Federal infrastructure loan programs are well-positioned — for obvious and not-so-obvious reasons — to offer contingent loans for climate adaptation investment in public infrastructure projects.
Two things are certain. The first is that a lot of basic public infrastructure will need to be built, replaced or rehabilitated in the near term. The second is that these long-lived projects will be operating for decades in changing climate conditions.
These certainties create a potentially expensive uncertainty. Decisions about the benefits and costs of climate adaptation must be made when projects are designed and built. But a major input of that decision is now a moving target because the climate conditions in which the project will operate can’t be predicted with confidence. Climate systems are too complex to model precisely and there’s not enough data for accurate extrapolation yet. What’s the real chance over the next thirty or forty years of what used to be a 100-year rainfall, drought or sea-level rise event? It’s certainly going to be different than the historical baseline, but by how much? We’ll find out eventually. But by then we’ll need to live with the outcomes of infrastructure decisions that are made today. And there’s plenty of scope for expensive mistakes both in projects that are over-adapted (if conditions are closer to current baseline trends) and those that are under-adapted (if conditions are extreme).
These decisions are especially tough for public infrastructure in the US, most of which is funded at the state and local level. It’s hard enough to get people to accept higher rates or taxes to pay for basic replacements and upgrades that have certain and immediately visible value to their own community. Proposing even higher rates or taxes for additional adaptation investment that may (or may not) have value (at some point) in the future is a heavy lift that many local politicians won’t attempt. Regardless of nuanced analyses or the simple prudence of erring on the side of caution, in many cases a local consensus for funding will not be practically possible. Adaptation investment will too often be another can that gets kicked down the road.
That’s bad enough on a local level. But the impact of widespread under-adapted basic infrastructure on an aggregate national level will be much worse if extreme conditions develop due to infrastructure’s very significant direct and indirect network effects. A national undersupply of adaptation investment is the most likely result of cumulative local decisions. Accepting that outcome – or simply ignoring it — becomes in effect a gigantic national bet that the investment won’t turn out to be necessary. Are we feeling lucky?
Adaptation Investment is a National Public Good
There’s a straightforward and non-ideological case for federal involvement in this situation, right out of the economic textbooks. On a national level, if conditions prove to be relatively benign, the cost of writing off an over-supply of infrastructure adaptation investment will likely be far less than the unbounded direct and indirect costs of a pervasive under-supply if extreme conditions arise. This can be seen as analogous to a classic public good – national defense. Everyone hopes that it isn’t needed. Its specific local utility is highly variable. And certainly, no one wants to pay for it. But it’s universally acknowledged that the cost of being adequately prepared for an uncertain (and ideally, strenuously avoided) event with big national-level implications is much, much less than the alternative. As a result, there is a national consensus to pay for what usually will be (in grateful hindsight) an over-supply of defense resources. Luck is not part of the discussion.
As a national public good, climate adaptation investment for basic public infrastructure should in theory be funded with national resources – federal taxes, in effect. And in many cases, that straightforward path will be both appropriate in terms of optimizing resource use and (perhaps more importantly) practical in terms of politics.
But direct federal funding shouldn’t be seen as the only path for federal climate adaptation investment for local infrastructure, for two reasons. The first is that federal deficits, in substance and in practical political form, will be a limiting factor. The new Administration has a big agenda, one that will necessarily entail big deficits. Any innovative policy approach that can lessen its deficit impact while still achieving its goal should be considered – right out of the gate, because hitting the deficit wall (real, political or both) is not a question of ‘if’ but ‘when’.
The second, more fundamental, reason is that in the case of climate adaptation investment for state and local public infrastructure, there will be a visible local benefit when extreme conditions actually develop. Such localized benefits create a path for localized funding from communities that will then be both able and willing to provide it. As noted above, it’s hard to get people to pay for a hypothetical. It’s much easier when things have become distinctly and indisputably real – the sea is suddenly flooding stormwater systems or reservoirs are drained to the bottom. And the effects of extreme climate conditions on local infrastructure won’t be hard to see for people who live nearby or rely on its services – our flooded sewers, our empty reservoirs.
Since planning long-lived infrastructure involves thinking about the future anyway, state and local public infrastructure agencies (and even politicians) can easily imagine all this and realistically assume that when extreme conditions do develop, they’ll be able to access local funding through tax or rate rises to pay for local adaptation. Of course, as noted above, that funding is still contingent on uncertain future conditions. But infrastructure investment decisions need to be made today. Can this non-federal source of future funding (solid, but contingent on observable future events) be connected to paying for adaptation investment today, when it’s far more efficient to do so?
Federal Infrastructure Loan Programs
This where federal infrastructure loan programs can play a role. Enabling current public investment with future funding is what long-term public finance is all about, so the basic framework is already there. The time frame of public infrastructure lending (forty or fifty years, corresponding to the useful lives of these assets) also fits with the expected arrival of extreme conditions and the potential confirmation that yes, adaptation was a very good idea. Finally, federal infrastructure programs like WIFIA and TIFIA are already fundamentally based on local investment decisions that must be backed by a secure and long-lasting source of local funding.
The missing piece is simply the contingent nature of that future funding. If extreme conditions, which can be defined in terms of painfully precise and observable metrics like sea level and annual rainfall, occur by or within a specified time period, local funding for the adaptation investment made years before will be there. If not, then it won’t. The financial mechanics of a long-term loan for climate adaptation investment that reflects this well-defined contingency are equally straightforward. If extreme conditions arrive, so will funding and the loan will be repaid in full. If we’re lucky and future climate conditions aren’t extreme, funding for the now-unnecessary investment will not be forthcoming. And the loan won’t be repaid. There are infinite variations and gradations on this theme, but the basic story is the same.
The only hard part is the critical one: What lender would make such a contingent loan? Since it’s safe to assume that no one (certainly no institutional lender, in any case) has divine prescience about future climate, the rational basis of a climate contingent loan will be some type of hedging investment that pays more if extreme conditions don’t arrive. It’s easy to imagine that private-sector markets will eventually develop and sell such hedges, and that public sector infrastructure agencies will be able access loans with climate contingent features. That’s a topic for a future post.
For now, the only realistic source of climate contingent infrastructure finance is the federal government, which is consistent with the fact that climate adaptation is a national public good. However, if properly understood (I know…) this does not bring us back to the deficit wall. For one obvious thing, if extreme conditions arrive, the federal lender will be fully paid back from non-federal local sources, who will be appreciating their well-adapted local infrastructure.
But another, less-obvious thing is the compelling reason why federal infrastructure loan programs should offer climate contingent loans. Yes, if extreme conditions don’t arrive, some or all of the contingent part of the loan portfolio will need to be written off. But under those fortunate conditions, the federal government will be looking at far fewer obligations than extreme conditions would have certainly entailed. And most of those obligations would be in the giant deficit-generating, current emergency and disaster spending category — just when revenues are likely plummeting as climate conditions hit the national economy. If those bullets are dodged, the national balance sheet will easily absorb some infrastructure loan write-offs, likely accompanied not by criticism, but much sighing of relief.
In effect, the federal government is – like it or not — already a naturally hedged lender to climate contingent infrastructure loans due to its overall risk exposure to climate conditions. In extreme conditions, the loans will pay off just when the revenue is most needed to cover other ineluctable obligations. In more benign conditions, they won’t, but other federal spending will be lower and revenues higher. This economic efficiency is on top of the solid (if somewhat theoretical) rationale for climate adaptation investment as a national public good, as well as the less solid (but completely untheoretical) arguments for adaptation investment as a near-term source of jobs and stimulus.
Climate adaptation investment is likely one of the most important things that federal loan programs can encourage. But it may also be one of the hardest. Contingent loans would seem to be a useful tool for that mission. They’ll fit into the existing framework of programs like WIFIA and TIFIA, so possible development can get into concrete details quickly. More fundamentally, this type of loan can help hedge the climate risks the federal government faces anyway. Recognizing difficult realities is always a good place to start.
Short technical sketch about how Contingent Loans might work at the WIFIA Loan Program.