A Model of Infrastructure Financing

Infrastructure projects often require large investments, can have long gestation periods, and typically involve multiple parties: government, private sector firms and outside investors. Government and private sector firms must expend effort to implement and maintain the projects, may derive private benefits in participating in the project, and may possess only limited information. Moreover, governments’ ability to finance infrastructure may be limited by fiscal deficits. These factors can potentially limit the willingness of the outside investors to supply capital. In this paper, we survey the approaches to infrastructure financing that have been developed in different parts of the world and offer a simple theory, which takes into considerations some of the ground realities in infrastructure investment projects. We show that government guarantees (for “bad states”) coupled with taxation of project revenues (in good “states”) mitigate the double moral hazard problem and leads to greater private sector investments in infrastructure projects. ∗New York University †Columbia University, ‡The current version of the paper is preliminary and incomplete. Comments are welcome.