Paying for private profit
Graham Larcombe & Paul Fitzgerald
A large body of government and private sector reports has been generated by the emergence of PPPs. Little of it is objective and it depends on the vested interest of the particular group. Many myths about PPPs need to be challenged.
By reducing the call on public funds the amount of funds available for other essential services is increased.
A reason often stated for the adoption of PPP arrangements is that it frees up public funds that could be used in other essential services. This argument would have some validity if in practice these 'savings' were applied in this way. There is little evidence of this actually happening. Funds saved in this way have mostly been allocated to consolidated revenue to be used to retire debt and not used in the provision of better community services and infrastructure.
A number of commentators point to the higher cost of financing infrastructure through PPPs compared to traditional public sector debt financing. According to economics writer Ken Davidson, the private sector requires a rate of return of around nine per cent per year compared to 6 per cent per year for the public sector.1 Davidson suggests that, using these rates, a project costing $4 billion through conventional public sector financing would cost $5.6 billion if financed through a PPP. The $1.6 billion difference could have been used to finance new schools or health services.
This impacts on government finance and the government's capacity to maintain and expand existing services.
Private sector investment accelerates the availability of community goods and services.
Another key argument put forward by advocates of PPPs is that the injection of private sector funds into community assets and services accelerates their creation. The argument is that without the injection of private investment much needed goods and services would have to be deferred or not undertaken. While this has some short term attraction it fails to recognise:
· the longer term financial liabilities that accumulate with such a strategy,
· changes that will occur to the investment strategies of the partnering organisation over the life of the project due to a change of ownership or board direction; and,
· the asset allocation decision making process that comes with the partnering, which can see a partnering organisation remove itself or be wound up.
This latter issue is often not recognised but is important in terms of equity and is inherent in the nature of these projects.
Typically PPPs emerge when an investor or government identifies an opportunity. They are rarely developed out of any identified priority of need or, if they are, they are developed at a premium to government.
In NSW the government has contracted a private sector consortium comprising ABN AMRO, St Hilliers, Hansen Yuncken and SSL Facilities Management (Spotless) to build, maintain and provide security in nine state schools, which the government will lease back for 30 years.
Although this PPP was announced with much fanfare, the government has acknowledged that, if all goes well, the project will produce only a four per cent saving over 30 years to taxpayers. The benefit according to the government is that the schools can be built in 2005 rather than 2010 with the involvement of the private sector. This assumes that funds cannot be raised in other ways such as through traditional public sector debt financing.
PPP agreements can produce significant unforeseen outcomes and reduce the capacity of governments to provide adequate services.
In California the existence of a 'non-compete clause' in the state's franchise agreement with a private toll road operator has forced the Orange County Transportation Authority to buy back the 91 Express Lane Toll Road from its private operator. The County paid over US$380 million to allow much needed road upgrades in the area surrounding the private toll roads. Non compete clauses are common in infrastructure PPPs where assumptions are made as to the level of patronage/toll that can be expected. Similar clauses exist in a number of tollways operating in Victoria and NSW.
The private sector is inherently better at providing services.
Supporters of PPPs argue that the private sector is able to deliver services in a more effective and efficient manner than the public sector. Advocates of PPPs often argue that the introduction of PPPs into the provision of public sector goods and services will improve the provision of services through better management and systems. The private sector is motivated by bottom line profit, and hence it has an incentive to continually reduce costs and to improve delivery mechanisms. While this is superficially appealing, it fails to recognise some of the distinct differences that exist between the two sectors and therefore the fallacy of such comparisons. The public sector has different responsibilities compared to the private sector. Not all services can be provided profitably. That is not to say that the public sector does not need to constantly improve its performance. However the criteria for comparing the two sectors needs to be differentiated. Private sector failure is sufficiently well documented to demonstrate the fallacy of any 'inherent' argument.
Inherent within the debate over the introduction of PPPs into what has been traditional public sector service provision is that the private sector will bring better service delivery. Through the prescription, monitoring and measurement of service provision, it is argued that a better service outcome can be achieved in the provision of community infrastructure and services. While it is generally true that any service can be delivered better where the outputs are clearly stated, this is true for both sectors and not an argument for or against the provision of services by the public or private sector. Secondly, there is sufficient evidence of high quality service provision delivered by the public sector to illustrate the fallacy of this proposition.
A recent report on the private financing of health services in the UK concludes that there are serious problems with privately financed projects.2 The report, compiled with a series of interviews with health care workers in nine hospitals involved in privately financed projects, identifies four major problems:
· All hospitals were desperately short of beds, putting pressure on hospital staff to get patients out as quickly as possible.
· All trusts running the hospitals were under severe financial pressure, partly as a result of the escalating costs associated with PFIs.
· There were concerns over poor quality of design of buildings, including poor ventilation, lack of space and inadequate fittings and materials.
· The quality of care had declined, with concerns about time spent with patients and the level of multi skilling required.
Private sector involvement in the provision of goods and services is free of political interference.
Many advocates of both privatisation and PPPs argue that, by removing the provision of services from the public sector, the capacity for political interference is reduced. Political interference is seen as causing inefficiency, corruption and poor resource allocation. Such an argument fails to recognise that inefficiency, corruption and poor resource allocation can also exist in the private sector. In many instances, the growing interrelationship between the public and private sector associated with PPPs increases political pressure for governments to endorse projects that may or may not be required.
Private sector companies are putting forward unsolicited proposals to government and then mobilising public opinion to support the project. The Very Fast Train is a good example. There have been various proposals over the past 15 years to construct a Very Fast Train link between Melbourne Sydney, Sydney Canberra and Melbourne Brisbane. Despite intense private sector lobbying for these mega projects, it was clear they required massive public subsidies and government would not take them on. The Inland Railway linking Melbourne and Brisbane was heralded by the federal government in many rural electorates during the 2001 national election campaign, only to be quietly downgraded after the election.
The public sector does not have a monopoly on corruption or interference in decision making. The HIH Royal Commission exposed a corporate culture of boards or senior executives interfering to secure rewards for themselves, demonstrating that 'political' interference can exist in any culture and is not removed just by the presence of private as against public sector management. What is important is robust governance processes whatever the ownership structure.
Private sector involvement reduces the level of financial risk to government.
One reason for the introduction of PPPs in recent times is the desire of governments of all persuasion to reduce public sector financial risk. The argument is that by transferring debt and risks to the private sector, the public sector balance sheet is improved. This may be true in the short term.
However, the use of private funds as against public funds increases the level of contingent liability exposure when service contracts fail. As the Sydney Airport Rail Link contract (New Southern Railway) demonstrates, when essential services provided by the private sector fail, the public sector is forced to act as guarantor. The public sector risk can be greater as the ability to directly manage the risk is reduced.
The New Southern Railway linking central Sydney CBD with Kingsford Smith Airport shows that government must continue to underpin major infrastructure projects even if they are run by the private sector. Professor Bob Walker has estimated that in the case of the Sydney Airport Rail Link, the private sector stood to make a 23 per cent rate of return despite incurring minimal risks.3 On the other hand, the NSW government incurred construction and volume risks, contributed most funding, and may only break even after 23 years and at best earn only 2 per cent pa on its investment.
The public sector remains the provider of last resort. In cases where the private sector loses money and walks away from a contract the public sector must intervene to maintain services. After reporting a loss of $6.2 million in 1999, the 257 bed La Trobe Hospital, which had been owned and operated by private company Australia Health Care (AHC), was handed back to the Victorian government.4
There is currently no accredited accounting standard being applied by any government in Australia to quantify the contingent liabilities inherent in PPPs. What this means is that government accounts do not accurately reflect the risks they are carrying within their accounts, leaving them exposed to significant expenditure for which they have not made allowance.
PPPs reduce taxation.
Advocates of PPPs argue that through the injection of private funds overall taxation rates can be reduced. Reduced government spending can mean reduction in the need for revenue. However, in practice, this is only true in the short term.
PPPs don't provide free goods and services. The public sector borrows funds to meet annual lease payments to the private sector over the life of project, normally in the order of 20 30 years. This simply passes the costs onto future generations. According to a UK paper on public services and the private sector, additional costs, problems and deficiencies will fall on future taxpayers and users.5
With many infrastructure PPPs having an operational life of over 20 years the real cost and therefore tax liability could be significant. This is especially the case as replacement and refurbishment costs accumulate over the life of the project but the income stream is channelled to only one of the partners. To date, taxation has not been reduced but has increased through the application of user charges for example, freeway charges in effect are an indirect tax. Consumers and often the environment bear most of the costs of privatisation.
The costs of establishing and maintaining PPPs are high for governments. Governments pursuing PPPs have to create bureaucracies to administer and manage them. Transaction costs are high. This includes establishing guidelines, tendering procedures, legal documents and negotiating with the private sector.
The user pay principle is inherently a fairer way of paying for services.
Inherent in the use of PPPs is that the end users of such services pay a fee to the PPP partners. Rather than the community paying through general taxation, it is argued that the users of such services should pay, and that this is more equitable. However, in practice this is difficult to demonstrate. As the application of rebates paid to users of motorways illustrate, the application of the user pay principle is not equitable as it charges a fixed fee to all users regardless of their ability to pay.
Motorists dependent on motorways are often lower income earners living long distances from workplaces at the centre of our major cities. To ensure a reliable rate of return to the operators of such motorway schemes, governments have tended to enter exclusive supply agreements with the partnering developers, whereby alternative and pre-existing services are downgraded, and in the case of some infrastructure removed, as a way of reducing competition.
The closure and incorporation of existing public infrastructure into new PPP motorways is a case in point.
Private sector involvement can inject world best practice into service provision.
Some advocates of PPPs argue that the introduction of private sector partners can produce important and required organisational change through the introduction of new techniques and processes. While there is little doubt that partnership arrangements can lead to learning opportunities, PPPs do not inherently produce this result. Sometimes in practice the transfer of knowledge flows in the opposite direction, with the operating partner learning information of a critical nature that makes the relationship one of dependency rather than a real partnership. In addition, in practice there appears to be a tendency to transfer personnel from the purchaser partner to the provider partner, which can see a reduction in the skill base of the former.
PPPs can unnecessarily increase complexity. For example, under the PPP arrangement for London Underground, infrastructure companies maintain the tracks, stations and trains. The public authority London Underground manages the day to day operations of the network and has overall responsibility for the safe operation of the system. In April 2003, Tubeline Cleaners, one of the maintenance contractors undertook a cleaning project on the Central Line Station. In the process of cleaning, considerable dust residues were dislodged which in turn stuck to glue left by another contractor placing advertising hoarding at the station. This seemingly simple demarcation of responsibilities produced a fire within the system and the temporary closure of the line. Despite provision within the contract, no fines were demanded for lack of performance, essentially due to the difficulties of apportioning responsibility in such a complex arrangement.
In the case of British Rail privatisation, the rail sector was fragmented beyond recognition. Today there are 25 train operating companies; six freight operators, three rolling stock operators, two infrastructure controllers and seven infrastructure maintenance contractors. Under this complex regime are some 1,500 subcontractors. A once integrated whole has become a patchwork of competing interests that have seen costs rise from $3.75 billion in 1999 to $12.5 billion in 2003. When responsibilities are split between a number of parties through contractual arrangements, responsibility is reduced. Contract competition has not led to overall savings. The problem has not been a lack of competition but a failure to invest properly in the maintenance and upgrading of the infrastructure.
The introduction of new players will increase employment and improve conditions.
The claimed capacity of PPPs to accelerate investment is said to increase new employment opportunities. While new investment in infrastructure and services will create new jobs, it may not increase overall employment. Experience suggests that if the PPP takes over an existing project, the net employment in the post-construction phase will reduce as a means of reducing costs. Where a new project is created, net employment may increase. In the case of a competitive market, cost competition may see a reduction in employment. Unlike most commercial transactions, PPPs rarely allow for an increase in charges to occur, therefore operators have little choice but to reduce outlays if their shareholders' interests are to be protected.
British health workers are concerned about the transfer of staff from public to privately financed projects.6 Unions representing health workers rejected the UK government offer of "retention of employment" rights to blue collar workers such as cleaners and porters because it excluded 200,000 staff, including clerical staff, receptionists, building maintenance workers and patient transport vehicle drivers. A two tiered workforce has emerged in the UK with workers remaining with an existing but privatised entity remaining with public sector wage parity, but with workers recruited after the privatisation being recruited at lower levels of pay and conditions.
PPPs improve accountability.
Proponents of PPPs argue that through the use of performance contracts, transparency is created and therefore greater levels of performance accountability can be achieved. While it is true that greater specificity can lead to greater accountability of performance, such arrangements presuppose strong contract administration skills and capacity. Performance indicators often depend on data provided by the service provider, and many mechanisms can be used to inflate or deflate statistics. Strongly prescribed performance contracts have led to increased costs in terms of accountability regimes and contract variations made during the life of the contract, often at a high cost to the community.
The use of performance contracts with measurable outputs is a key characteristic of PPPs. However, they are not unique to PPPs, and the use of PPPs is not the only way to ensure robust performance. There are significant risks in establishing fixed outputs in service contracts that can span a number of years over a period of uncertainty. Because of the cost, complexity and time involved in setting up PPP contracts, governments are reluctant to break a contract with a private sector partner once a project is up and running. Once a private sector partner has been awarded a project the government is "locked in" and will seek to renegotiate rather than terminate a contract. There is a tendency for costs to escalate once projects are up and running, with public and private sector partners sitting down to accommodate cost increases. Higher prices to sustain profitability is normally a better option than terminating a private sector partner, because the costs of bringing in a new private sector partner or getting the public sector to take over the project is too high in both practical and political terms as well as financial terms.
Graham Larcombe and Paul Fitzgerald are the authors of the report, Paying for private profit: a review of the public private partnership model in the provision of community infrastructure and services, Strategic Economics, which was launched at the Evatt Foundation breakfast seminar on 11 November 2003. Copies of the report are available from the Rail, Tram and Bus Union National Office, the Australian Education Office (Federal Office), the Australian Nursing Federation (Federal Office) and the Community & Public Sector Union - SPSF Group (Federal Office).
1. Kenneth Davidson, "Brumby ignores Labor and we pay the price", The Age, 23 May 2002.
2. John Lister, The PFI experience: Voices from the Frontline, A PFI report for UNISON, March 2003.
3. Bob Walker, "Privatisation, Infrastructure and Local Government", address to the NSW State Assembly NSW Local Government and Shires Association, Sydney, 2001.
4. Allyson Pollock, Jean Shaoul, David Rowland and Stewart Player, Public services and the private sector, Catalyst Working Paper, November 2001.
5. Allyson Pollock, Jean Shaoul, David Rowland and Stewart Player, Public services and the private sector a response to the IPPR, A Catalyst Working Paper, November 2001.
6. Patrick Butler, Government faces union challenge on NHS staff rights, Guardian Weekly, Tuesday March 26, 2002.