Authors: José A. Gómez-Ibáñez, Zhi Liu
Across the globe, there is an urgent demand for infrastructure construction and upgrading. Yet governments frequently struggle to cover the high costs of infrastructure development and maintenance. Two chapters in the new book Infrastructure Economics and Policy: International Perspectives, published by the Lincoln Institute of Land Policy, address infrastructure finance and introduce replicable innovative financing models.
Fundamentals of Infrastructure Finance
In Chapter 9, Akash Deep, an economist at the Harvard Kennedy School, explains why financing constitutes a core challenge for infrastructure development. Governments are generally required to front all infrastructure costs upfront, while corresponding benefits accrue gradually over many years. This timing mismatch between costs and benefits is typically bridged through borrowing.
It is critical to distinguish financing from funding. The funder refers to the entity that ultimately bears infrastructure costs, which can be the general public via taxation or direct end-users through user charges. Parties engaged in project financing are borrowers and lenders, who resolve the temporal imbalance between costs and benefits. Both public and private entities may act as borrowers or lenders. Capital structure is designed to reflect risk levels and financing costs, thereby determining the financial value of infrastructure. Appropriate structural design and risk allocation can render infrastructure finance more efficient and less risky.
Infrastructure investments usually feature lengthy payback periods, making them less appealing to investors compared with other asset classes. Deep elaborates on innovative potential in infrastructure financing, including tapping into massive, steadily growing savings held by insurance and pension funds. Fund managers favor infrastructure’s modest yet stable long-term returns, but their debt portfolios are generally required to maintain investment-grade credit ratings. To mitigate investment risks for insurance and pension funds, the European Investment Bank offers two credit enhancement tools: direct financing via subordinated debt and financial guarantees.
The infrastructure fund model, pioneered by Australia’s Macquarie Group in 1996, has become a widely replicated innovation. Macquarie introduced mechanisms including equity pooling across multiple projects, active asset management, financial engineering, and capital market listing. These measures improved the liquidity of infrastructure equity funds, rendering them highly attractive to pension funds. Such infrastructure funds draw both institutional and retail investors, greatly expanding the pool of equity capital available for infrastructure investment.
Infrastructure Finance via Land Value Capture (LVC)
The costs and benefits generated by infrastructure projects are location-specific. In urban areas where land supply is constrained and fixed infrastructure assets are immobile, infrastructure improvements commonly push up surrounding land values. Under such circumstances, public authorities can finance infrastructure upgrades by levying property taxes, selling development rights, or adopting similar tools to capture all or part of the land value appreciation created by public works. These mechanisms ensure that parties who reap benefits bear the costs of infrastructure development.
Chapter 10 is co-authored by José A. Gómez-Ibáñez, Yu-Hung Hong (former Director of the Samuel Tak Lee Real Estate Entrepreneurship Lab at MIT), and Du Huynh of Fulbright University Vietnam. It reviews global practices of land value capture. The authors argue that land value capture holds particular promise for developing nations, which face enormous infrastructure demand yet lack diversified funding channels. Chapter 10 focuses on Brazil and their experience with the sale of development rights, one of the most vital land value capture instruments.
The São Paulo case in Brazil is internationally renowned and widely acclaimed. The city rolled out a market-based value capture program by auctioning Certificates of Additional Construction Potential (CEPACs) to developers, granting them the right to build at higher densities in designated zones. Revenues generated from auctions have been allocated to affordable housing, transportation upgrades and other public amenities. Ho Chi Minh City in Vietnam sold rural land development rights through ad-hoc special procedures to advance urbanization, though the practice remains highly controversial.
Both cases verify that the sale of development rights can generate substantial proceeds, often sufficient to cover additional infrastructure required for new development. However, they also demonstrate that successful implementation hinges on clear, widely recognized property right delineation. Equally essential are land registration systems, impartial judicial institutions to record and protect property rights, a realistic, granular comprehensive land use master plan, and politically adept project advocates. Governments worldwide are exploring innovative infrastructure financing mechanisms. Given the global urgent need for infrastructure construction and renovation, these approaches deserve broader adoption and implementation.
About the Authors
José A. Gómez-Ibáñez, Derek C. Bok Professor Emeritus of Urban Planning and Public Policy, Harvard University
Zhi Liu, Senior Fellow and Director of the China Program, Lincoln Institute of Land Policy
Image Credit: Octavio Frias de Oliveira Bridge, São Paulo, Brazil, R. M. Nunes via iStock/Getty Images Plus
