Partnerships, privatisation & the public interest
"Six years ago, we were looking at returns of 15 per cent, now we are looking at 10 or 12 per cent, because the market is expanding and maturing. But then again, 12 per cent is not a bad return these days." 1
This is what one British PPP Executive recently told an AFR journalist. With returns of around 10 to 12 per cent PPPs have been a gravy train for consultants, lawyers and developers in Britain. But slightly lower returns are shifting their attention to countries like Australia, where the tantalizing prospect of 15 per cent returns remain. The market for PPP projects is projected to be worth around US $35 billion by 2007.2 Around 74 Private Finance Initiative (PFI) projects worth around Â£5.1 billion have been completed in Britain. Many European governments, including Ireland and the Netherlands, are going down the PPP path and are establishing PPP units within government. The Netherlands has around 40 projects either underway or under consideration.3 The global infrastructure industry is in town looking for new opportunities for investment. They are well resourced and persuasive, lobbying hard to sell the benefits of PPPs. The prospect of funding new infrastructure projects without increasing taxes or increasing public debt is the main message. Sounds to good to be true? It is.
Most analysts agree that South Australia's public infrastructure is ageing and in need of modernisation. The need for substantial new infrastructure investment is pressing, but resources available through the state budget are limited and borrowing is unfashionable. Responding to this challenge, the state government is considering different methods of financing infrastructure development. It rightly recognises that South Australia's future prosperity will greatly depend upon a substantial increase in public and private infrastructure investment over the next five to ten years.
Concern about the impact of direct financing of infrastructure projects upon public sector debt levels is driving the obsession with PPPs. In essence, PPPs shift responsibility for the funding of infrastructure and services from the public sector to the private sector. This is a very attractive option to state governments straight-jacketed by their commitments to no new taxes and lowering public debt. In my view the widespread use of PPPs internationally and in Australia represents a third wave of privatisation. It is driven by an influential PPP industry and governments willing to conspire in the face of overwhelming evidence that PPPs are not the optimal solution to the infrastructure investment crisis facing Australia.
Why are governments so enthusiastic about PPPs? Historically, the South Australian government has been the major source of finance for key infrastructure projects. It has used its capacity to borrow at more favourable terms than the private sector to achieve this. Significant investment in infrastructure by the state government has created direct and indirect benefits for the private sector. The building and construction industry has been a major direct beneficiary, while the private sector as a whole has benefited from the increased efficiencies and advantages that flow from the existence of modern infrastructure such as roads, telecommunications, education and health systems. Once completed, publicly funded infrastructure projects have been the property of government.
In an attempt to reduce exposure to risk and public debt, governments are retreating from direct financing of infrastructure. This is being achieved through long-term lease arrangements with the private sector. Such arrangements are a feature of PPP programs. Some regard these methods of financing infrastructure as a pragmatic necessity to reduce exposure to risk and public sector debt. They argue that private financing of infrastructure is a necessity given the lack of public funds available. Others are concerned that government cannot afford to allow infrastructure like electricity, water, hospitals and schools to fail, so the government will inevitably be exposed to risk when private sector failure arises. In any case, they assert that it is more cost effective for the public sector to fund such infrastructure given the lower cost of capital available to government compared to the private sector.
The financing mechanism underpinning PPPs has its origins in the Thatcher government's attempt to move debt 'off balance' sheet in order to create the illusion that public sector debt levels are declining. The legacy of 'balanced budgets' and tax cuts made fashionable by the Thatcher government remains with us, with most governments finding PPPs an attractive option. This is essentially because government payments on PPPs are regarded as expenses rather than debt. As such, the payments that governments make over a twenty to thirty year period towards PPP projects are kept 'off balance' sheet, ensuring no addition to officially measured public debt. It seems ironic that PPPs are gaining momentum in contexts where public debt is historically low.
On the gravy train Cashed-up superannuation funds and financial institutions see PPPs as relatively low risk investments, with assured revenue flows from government over a twenty to thirty year period. With the promise of a steady flow of revenue and a relatively low risk investment structure, the private sector cannot be blamed for taking a strong interest in PPPs. A toll-highway project in Nova Scotia illustrates one reason why they might be so interested: On the Nova Scotia toll-highway project ... the government not only raised the speed limit of the toll highway, but lowered the speed limit on the alternative route, thereby increasing demand for the new road. And trucks were obligated to use the toll road unless they had a secondary road delivery address on their waybill.4
Many of the microeconomic reform policies that have been implemented in Australia began life in the UK, mostly under the Thatcher and Major conservative governments. Examples include privatisation, competitive tendering and contracting, pool markets for electricity and, most recently, PPPs, which were introduced in the UK as PFIs. In all these cases, the policy process has followed a similar pattern. Initial reports from the UK suggest that the policy has been wildly successful. These reports generate enthusiasm in Australia. By the time the policy is ready for implementation in Australia, serious problems have emerged in Britain. Australian advocates of microeconomic reform make changes which, it is claimed, will overcome all the defects of the British approach. With an inquiry into PPPs emerging from the recent British Labour Party conference, the Blair government is under intense pressure to wind back its ambitious PPP program. So what are some of the concerns about the program so far?
Core or non-core The case for PPPs has, in part, been justified on a division between core (teaching, clinical services) and non-core services (such as facilities management). This is misleading because such a division can rarely be made in practice. In practice, PPPs are not being limited to the provision of buildings and related services. The British government recently negotiated with private health companies seeking to control 26 new National Health Service fast-track diagnosis and surgery centres employing doctors, nurses and all clinical and non-clinical services. Once the private sector controls the operational management of facilities, it is in a powerful position to influence service delivery policies.
Relative cost of finance Advocates of PPP's cannot escape the fact that privately financed projects normally incur higher interest rates on borrowings.5 A sample of PFI schemes in Britain concluded that the current weighted average cost of private sector capital on PFI projects is 1-3 percentage points higher than public sector borrowing. The British government has claimed that the private sector "can compensate for the higher cost of borrowing" by being more innovative in design, construction, maintenance and operation over the life of a contract by: avoiding "costly over-specification in design"; creating greater efficiencies and synergies between design and operation; investing in the quality of the asset to reduce maintenance costs; and "managing risk better".6 These claims don't stack up against experience.
Project costs Escalating project costs are a common feature of PFI/PPPs. For example, costs for a Birmingham City Councils schools project rose from Â£20 million for eight schools to Â£65 million for ten schools prior to selecting a preferred bidder (ADLO, 1999). The first 14 National Health System projects had an average 69 per cent project cost increase.
Future commitments PFI/PPP contracts commit public bodies to payments for 25-35 years. This binds future governments to allocating substantial budget expenditure to PPP payments. By 1999, future commitments for PFI projects in Britain totalled Â£83.8 billion (up to 2026).7 The cumulative impact of PFI/PPP payments will mean future governments may have to raise taxes, impose charges for services which are currently free, reduce borrowing available to fund existing public services, or cut spending.
Transaction costs There are considerable costs to government associated with implementing PPP projects.8 The 'adviser' costs of the first fifteen NHS PFI hospitals were Â£45.2 million. Adviser's fees represented between 2.4 per cent and 8.7 per cent of the capital cost of the projects. The British Home Office alone spent Â£5.3 million on legal and accountancy fees between May 1997 and March 2001 for PFI schemes in the prison service and various IT projects.9 The cost of public sector staff time in developing PFI projects and the cost of the procurement process is rarely taken into account, so the actual transaction costs are substantially higher.
Impact on labour standards and employment The PFI is estimated to result in 150,000 transfers and 30,000 job losses between 1998-2007.10 Most facilities management staff in schools and hospitals are women. They take the brunt of job losses and wage cuts.
The Australian experience
Most state governments now have PPP policies and programs in operation. The South Australian government has just released its draft guidelines for consultation. Before having a look at these, it is worth reviewing interstate experience.
New South Wales
Project: Sydney airport rail link
The Sydney airport rail link involved the construction of a 10 kilometre underground railway line linking the Sydney CBD to the airport. The former Coalition Minister for Transport, Bruce Baird, called for expressions of interest for the privately funded rail link in October 1990. Minister Baird assured the community that the "airport link will not require one cent of government money".11
The experience so far: By January 1994 it was clear that the government would pay $470 million out of the $600 million cost. Over the five years since the contracts were signed, the taxpayer contribution continued to grow. In May 1996 the taxpayer had contributed $570 million. Furthermore, a station at Wolli Creek added a another $130 million, amounting to a bill of $700 million. In July 2000 one of the PPP consortium members, ALC, lodged a claim with the State Rail Authority claiming $15 million. In November 2000 the consortium defaulted on a $200 million loan with the National Bank. ALC went into receivership on 30 November 2000.
A number of other critical problems arose with the project. Passenger levels were projected to be around 48,000 when the link opened, rising to 68,000 within 10 years. In practice they were around 12,000 a day. Problems with the service included overcrowded carriages at peak times, lack of luggage space and high ticket prices. A one-way ticket from the airport station at Mascot to the city's Central Station is $9, compared with $7 on a bus and approximately $22 by taxi. The end result of this PPP was that the NSW Carr Labor government had to bail out the project, costing taxpayers $704 million.
Project: Airport-city Rail Link
The Airtrain-city rail link commenced on 7 May 2001. Airtrain links Brisbane's international and domestic airport terminals with Brisbane and the Gold Coast. Airtrain Citylink Limited will operate this service under a build, own, operate and transfer (BOOT) arrangement. The private company has agreed to build, own and operate it for five years, and then transfer the rail link back to the state of Queensland. Airtrain is Queensland's first privately owned and operated commuter railway network. This is a $233 million project. Contractual arrangements require that the state government take control if Airtrain fails.12
Experience so far: Low patronage levels are threatening the viability of the project. In June 2002 Queensland's Beattie Labor government was reported to be holding talks over the fate of Brisbane's Airtrain, with the Treasurer Terry Mackenroth "admitting he is not confident the airport-link can survive".13
Project: St Vincent's Hospital (Gold Coast) - Sisters of Charity Health Service
Saint Vincent's Hospital was one of Queensland's first PPPs. The Sisters of Charity group built and managed the $48 million hospital. This group runs more than 30 charitable health services, making it the largest such provider in Australia. St Vincent's Hospital has 500 staff, 50 private beds and 150 public beds.
Experience so far: The Sisters of Charity Health Service national chief executive officer, Stuart Spring, has claimed that "..the funding arrangement with the government was unworkable".14 In June 2002 the Beattie Labor government was forced to take over the hospital due to a financial collapse, with losses of $10 million.15
Conclusion Read at their widest, the policies that have been represented as PPPs in Australia amount to a New Right Utopia. There is no barrier within these policy papers that can prevent state governments being reduced to the point where they own nothing, and their sole direct tasks will be teaching school children and tending the sick. In Victoria and Western Australia, governments will also continue to employ our judges. Western Australia also promises to continue to employ police and manage 'offenders'. These policy papers supply no other limits. Beyond these small commitments, PPPs amount to open slather for privatisation.
Actually, the policies don't even really supply these slender limits. While the Victorian policy, for example, says that the government has promised to remain directly responsible for 'core' services, the definition of 'core' does not even unequivocally include education and hospital services. Rather, the policy only says that these tasks "are widely regarded as core services".
The Western Australian government's policy is perhaps the most explicitly open-ended. In contrast to the vagaries employed to describe the few functions that the government commits to keeping, the policy paper presents an explicit list of areas that the West is actively seeking to privatise, which are: transport and port facilities, health facilities, education facilities, water supply and waste water treatment, electricity generation, transmission and distribution, gas supply and distribution, housing development and new housing estates, land development, and major construction processes. This list, the paper emphasises, is 'non-exclusive'.
TIn sum, the state governments have all released policy papers that set out privatisation policies, which they insist are not privatisation policies. Let's be clear. Private isn't public. Privatising water, electricity and transport can only mean privatising water, electricity and transport, regardless of whether the government does or does not continue to directly employ judges and police. Likewise, privatising school and hospital facilities, which are presently at the front-line of the PPP policies, can only mean privatising school and hospital facilities, irrespective of whether the government does or does not continue to employ schoolteachers and nurses.
The reason why state governments are refusing to say that their privatisation policies are privatisation policies is obvious. Despite the Australian public having been barraged by 20 years of bi-partisan pro-privatisation rhetoric, accompanied by a privatisation program valued at around $150 billion, the public has remained firmly opposed to the policy.16 Opinion surveys always show that between 60 and 70 per cent of Australians are opposed to privatisation. The opposition that stretches across all demographics and voting intentions. So entrenched is the public's opposition that even the majority of Telstra shareholders are opposed to the further privatisation of Telstra.17 Given the unpopularity of privatisation, Australia's politicians have simply removed the word; they have rubbed out 'privatisation' and replaced it with 'partnership', and continued to advance their privatisation policies under the new banner.
The role of the 'partnership' rhetoric is to hide the unpopularity of privatisation behind a term that implies relationships of equality. There are places for genuine partnerships with government, but it is misleading to characterise PPPs as partnerships when they represent a transfer of wealth and power from the public to the private sector. In the end, PPPs allow select private firms privileged access to market and political intelligence. They represent the hollowing out of government, drawing no distinction between public and private interests.
The PPP policies have effectively been created from an unholy alliance between the irrational economics that underpin the zero public debt policy and the special pleading of vested financial interests. There are no mysteries about why the lobbyists are pushing so hard for the policies. Private consortia will always seek to purchase the benefit of a very secure income stream, with risk characteristics similar to a government security, but higher returns. Who can blame business for chasing the security of government contracts, as they always have? For business, self-interest is the focus and PPPs are recession-proof forms of corporate welfare. For business, the nanny-state is to be deplored, unless it is business that's being nannied.
There are alternatives to PFI/PPPs. Governments could choose to increase public sector capital expenditure without risking their reputations as 'sound economic managers'. Government's capacity to borrow on favourable terms or issue public infrastructure bonds is a prudent alternative in comparison to reliance on PFI/PPPs, as British and Australian experience indicates.
Borrowing for productive infrastructure investment accords with the golden rule of public finance, which is that on average over the economic cycle, governments should only borrow to invest and not to fund recurrent expenditure. With current public debt levels at historically low levels in South Australia and relatively slow economic growth rates, there is an overwhelming case for substantially increasing public sector infrastructure investment in order to underpin higher economic and employment output.
After more than two decades of under-investment, South Australia's infrastructure is badly in need of modernisation. As urgent as this challenge is, it is vital that policymakers carefully examine the relative merits of different methods of financing infrastructure development. PPPs are not the solution to the problem of under-investment in infrastructure. In juggling political and economic imperatives, governments should not retreat from direct financing of infrastructure. Governments should use the full range of financing methods available to them and be cautious and judicious in the application of PPPs, as tempting a solution as they may appear.
Because there are many vested interests touting the use of PPP schemes, it would be prudent for the state government, in conjunction with other states, to initiate an independent national review into the PPP experience so far. This should include a review of the relative merits of all infrastructure financing methods available.
John Spoehr is Senior Research Officer with the Centre for Labour Research, University of Adelaide. This is the text of a speech based on a new report prepared for the Public Service Association of South Australia by John Spoehr, Dexter Whitfield, John Quiggin, Christopher Sheil and Kathryn Davidson, Partnerships, privatisation and the public interest: Public private partnerships and the financing of infrastructure development in South Australia, Centre for Labour Research, University of Adelaide, September 2002. The full study can be read in pdf format at: http://www.sisr.net/apo/PPPPSA.pdf.
NOTES 1. PPP Executive quoted in the Australian Financial Review, 4 October, 2002, p 73 2. Stern, S. and Harding, D. (2002) "Profits and perils of public private partnerships", Euromoney, February, Issue 394, p. 126. 3. Ibid. 4. Ibid. 5. Ibid. 6. HMS Treasury 2000. 7. Budget Red Book, 1999. 8. Hansard, Written Answer, 28 February, 2000. 9. Hansard, Written Answer, 23 March 2001. 10. Association of Direct Labour Organisations (1999), The Employment Impact of the Private Finance Initiative in Local Government, Manchester. 11. Wainwright, R. (2000) "Taxpayer became a passenger as debt-laden ghost train ran off the rails", Sydney Morning Herald, 22 November, 10. 12. Emerson, S. (2002) "Secret talks to save rail link", The Weekend Australian, 15 June 2002, 4. 13. Emerson, S. (2002) "Secret talks to save rail link", The Weekend Australian, 15 June 2002, 4. 14. Emerson, S. (2002) "Hospital in critical condition", The Weekend Australian, 27 July 2002, 9. 15. Thomas, H. (2002) "Health bungle ruins hospital", Courier Mail, 6 June 2002, 7. 16. For a recent survey, that only managed to find one poll in favour (in the case of privatisisng ports in 1994, and even then only by a 3 per cent margin), see David Hayward, 'The public good and the public services: what role for the private sector?' Dissent, Autumn-Winter 2002, pp. 8-12. 17. Ibid.
Spoehr, John, 'PPPs in South Australia', Evatt Journal, Vol. 2, No. 7, November 2002.<https://evatt.org.au/post/ppps-south-australia>