There are other ways

PPPs & public policy
Sharan Burrow

Infrastructure & Australia's mixed economy

Australia has a mixed-market economy, just like every other country in the developed world. Co-operation and partnership between the public and private sectors helps the mixed-market economy along, and makes it work better. In mixed-market economies, both the public and private sectors account for a share of employment and output. There is no sharp and immutable dividing line separating black from white; rather, there is a thick and smudgy grey region where the two sectors overlap and interact. The private sector accounts for the greater share of output and employment in Australia's economy, and much more than in most other OECD countries. The public sector is a more significant player in planning and delivery of infrastructure - long-lived physical assets and systemic social services - than in simple production of goods and services for market. The role of the public sector in provision of public infrastructure has changed markedly over the years, and this will continue, but there will always be some partnership with the private sector involved.

What matters for the community is the quality of the physical and social infrastructure available to it, and its cost. Infrastructure requires a special business case. Its provision involves long lead times. Planning and sequencing means lengthy gestation periods. Physical infrastructure typically has a long economic life, delivering economic benefits across generations of citizens and taxpayers. There is significant judgement and some degree of risk and uncertainty involved in infrastructure projects. And infrastructure is expensive. Substantial financial resources must be marshalled and drawn down during planning and construction, and the ensuing debt serviced over long pay-back periods. All this is as true of private infrastructure (such as shopping centres and high-rise office towers) as it is of public infrastructure (such as freeways and bridges). Traditionally in this country, the private sector has played a major role in the construction phase of public infrastructure provision, even in those distant times when substantial 'Public Works' departments of the state existed.

So what's new

So what is new today? Essentially, the claim is that PFIs and PPPs provide governments with a new way to skin the infrastructure cat. Cut through the eco-babble, through the thicket of jargon, and at the quick we find that 'Public Private Partnerships' is another name for 'Private Funded Infrastructure', and what is entailed is simply a scheme for having the private sector deliver something on behalf of the state for a fee, but financed in a different way.

Traditionally, governments or semi-government authorities have raised finance directly from private capital markets to fund infrastructure development. The resultant financial instruments are government and semi-government bonds. This mechanism allows the community to enjoy the infrastructure provided, with their taxes servicing the resultant public debt. Under the PFI/PPP model the private sector (often a consortium of firms) raises the finance from private capital markets to plan, build, own and operate infrastructure commissioned by government. (Under some versions of this model, ownership is transferred back to the state after a period of time). This model allows the community to enjoy the infrastructure provided, and to service the private debt indirectly through a contractual arrangement between the state and the private provider. One variant gives the private infrastructure provider rights to collect tolls or charges on users of the facility (road or bridge or power), indefinitely or for a set period. Other variants involve a series of contractual payments from the government to the private infrastructure provider (prison or detention centre or public transport), for the services provided. With historically accepted accounting conventions, the PPP/PFI model also keeps the infrastructure project and its financing off the public accounts, giving the appearance of smaller government and lower public debt.

In a modern mixed-market economy, where innovation rules and diversity is king, there is a place for partnerships of this sort, alongside and supplementing more traditional arrangements. The case is even stronger when such infrastructure developments have regard to public equity returns for taxpayers' money invested or public land provided. These might incorporate clear requirements for the development of education or health or childcare or aged care facilities for public management. Equally, residential development might mandate a percentage of low-cost housing.

But, whatever they are called, PPPs or PFIs are no panacea for society's fiscal problems, and no magic bullet for the provision of public infrastructure in today's Australia. Indeed, care and caution is required if the community is truly to benefit from these arrangements and not be left shortchanged. Perhaps the most enduring legacy of the PPP/PFI phenomenon is what a colleague of mine has dubbed "the 5 per cent Club".

What is the '5 per cent Club'?

What is this 5 per cent Club? It's the collection of institutional investors, lawyers, accountants, merchant bankers and other private sector service providers, who take what could be a public sector infrastructure project and turn it into a private sector commercial venture, in order to both provide the infrastructure and make a quid. This private venture bids for a contract being let by the state. If successful, the venture raises the necessary finance from the nation's capital markets to fund the project. When private infrastructure providers go to private capital markets for finance, the bulk of the funds raised comes from institutional investors, and not directly from mums and dads. Institutional investors seek a minimum risk adjusted return. For private equity in private companies, that minimum return is what is achieved for listed equities plus 5 per cent. For private equity in infrastructure projects, that return is the long term bond rate plus 5 per cent. Add to that the margin on debt financing, and a list of fees as long as the list of wines on offer at Dan Murphy's, and one begins to get a feel for what the 5 per cent Club does when the private sector gets involved in public infrastructure.

Public-private infrastructure projects are 'win-win' situations for government and the 5 per cent Club. Governments keep the spending off-budget, even though they can do the projects themselves at close to the long term bond rate (being the cost to governments of borrowing funds). This is a curious thing in an age of alleged economic rationality. The virtue of appearing to deliver 'small government' is seen to exceed that of obtaining the facility for the community at the best price and with the highest standards of corporate governance and public accountability.

The 5 per cent Club pockets the 5 per cent premium, plus all the management-advisory fees and executive style salaries, so that its members can live in the life-styles to which they have become accustomed, since privatisations and private funding of public infrastructure created the 5 per cent Club in the 1980s. And the fees that support such life styles from private sector infrastructure provision are substantial. There are legal fees, due diligence fees, a wide range of technical, financial and other advisory fees, success fees for winning a project, underwriting fees for fund raising, performance fees for exceeding the expected returns of 5 per cent Club members, and ongoing management fees for a variety of services provided through the life of the project. This is all before we get into the list of fees and penalty payments that arise, should a dispute occur between the public and private sector, such as that at Seal Rocks, over the terms and conditions of contract performance. It is also before the fees and public sector top up subsidies funded by taxpayers when commercial or political realities require it. For example:

  • the $118 million paid by the Victorian government to cover electricity price increases with the move to full competition;
  • the $105 million paid to public transport operators Connex, National Express and Yarra Trams;
  • the $65 million paid to ticket machine operator Onelink.

The inevitable consequence of paying an excessive risk premium, and this legacy of a cascading series of fees, penalty payments, litigation costs and public subsidies (almost all of which were not included in the cost-benefit equation in past studies purporting to show PPPs as the lowest cost option), will be a substantial increase in the future cost of regulating PPPs.

This raises a further issue. If the public sector is to regulate PPPs, it will be essential that the public sector retain key personel with the technical competence to conduct the appropriate assessments on tenders and proposals. Someone responsible to government must be able to distinguish the wheat from the chaff and to advise accordingly. In earlier times, these same public sector people were responsible for planning public infrastructure projects, and organising finance and letting construction contracts to private firms. No government relying on PPPs to deliver infrastructure can responsibly divest its public sector of the capacity to make the necessary project and contract assessments.

In my judgement, given the current debate on corporate governance, the additional regulatory costs are likely to dwarf the post September 11 surge in insurance premiums. As ever, it will be the taxpayer that foots the bill for all of this. Though risk transfer is often said to be at the heart of PPPs, the fact is that the Club gets its risk premium and its elaborate set of fees, whether it's a relativity risk free project like a toll road, or a higher risk investment like public transport, where the private provider is likely to be bailed out by government if worst comes to worst. Whatever the PPP contractual provisions stipulate, at the end of the political day the risk stops with the public purse, because governments simply cannot or will not abdicate their obligations to their constituents.

Other ways

There are of course other ways, and I am encouraged by the wide ranging public and private discussions now occurring over some of these alternatives. For example, a number of people are now arguing that, to fund nation building over the next two decades and increase the long term savings of workers through ownership of assets, and to circumvent the 5 per cent Club, governments should issue national developments bonds.

Where appropriate, governments should also take a role in project management and other management-advisory services, or at least foster greater competition to cut such fees by a substantial margin. Australia's public debt-GDP ratio is artificially low (6 per cent compared to the OECD average of 40 per cent). The off-budget funding of infrastructure through PPPs disguises huge corporate governance issues and has excessive hidden costs. In the UK, this is plainly evident since the government funding of collapses as contingent liabilities, as in the case of the $800 million bailout of Railtrack. National and State development bonds should be issued to fund essential infrastructure projects. This approach would facilitate pulling forward some projects, as well as creating room for more infrastructure investment. Such bonds (priced at say 0.25 per cent above the long term bond rate) could be sold to both institutions and mums and dads, and could be targeted at working families. A welcome by-product of this approach would be the restoration of a government bond market, providing the nation's super funds with a sound-finance alternative to buying even more offshore debt to balance their fixed interest asset portfolios. The selling of such bonds, coupled with initiatives to ensure more competition on management fees-advisory services, would slash the returns of the 5 per cent Club and return the surplus to taxpayers through their elected governments.

In addition, and in accordance with best practice corporate governance, this would return the responsibility to governments for riskier projects, rather than pretending governments won't bail out large-scale corporate collapses. As the Economist magazine ("Enron-on-Thames", 30 March 2002) put it in relation to the fiasco with the privatised Railtrack company:

If risk cannot genuinely be transferred (from the public to the private sector) then the Treasury should own up to the actual cost of the borrowing that the private sector is undertaking on its behalf. Keeping risky investments off the books is the sort of thing that Enron did to its shareholders. It is not the sort of thing that governments should do to taxpayers.

For less risky large-scale investments, the current risk premium and fees appropriated by the 5 per cent Club would be slashed by government financing the project on-budget, and encouraging a wider range of public and private service providers. Mums, dads and institutions would have long-term government guaranteed returns, with an asset that funds the building of the nation and complements their assets purchased through their superannuation funds (some 40 per cent of which are Australian shares). This would help provide the asset base required to borrow for a home. The long term increase in public debt interest from the sale of such bonds would be minimal relative to the long-term surplus otherwise appropriated by the 5 per cent Club, and the real contingent liabilities that governments seek to keep off-budget through PPP schemes.

Superannuation trustees with a large exposure to infrastructure are paid up members of the 5 per cent Club. But by moving a small part of their lower yielding cash asset allocation to national development bonds, and a small shift of fixed interest investments to listed or private equity, returns can be sustained, the 5 per cent Club retired, the nation's infrastructure renewed, and an Enron or Railtrack crisis of confidence avoided when the pitfalls of public-private partnerships come home to roost.

 

The bottom-line

In a modern mixed-market economy, transparent co-operation between the public and private sectors is wholly laudable. However, as a device to shift public expenditure off-budget, 'public-private partnerships' are not only an expensive option, but also an approach that many are now questioning for other reasons I have not dealt with today. In particular, there are a number of alarming claims coming out of the UK and elsewhere about the pursuit of commercial returns by sacrificing safety standards, excessive price increases, diminution of the wages, working conditions and job security of the workers, and short circuiting the normal processes of public audit and scrutiny such projects warrant. There is also a fundamental public policy issue about increasing private control over a country's social and economic infrastructure. What are the long-term implications of this for public choice about the future options for nation building?

The bottom line of all this is that, while there are some who want to turn the 5 per cent Club into the 10 per cent Club, there are many more of us questioning the very existence of the Club and its future role in infrastructure provision. Ultimately, it is in the interests of a vibrant private sector that these issues of transparency, governance, taxpayers' interests, and public benchmarks, be resolved openly through public scrutiny and debate. Where major infrastructure works are undertaken, much of the economic action will be delivered by private concerns and the finance will largely be drawn from private capital markets, one way or another.

It is not PPPs or PFIs as such that are the issue. It is the objective basis on which they do or do not proceed, in preference to other delivery mechanisms, that is the issue at the heart of the public policy debate. The esteem in which private financial and commercial enterprises are held by the Australian public will rise with openness and transparency, but the merest hint of sharp practices or subterfuge attaching to PPPs can only be corrosive to the long-term standing in Australian public life of both government and the private sector.


Sharan Burrow is the President of the Australian Council of Trade Unions (ACTU). This speech was delivered to the Australian Financial Review Infrastructure Summit held in Melbourne on 15 August 2002. Image courtesy Workers Online. Also see "Welcome to the 5% Club" by Nixon Apple in D!SSENT, No. 9, Spring 2002.


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Read Letters in response:

  • The next great privatisation debate, writes Geoff Lazarus
  • A misleading and coercive reform, writes Athena Vongalis