[Economic Report of the President (2008)]
[Administration of George W. Bush]
[Online through the Government Printing Office, www.gpo.gov]


 
CHAPTER  6

The Nation's Infrastructure

Our economy depends on infrastructure that allows goods, people,
information, and energy to flow throughout the Nation. This
infrastructure-ports, roads, airports, communication networks, power
lines, and many other systems-represents an important input into the
economy. Just as firms must use labor and raw materials to produce
output, they must also use airports and power lines. Similarly,
consumers rely on cell phone towers and highways in their daily
lives.

Infrastructure is often provided either directly by government agencies
or by firms regulated by the government. Accordingly, the quantity and
quality of infrastructure available to a firm or consumer often depends
on government policy in addition to market forces. In recent years, the
United States has experienced growing demands on its infrastructure,
thanks to economic growth and successful deregulation in sectors that
are heavy users of infrastructure. The policy challenge is how best to
respond to these increased demands.

``Infrastructure'' is a broad term, and this brief chapter does not
provide a comprehensive review of all of the U.S. infrastructure
systems. Instead, it discusses some of the economic issues associated
with major transportation, communication, and power transmission
systems, and some of the policy challenges in each. The key points of
this chapter are:

  Infrastructure typically requires large capital investments
to build and maintain capacity. Once built, however, the
cost of allowing an extra person to use the capacity is
typically low, as long as the number of users is less than
the infrastructure's capacity. This cost structure often
means that infrastructure cannot be provided efficiently by
a competitive market. As a result, many types of
infrastructure are instead provided by Government-regulated
companies or, in some cases, by the Government itself.

  Demands on the U.S. infrastructure grow as the economy
expands, and Government policies often determine how
effectively infrastructure can accommodate that growth.
Properly designed user fees can help ensure efficiency by
revealing information about what infrastructure consumers
value most.

  The price people pay for using infrastructure should
reflect the extra cost associated with its use. This
includes the cost of maintaining the infrastructure itself,
as well as delays caused by increased congestion.

  The private sector plays an important role in providing
infrastructure. However, lack of competition in markets for
infrastructure raises concerns about market power, so that
Government oversight is sometimes necessary. Government
must continually reassess the need for oversight in the
face of changing market conditions.


The Basic Challenge of Infrastructure Policy

As the economy grows, demands on our infrastructure increase. Since
1980, vehicle traffic on U.S. roads has nearly doubled, passenger-miles
of air traffic have increased by more than 150 percent, and ton-miles
of freight on U.S. railroads have increased by more than 80 percent.
The Nation's growing demand for energy resources, together with a
greater emphasis on new sources of power, is placing new demands on our
energy infrastructure. And the growth of the Internet and information
technology means that telecommunications networks are becoming more
central to the U.S. economy.

Infrastructure systems-whether pipelines, roads, fiber optic
networks, or port facilities-require large investments in long-lived
capacity. Once this capacity is in place, however, small increases in
usage may cost relatively little to provide. Marginal cost refers to
the extra cost associated with a small increase in production of a
good. Infrastructure investments produce goods, like passenger trips or
phone calls, that typically have low marginal cost as long as total
demands on the infrastructure do not approach the capacity it was
designed to support. Once usage approaches capacity, however, marginal
cost can increase substantially as extra use makes the entire system
less effective.

These features create certain policy challenges that are common to
many types of infrastructure. To illustrate these challenges,
imagine a growing city where construction of a new bridge across a
river is being considered. The bridge will provide significant
benefits relative to the existing options for crossing the river-for
example, taking a ferry or traveling several miles to cross at
another point.

One possibility is that a private party will construct the bridge,
planning to earn a profit by charging tolls. If the private sector
builds a bridge, the market for river crossings at any given point will
likely be provided by a single monopolist. This is because providing a
bridge involves economies of scale: it is cheaper to build a single
bridge that serves 20,000 people per day than two bridges that each
serve 10,000 people per day. Because of economies of scale, the market
for bridge crossings is called a natural monopoly. Even if there are no
artificial barriers to market entry, a monopoly is likely to emerge
simply because a single firm can produce the good more cheaply than
multiple firms could.

A monopolistic bridge owner may choose to charge prices that are too
high from society's perspective. A monopolist will choose a toll that
generates the highest possible profit, even though the cost of allowing
an extra person to cross the bridge may be very close to zero. This
means lost opportunities: some people will choose not to cross because
of the high toll, even though the cost of allowing them to cross is
very small. The people who choose not to cross may waste time and fuel
traveling to a toll-free bridge, or may choose not to cross, perhaps
visiting friends less often or not shopping at stores that would
require a bridge crossing. Economists refer to this type of foregone
benefit as a deadweight loss, and it is a key economic reason for
preventing monopoly pricing. To avoid this deadweight loss, government
often attempts to prevent monopoly pricing of infrastructure, either by
regulating the price or by providing the infrastructure itself. While
government involvement can address monopoly concerns, it can create
other inefficiencies: regulators may lack the information necessary to
make efficient choices and may make decisions based on political
considerations rather than on a cost-benefit analysis.

If the government builds and operates the bridge, it must make a number
of decisions. First, the government must decide how to pay for the
bridge. One approach is simply to charge a toll, for each use of the
bridge, that is high enough to cover the average cost of providing the
bridge. This approach seems sensible: the bridge will be paid for by
those people who use it, and their willingness to pay for the bridge
reveals that it passes a cost-benefit test. However, this approach is
likely to create some inefficiency, because the average cost of
providing the bridge will be higher than the extra cost each person
imposes when he or she crosses at uncongested times. Thus, some people
will choose not to cross even though it would cost the government little
or nothing to allow them to cross. This can create a deadweight loss
similar to the loss that occurs when a monopolist chooses the toll,
though the deadweight loss will generally be smaller than under monopoly
pricing.

One response to this problem would be to charge a two-part tariff: a
fixed charge for a permit to use the bridge, in addition to a per-use
toll that would be low to reflect the small marginal cost of using the
bridge. This approach creates efficient incentives for those consumers
who obtain permits, because the toll they pay for each crossing reflects
only the cost of their use. However, some drivers will choose not to
obtain a permit, and their failure to use the bridge is a deadweight
loss.

Other issues arise if the bridge becomes congested. Suppose that, at
peak hours, so many people attempt to use the bridge that traffic jams
develop. At such times, each person who uses the bridge contributes to
the delay that everyone on the bridge suffers. Congestion means that,
from society's perspective, the marginal cost of bridge trips is no
longer small: each additional trip makes traffic slower, adding to the
delay costs of everyone using the bridge.

When the bridge becomes congested, users of the bridge may urge the
government to invest in expanding its capacity. If people can use the
bridge for free, frequent users are likely to insist that greater
investment is a good idea, while those who do not use the bridge will
object to spending tax dollars on the project. If the bridge is
financed by tolls that are the same at all times of day, people who use
the bridge at peak times will receive the benefit of extra capacity,
even though they do not bear the full cost of the expansion. People who
use the bridge at uncongested times will pay more in tolls to finance
the expansion, but receive no benefit. Thus, peak-time users may support
expansion even if the benefits to society do not outweigh the
construction costs.

Setting aside the question of whether the bridge should be expanded,
the congestion described above reflects a system that encourages
inefficient choices. Each person who uses the bridge decides when to
cross without considering the costs this creates for others because of
increased congestion. Addressing this inefficiency can help ensure that
existing capacity is used as efficiently as possible.

The questions of building the bridge-who should provide it, how it
should be paid for, and when new capacity should be constructed-are all
present to different degrees in debates about the major infrastructure
systems in the United States. The next section gives an overview of
some of these systems and some of the specific issues they face.


Current State of the Nation's Infrastructure


This section discusses aspects of the U.S. transportation, energy,
and communications infrastructure. Economic growth has meant increased
demand for transportation, raising questions about how best to address
congestion. In energy and communications, changes in technology and
market structure are transforming the way that infrastructure serves
these sectors.

Roads

Roads play a central role in the U.S. economy. Both firms and
consumers depend on cars and trucks in their everyday economic lives.
Most U.S. freight shipments take place by road; for example, trucks
handle over 70 percent of U.S. freight shipments (by value). On
average, drivers travel 29 miles by car each day and spend almost an
hour a day behind the wheel. Americans use roads in all parts of their
daily lives, from commuting to work to shopping and visiting friends.

The amount of traffic on U.S. roads has been increasing steadily for
decades. As traffic has increased, priorities have shifted from building
new connections between places to accommodating growing traffic on
existing routes (see Box 6-1). Although Federal, State, and local
governments have built new roads and added lanes to existing roads, new
construction has not kept up with the increases in traffic. Chart 6-1
shows that vehicle miles traveled in the United States have almost
doubled since 1980, whereas total lane-miles of road have expanded by
less than 6 percent. Put somewhat differently, each mile of road
serves more traffic. For example, on urban highways the average number
of vehicles using a given mile of road each day has increased from
3,785 in 1980 to 5,527 in 2005. We would not necessarily expect new
road investment to match increases in miles driven, because a mile of
road that serves 500 vehicles per day may easily accommodate 1,000
vehicles per day without any new construction. But at peak hours, the
number of drivers attempting to use many urban roads approaches or
exceeds the roads' maximum capacity. In 2004, almost two-thirds of
peak-hour travel on urban interstates took place on roads carrying at
least 80 percent of their theoretical maximum number of vehicles. More
than a third of travel on urban interstates took place on roads carrying
at least 95 percent of their theoretical maximum.

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Box 6-1: The Interstate Highway System

The Interstate Highway System began when President Eisenhower
signed the Federal-Aid Highway Act of 1956, which authorized $25 billion
for the construction of 41,000 miles of interstate highway designed to
a common standard. One of the original motivations for construction
was to move materials and troops in times of emergency. President
Eisenhower originally hoped to finance the system with tolls, but the
system was instead financed through a fuel tax because of concern that
tolls in less densely populated areas would be insufficient to cover the
cost of those roads.

The Interstate System has come to play a central role in our Nation's
economic life and has lowered the cost of transporting goods around
the United States. The construction of the Interstate System may have
made important contributions to economic growth, although there is no
consensus among economists regarding highways' economic effects,
and it is therefore difficult to say what parts of the Interstate System
have benefits that outweigh their costs. Today, the local objective of
reducing congestion in urban areas has replaced the National objective
of connecting distant markets and providing for National defense. Now
that interstates connect the country, the priority is to find ways of
using these resources as efficiently as possible, and in particular to
address congestion on the most heavily traveled interstate corridors.
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When traffic approaches a road's capacity, the road becomes congested,
resulting in real costs for drivers and businesses. The extra fuel
consumed in all urban areas amounts to 2.87 billion gallons per
year-about 2 percent of U.S. gasoline consumption. On average,
commuters in urban areas lose almost 38 hours per year due to traffic
congestion, and in the largest cities congestion costs the average
commuter 54 hours per year. In the largest urban areas, over 40 percent
of travel takes place under congested conditions. Congestion is worst in
the Nation's largest cities, but is increasing in urbanized areas of
every size. Chart 6-2 shows that congestion is increasing even in
urbanized areas with fewer than 500,000 residents.

Traffic congestion is the predictable result of a situation in which
a scarce resource-road space at rush hour-is made freely available to
everyone. Individual drivers choose to travel at the time they find
most convenient. When they travel at congested times, however, they
contribute to the wasted time, fuel, and increased pollution borne by
everyone else on the roadway. Individual drivers do not take this cost
into account, so they use the road even though the social costs they
create may be greater than the individual benefits they receive. This
is the ``tragedy of the commons'': when a resource is freely available
to anyone who wants to use it, it is overused, potentially leaving
everyone worse off.

With highway traffic, as with other types of infrastructure, the
problem is not simply that so many people use a road, but that they
choose to use it at




the same time. At hours when many drivers want to travel, a certain
amount of delay can be optimal, given the benefits that many drivers
receive from traveling at their most preferred time. But as a road
becomes very crowded, small increases in the number of cars can cause
large decreases in the speed of traffic. When too many people attempt
to enter road space at one time, traffic flow "collapses," meaning
that a road is able to handle fewer cars in a given amount of time.
Spreading out the times at which drivers enter a roadway can permit
higher speeds, allowing a road to handle more traffic with the same
amount of pavement.

One response to road congestion is to build more roads or widen
existing roads. While new construction can be justified in many cases,
it is not the solution to all congestion. Road construction is
expensive; each additional lane can cost millions of dollars per mile.
Furthermore, the tragedy of the commons applies to new capacity as well
as to existing capacity. If a new lane makes a road less congested at
peak hours, drivers who had previously avoided travel at peak hours will
start to use the road at those times. This increase in rush-hour drivers
means that the road will again become congested. This phenomenon is
often referred to as the ``fundamental law of highway congestion'':
increased capacity induces new traffic at peak times, so that moderate
increases in capacity do not eliminate congestion.

A solution that does address the tragedy of the commons is to charge a
price for using a road that reflects the extra delay each driver causes.
Congestion pricing refers to a policy of charging tolls that reflect
how crowded a road is at particular times. When drivers are required to
pay such a toll, some drivers will choose to travel at less crowded
times, take less crowded routes, or take alternative means of
transportation. Those for whom it is especially important to travel a
particular route at a particular time will pay the toll and be able to
travel without inefficient levels of delay.

Congestion pricing has proven effective in many areas in reducing
congestion and increasing traffic flows. For example, on a busy 10-mile
stretch of State Route 91 in Orange County, California, drivers can
choose between free lanes and toll lanes, for which prices adjust
during the day on a schedule designed to maintain a free flow of
traffic. Speeds in the toll lanes exceed 60 miles per hour even at the
busiest time of day, with the result that, at the busiest part of the
rush hour, each toll lane can produce almost twice as many vehicle trips
each hour as the nontoll lanes. Because prices discourage drivers from
entering the toll road when it is already crowded, traffic does not
become so dense that flows collapse, and the road is able to serve more
drivers during any given period of time.

More and more urban areas are becoming interested in using congestion
pricing as a way to alleviate clogged roadways. As part of its
Congestion Initiative, the Department of Transportation has developed
Urban Partnership Agreements with five cities across the country,
working with local authorities to mitigate the increasing congestion.
In August 2007, the Secretary of Transportation announced the selection
of Miami, Minneapolis/St. Paul, New York, San Francisco, and Seattle as
the cities chosen from dozens of applicants to receive a share of $850
million in Federal funds to help alleviate highway congestion and the
mounting costs it imposes. Each of these cities has developed plans to
use some form of congestion pricing to reduce traffic delays. For
example, New York City is proposing ``cordon pricing,'' following an
approach that has been successfully implemented in London and
Stockholm. Between 6:00 a.m. and 6:00 p.m. on weekdays, cars would pay
$8 per day to drive in the busiest parts of Manhattan, while trucks
would be charged $21. Vehicles driving in the area could be identified
by electronic ``E-Z Pass'' readers or, for vehicles without the readers,
through a license plate recognition system using digital cameras.

New York's plan is targeted at a heavily congested urban area; other
cities have followed different approaches targeted at certain roads or
stretches of road that are especially congested. On SR-520 in the
Seattle area, regional planners are proposing to use demand-based toll
rates both to alleviate peak-hour congestion and to raise funds to
replace a high-traffic bridge over Lake Washington. Under the plan,
toll rates would be updated in real time to reflect current traffic
conditions, and in-vehicle transponders and supplemental cameras would
collect the toll while drivers travel at highway speed.

Bridges

On August 1, 2007, the I-35W Bridge in Minneapolis collapsed, killing
13 people. This was the first collapse of this magnitude since May 2002,
when a barge collided with a bridge in Oklahoma, causing the collapse of
a section of I-40 and killing 14 people. The recent tragedy focused
national attention on the condition of our highway bridges. Bridge
repair and maintenance are important for two reasons: to ensure safety
and to maintain or increase the capacity of a bridge to carry traffic.

There are nearly 600,000 bridges in the United States. Bridges are
inspected using the National Bridge Inspection Standards, in most cases
every 2 years. The Department of Transportation collects this
information in the National Bridge Inventory, a database of information
on bridge conditions. About 12 percent of the bridges in the United
States are classified as "structurally deficient" by the Department of
Transportation, meaning that the bridge is subject to certain weight or
other restrictions due to its condition. This share has been shrinking
as States have focused greater resources on bridge maintenance and
repair (see Chart 6-3). These numbers suggest that bridges have become a
higher priority for States in recent years.





Ongoing inspection and maintenance is especially important for
bridges. Infrastructure investments should be based on a cost-benefit
analysis. In some cases, new projects might seem more appealing to
decisionmakers than routine maintenance, but maintenance is essential.
One way to encourage investment in projects with the greatest return
is to ensure greater transparency in reporting the costs and benefits
of different infrastructure projects. For example, by publicly
identifying the bridges in greatest need of repair, the National Bridge
Inventory may help generate political support for targeting resources
where they are most productive.

Railways

Railroads have played a central role in our Nation's history, linking
markets over long distances and helping create a national economy. Rail
continues to be an important mode of freight transportation,
particularly for heavy bulk materials such as coal. Chart 6-4 shows that
railroads carry almost one-third of the Nation's freight, measured in
terms of ton-miles, but because rail tends to be used for lower-priced
goods, this represents a small fraction of the total value of goods
shipped. In 1980, the Staggers Rail Act deregulated the freight rail
industry. At the time, observers expected prices to increase, but in
fact deregulation unleashed significant efficiencies and lower rates.
After decades without changes in rates or traffic, shipping rates have
fallen substantially in real terms since 1985, while the volume of
freight rail traffic has nearly doubled. In the last few years, rising
fuel prices have made rail an attractive alternative to trucking,
because railways are about three times more fuel efficient than trucks.
Increasing highway congestion may also have contributed to increasing
demand for rail. As a result of the increased demand for rail shipping,
its real price has increased for the first time in many years, and
railroads are investing increasing amounts in new capacity.

Railroads serve a variety of customers who face different sets of
options for shipping their freight. Some routes are served by only one
railroad, while other routes are served by competing railroads. Some
products (such as goods in containers) can be economically shipped by
road, whereas others (such as coal) may be prohibitively expensive to
truck over long distances.

Like roads and other infrastructure, rail systems are very capital
intensive, and railroads must pay the cost of maintaining their rail
lines and other capital stock regardless of the amount of freight they
carry. This creates difficulties for railroads that serve competitive
markets. To remain profitable overall, the total revenue from all
shipments must cover the railroad's capital costs. But a particular
shipment will increase a railroad's profit as long as revenue from that
shipment is greater than the marginal cost of that shipment. In markets






where shippers have an alternative to rail, this means that railroads
will offer rates to some shippers that do not cover a full share of
their capital costs. They make up for this by charging prices that
cover more than a shipment's share of capital costs in markets where
shippers do not have economical alternatives.

Understandably, many shippers in these markets complain that they pay
shipping rates substantially higher than those paid by shippers in more
competitive markets. However, the railroads' ability to charge
different rates to different shippers plays a vital role in enabling
railroads to maintain the large capital investments needed to operate a
railroad. If railroads were forced to charge the same price for all
freight, many shippers that have alternative shipping options would
respond to an increase in rail rates by shifting toward road, water, or
other transportation. This reduction in revenue would make railroad
capital investments less profitable, and the likely result would be
reductions in investment and in rail capacity. In the long run, the
result could be even higher shipping rates for those who continued to
use rail transportation.

Container Ports

Over 800 billion dollars worth of goods, representing over 40 percent
of U.S. trade, passes through U.S. seaports each year. Container
trade-that is, goods packed in containers that can be moved from ships
to trucks or trains without being unpacked-continues to grow
dramatically, more than doubling in the United States since 1995. All
of those goods pass through a relatively small number of facilities. A
complex system of cranes, berths, skilled labor, warehouses, and ground
transportation facilities is necessary to transfer goods from
oceangoing ships to the domestic transportation network.

Increases in global containerized trade have meant an increase in the
size of container ships. In the late 1980s, shipping companies
introduced the first container ships that were too large to use the
Panama Canal, and today such ``post-Panamax'' ships represent at least
30 percent of container shipping capacity. As ships have gotten bigger,
port traffic has become more concentrated among those ports with
waterways and port facilities capable of handling such large vessels.
Today, the 10 busiest U.S. ports handle 85 percent of U.S. container
traffic, up from 78 percent in 1995. Chart 6-5 shows that increased
concentration has been most noticeable at the 3 busiest U.S. ports
(Los Angeles, Long Beach, and New York), where the share of National
container traffic increased from 41 percent in 1995 to 49 percent in
2005.




Freight shipments into and out of the United States will continue
to grow along with the growth in U.S. trade. This increase in trade
flows will place tremendous demands not only on port facilities, but
also on the land-based systems that carry traffic to and from the port.
For example, the ports of Los Angeles and Long Beach together handle
container traffic representing over 10,000 truckloads each day (not to
mention goods shipped in tankers, dry bulk, and other ships). All of
this traffic must be accommodated on the roads and railways serving
the port.

Increased demands on port facilities are creating opportunities for
smaller ports to expand their traffic. For example, the Port of
Savannah, Georgia, more than tripled its container traffic between
1995 and 2005. Savannah's growth reflects significant investments in
expanding warehouses, docks, and rail yards, as well as the desire of
shippers to avoid congestion at the larger ports in New York and Los
Angeles. Increased U.S. sea trade also creates opportunities for ports
in Mexico and Canada, which can connect by road or rail to U.S. markets.
For example, a new container port in the town of Prince Rupert, British
Columbia, opened in 2007, offering facilities for the largest container
ships and rail connections to Chicago and the Midwest.

Faced with growing demands, congested ports have implemented
innovative strategies for reducing the attendant strain on local
infrastructure. The Ports of Los Angeles and Long Beach developed a
program called ``PierPass,'' designed to move traffic to off-peak periods
during the nights and weekends. Carriers unloading during peak hours pay
a surcharge of $100 for a 40-foot container, and proceeds from the
surcharge fund port operations during the weekend and overnight.
According to the program, 36 percent of the container volume at the
Los Angeles-Long Beach complex is now moved during the off-peak shifts,
removing 60,000 trucks from the roads during rush hour each week.


Aviation

Since 1975, the real price of air transportation has fallen, while the
number of miles traveled by air has grown by almost 300 percent. An
important part of these changes was the deregulation of the airline
industry in 1978. By permitting airlines to introduce new flights and
schedules, deregulation introduced competitive forces that have led to
entry by discount carriers and reductions in the real price of air
travel. In 2006, air travel generated approximately
$164 billion in revenue, equivalent to approximately 1.2 percent of GDP.

Air travel requires not only planes, but also runways, terminals, and
an air traffic control system to maintain a safe distance between
planes. The capacity of these systems has not increased as rapidly as
the growth of air traffic. Our air traffic control system is largely
based on antiquated technology. New investments in infrastructure have
been hampered by several factors, including political opposition from
communities near airports and the fact that air traffic control is
provided by a government bureaucracy that has no financial incentive to
respond efficiently to increased demand for its services.

Growing traffic has created congestion in both the Nation's airspace
and its airports. The result has been longer flight times and increased
delays. Airlines have accounted for congestion, in part, by building
more time into their schedules, although delays have grown despite the
longer schedules. Chart 6-6 shows that the average scheduled time for a
flight from New York's La Guardia airport to Atlanta's
Hartsfield-Jackson International Airport has increased from 2 hours and
18 minutes in 1988 to 2 hours and 34 minutes in 2006. The average delay
has also increased from 12 minutes in 1988 to over 20 minutes in 2006.
This has been the trend for the busiest routes in the continental United
States: for the 10 city pairs with the highest number of airline
passengers, scheduled times have increased by an average of 14 minutes,
and delay has increased by an average of 6 minutes. Delays have also
become more severe: for these same routes, the number of flights that
are delayed by more than 60 minutes has increased from 2.7 percent to
7.4 percent. The summer of 2007 saw especially severe flight delays,
with particularly acute problems in New York (see Box 6-2).





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Box 6-2: Delays at New York City Airports

Some of the worst air traffic congestion in the United States occurs
in the New York City area. Problems in New York have a large impact
on delays nationwide, because a large proportion of U.S. flights travel
to, from, or over New York airspace. Delays in New York became
especially acute in the summer of 2007, after restrictions were lifted on
landings and takeoffs at John F. Kennedy International Airport. With no
limitations on how many flights could be scheduled into the airport, the
number of scheduled flights increased by 20 percent, and far more flights
were scheduled to arrive during peak periods than the airport could
handle. The result was long delays: only 56 percent of flights arrived on
time during the summer of 2007, with especially severe delays in the
peak hours.

In September 2007, the President called on the Secretary of
Transportation to seek solutions to mounting air traffic congestion
and the frustrations it creates for passengers. The Federal Aviation
Administration convened an Aviation Rulemaking Committee to explore
ways of relieving congestion, including market-based mechanisms
such as congestion pricing or auctions for the right to land or take off
at congested times. In December, the Department of Transportation
announced that it would limit the number of flights to and from New
York airports beginning in spring 2008, while continuing to pursue
market-based approaches to reducing congestion in the near term.

History has shown that such market-based solutions can work. In
1968, for example, the Port Authority of New York and New Jersey
implemented a congestion-pricing fee on small aircraft by raising
the minimum landing fee during peak hours. As expected, travelers
responded to the price incentives: general aviation peak hour activity
declined by 30 percent, reducing delays at the region's airports.
----------------------------------------------------------------------

The Federal Aviation Administration, working with other agencies, has
begun an effort to expand capacity by upgrading the air traffic control
system. The Next Generation Air Transportation System (NextGen) would
use satellites and digital communications to provide both controllers
and pilots with a much more accurate picture of where planes are in the
airspace. Together with other technologies, these upgrades have the
potential to reduce the amount of separation necessary for safe flight,
allowing more planes to use a given amount of space and increasing the
system's capacity.

Airport congestion reflects capacity constraints and indicates a
failure to manage and price that capacity in a way that reflects the
costs each plane creates for air traffic control and for other users of
congested space. Each plane that lands or takes off at a busy airport
takes up roughly the same amount of space and time regardless of size,
but the fees paid for using an airport are much higher for larger
planes. The airport fees that airlines pay each time they land are based
on the weight of a plane, and the national air traffic control system is
funded largely by taxes on airline tickets. Both approaches mean that a
regional jet carrying 50 passengers pays much less than a large jet
carrying 200 passengers, even though each creates roughly the same burden
for air traffic control and the same amount of congestion in the
airspace. Similarly, fees are the same whether the airport is busy or
empty, even though scheduling an arrival at a busy time can generate
significant costs for other users. This system creates the wrong
incentives, encouraging airlines to use inefficiently small aircraft and
to schedule too many flights at the most popular airports and times of day.

The market-based mechanisms discussed earlier in this chapter can help
encourage airlines to use airport infrastructure more efficiently.
Different options are available for using market-based mechanisms to
manage airport congestion. One is to change the structure of landing fees
so that planes pay more to land at more congested times and airports.
Similar to congestion pricing on roadways, this would encourage
airlines and others to schedule flights at times when the airports and
airspace are less crowded. Another approach would be to fix the number
of landing and takeoff slots available during the busiest times of day,
and auction the right to use those slots. Slots would, in effect, be
leased for a fixed period of time, with slots turning over and being
reauctioned on a regular basis to accommodate new entrants and promote
competition. Assigning slots through a market process would have a
similar effect to congestion-based fees, because the price of slots at
the most popular times would be greater than those at less popular times.
Under either approach, airlines would have an incentive to schedule
flights at less busy times, and passengers who attach high value to
flying at busy times of day would be able to pay a premium to schedule
flights at those times with greater confidence that flights will be able
to depart on time.

Market-based mechanisms could also improve efficiency when airport
capacity is reduced as a result of bad weather or other temporary
problems. For example, airlines could pay a premium for the right to
land with higher priority when capacity is reduced. Airlines that pay
for higher priority could advertise their higher reliability, whereas
other airlines might offer price discounts to travelers who were willing
to accept a higher probability of delay.


The Electrical Grid

Although they transport electricity rather than goods or people,
power lines share important characteristics with roads and other
infrastructure. Building transmission lines requires a large capital
investment. Once this capacity is built, the marginal cost of
transmission is low as long as the amount of power being delivered is
less than the capacity of the lines.

The transmission of electric power was once primarily a local affair:
a utility generated electricity and distributed it on its own power
lines to the surrounding area, with rates set by a local regulator. But
over time, the United States has moved from this local model to one in
which the Nation is covered by grids of high-voltage transmission lines,
and power generated in one place may be used hundreds of miles away.
While some power plants continue to serve a particular local population,
others take advantage of the grid to sell their electricity on a
wholesale market.

By permitting power to be generated in low-cost areas and delivered to
high-cost areas, the national electrical grid can allow generating
capacity to be used much more efficiently. For example, on the West
Coast, long-distance transmission lines allow hydroelectric power from
Washington State to be transmitted to California to help meet peak
summer demand. Long-distance transmission can make alternative energy
sources more viable as the United States attempts to reduce its
dependence on fossil fuels (see Chapter 7). For example, production of
significant amounts of wind power is economically feasible only in
certain areas of the country. Similarly, it is easier to site power
plants in certain areas. Long-distance power lines mean that electricity
can be produced in areas where production is most efficient and
delivered to areas where it is most needed.

The legacy of State-regulated local utilities creates obstacles to
developing an efficient national electrical grid. One problem is
fragmented ownership of power lines. Different parts of the electrical
grid are owned and maintained by a large number of investor-owned
utilities and other entities, so that power may need to pass through
lines belonging to multiple parties before reaching its destination.
This can create coordination problems. Each utility must decide
independently how much to invest in the capacity of its power lines,
even though these decisions will affect many other parts of the network.
It may not make sense for one party to invest in greater capacity unless
others make similar investments.

Such problems are exacerbated by the fact that different regulators
govern different parts of the electrical grid. Utility investments
often must be approved by State or local regulators applying rules
designed for the model of a local utility. Regulators in one State may
not have incentives to account for the benefits of new transmission
capacity for residents of other States. In fact, regulators in an area
where production costs are low may object to making it easier for local
power generators to sell in areas where production costs are high,
because more power will flow to the high-cost market, potentially
raising wholesale prices in the local market in the short run. In the
long run, however, making trade in electricity easier will lead to
greater generating capacity in areas where electricity can be generated
at lowest cost. The Federal Government has taken steps to coordinate
interstate transmission projects by giving the Department of Energy the
authority to designate certain transmission corridors as high priority
and to help develop new capacity in those areas.


Telecommunications

Not long ago, the U.S. telecommunications infrastructure consisted
largely of copper wires used to transmit the human voice. Today,
information travels any number of ways-satellites, cellular systems,
and fiber optic cable, to name some examples-and industry continues to
develop new communication technologies. New choices mean consumers and
businesses enjoy the benefits of competition among providers. As
information technology becomes faster and cheaper, communication
infrastructure is allowing workers to telecommute and consumers to
shop online.


Broadband Internet Service

Broadband refers to Internet connections that can transmit data at
high speeds (the Federal Communications Commission defines a high-speed
connection as one that allows transfer rates greater than 200 kilobits
per second in at least one direction, but many connections are much
faster than this). As recently as 1999, broadband access was very rare,
but by 2007 nearly half the country had a broadband connection at home,
and the United States had over 80 million high-speed connections. Until
2005, almost all broadband users had either a cable modem or a digital
subscriber line (DSL) connection, but recently, mobile wireless
subscriptions have increased rapidly (see Chart 6-7).

Like other forms of infrastructure, broadband capacity requires large
capital expenditures, and once capacity is installed, the marginal cost
of delivering data over a line is close to zero. Telecommunications
companies have invested large amounts to expand broadband
infrastructure, installing new high-capacity transmission lines and
investing in new technology to send data over existing telephone and
cable wires.

Despite large fixed costs of deployment, there are multiple broadband
providers competing for subscribers in most U.S. markets. The Federal
Communications Commission (FCC) reports that by the end of 2006, over
80 percent of U.S. ZIP codes were served by at least four broadband
service providers. Nationwide, 79 percent of local telephone subscribers
had access to DSL, and 96 percent of cable subscribers had access to cable
Internet service. Broadband service provision remains an extremely
dynamic area, and telecommunications providers are exploring new models
to determine what type of broadband provision can produce the greatest
benefits for consumers. For example, last year, the fastest-growing
category of high-speed Internet





access was in mobile wireless connections-a category that grew from
about 3 million connections at the end of 2005 to over 20 million
connections at the end of 2006. Broadband providers are also offering
dramatically higher transmission speeds, enabling consumers to access
new services such as streaming video and voice-over Internet protocol
(VOIP). The tremendous value the Internet creates for consumers has
provided strong incentives for the private sector both to invest in
building out the Internet infrastructure and to innovate in finding
new ways of serving the market.

Wireless Communication

Wireless technology, such as that used in cellular phones, has been
one of the most dynamic sectors of the economy in recent years, with
considerable growth in both the number of users and the quality of
services. Today, the United States has 243 million wireless
subscribers, up from 16 million at the end of 1993. Several wireless
service providers compete to offer communication features that will
attract new customers, such as the opportunity to share pictures,
download news and other information, or view a map of their current
location and directions to their destination.

Wireless communications systems transmit radio signals using specific
frequencies of the radio spectrum. If different signals were to use the
same frequency, the result would be interference that prevents
communication. To prevent interference, the Government regulates who
can use each part of the spectrum. Private sector users obtain licenses
from the FCC that grant exclusive permission to transmit signals in a
certain area. Certain frequencies are reserved for use by Government
agencies, and use of this spectrum is coordinated through the National
Telecommunications and Information Administration in the Department of
Commerce.

The right to use spectrum is a scarce resource, with many competing
demands. Early in the history of radio, the U.S. Government began
allocating the right to use spectrum through an administrative process,
in which different potential users applied for licenses and the FCC
attempted to determine which use would generate the greatest social
benefit. This approach requires the Government to evaluate an enormous
amount of information about the competing benefits of using resources
in different ways. Markets can help solve this problem, because the
prices people are willing to pay for a scarce resource reflect all the
information they possess about how the resource can be best used.

Recognizing these benefits from market allocation, the U.S.
Government has moved to a system in which the right to use spectrum for
wireless communication is awarded through auctions. In 1994, the FCC
began a series of auctions for the rights to use spectrum for personal
communication services. Since then, the FCC has held about 70 spectrum
auctions, generating nearly $60 billion in revenue and opening up new
opportunities for firms to offer wireless services.

The spectrum auctions have put the right to use spectrum in the hands
of those who believe they can use it to generate the greatest value.
By creating clear property rights to use particular frequencies, the
auctions have given companies the incentives to invest in the
resources they have obtained. The result has been a rapid build-out
of networks of towers for cellular communication. Chart 6-8 shows
that the number of wireless transmitters in the United States has grown
from about 20,000 in 1995 to 210,000 in 2007-an increase of 22 percent
per year.

Through the President's Spectrum Management Initiative, the
Administration has sought ways to ensure that spectrum is used in the
way that generates the greatest value. One way to do this is to create
incentives for Government users of spectrum to consider the opportunity
cost of the spectrum they use. Currently, Government agencies obtain
spectrum licenses through an administrative process-in contrast to
other valuable resources, such as electricity and labor, for which they
must pay. Policies that lead agencies to recognize the cost of using
spectrum will encourage them to free up this resource when there are
others who could use it more efficiently.





Infrastructure Policy


Though the U.S. infrastructure systems face a diverse set of issues,
they have certain features in common, such as high capital costs and
limitations to capacity that create the potential for congestion. This
section discusses some of the key policy questions that are common to
many forms of infrastructure. First, how should infrastructure be paid
for? The price of infrastructure should reflect marginal cost, but this
may not be sufficient to cover capital costs. Second, how should
policymakers set priorities for infrastructure investment? In many
cases, the government can look to markets for ideas as to how to best
identify which projects have the greatest return. Third, should
infrastructure be provided by the private or public sector? Policymakers
can often choose between government provision and private sector
provision with some degree of government regulation. Fourth, when
should infrastructure be provided at the Federal level, and when is it
better provided at the State or local level?

How Should Infrastructure Be Paid For?

As discussed at the beginning of this chapter, efficient use of any
good or service requires that the price people pay for using the good
or service equals the extra cost they impose when they use it. If the
price is lower than this cost, people will have an incentive to overuse
the good or service. For example, if electricity is available for free,
consumers may leave lights on when they are not using them. If the price
is higher than the extra cost of providing the good, it will be
underused, creating a deadweight loss.

For much infrastructure, the marginal cost of extra use may be very
low or close to zero when use is well below capacity. This creates a
dilemma in financing infrastructure because encouraging efficient use
means setting the price equal to marginal cost. If this price is at or
near zero, revenue will not cover the cost of providing infrastructure,
requiring either a higher price or some other source of revenue. For
some forms of infrastructure, firms address this problem with a
two-part tariff: a fixed fee for access to the infrastructure, in
addition to a per-use fee that reflects the marginal cost of providing
the infrastructure. For example, telecommunications providers typically
charge users a monthly subscription fee but allow users to transmit as
much data as they like at little or no extra charge, reflecting the
fact that once a user is connected to the network, extra data
transmission involves little or no extra costs. This approach creates
efficient incentives for those consumers who subscribe, while still
allowing telecommunications providers to finance the cost of their
investment.

When roads or other infrastructure become congested, the efficient
response is to charge fees that reflect the cost each additional user
imposes on others. Congestion prices can lead to efficient decisions
about whether and when to use infrastructure and yield information
about where additional capacity would be most valuable.

Efficient tolls can also generate revenue that can help pay for
infrastructure. Fees collected through congestion pricing can be used
to fund expansion of existing infrastructure and reduce current
indirect taxes and fees. Under the right circumstances, efficient tolls
will be sufficient to completely fund new infrastructure construction-
meaning that congestion is reduced, while at the same time roads are
financed almost entirely by the drivers who use them during the
busiest periods.


How Should Government Set Priorities for
Infrastructure Projects?

In competitive markets, firms decide whether to invest in new
capacity based on the value that capacity creates for consumers. For
example, imagine a coffee shop that has long lines during the morning
rush. The shop's owner could shorten the wait by adding an extra
cashier. This would cost money, but would please her customers,
potentially leading to greater sales. The owner will add a cashier if
the extra coffee she can sell will generate enough revenue to justify
the extra expense.

In areas in which infrastructure investment is made by private
parties, such as broadband or wireless communications, companies
undertake exactly this type of analysis. Similarly, when the
government decides whether to undertake new infrastructure
investment, it should conduct an analysis similar to that of the
coffee shop owner, comparing the costs of a new project to the
benefits it generates for users. Rigorous cost-benefit analysis should
be used to determine whether the benefits of a particular project
outweigh its cost and whether the benefits of dollars spent are greater
than the social benefits from spending money in other areas.

Private sector firms use the prices consumers are willing to pay to
measure the benefits of extra investment. When the government makes
investment decisions, however, there is frequently no market price that
reflects how much consumers are willing to pay for greater capacity or
for a particular new project. When infrastructure is provided for free,
one cannot infer from heavy use that users attach a high value to using
certain infrastructure. Free access also makes it difficult to evaluate
users' stated preferences. For example, residents of a particular area
may be strong supporters of expanding a freeway serving their
community, given that they are able to use that freeway at no
additional charge. But this support is not responsive to the real
question that a policymaker would want to answer, which is whether
those residents would support the construction project if they had to
bear all of its associated costs, in addition to receiving the benefits.

The problem of determining the value users receive from infrastructure
projects is another argument on behalf of user fees that reflect
marginal cost. When users pay for the infrastructure they use, we can
be more confident that the infrastructure produces benefits that reflect
the cost.


When Should the Government Regulate or Provide
Infrastructure?

As discussed earlier in this chapter, infrastructure is often a
natural monopoly, meaning that one firm can serve the market more
cheaply than multiple firms could. This may create a role for the
government to prevent the distortions that result from monopoly
pricing. However, large capital costs by themselves do not necessarily
imply natural monopoly; when a market is large, it may support multiple
firms even though the costs of participating in the market are high.
When several firms compete to provide a service, government regulation
is not needed to prevent monopoly prices.

Technological innovation has the potential to fundamentally alter the
makeup of markets, and government regulation should adapt to changes in
market structure. Markets once dominated by monopolies can become
competitive over time due to innovation. Regulations should be
eliminated as markets become more competitive.

A good example of this phenomenon is telecommunications. Although the
industry was once dominated by a single firm or by a few large firms,
today numerous providers compete to provide customers with voice,
Internet, and video over numerous platforms, including telephone (DSL),
cable, fiber-optic, satellite, wireless, and even the electric grid. In
the face of such innovation and digital convergence, the government
must reassess legacy regulatory regimes and replace regulation with
competition wherever possible to most efficiently maximize consumer
welfare.

When infrastructure provision is a natural monopoly, economic theory
provides no clear answer to the question of whether infrastructure is
better provided directly by the government or by a regulated
monopolist. In both cases, decisions will be insulated from market
discipline. Government regulation of a private firm involves some
duplication of effort, because the regulator must examine firm
decisions to prevent abuses of monopoly power. But a government agency
may not have incentives to produce efficiently, because it does not
have the profit motive of the private sector. Private firms may also
be able to provide management with stronger incentives to increase
efficiency.

Empirical studies of privatization around the world have shown that,
in general, private firms in various industries produce and invest
more efficiently than state-owned enterprises. Although these
privatizations have occurred in a wide variety of different countries
and industries, privately run enterprises on average produce more
efficiently and invest more in their industry. Recent U.S. experiences
have also demonstrated that, in some cases, there can be benefits to
greater private sector involvement in provision of transportation
infrastructure.

Some urban areas, wanting to improve congested roads in the face of
tight budgets, have turned to private investors to build and operate
toll roads. In 1990, for example, Virginia authorized a private
investment partnership to construct the Dulles Greenway, a 14-mile
stretch of highway in a congested part of the Washington, D.C.,
metropolitan area. The partnership was authorized to collect tolls
that would provide no more than a reasonable return on the invested
funds. Since construction in the mid-1990s, the road has become an
integral part of the region's transportation network, carrying over
50,000 vehicles each day in 2006.

In 2005, the Federal Aviation Administration contracted with
Lockheed Martin to take over operation of the FAA's Automated Flight
Service Stations. These stations provide general aviation pilots with
weather briefings, updates on airport closings, flight plan assistance
and emergency communications. The contractor has successfully
consolidated operations and reduced costs, and the FAA projects that
it will save $2.2 billion over the contract's first 5-year period.
The FAA continues to monitor the stations to ensure quality and service
levels.

Although private firms have strong incentives to produce efficiently,
some argue that they will tend to provide a lower quality of service
than the government, because higher quality may yield lower profits.
This concern suggests that when government contracts with a private
firm to provide public infrastructure, it should pay careful attention
to the terms of the contract to ensure that the firm can be held
accountable for the quality of the infrastructure.

What Are the Proper Roles for State and Federal
Government?

Both the Federal and State Governments provide and regulate
infrastructure. For example, most funding for road construction and
maintenance is provided by the States, although substantial funds are
also raised through Federal taxes on fuel and other transportation
goods and then distributed to the States. Similarly, electricity
transmission is regulated both by the Federal Energy Regulatory
Commission and by State utility regulators.

There are advantages to making decisions about infrastructure policy
at the State level. State Governments can tailor infrastructure
decisions to local preferences and conditions, rather than providing
a single one-size-fits-all policy for the entire country. States that
implement policies that their citizens dislike will fail to attract
new people and businesses.

Federal provision or regulation can be important when infrastructure
in one State provides benefits to residents of other States. For
example, power lines transmit electricity across State borders, but
State electricity regulators may think only about how regulation
affects their own citizens. Federal regulation may be more appropriate
when State infrastructure produces national benefits. Similarly, State
Governments make decisions about infrastructure investment based on the
benefits to their own citizens, and will be reluctant to make
investments with their own taxpayers' money if a large share of the
benefits goes to out-of-state residents. The Federal Government should
take into account the total benefits to the Nation, so when
infrastructure projects provide significant cross-state benefits, it
may be best to set infrastructure policy at the Federal level.


Conclusion


Infrastructure policy is not simply an engineering problem of how best
to build the systems to meet the country's needs. Although Government
may play an important role because infrastructure provision is often a
natural monopoly, economic incentives matter and must be taken into
account. There are two central questions of infrastructure policy.
First, what investments in new capacity generate benefits that exceed
their costs? Second, how can we ensure that the capacity we invest in
is used in the most efficient way possible? By subjecting
infrastructure policy decisions to these threshold questions and using
market-based solutions where action is taken, Government-at the local,
State and Federal levels-will increase certainty that future
investments in infrastructure are socially worthwhile and allocated
appropriately.