2. Enabling O&M Best Practices:
2.1 Ensure funding
The funding (or revenues) for operating and maintaining infrastructure assets needs to come from somewhere.160 Traditionally, the funding would come mainly or entirely from the government, through tax revenues, and would act as a full or partial subsidy, in that the services were provided to users for free or at prices below cost. With public budgets often depleted nowadays, however, that model is unsustainable, and more diversified funding sources are needed.
One particular problem with traditional public budget funding is that it makes maintenance budgets vulnerable to political expediency: when politicians need to make overall budget cuts, O&M funding suffers. Even without these rival claims on funding, however, politicians have little incentive to make provision for O&M, given the low profile of O&M projects relative to those for new construction. In addition, the oft-employed pay-as-you-go funding might defer maintenance work, or even stop it midway, and thereby create additional inefficiencies as well as an undue focus on achieving the lowest-possible initial costs.
What O&M needs is long-term planning certainty and continuity of funding across multiple government cycles. To ensure sufficient and stable funding for O&M, governments can earmark a proportion of user taxes, apply user charges or capture ancillary business opportunities. (The following discussion mainly relates to publicly operated infrastructure. In a PPP model, the same funding sources are available, but the government automatically enters a long-term O&M funding commitment through the contract with the private party.)
Dedicate user taxes to a maintenance fund
User taxes, such as a fuel tax, are often channelled into a nation’s general budget; the relevant agency receives discretionary allocations from that general budget, and in turn allocates them to O&M, which is often subject to political expediency. A sounder system would ring-fence all or some of the user taxes for the O&M of the infrastructure asset – whose users actually pay those taxes, after all. One approach is to set up a dedicated maintenance fund, which receives the user taxes and disburses the money to the agencies implementing O&M. The road sector, for instance, benefits from a “road fund” in many countries.
This closed monetary cycle will enable a reliable source of maintenance funding, and prevent alternative uses of the user taxes. The ring-fenced maintenance fund means that maintenance can now take place when needed, rather than when current liquidity allows. The fund effectively provides long-term predictability and a multiyear funding guarantee by decoupling funding from the annual logic of public budgets.
The benefits go further than that. The fund enhances transparency on spending levels and resource allocation. If the fund is able to issue debt to raise liquidity for investments, enhanced public budget control and better financial planning result, as the fund needs to repay those loans using its dedicated future income streams.
The gain in predictability has a downside: less fiscal flexibility for the government. The current government loses its allocation rights over a part of the tax revenues and so has less room to manoeuvre in its overall budgeting.
A dedicated fund can create a more stable funding base for O&M, but it is no panacea and does not guarantee efficient use of the acquired funds. Many first-generation road funds in the 1960s and 1970s in Africa, Asia and Latin America were characterized by insufficient revenues and poor governance, resulting in poor allocation of funds and low operational efficiency.161 Governments should consider the following lessons when designing O&M funds:
Secure a sufficient and diversified revenue base.
- Consider the various user taxes (for roads, these include fuel tax, vehicle licence fee and vehicle purchase tax), as well as user charges (such as tolls, vignettes, overweight charges and fines) as potential funding sources besides regular government appropriations from the general budget.
- Evaluate the performance of each revenue source in terms of economic efficiency, user incentives, social fairness, collection cost, susceptibility to evasion and adaptability over time.
- Strive for a diversified and robust funding mix. For example, the Swiss national road fund receives 50% of the fuel tax, 100% of the fuel surtax, and 100% of the income from vignettes.162
- If appropriate, raise the level of user taxes to top up funds. For example, in Ukraine, the excise tax for fuel had to be increased threefold over a few years to ensure sustainable funding for the road sector.163
- Implement mechanisms to protect against inflation. When maintenance is partly funded from a user tax, politicians are often unwilling to index those taxes to inflation, so revenues erode over time. The dangers are shown by the US Highway Trust Fund: fuel tax rates have remained flat since 1993, but as cars have become more fuel-efficient, so the fund’s income base has declined while its expenses have grown owing to inflation. In the end, the only way to rescue it was through transfers from the general budget. By contrast, the Austrian road fund ASFiNAG avoids such underfunding because toll pricing is adjusted annually through a formula based on the consumer price index.
Design an appropriate governance structure.
- Separate control over funding from implementation responsibilities. For instance, when policy-makers establish a road fund, they might simultaneously set up a road agency – an autonomous and independent entity charged with efficiently implementing road maintenance and rehabilitation works.
- Review and if necessary improve the various aspects of the fund to ensure that its legal basis is sound, its governance is independent, the eligible expenditures are clearly defined and the allocation mechanisms are transparent (Figure 28).
Figure 28: Lessons Learned for O&M Fund Design
Source: Road Funds Revisited: A Preliminary Appraisal of the Effectiveness of “Second Generation” Road Funds, January 2012. Washington D.C.: World Bank
If appropriate, supplement the perpetual maintenance fund with time-limited funds for large new construction projects or previously missed/neglected rehabilitation. Switzerland, for example, has established a specific fund for financing four large-scale rail expansion projects.
An important role can be taken here by IFIs in urging countries to establish such fund structures or similar accounts. The European Bank for Reconstruction and Development (EBRD) established Maintenance, Replacement and Development (MRD) accounts for Romania, by which dividends, taxes and concession fees from local water utilities are dedicated to servicing debt and funding future MRD works.164
Apply inclusive user charges where possible
In many infrastructure sectors in many countries, user prices have traditionally been artificially low. As a result, users have had little incentive for efficient use of scarce infrastructure capacity, and operators have been left underfunded and struggling to provide adequate services and attract investment. Low water prices, for example, have led to over-extraction in China and underinvestment in India. Similarly, low road charges lead to inefficient capacity use: in most European countries, 20-30% of truck movements are empty backhauls165, a waste that could be partially avoided with a state-of-the-art logistics model – but those models often only pay off if charges are levied on each kilometre of drive.
Figure 29: Overview of Infrastructure Funding Sources
HIC = High Income Countries; UMIC = Upper Medium Income Countries; LMIC = Lower Medium Income Countries; LIC = Lower Income Countries
Source: Nakagawa et al.: Calculations of the shares of financial resources paid by actual payers for transportation improvements. In Transport Policy,1998; Managing Water for All. An OECD Perspective on Pricing and Financing, 2009. OECD.
In reality, the use of user charges varies greatly by sector and country (Figure 29). Around the world, most major airports and ports are funded mainly by user charges, whereas roads and railways are more reliant on tax funding. For electricity and water utilities, the predominant funding depends on the region: in developed countries, user charges cover most of the funding, but that is typically not the case in developing nations.
Introducing user charges could bring many benefits:
- They are beneficial from an economic point of view, as they motivate consumers to use the capacity responsibly and sparingly, and thus reduce congestion and increase asset utilization (“demand management”).
- They can contribute directly to funding the infrastructure asset’s O&M and can thus ensure the operator’s financial sustainability, as they provide a steady source of funding over the life cycle (“cost recovery principle”).
- They potentially internalize environmental and social externalities into prices, and thus encourage responsible consumer decision-making (“polluter pays principle”).
- They give a performance incentive to the infrastructure operator, which leads to higher quality for the user.
- They can be viewed as financially fair, as only users pay, and the debt burden on future generations will be minimized.
However, user charges also have certain disadvantages or limitations:
- They impose a financial burden on users, and raise the risk of social exclusion. For social reasons, some essential public services, notably water, should be affordable for everyone.
- User charges could give rise to unintended second-order effects. For instance, a toll road could lead to rat-run congestion on a parallel uncharged road; and, the imposition of congestion charges to reduce traffic levels could result in lower revenues for shops within that zone.
- They involve transaction costs for the operator, and can mean time costs for the user (e.g. queues that form at some highway tollbooths). The issue is receding, however, in step with technological progress; e-tolling, for example, eliminates such delays.
- User charges are by no means applicable for all assets. Only in some sectors, such as airports or ports, or in particular parts of a network, such as expressways, is there enough demand to support charging users. For other infrastructure assets, particularly in rural areas, additional government funding arrangements need to be in place.
Once again, IFIs can play an important role in introducing user charges. For example, the EBRD’s Municipal Environmental Loan Facility provides loans to commercialized utilities in Romania, on condition that cost recovery user charges are levied and effectively collected.166
The following is a list of measures for policy-makers to consider when introducing user charges:
Forestall or at least defuse the likely resistance from users.
Upon initial introduction, user charges tend to arouse opposition. They typically gain acceptance, however, if any of the following measures are applied:
- If initiating user charges, correlate them with significant quality improvements, as when an upgraded toll road saves motorists valuable time commuting to work each morning. If appropriate, actively communicate this added value in a publicity campaign. In the long run, people tend to moderate their opposition or modify their behaviour. For example, when the congestion charge was introduced in Stockholm, Sweden in 2006, more than half of the population was against tolls, but in 2011, 70% supported the charge, given the 20% reduction in rush-hour traffic.167
- Offer user-friendly, efficient and accessible payment options. Highway 6 in Israel bills its users automatically, using an in-vehicle transponder unit. Alternatively, non-registered users are billed through licence plate recognition, allowing the highway to operate as a normal freeway with interchanges and without tollbooths, while achieving a toll collection rate of 97%.168
- Educate the public on the advantages of the new system and the anticipated payments. For the Barranquilla water PPP, a publicity campaign explained how the new water supply line greatly reduces the cost of water in comparison with the traditional supply from water trucks.169 Education initiatives can also help users to reduce their consumption, and hence their bills. In the case of the São Paulo (Brazil) Slum Electrification and Loss Reduction Programme, user consumption fell by 40% partly as a result of an information campaign and various energy efficiency measures.170
Set user charges by balancing financial sustainability, user incentives and affordability objectives.
Various objectives need delicate balancing, as in ensuring that the asset is financially sustainable, encouraging users to deliberately use the asset and making the service affordable for all potential users.
- Ensure the operator’s financial stability, within limits.
- Determine the user charge based on the investment and operating costs, so that a risk-adequate return can be generated; alternatively, consider subsidies to fill the funding gap.
- Establish mechanisms to adapt the user charge over time to adjust for inflation.
- Set a cap on the user charge to avoid an abuse of monopoly power by the operator.
- Embed incentives into user charges to manage demand (see chapter 1.1).
- Ensure that user charges are affordable to all user groups, based on an analysis of willingness and ability to pay. According to an international rule of thumb, an affordability problem arises when households spend more than 3-5% of their income on a particular infrastructure service, such as water or public transport.171
Design “inclusive user charges” to mitigate the adverse social consequences.
- Consider reduced tariffs for at-risk groups, or design socially inclusive tariff structures. Several countries have used a tiered water pricing system: for instance, a certain amount of water a day is provided at a low price to satisfy basic needs, and thereafter, as water consumption increases, so does the price. Some public transport systems apply flat pricing, which effectively subsidizes the daily commute of poor working people who live in distant suburbs.
- Provide different service levels to address affordability concerns. Manila Water’s “Water for the Poor” programme, for example, offers relatively modestly priced community connections.172
- Improve alternative infrastructure. When the inner London cordon toll was introduced in 2004, the social exclusion effect was offset by simultaneous improvements to the public transport system. The combined intervention reduced car traffic by 15% and congestion by 30%, while increasing bus ridership and bus reliability.173
- Seek subsidies where appropriate. When an asset receives a subsidy (or viability gap funding), user payments can be reduced, and ideally that will make the service affordable for all users. For example, most public transport systems in the world cannot recover their expenses through fares alone; they regularly receive supply-side subsidies for the sake of positive externalities, such as increased frequency of service, reduced congestion and less adverse environmental impact. An alternative approach is that of direct demand-side subsidies targeting specific users, but it is often difficult to implement in practice.
Capture ancillary business opportunities
Operators of infrastructure assets often have many opportunities to generate additional revenues from ancillary businesses, such as retail outlets, advertising, accommodation and cross-selling. The type of ancillary business is sector-specific, but various possibilities exist in each sector. Some sectors have explored the possibilities systematically and vigorously – notably, best practice airports generate 50% or more of their revenues from so-called non-aviation business (Figure 30). (In addition, refer to chapter 1.2 on enhancing quality for users, and the Phase II report of the Strategic Infrastructure Initiative.)
Figure 30: Revenue Potential of Ancillary Businesses
Source: Strategic Infrastructure: Steps to prepare and accelerate Public-Private Partnerships. May, 2013. Geneva: World Economic Forum
Build a strategy and skills specifically for ancillary business, or leverage specialist firms.
The required skills in ancillary businesses are quite different from those for the core infrastructure business. Airport retail activities, for instance, require a deep understanding of customer demands and shopping behaviours, whereas conventional airport operations are more about operations processes and capital asset management.
- Devise a comprehensive and long-term strategy and plan. For example, the ACP, already generating more than 20% of revenues from the sale of electricity, water- and transit-related services, is studying many other ancillary business opportunities, including a container terminal, a ship repair yard and logistics parks.
- Build a skilled team to implement the strategy holistically. Executing an airport retail master plan, for instance, requires more than installing new shops: the team needs to optimize the shop mix to have the right products on offer; find the right balance between high-margin and high-turnover business; and optimize passenger flows and the aircraft gate allocation (e.g. guiding Russian and Chinese travellers through luxury goods areas can double per-passenger spending).
- Constantly seek innovative business opportunities. In China, Shanghai Metro introduced virtual supermarkets in 70 stations; large LED screens advertise the goods, which are then scanned by shoppers and delivered to their homes within two days.174
- Contract external partners if the required skills are not available in-house. For example, most airports award concessions for individual shops or even for the entire airport retail operation. When Pittsburgh International Airport (US) awarded the concession for its retail business to an external specialist in the 1990s, the retail revenues per passenger tripled over the next decade. More recently in the US, Virginia’s Office of Transportation posted a request for information for a pilot project on the development of mixed-use facilities at two metro stations, in order to get private-sector feedback on an area of business having little in common with its roadway-centric heritage.175
Leverage scale and all assets for ancillary business.
Leverage the project’s scale, its tangible assets or even its intangible assets. An example of each:
- Scale: a motorway PPP might offer road cleaning services to nearby villages.
- Tangible assets: a highway operator might rent space for fibre-optic cables, or charge for right-of-way to solar and wind power generators.
- Intangible assets: a public transport network could make its electronic payment scheme available to other businesses to accept payments or conduct promotion activities. As an actual example, New York City secured a US$ 41 million deal from a bank, giving the latter the naming rights to the city’s bike-sharing programme.176
Capture land value.
Land value capture is mainly applicable in greenfield settings, but not exclusively so. Operators of existing infrastructure assets can benefit as well:
- Make the most of existing land. In Hong Kong, MTR derives more than 30% of its operating profits from property development, ownership and management.177
- Increase the space efficiency of existing operations, and thereby free up land or increase capacity. Dusseldorf Airport in Germany is introducing an automated parking system that enables cars to park closer to each other, thus increasing space productivity by 40%.178
- For expansion projects, pursue further opportunities to apply land value capture. During the brief window of opportunity between planning and publicizing the project, buy up the land and then either sell it to independent real estate developers or make it part of the development package. For example, the new metro lines in Brasilia (Brazil) and Copenhagen (Denmark) raised 85% and 50%, respectively, of their required funding through land sales.179