What’s Your Government’s Growth Portfolio?

by James A. Bacon

If local governments want to avoid Detroit-style insolvency and financial collapse, they need to be savvier about how they make capital investments, argues Charles Marohn on the Strong Towns blog. They need to ask themselves three questions:

  1. Will the capital investment generate a real rate of return (ROI)?
  2. Will that rate of return be capturable in amounts sufficient to fund the project?
  3. Will the revenue stream sustain the improvement over multiple life cycles?

If the answer is yes, the investment qualifies as low risk. If local government can’t answer the questions, the project is speculative… a gamble.

Marohn contends that local governments should devote 95% of their capital investments to low-risk projects, where there is a high degree of confidence in the payback, and 5% to high-risk projects with uncertain payoff but the prospect of outsized gains. Many of these experimental projects, he suggests, could go to “tactical urbanism,” small-bore initiatives like creating parklets, planting trees, making streets more walkable and the like. If they flop, there’s no big loss. But if they succeed, they can be replicated to great benefit.

Bacon’s bottom line: Needless to say, nothing like this is practiced in Virginia. State and local government officials talk all the time about “investing” in roads, education and what have you, but few of them have the faintest idea of how to go about calculating ROI, much less possess the political will to do it. No successful business would ever “invest” money the way government does, with no idea of projected return and no method to track it to determine if it succeeded.

It would be difficult for Virginia government to start treating its capital investments like a growth portfolio with specified risk-return objectives, but it’s essential to start doing so. Yes, essential. It’s no longer a matter of merely saving  taxpayers money, as I once would have argued, but of avoiding avoid fiscal collapse within another generation.

Once upon a time, the United States was an extraordinarily wealthy country with powerful economy that could afford to be wasteful. No longer. The economy is flying at just above stall speed, federal finances are a toxic waste dump, and the condition of state/local finances, even in fiscally conservative states is far more precarious than anyone cares to admit.

Once upon a time, Virginia was a national growth leader. We haven’t fallen to basket case status — Illinois and California will go belly up long before we will — but our growth is slowing, fiscal pressures are mounting and we remain scarily dependent upon the solvency of the federal government. It is policy folly to expand programs (Medicaid) that we may not be able to fund 10 years from now, and fiscal quackery to embark upon infrastructure improvements (expansion of the Washington Metro) without any idea of where the money will come from to maintain them.

The answer isn’t to stop investing — that’s a recipe for stagnation. The answer is to invest intelligently.

If I were running the Virginia Municipal League or the Virginia Association of Counties, I would make it the No. 1 highest order of priority to pull together the best brains in the business to figure out how local governments can calculate ROI on their capital spending projects. Anything else is just applying Band Aids.

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25 responses to “What’s Your Government’s Growth Portfolio?”

  1. reed fawell III Avatar
    reed fawell III

    A great article. This should be read by all.

  2. Agree with Reed.

    Mr. Bacon’s ROI on the so-called Western Bypass of Charlottesville found less than $8 million in benefits for the base-price of $240 million — now expanded due to the Southern Terminus “bait and switch” to $300 million. Mr. Bacon’s return on investment was a very good and seemed to cover the crucial aspects, according to two Darden Business School finance professors.

    A year later, it remains the ONLY ROI on a project which Taxpayers for Common Sense calls one of the worst eight in the nation yet the McDonnell Administration is still fast-tracking it past unwary taxpayers.

  3. larryg Avatar

    Of course, the obvious question are there ANY examples of such ROI processes by any govt?

    That might be a good start for such advocacies!

  4. larryg Avatar

    This is actually a fundamental philosophical question about the purpose of govt and some who hail from the right would say if there is an ROI in a venture to start with that its a private sector task not a govt one.

  5. DJRippert Avatar

    Let’s stop the penny ante BS. I want to save some real money. What’s the ROI for the US Navy?

    I make that tongue – in cheek comment for a reason. Outside of purely financial transactions returns on investment are very challenging calculations. The costs are usually understood but the value of the expected benefits are often not well understood.

    Soon you are going to hear a justification for the outer beltway – namely, that the existing beltway is reaching the end of its useful life and is in decay far below the surface. People will say that the required closures to rebuild (not repave) the existing beltway will snarl interstate transit for years.

    Let’s assume that’s true. Just assume. How much is that worth?

    By the academic logic of Jim Bacon, the future value of all stocks should be predictable because we need only estimate the cash flows of the underlying company in perpetuity. Bacon would have loaded up on Eastern Airlines and laughed at Apple.

    ROIs do improve the level of analysis and help avoid some mistakes. However, the belief that an ROI will yield a magic number that will provide a go / no go answer on a road with a 50 year useful life is academic folly.

  6. “The belief that an ROI will yield a magic number that will provide a go / no go answer on a road with a 50 year useful life is academic folly.”

    A total straw man argument. No one is saying this. Even in the presence of rigorous ROI analysis, there will be imponderables and uncertainties that create lots of gray area. Public leaders still will have to make judgment calls.

    Right now, though, public leaders are making judgments on the basis of totally inadequate information. Decisions are made on the basis of politics, lobbying and ideology. I guess you’re OK with that.

    1. DJRippert Avatar

      From the comment provided by Salz:

      “Mr. Bacon’s ROI on the so-called Western Bypass of Charlottesville found less than $8 million in benefits for the base-price of $240 million … “.

      Sounds like a magic number to me Jim.

      If you have developed an ROI of $8M for the bypass I’d love to see your analysis so that I can shred it to pieces. Why am I so confident in being able to shred your ROI? Because a person with decent finance and engineering skills can shred any ROI analysis. My UVA BS in Commerce came with concentrations in Accounting and Finance. So, let’s see the ROI.

      In fairness, I do believe that the process of going through an ROI is very useful. In a business setting, surrounded by fellow employees, it’s a must. I just wonder about the same process in the public domain where every assumption can be twisted and turned by every group with a vested interest. I’d be afraid that the debates would never end and nothing would ever get done.

      By the way – I am very interested in seeing the details of your $8M ROI calculation for the Charlottesville bypass if you are willing to share them.

  7. reed fawell III Avatar
    reed fawell III

    Don makes a valid point. Ideologues can twist any fact finding into an abusive process. Witness how the Endangered Species Act has been abused in some cases. And ROI will be abused so long a people tolerate it.

    But here the imposition of ROI standards will bring much needed logic and reflection to the discussion. It’s a tool that forces people to stop, think and reflect on what they are doing and why they are doing it, and show taxpayers the the projected return justifies the spending of their money. Thus it should be more difficult to spend other peoples’ money on a whim, crony or otherwise, and also encourages the discussion for other more cost effective solutions.

    Yes, there are many gray areas. But having standards for measure cost versus return are far better than none at all. It injects some sanity into the process giving those who insist on proper returns before others spend their money a leg to stand on and forces the necessary pause and reflection.

    Then we have to fix the procurement problem. Bring Old Joe to the Table. ROI and Real Construction Pricing and Management are sorely needed.

  8. larryg Avatar

    this is a pretty significant post IMHO because it touches on a couple of importnt things.

    1. – Is ROI something that is subjective or objective?

    2. – Is ROI for a govt project different from ROI for a non-govt project?

    3. – Is the value of ROI always the same common denominator – money?

    so let me give an example.

    what is the ROI of keeping city streets clean?

    how about the ROI for keeping a WalMart parking lot clean?

    if 5 different people/organizations did an ROI analysis on the same project (say the Cville bypass) – would all 5 come up with the same ballpark ROI?

    call me a skeptic at this point.

    1. DJRippert Avatar

      1. ROI calculations always have some subjectivity. In purely financial calculations, especially over the short term, they get more and more objective. However, the value of a road with a 50 year life will be necessarily subjective. The goal of an ROI analysis for something like a road is to improve the way you think about the project. More importantly, if you use consistent assumptions and a consistent process and honest practitioners you might well be able to rank various projects against each other by ROI. However, this doesn’t mean you will get the calculated return, only that you’ll have a better way of ranking projects.

      2. There should be no difference in the basics of ROI for a government vs non-government project. However, government projects often involve “social good” which would have to be quantified into dollars in order to run the ROI calculation. This adds subjectivity but does not change the process.

      3. Every ROI I have ever seen was reduced to money. Sometimes that reduction is very subjective – such as calculating the value of people’s time caught in traffic.

      With enough assumptions you could calculate the ROI for keeping either a street or a parking lot clean. Then, we would argue over the assumptions.

      “if 5 different people/organizations did an ROI analysis on the same project (say the Cville bypass) – would all 5 come up with the same ballpark ROI?”

      If 5 honest, reasonable and experienced people did an ROI analysis on the Charlottesville bypass they would come to a range of returns that would be useful even with the variability. If a smart growther, a developer, a no taxer, a politician and a chamber of commerce president all did an ROI for the Charlottesville Bypass you would get wildly varying (and effectively useless) results. Which is exactly my concern. Any ROI calculation done by the government would immediately be redone (with different assumptions) by smart growthers, developers, no taxers, etc.

  9. reed fawell III Avatar
    reed fawell III

    Lets assume the truth of Don’s “If a smart growther, a developer, a no taxer, a politician and a chamber of commerce president all did an ROI for the Charlottesville Bypass you would get wildly varying (and effectively useless) results.” In such a case, would not “such wildly variable results” still be useful to the 5 reasonable, honest, experienced people, including a smart growther, developer, no taxer, politician and/or chamber president among them so long as they were not ideologues?

    1. DJRippert Avatar

      I was trying to list known ideologues! The ROI calculation is worth doing so long as people understand that what looks like a scientific answer is merely the quantification of guesswork.

      1. reed fawell III Avatar
        reed fawell III

        Then who is not an ideologue?

  10. larryg Avatar

    So if a company in the TollRoad business did an “investment grade” ROI analysis for the Cville Bypass…. would it be:

    1. – best, most objective, of the ROIs done by all parties?

    2. – depend on whether or not the TollRoad company was bidding on the project?

    My bias is that ROIs that are part of a prospectus to potential investors are more trustworthy.

    and I would find an ROI analysis of cost vs benefit of keeping a WalMart parking lot clean to be highly amusing…and entertaining… but I bet the anti-tax folks would suggest that keeping city streets clean and safe is an example of government “excess” because there is no ROI.

    1. DJRippert Avatar

      Anytime you can get somebody to do an ROI on an investment that requires their own money you are ahead of the game. I’d be especially swayed by a couple of ROI calculations from a couple of companies bidding against each other.

      The issue is change orders. The bidders would have to buy the eminent domain rights and build a truly private road. Beyond meeting minimum safety standards the winning bidder can do whatever they want. Charge a lot, charge a little. Whatever. Of course, politicians and governments can’t stomach that. So they start adding restrictions. Eventually, the bidder wants some assurances from the government in return for the restrictions. When (inevitably) the situation changes, the bidder calls it a change order and the ROI that originally justified the project is no longer valid. Now what?

      There are A LOT of retired executives from companies like Bechtel who know more about ROI calculations than everybody in the state government added together. They would work for free on a part time basis just to be able to tell their friends at cocktail parties that they “just met with the governor”. You could pick overtly non-partisan people. They would produce as good an ROI calculation as could be produced. Then, the government could decide what to do with those calculations.

      1. reed fawell III Avatar
        reed fawell III

        BINGO DON – THAT’S OLD JOE! WHAT THE GOVERNMENT NEEDS IS A BUNCH OF OLD JOEs riding shotgun on the US MAIL stagecoach.

        We’ll finish old Joe’s story this weekend.

        1. reed fawell III Avatar
          reed fawell III

          Jim’s article is quite remarkable. Surely it tells how our experts today so often fail us. Deserted by common sense, awareness and the ability to cut through fog, they are unable to see facts, reach conclusions, and take action that achieves the proper solutions given circumstance. It’s why many of today’s problems appear intractable when solutions are at hand. We just don’t have the means to see and grasp them.

          Our systems are broke. Our experts are making so much money off the process they can’t afford to solve the problem. Transformed into the old TV Professor Doctor Irwin Cory, they’ve become nonsensical and impenetrable. And so have we.

        2. DJRippert Avatar

          That’s it? One day of driving for one hour? I think I’ll make the same calculation and see if I get a different result. However, I’ll pick the day that entering first year students arrive at UVA.

          The wireless companies have almost a census of traffic data since almost every car has a cell phone these days. They could release the congestion information for a year without ever releasing any individual subscriber’s personal information. From there, you could start a real analysis.

          Jim, don’t water down your generally good ROI idea by over-hyping what is essentially a single data point.

          1. I don’t believe I have over-hyped my ROI conclusion. As I state clearly in the article, my findings are not definitive (although they are better than anything that anyone else has come up with yet because no one else has even attempted the exercise). My goal was to prompt a conversation on how to conduct ROI analysis on road projects. One has to start somewhere.

            Let’s identify the limitations of my humble, under-funded effort and create a methodology that will withstand even Don the Ripper’s scrutiny.

          2. larryg Avatar

            DJ makes an excellent point! The day is here – where you can predict how long your trip will take – on any given day at any given hour.

            We have not only transponders, but we have license-plate readers as well as smartphones – and soon – smartphones that will pay tolls.

            Now.. I realize that I’m conflating the idea that we have enough data as DJ suggests to determine real-time traffic congestion, incidents and delays …and tolls… and specifically real-time tolls that now can be used to “shape” congestion.

            And the reason why is that tolls are no longer physical structures that manually collect one-size fits all tolls.

            tolls are now automatically collectible without slowing down one mile per hour but they are also instantly changeable so that when congestion is on the rise – that tolls also go up and people can and will make more economic decisions about the real value of their trip – at a particular time.

            Just as people get used to, in general, the time period associated with rush hour congestion – they will, with tolls, start to realize that other options exist other than only one – i.e. making a solo car trip at the height of rush hour.

            We now live in an information-laden world and it’s not just heaps and gobs of information laying around cluttering up things. It’s information that more and more people are using to make decisions with – and those decisions – on a collective basis are starting to change the way the world we live in – works – literally.

            I’m personally convinced that Connaughton and some others at VDOT have figured out some of this and are way, way ahead of most people who basically are still thinking about roads and traffic in a 20th century mindset.

  11. larryg Avatar

    I was/am persuaded by toll roads built/operated by private sector companies and ones built/operated by the govt.

    Two in particular strike me. The ICC done by Maryland and the Pocahontas Parkway done by Va.

    To be fair – Va also operates the PoWhite Parkway and the Chesapeake Bay Bridge Tunnel.

    And we have to acknowledge that the private sector did bite on the HOT Lanes – not without some major taxpayer inducements.

    Then finally, we have the 460 project where VDOT continued the “blending” of trying to attract a private sector bidder/operator but also did have to sweeten the pot with taxpayer money.

    I would assert that all of the projects used some form of a private sector ROI – that actually put a dollar value on the difference between total private sector operation and the reality that those projects could not be a total private sector ROI.

    So would we ever see…for instance, govt movement towards contracted out libraries, fire and rescue, schools?

  12. larryg Avatar

    There are so many bad uses of ROI by govt that it’s tempting to ask if someone has some good examples of a valid govt use of ROI.

    I know there are those in this blog who don’t think highly of the EPA but they do have a rigorous ROI process for regulating toxics and other deadly but necessary/useful chemicals.

    For instance, they’ve pretty much banned dioxin and PC Bs but not mercury from powerplants yet but have advocated cutting it back. They’ve implicated particulates as particularly harmful to children, elderly and those with compromise immune systems, etc (which tells you that it’s NOT one-size-fits-alls on such analyses).

    The Chesapeake Bay Bridge Tunnel has operated for many, many years as far as I know solely on tolls without requiring any government subsidies as far as I know BUT it does not appear to be an “investment grade” profitable enterprise that a private company would see as a potential cash cow.

    As I recall, when CBBT was built, it was decided that it operate on a break-even basis not a “profitable” basis but also remember that prior to it’s construction, the State did operate a ferry at a horrendous cost, not recovered from fares.

    http://jlarc.virginia.gov/reports/Rpt287.pdf some pretty good history available about the Virginia Ferry Corporation when ran those ferries until 1946….. when Virginia “seized” the company….

    okay, so I’m blathering a bit at 5am… but I tend to think that ROI used in a govt context is mostly a bogus exercise intended to convince the gullible that the use of the tax dollars for some purpose is “beneficial” if you tweak the ROI analyses to include some subjective and not-easily-quantifiable “benefits”.

    When a private entity does an ROI – and it involves real investor money – as in real investors expecting to not only get all their initial money back plus earned income – the people who do the ROI and the people who review/certify it have some reputations on the line if they expect to be called again in the future to do analyses – and that’s why such analyses are often characterized as “investment grade”.

    so ..there are many “grades” of ROI analyses and to be perfectly honest, I’ve seen few done by government that are so characterized but we do have some clues with the Pocahontas Parkway that VDOT initially claimed had a wonderful ROI but that was proven spectacularly wrong in a short period but subsequently, they managed to convince/hornswoggle/crony bribe a private company, Transurban to take it over for 99 years or some such – a horizon window that apparently is long enough for Transurban to ultimately a pay back….

    or perhaps it was a quick-pro-quo for the HOT lanes, eh?

    At any rate… I’d like to see Bacon pursue this further perhaps with some actual real examples of govt ROI at the State or Local level…hopefully.

    1. Good comments, Larry, I certainly will point out examples of government ROI analysis when I come across them.

  13. larryg Avatar

    here.. start with this:

    ” The Acts of Assembly offer the commission no authority to
    establish or promote economic development policy on behalf of the district’s member localities or for the Commonwealth. Clearly, the use of the CBBT toll structure to manage economic growth and development was not anticipated in the authorization for the commission to use tolls to finance construction and operation of the facility.

    Instead, the same Acts of Assembly that set out the important economic
    purpose of the facility also explicitly authorize the commission to “fix, revise, charge and collect tolls” for two purposes: (a) to pay the cost of maintaining, repairing, and operating the facility, and (b) to pay the principal of and the interest on bonds issued by the commission, and to create reserves for those purposes. Therefore, the com­mission is not authorized to revise the toll structure to promote or discourage eco­nomic development. Rather, the obligation of the commission is to collect the lowest possible toll which provides sufficient funds for the purposes set out in law.”

    http://jlarc.virginia.gov/reports/Rpt287.pdf page 32

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