In the news: Urbanization, Resource Scarcity, Cities, and Political Stalemates

(Updated March 35)

By John Macomber

Once you start tying phenomena together, the topics of our course are in the news everywhere. As we head into the last days of the Q3 term, here are a smattering just from the last week or two. It would be plausible to spring from these into an original post that applies some analysis or frameworks or segmentation to add the “so what” utility. Continue reading

A new way to fund infrastructure

By Alice Heathcote

In a recent class, it was noted that for all of our case studies on ‘new cities’ the developments were inevitably funded with a mixture of both public and private capital. The discussion seemed to conclude that you aren’t ever able to build new cities with the government or private sector alone.

I can think of an example which runs counter to that trend. In the western Pilbara desert of Australia, about 100km from anything that resembles civilization, there are the beginnings of construction for what will be one of the largest mining projects in the world, the Roy Hill Iron Ore mine. At an estimated value of $10 to 15billion, it’s worth more than the GDP of about 60 countries in the world. The mining project is majority owned by Australia’s Hancock Prospecting, with minority stakes held by a number of Asian industrials, including Marubeni Corporation and China Steel Corp. Continue reading

Markets build bad cities

By JW

The cases of Paredes and Dharavi are examples of a centralized approach to urban development. Both were led by private consortiums and supported by public-private partnerships. Both aimed to create a safer, more sustainable living and working environment for the people who would live there.  And, as we discussed, both seemed destined to fail. However, I would argue that we should draw markedly different conclusions from these failures about the role of central planning in the growth of cities.

There are two kinds of cities in the world – those home to over 50% of the world’s population today, and those that will absorb nearly 100% of future growth for the next four decades (with a considerable degree of overlap). Cities like Bombay are adding over a thousand people per day – new neighborhoods springing up overnight. Governments are able to direct this growth to an extent through regulation (e.g., zoning) and the provision public services (e.g., mass transit). Markets do the rest.

In the case of Dharavi, markets may be enough, provided slum dwellers gain legal ownership over their homes. Offering land rights to families who have lived in the same home for generations is a complex process, but one with a relatively clear outcome – organic, continuous real estate improvement. When managing a built environment, the government has far greater constraint on sweeping public works projects. The process of razing thousands of homes and relocating thousands of families in Dharavi was virtually guaranteed to be corrupt and unpopular.

At the same time, markets seem to be bad at developing sustainable cities. As most industries have become more efficient, real estate development by some measures has become less so. Living PlanIt proposed to eliminate the massive waste endemic in traditional construction and urban design by building a ‘city’ from scratch. While they ran up against massive coordination and complexity problems, the idea was cogent. Centralized planning and development can ensure that the design and spacing of every building makes sense from an efficiency standpoint, and capture huge savings in reduced energy use and CO2 emissions. While there is a risk of building a ghost town (e.g., in China), there are ways to mitigate this risk (e.g., using large businesses as anchor tenants).

As governments look to create room for new urban populations, they would do well to review examples such as Living PlanIt and New Songdo City for inspiration. Greenfielding a city center is no easy task, but getting it right may be the best way to create a sustainable path for urbanization. For existing urban centers, government should focus on installing the right regulations and public services, rather than rebuilding from scratch.

Charter Cities: A Tool to Address the Failures of Government?

By Anonymous

When public resources are limited, governments can use public-private partnerships (PPP) to solve their largest problems, while minimizing the use of public assets. However, what if the government and its policies are the problem? In places like the Dharavi slum of Mumbai, the government has failed for decades to enforce property rights and laws, provide basic sanitation or foster prosperous economic conditions. Solutions that do not address the failures of such governments are tantamount to treating the symptoms of a chronic medical condition instead of curing the disease; they are wasteful and only prolong the underlying issue. An optimal solution needs to address root problems with such a government; posing the question, can a PPP provide safety, security, sanitation and pro-growth economic conditions? In other words, can a PPP be leveraged to provide even the most basic public goods traditionally provided by the government?

Professor Paul Romer of NYU’s Stern School of business believes that PPPs can accomplish such goals in through the charter city concept. A charter city would create a special economic zone (SEZ) that would be administered by a semi-independent government, unrestricted by economic policies of the sovereign nation and funded by external investors. Residents could choose to live or work in the SEZ or to remain in their current conditions. Under such a system, the SEZ’s government could develop its own laws and electoral practices, provide its own services and create conditions amenable to economic growth. The sovereign state would receive tax revenue from the charter city for use of the land. In order to succeed, the SEZ would have to earn the trust of the residents by providing services superior to those of the sovereign nation. If successful, the practice could be scaled or better yet emulated by the sovereign government. Such a solution would address the root causes that lead to slums in Dharavi and provide the investment and incentives to both the residents and government to redevelop these areas.

Of course, Romer’s concept can be criticized due to the additional implementation challenges it faces. First, convincing a government to fire itself and outsource its sovereignty is a hurdle beyond the traditional challenges of development projects. In fact, political gridlock ultimately blocked Romer’s attempt to execute this model in Honduras. Furthermore, the concept can be interpreted as a privatized regression to colonialism, a model that would be met with deep suspicion in a country like India, which recently gained independence from its colonizers. However, with adequate protection of rights and enough transparency to demonstrate the fairness of system to all stakeholders, such challenges could be overcome.

However, as demonstrated by previous redevelopment efforts in Dharavi, PPP solutions are not effective if they do not address the problem underlying the need for development. In extreme cases like Dharavi, where the government is the problem, if implemented correctly, charter cities can provide the requisite change to provide sanitation, safety and opportunity to those whom have not received it from their governments.

Urban Transportation — Lessons learned from Colombia’s TransMilenio success vs. Germany’s Stuttgart 21 disaster

By Valerie Scheer

In 2012, Colombia’s infrastructure ranked #64 on World Bank’s Logistics Performance Index vs. #1 Germany [1]. However, this nation who prides itself on being highly disciplined and organized, failed miserably compared to the developing country. Columbia’s new BRT system (TransMilenio) and Germany’s Stuttgart 21 (remodeling of Stuttgart’s train station into an underground station) yielded different results.

Phase 1 of TransMilenio has been a huge success and became one of the most acclaimed and imitated transportation systems.

In contrast, Stuttgart 21 (construction period 2010 – 2021), is still highly controversial, sparking several large protests [2] and exploding budgets (from estimated €3 billion in 2009to €7 billion in 2012[3,4]) that might even lead to project cancellation [5].

So what are the key factors leading to success or failure?

 

1) Government Support

TransMilenio was built on the goodwill of politicians and strong leadership from the mayor, allowing for collaborative efforts and fast elimination of roadblocks.

Stuttgart 21 is challenged by financing from the EU, federal government, state government and German Railway — several parties with differing views and priorities. Unlike the former government, neither Stuttgart’s newly elected mayor (2012) nor the newly elected government of Baden-Württemberg (2011) is a big supporter of Stuttgart 21. Also recently, a report from the federal government leaked, calling continuation of the project into question [6].

2) Concept

TransMilenio has aspirations to expand substantially, yet has a sound economic business model (no operating subsidies, “modest” CAPEX of $240 million).

Stuttgart 21, in contrast, appears to be less about logistic or economic needs but more about building a legacy for key leaders. Several experts have argued for cheaper and equally efficient alternatives to Stuttgart 21.

A feasible, economic concept is not only important to ensuring project realization, but critical to creating public acceptance and reducing financial burden to the developer.

3) Stakeholders

TransMilenio involved key stakeholders (e.g., bus operators) early on in the planning and implemented large marketing campaigns.

Stuttgart 21 put the focus on obvious stakeholders (such as politicians and people living near the train station), completely neglecting the German population as a whole. The billions of tax Euros spent on this project in an era of high state debt gave way to strong opposition and public dissatisfaction was one strong reason why Baden-Württemberg’s former governing party of nearly 60 years has been deselected, leading to further decreased support of Stuttgart 21.

4) Project Structure/People

TransMilenio was realized within 36-month thanks to an appropriate project structure. Experts provided input and contractors were selected through a competitive bidding process [7].

While Stuttgart 21 also implemented competitive bidding and German Railway had extensive experience developing train stations, several issues prevented a more efficient project.

Given the number of financiers involved, the project took many years from idea (1994) to realization, resulting in compromises and increased costs. Also, as a state-owned company, German Railway’s board of directors comprises predominantly of politicians with lack of infrastructure expertise and potential conflict of interest (Baden-Württemberg’s Minister of Transport is also on the council of a RE-developer building a new mall on the old train station land [8]).

 

Summarizing these differences one could question whether Stuttgart 21 would have been more successful with a PPP (as for TransMilenio)?

 

 

[1] The World Bank, Logistics Performance Index 2012   http://lpisurvey.worldbank.org/international/global?sort=asc&order=Infrastructure#datatable

[2] Stuttgarter Zeitung, So viel Protest wie noch nie                                  http://www.stuttgarter-zeitung.de/inhalt.demonstration-gegen-s-21-so-viel-protest-wie-noch-nie.dedd248a-36a7-49ca-8a31-2b1cd57b0399.html

[3] State parliament of Baden-Württemberg, Finanzierungsverträge zum Bahnprojekt Stuttgart–Ulm                                                                                            http://www9.landtag-bw.de/WP14/Drucksachen/4000/14_4382_d.pdf

[4] Der Spiegel, Bahn-Prestigeprojekt: Ramsauer spielt Kritik an Stuttgart 21 herunter http://www.spiegel.de/politik/deutschland/regierung-spielt-zweifel-an-stuttgart-21-herunter-a-881593.html

[5] Der Spiegel, Prognosen der Bahn: Regierung bezweifelt Ausstiegskosten für Stuttgart 21                                                    http://www.spiegel.de/wirtschaft/soziales/stuttgart-21-aufsichtsraete-zweifeln-an-kosten-fuer-den-ausstieg-a-882243.html

[6] Stuttgarter Zeitung, Beim Bund mehren sich die Zweifel an Stuttgart 21 http://www.stuttgarter-zeitung.de/inhalt.vertrauliches-dossier-beim-bund-mehren-sich-die-zweifel-an-stuttgart-21.4b46aa2c-3c0a-47fc-9a97-e54480e542f4.html

[7] The National Council for Public-Private Partnerships , TransMilenio Case Study http://www.ncppp.org/undp/bogota.html

[8] Die Zeit, Ministerin Gönner sieht sich mit Filz-Vorwurf konfrontiert    http://www.zeit.de/wirtschaft/unternehmen/2010-10/stuttgart-goenner-einkaufszentrum

Picture_Stuttgart 21

Picture: Der Mobilitäts Manger, Stuttgart 21 vermutlich bis zu 1 Mrd. Euro teurer                                     http://dmm.travel/news/artikel/lesen/2012/12/stuttgart-21-bis-zu-1-mrd-euro-teurer-47051/

 

Slum improvement – paternalism versus practicality

By Jonathan

In class we discussed the stunning complexity involved in redeveloping the Dharavi slum in Mumbai. The solution proposed for Dharavi, while innovative in its structure and economics had some clear faults, not the least of which being it provided very little autonomy to the residents of the neighborhood. The timetable, terms, conditions, and construction and design decisions would be made by a select few and imposed on the 700,000 residents of the slum. What’s more, given this centrally-planned approach the resulting community would likely feel monolithic, sterile and completely inorganic.

As flawed as this approach is, it remains an improvement over the most often discussed alternative – providing property rights to the current residents of Dharavi and allowing them to develop the land as they see fit. Technical complexities aside, this alternative approach appears to solve some of the most troubling problems posed by the large-scale, centrally-controlled scheme. First and foremost, it provides the residents complete control over their assets, just as they would have if they lived in non-slum areas. Along with these decision rights come the dignity and respect that all citizens, slum-residents and otherwise, deserve. Additionally, this alterative represents a far less disruptive approach to redeveloping the slum. It wouldn’t necessarily require the wholesale removal of people from their homes to accommodate the massive, simultaneous construction projects. Furthermore, this piecemeal style of development may encourage a more organic-feeling community that is often so lacking in centrally-planned neighborhoods.

While these benefits are not to be discounted, I’m afraid the land-rights approach simply would not work in practice, particularly in a slum like Dharavi where the land values are so high. The first reason I find a flaw in this is that it provides no protection for the citizens from unscrupulous developers that want to take advantage of a slum dweller who is almost certainly inexperienced in dealing with real estate assets, particularly ones of such high value. It’s easy to imagine how this could go wrong. Residents could be cheated out of their property, manipulated or pressured into selling it at discounted rates, and so on. With little to no experience in this regard, they would be unprepared for the challenges of managing their new assets. Furthermore, given the density of the Dharavi I fear the resulting set of property rights would be so fragmented as to prevent any development of meaningful size or scope. Coordinating the perhaps hundreds of property owners that would be required to build a large building could prove so cumbersome that the land would remain undeveloped for years to come.

While never an advocate for paternalism, I’m concerned that there is no superior alternative to the centrally-planned approach. The Dharavi area is in a unique position to take advantage of its sky-high property prices and provide its residents with new, improved housing. While this is far from perfect, I do believe it ultimately provides the greatest benefit to the Dharavi citizens.

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The importance of incentives in making public private partnerships (PPP) work

By Nour El Hoda Farrag

Governments’ objectives have been called into question regarding capital intensive infrastructure projects in which private sector investors participate. At least two cases we’ve studied, Poland’s A2 Motorway and India’s Dharavi, allude to such tension. The cases, however, also establish governments’ inability to undertake such projects on their own, and the importance of the private sector in securing financing needed and ensuring coordinated, efficient execution. The purpose of this blog is not to evaluate governments’ decision to implement such projects, but to highlight challenges faced by the government once the decision has been made and to defend incentives offered to attract private sector players.

In India’s Dharavi case, improvement/redevelopment of India’s largest slum was product of a long iterative process; the idea has been around since the 1970’s. The final and only successful attempt to get traction from private sector participants was based on a strong incentive scheme, which leveraged booming real estate prices. The project’s economics as set forth in the case suggest that real estate developers can only benefit from the gain achieved on the sale of commercial projects. At a profit margin of 10%, the project’s economics are unattractive against a system lending rate of 13% for 2008. After incorporating “bidder’s premium” captured by the government, net profit represented 39% (not taking into account time value of money) of the equity tranche contributed by the private sector. This implies that in order to recover their equity and earn a profit, private investors might need to refinance the loan portion as the underlying value of the project increases, and dividend out proceeds. Alternatively, private sector developers can employ creative design (increased tower/unit density) to maximize profit, but this is subject to government limits/ratio of commercial to residential land utilization. Accordingly, government’s bidder’s premium, representing 6% of total cost and revenue, is relatively insignificant. In my view, the purpose of such premium is to fend off public criticism of squandering/giving away public assets, and not to profit from the slum’s redevelopment.

Similarly, in the case of Poland’s A2 Motorway, private investors’/industrials’ estimated financial IRR was 10% over 23 years of the 40-year “build-operate-transfer” (BOT) contract, according to my calculation (assuming no increase in revenue beyond year 23, IRR falls to 8%). Against a backdrop of 10% inflation rate and 17% bank lending rate for 1999; such returns are not attractive. However, aggregated with income earned from actual development enhances the project’s feasibility for private investors, while their equity contribution (“skin in the game”) hedges execution risk.

Coming from a developing country, I have witnessed government-promoted developments that came under public pressure. Especially in real estate projects, critics fail to attribute improved conditions/land prices to the projects’ success with the benefit of hindsight. In one example, the government had offered land at discounted prices to a real estate developer who in turn had transformed it into high-profile and over-subscribed developments for middle-income households. The developer introduced basic infrastructure to what otherwise would have remained a desert. Had he not been properly incentivized to do so, none of his successful projects would have come to fruition. Granted, the project was a for-profit development, it contributed to the country’s much-needed sustainable urban development, while the government earned a mild return in-kind, and through taxes post-completion.

If we agree that such infrastructure projects are critical from a sustainable development point of view, creating an offer that private sector investors can’t refuse is critical to successful implementation, which in turn should be the government’s main objective.  Because long-term government backing in such projects is essential, private investors also bear significant political risk, which should be acknowledged and compensated for.

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