PPPs

The issue of PPPs (public-private partnerships) has been bubbling along for almost a decade, but it has suddenly exploded, partly because of the fiasco with the Cross-City Tunnel in Sydney and partly because of a more general reaction against the string of bad deals that has been handed to the public in the process. I had a piece in the Fin a few weeks ago which elicited a very hostile response from Mark Birrell (former Kennett minister and now head of an industry lobby group). He quoted the British Auditor-general in favour of the British version (PFI), but as a subsequent letter-writer pointed out, some senior figures within the National Audit Office, notably Jeremy Colman, have been highly critical of the accounting for these projects, as have most academics who’ve looked at them.

Since then, there’s been a string of articles and media segments. The Australian, amazingly, has suddenly come out violently against PPPs. I just watched one on the 7:30 report with the redoubtable Tony Harris (whose recent piece has been reprinted at Troppo and also John Goldberg, a long-time critic of the traffic projections and tax arrangements in these deals. There’s some history from Chris Sheil over at LP. My column is over the fold.

Melbourne’s Scoresby freeway project, now the Eastlink tollway, has caused plenty of grief to both sides of politics. Federal Labor’s political woes of 2004 were worsened when the Bracks government announced, repudiating previous promises, that the project would be a toll road. Now Opposition leader Robert Doyle has been forced to abandon his own pledge to remove the toll.

Although Scoresby is commonly described as a $2 billion project, Doyle was advised that buying out the toll would cost at least $4.3 billion. The Bracks government published an even higher estimate, of $7 billion. Although the basis of these calculations was, as usual, not clear because of commercial confidentiality, it appears that the $7 billion is an estimate of the present value of tolls, discounted at the government bond rate, while the $4.3 billion is an estimate of the market value of the project, taking account of the additional risk borne by private investors.

This is not the first instance of this kind. The Carr government in NSW came to office promising to buy out a number of toll road contracts, but found that it was effectively impossible to do so, and had to resort to a complex system of compensating drivers. Undeterred, it has engaged in more toll road projects.

The most recent of these, the Cross-City tunnel, has been particularly controversial, since it has actually made traffic problems worse for many drivers. Apparently to protect toll revenue, other streets were closed when the tunnel was opened.

There are two major lessons in all this. The first, the consistent finding of many studies over the past decade, is that public-private partnerships are, in nearly all cases, an inefficient and costly method of financing network infrastructure projects such as roads. On top of the higher rates of return required by private investors to take risks that are more appropriately borne by governments, these projects typically involve substantial fees paid to financial intermediaries. The difference between the construction cost of projects like Scoresby and the figures quoted when considering a buyout of the toll is due, in large measure, to excessive financing costs.

Reliance on private funding for infrastructure was originally a method of getting around Loan Council restrictions on aggregate government borrowing. Despite some public disclaimers, it seems clear that the desire to deliver projects with the spurious appearance of no additional public debt remains a central component of the appeal of such public-private partnerships. In economic reality, a toll is a tax, and alienating a stream of tax revenue is exactly the same as taking on additional debt. The public is paying a high price to allow politicians to make spurious claims about ‘zero public debt’.

A more fundamental problem is that, in most cases, tolls are a perverse method of financing new road projects. The central aim of such projects is to shift traffic away from existing congested roads and onto the new roads, which are designed to have capacity for years into the future. The effect of a toll is to divert cars from the new roads to the old, congested routes. This is exactly the opposite of economically sound road pricing policy.

The need to collect tolls plays havoc with the design of the road system. Entrances and exits must be designed, not to smooth traffic flow, but to make toll collection easy.

The only sensible system of road pricing is one in which charges are based on congestion, not on the historical accident that the government was short of money when the road was commissioned. Motorists may object to paying for something they previously got ‘free’, but the central lesson of economics is ‘there ain’t no such thing as a free lunch’. What you avoid in explicit charges, you pay for in time spent in traffic jams.

One of the few politicians willing to learn the lessons of economics is London Mayor ‘Red Ken’ Livingstone, also notable as an opponent of the Blair government’s partial privatisation of the London Underground. Drawing on the ideas of the great Chicago economist Milton Friedman, Livingstone imposed a congestion tax of five pounds on cars entering central London. The result was an immediate reduction in congestion and increase in average traffic speeds. And Livingstone remains highly popular.

The Bracks government has announced a review of Melbourne’s transport problems, and foreshadowed its openness to radical policy options. Only one option has been ruled out in advance as too radical. You guessed it — a congestion charge.

John Quiggin is an ARC Federation Fellow in Economics and Political Science at the University of Queensland.

41 thoughts on “PPPs

  1. I think a lot of what this boils down to is that if governements could build and run infrastructure as efficiently as private companies, it would be cheaper for them to do so, as they have access to cheaper financing.

    At least from recent history, this doesn’t appear to be the slightest bit true. The Geelong-Melbourne faster than slow train appears to have gone 10 times over budget. More incompetence went on there than could be imagined (like failing to calculate stopping distances of trains correctly–something you might find on a year 12 physics exam). At least if they were a private company you could sue them to try and retrieve some of the money.

    It seems reasonable to suggest that on balance, governement s in Australia are useless and incompetent when it comes to spending public funds on infrastucture, and in addition are extremeley suscpetible to corruption (like the train that goes through the centre of Australia). This isn’t the case with all governements — if the SNCF wants to come and build a real fast train for me, I’d only be too happy for them to do it and fund it via government debt, which would probably get paid off in a reasonable amount of time because people might actually want to catch the train. At least with a PPP you get an extra source of accountability and a private company that might actually be able to make somewhat accurate estimates of likely costs.

  2. At least from recent history, this doesn’t appear to be the slightest bit true. The Geelong-Melbourne faster than slow train appears to have gone 10 times over budget. More incompetence went on there than could be imagined (like failing to calculate stopping distances of trains correctly—something you might find on a year 12 physics exam). At least if they were a private company you could sue them to try and retrieve some of the money.

    Who did the calculations? The government or a private contractor? If the latter, then they can be sued just as easily as in a PPP. If the former then yes, it was a total cock up by the government, but there’s no way they should have been involved at that level of detail in the first place.

    You don’t have to have a PPP to get the private sector involved. Just borrow the money and contract construction out. The problem with PPPs is that in order to put no money into the project, the government has to hand over rights over decades of revenues from the project, which takes away all flexibility in an area that almost certainly requires it.

    Of course, the problem with State governments borrowing money and contracting out is that the process is open to corruption and political favouritism.

    IMO opinion the best solution is borrow and contract, but with the whole process open to public scrutiny to reduce the risk of corruption.

  3. I agree with Dogz on the feasibility question. State governments have used their takings power in the past without scaring bondholders too much.

    “t seems reasonable to suggest that on balance, governement s in Australia are useless and incompetent when it comes to spending public funds on infrastucture, and in addition are extremeley suscpetible to corruption (like the train that goes through the centre of Australia). ”

    Conrad, the Alice Springs-Darwin railway is a PPP

  4. I’m not sure that private companies are necessarily more efficient at building and running infrastructure projects – as the Spencer Street Station and Wembley Stadium projects would indicate. However I am prepared to accept that generally private companies will have more experience in this area than government and should therefore, in my opinion, be contracted by government to build and run the projects. In this way the project has the benefit of a cheaper source of funds and it removes the need to guarantee revenue from the infrastructure in the form of tolls to ensure the private companies profitability. Mind you government would have to develop a high level of contract negotiation skills.

  5. I had not realized that the AS->Darwin railway was a PPP. At least someone would have got the sack somewhere, unless they had very smart lawyers (or the government very stupid ones) working out the contract 🙂

    The calculations for the Melbourne->Geelong route are just the governments initial suggestions versus the estimated final outcome. There were lots of nasty stories in the papers documenting it some months back, like

    http://www.heraldsun.news.com.au/common/story_page/0,5478,12693772%255E25717,00.html

  6. rnr,
    The source of funds are not cheaper if the private sector borrows at all. It is in fact cheaper if the government borrows the funds, and devises the most effective and efficient use of those funds, consistent with current and future needs for capital investment in various services/projects that meet social and economic objectives determined by the polity as a whole.

    The financial product sales market is a very inefficient, ineffective and wholly counterproductive route to sound, equitable, and efficient investment decisions on behalf of the public, however innnovative it may be as a way of developing international best practice remuneration packages for merchant bankers,lawyers and the PR industry.

  7. stoptherubbish

    Sorry if I wasn’t clear – but I agree that government and not the private sector should do the borrowing.

  8. Bolt may be worthless, but Lambert is at least as biased in the other direction. I wouldn’t credit his opinion on Bolt, particularly when it comes to Flannery, who frankly does seem like one of the more egregious global warming scaremongers. He has a habit of saying things like:

    “These hurricanes are generated by high sea-surface temperatures – hot salt water,” he told ABC television.

    “As the planet warms, of course a lot of heat transfer is going into the ocean, so we have the potential to generate massive storms like this.

    “Many people fear that we’re seeing a permanent shift to a much more active atmosphere where these sort of storms will be now a permanent feature of life.”

    And then when confronted by people like Bolt he weasles out with responses like “I didn’t say Hurricane Katrina was _caused_ by global warming”. Yeah right Flannery, you didn’t say that exactly, but you sure as eggs implied it, and you know that most people will interpret your statements that way.

    I’m not a fan of Bolt but I am not much of a fan of Flannery either.

  9. 1. Conceding for argument’s sake that public enterprise is inherently less competent than private enterprise, at what is it more markedly less competent — funding, building and running infrastructure or negotiating and enforcing PPP contracts?

    2. How soon before all other PPP contracts become public? If the Cross City(‘s) Tunnel PPP contract was not confidential, why would any other be confidential? Are any FOI applications being renewed?

    3. The truth about PPPs is going to enhance the political saleability of congestion pricing just as the duration of PPPs precludes the implementation of congestion pricing. In a few decades’ time we’ll be screaming for it.

  10. Found some more great Flanneryisms:

    “I think there is a fair chance Perth will be the 21st century’s first ghost metropolis,” Dr Flannery said. “It’s whole primary production is in dire straits and the eastern states are only 30 years behind.”

    Tick tick tick….. 5 years into the 21st century and Perth is looking just fine….

    He said climate change tended to move in steps. In 1976, when the first step occurred, the south-western corner of Western Australia lost 20 per cent of its rainfall, and its catchment fell from 340 gigalitres to 111 gigalitres. The average is now 160 gigalitres. In 1998, when the second step occurred, the world experienced the worst El Nino effect and the death of 17 per cent of its coral reefs. South-eastern Australia was hit by drought

    Hmm, haven’t heard of this “step theory” of climate change before. Nor that climatologists attribute the severe El Nino or the drought to global warming. Still, I sure am glad Flannery is out there setting the record straight with calm, collected, and factually based statements (irony alert). What would we do without him.

    And he said Sydney needed to move immediately to hybrid-fuelled cars, and introduce stringent standards for housing that would foster solar and environmental industries.

    And that will have exactly how much impact on the global CO2 level Dr Flannery? (BTW, Flannery’s PhD is in Zoology, not Meterology. His (second) undergraduate was Earth Sciences, and first was English. He doesn’t seem that well-qualified on the climatology front – I suspect he wouldn’t know a partial differential equation if it bit him on the bum).

    Like I said, I am very very suspicious of this guy. Not convinced he is anything more than a rather adept self-promoter.

  11. Flannery doesn’t enter into this, dogz. You were asked to produce a credible reference. So, produce one.

  12. The Bracks government has announced a review of Melbourne’s transport problems, and foreshadowed its openness to radical policy options. Only one option has been ruled out in advance as too radical. You guessed it — a congestion charge.

    Nationalise the suburban highways.
    Congestion charge the urban byways.

  13. Re the Melbourne-Geelong “fast” rail project: As I understand it, Bolt is literally correct in that the Government contribution has risen from $80m to $750m. However, this was due to the original plan (a PPP, iirc) falling over. So the Vic Government is now meeting the whole cost, rather than a modest proportion of the total, as originally envisaged.
    This may allow an inference of incompetence on the part of Bracks and Transport Minister Batchelor but by itself it doesn’t prove anything about the merits of Government funding compared to PPPs. Further and better particulars required to make the point Conrad is advancing.

  14. That was just a specific example that was quick to dig up. I used it since it was of recent political controversey, where politicians were shouting and point scoring, rather than trying to find a solution.

    I’m just being pragmatic. Over the last 90 years or so, a country like France has constructed, via public funds, an extremely good, cheap, and efficient national train system. Because it is good, people use it (and it gets exported all over the place now as well). They have similar problems, in that France is a big country and you need long lines. There are also similar cultural tendencies, in that many people in one place like to go to another place for their holidays (North->South France, versus Victoria->Wherever). This shows that it is not just high people density countries that can have a decent train system.

    Alternatively, if I compare that to what exists in Australia (where people even have had difficulty trying to standadize track size) and how well it runs then there is an undeniably huge difference (is anyone saying the rail system has been well run in Australia ?). I wouldn’t even think of taking a train from Melbourne to Sydney, for instance, but I take the Marseille->Paris line (a similar distance) all the time (including over the weekend for a quick holiday). Its not just me here, as there are large numbers of buses that make trips like Melbourne->Sydney that no-one would take if there was a fast efficient train service. In addition, I suspect most people would favor the train over the plane for trips of about that distance (as is true of France), since a decent train would get you from the centre of the two cities in about 4 hours versus having to go through airports etc.

    So my conclusions is that if the French government wants to loan money to build a decent cheap train system, I’m all for it. Alternatively, I wouldn’t in the slightest bit trust the people who spent 90 years constructing the system in Australia, and still don’t seem to be able to construct or run things without controvesy today. Why should I ? If a private company wants to come along and join in with the government to run a better service, then I see that as better than no service at all (or the current state), even if it costs a bit more due to higher financing costs and higher profit margins.

  15. Flannery doesn’t enter into this, dogz. You were asked to produce a credible reference. So, produce one.

    Yes he does SJ, and no I wasn’t.

    Follow PrQ’s link – it is to Tim Lambert’s blog where he gets stuck into Bolt for attacking Flannery. PrQ is using that to justify his assertion that Bolt is “worthless”. Like I said, Bolt may be worthless, but looking at Flannery’s background and his pronouncements over the years, he looks like little more than a rather skilled self-promoter, with no background in anything relevant to the study of climate change, who has jumped on the global warming bandwagon to enhance his own media profile. Just an opinion of course, but that’s my take on the guy. Not someone I would hold up to prove Bolt worthless.

    And I never linked to Bolt in the first place – it was Conrad. Check your facts before getting stuck into others.

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