benefits for all Australians.
• Justin Mannolini is a partner, corporate advisory, at Gilbert + Tobin
By Justin Mannolini
