AIN THE PUBLIC INTEREST?

A Critical Look at Public-Private Partnerships (PPPs)@ by Frank Stilwell and Kirrily Jordan

The provision of good quality infrastructure underpins economic productivity and the quality of life. Historically, it has been well-nigh axiomatic that such public goods must be provided by government and funded through public investment. This connection between infrastructure and collective provision has had a central place throughout Australian economic history. It is a connection that has been undermined in recent decades by processes of privatisation and is now being severed by the proliferation of public-private partnerships (PPPs). The latter aspect has become particularly pervasive in the restructuring of infrastructure provision and management policies by State governments.

What are PPPs?

Public-private partnerships (PPPs) involve the government opening up more opportunities for the private sector in the provision of infrastructure and services. Common features include "the delivery of services normally provided by government, the creation of assets through private sector financing and ownership control, and government support through contribution of land, capital works, risk sharing, revenue diversion and other means."¹

PPPs can take many forms. Perhaps the best known are BOOT schemes (build, own, operate, transfer) where a company is responsible for design, construction, finance maintenance and commercial risks, and owns the asset for a set period (usually 20-30 years), during which time it operates it and collects user charges. When profits and costs have been recouped, ownership is transferred back to the government. BOO schemes are similar to BOOTs, except that the company retains ownership of the asset in perpetuity. A third variation is DBO schemes (design, build operate) where a company finances construction, the government purchases the asset for an agreed price and takes all ownership risks, and the company retains the management function and related risks.² Finally, there is the straightforward outsourcing of services previously delivered directly by government.

PPPs have been widely used in the UK under the Blair government, and are now increasingly being promoted by various governments throughout Australia, particularly the NSW and Victorian State governments.

Between 1989 and 2001, PPPs with contract values totalling $5.5 billion in economic infrastructure alone were implemented in NSW.³ Concern over the growth of PPPs in providing social services and infrastructure has led the State government to say that it will treat 'core services' in social infrastructure (such as health and education) differently to 'non-core services' and economic infrastructure (such as roads, power and water). That is, core services in social infrastructure will be provided by government, including the provision of medical and teaching staff. This allows private sector provision of infrastructure and 'ancillary' services, including cleaning, maintenance and non-clinical medical services.⁴ The Government argues that the precise differentiation between core and non-core services will be determined on a case-by-case basis.⁵

In practice there seems to be almost no limit. PPPs in NSW have been implemented or approved in a wide range of services and infrastructure, including schools, hospitals, prisons, housing and aged care facilities, as well as in construction, maintenance and operation of infrastructure assets in transport and utilities. Specific examples include Sydney's Cross City Tunnel, Western Sydney Orbital Lane Cove Tunnel and Eastern Creek Alternative Waste Treatment Facility, as well as the Port Macquarie Base Hospital and nine new schools in Sydney and the Central Coast. Still more projects are in the pipeline, including the Mater Hospital in Newcastle, a number of correctional centres, and a social housing project.

Why the push for public-private partnerships?

Proponents of public-private partnerships claim that PPPs provide significant social and economic benefits. It is argued that PPPs reduce government borrowing, and free up public money for essential services. Emphasis is also put on the role of PPPs in the sharing of investment risks between the public and private sectors, providing better value for money and earlier project delivery than public provision of infrastructure, and providing more competition in service delivery, increasing innovation, efficiency and customer focus.⁶ Sometimes there is the further claim that PPPs boost employment. For example, the NSW Minister for Health has claimed that the PPP for redevelopment of Newcastle's Mater Hospital will create more than 2000 jobs in "construction and related industries".⁷

Underlying these arguments one may also discern an ideological position that represents government borrowing, taxation and public debt as illegitimate, and sees the public provision of infrastructure and services as inherently inefficient.

A careful look at the evidence on PPPs casts serious doubt over their supposed benefits and paints a much more worrying picture. A number of deeply troublesome questions are raised.

Privatising the prof its and socialising the risks?

Do PPPs really facilitate a beneficial allocation of risks between the public and private sectors? Proponents of PPPs argue that the majority of financial risks are carried by the private sector. However, the nature of the services and infrastructure being provided means that the ultimate responsibility lies with the government. The viability of hospitals, schools and water supplies, for example, is too important for the government to stand aside and let the normal logic of the marketplace prevail. If a private company fails to provide and maintain an adequate service, the government must ultimately carry the cost.

For example, the Sydney Airport Rail Link was developed as a PPP between the NSW Government and a private consortium. The Government claimed that all of the financial costs would be borne by the private sector. In practice, as costs escalated, the Government contributed substantial public funds, eventually having to bail the project out to the tune of $704 million as the consortium defaulted on its loan and one member went into receivership.⁸

While proponents of BOOT schemes argue that risk is shifted to the private operator, standard clauses are often written into the contracts that actually shift the burden of risk towards the government. For example, many BOOT contracts "provide for an extension of the original hand-over deadline if the operator has not received an agreed cumulative minimum rate of return".⁹ The BOOT contract for Sydney's M2 Motorway contained a clause that "the substantial upgrading of an 'alternative road' would be 'a material adverse effect' for which compensation would be payable to Hills Motorway".¹⁰ While the government claimed that 'all the risk' was with Hills Motorway, the contract gave the company "substantial support from the government in the form of deferred rents on the motorway land. Repayments, with interest, would amount to $546 million, and were not scheduled to begin before 2028". Moreover, this might never be repaid because "there is a risk that compensation will have to be paid by the RTA under a wide range of scenarios".¹¹

These imbalances have led many to argue that PPPs in fact privatise the profits of infrastructure development but socialise the risks. As a group of Australian unions argue in their informative paper Paying for Private Profit, "generally, PPPs require that governments will be responsible for all of the outcomes except the outputs specified in the contract, and privatepartners remain the recipients of all of the profits."¹² Concerns have arisen that PPPs are indeed a form of 'privatisation by stealth', with the more innocuous sounding name allowing them to slip under the community radar.

Are PPPs cost-effective?

Governments have typically argued that PPPs are cost-effective and save the community money by facilitating private investment in infrastructure provision. However, this ignores the fact that governments can borrow at a much cheaper rate of interest than private firms can. So private companies require a greater return on their investments in order to recoup costs and make a profit, usually recovered either through higher user fees (such as road tolls) or direct government payments.¹³

Kenneth Davidson, economics writer for The Age, provides an example. He estimates that if a project cost the government $4 billion to finance publicly, it would cost $5.6 billion if developed as a PPP. In the case of a motorway this would impart costs onto the whole community, and not just the users. Not only would road tolls need to be higher in order to finance the private loan, but potential government revenue would be foregone.¹⁴

The method used by governments to assess the financial impacts of PPPs, the Public Sector Comparator (PSC), effectively ignores these concerns. The PSC requires comparison between the economics of public provision and a PPP. For this purpose the capital cost of a PPP is calculated by discounting the flow of contractual payments over the life of the project. The discount rate is the private cost of borrowing capital, rather than the interest rate that governments would have to pay on borrowed funds. Comparing this capital cost with the cost of conventional government financing imparts a pro-PPP bias into the PSC because governments can borrow more cheaply than the private sector.¹⁵

In addition to the increased costs of financing a project through private borrowing, governments often enter into contractual arrangements to pay lease or access charges to the private partner over the life of the project. Where governments need to borrow to meet these payments the costs are simply delayed, such that "additional costs, problems and deficiencies will fall on future taxpayers and users".¹⁶ Moreover, governments can use PPPs to disguise their debt as their PPP obligations do not have to be recorded in the balance sheet.¹⁷

The Port Macquarie Base Hospital is a case in point. In 1994 the construction and operation of the hospital was contracted under a BOO scheme to Health Care of Australia (HCOA), a subsidiary of Mayne Nickless. The government argued that construction of the hospital would cost $15 million less if carried out by the private sector, and that the private operation of the facilities would save the government $46 million over the 20 year contract. But the contract requires the government pay HCOA an 'availability charge' of $4 million a year, as well as a fee per service provided to public patients. In addition, when the contract expires, ownership of the hospital will be transferred to HCOA.¹⁸

The NSW Auditor-General estimated in 2000 that, instead of saving the government money, the Port Macquarie Base Hospital PPP scheme would cost the government an additional $93 million. He said "the government is, in effect, paying for the hospital twice and then giving it away."¹⁹ Performance records for the hospital have also been poor. In 1998 it was rated as the worst performing hospital in NSW according to a range of health department indicators, with waiting times for elective surgery more than double the State average. ²⁰

Despite these failures with the Port Macquarie Base Hospital, the current NSW Government is pushing ahead with plans for the PPP redevelopment of the Mater Hospital in Newcastle. This is in the face of strong community opposition, although the Government has recently given guarantees to the workforce about the retention of public sector jobs.

Do PPPs create employment?

New jobs are invariably created through the investment in infrastructure and services during the construction phase, whether publicly or privately financed. The key issue is whether long-term employment will be increased. Evidence from PPPs in the UK suggests that as projects continue, the net number of jobs usually declines as jobs are shed in order to cut costs and raise profits. 'Workplace restructuring' and 'rationalisation' are embraced as part of the new private enterprise ethos.²¹

PPPs also tend to reduce terms and conditions for staff. For example, critics of the outsourcing of cleaning contracts in NSW government schools point out that it has led to "cut-throat competition" based on "unrealistic output, reduced hours and intensified work arrangements".²² In a paper on public education delivered in 2001, NSW Greens Education spokesperson, John Kaye, described the situation: "the cleaners have nothing going for them. They are sacked at the drop of a hat, they are pushed around. I have a file in my office full of stories from cleaners about how, for example, their vacuum cleaner broke down, and they are told if you don't get it fixed yourself you are out of a job."²³ The Liquor, Hospitality and Miscellaneous Union (LHMU), which represents school cleaners, provides more evidence for these concerns: award breaches in the cleaning industry resulted in $450,000 in unpaid wages between 1999 and 2000.²⁴

Do PPPs provide better services?^:

Proponents of PPPs sometimes claim improved services but there are grounds for anticipating the opposite outcome in practice. Private operators are primarily responsible to their shareholders rather than to the community: their resultant focus on profit-maximisation and cost-cutting may jeopardise the standard of service. There is considerable evidence that this has occurred in PPPs in NSW. At the Port Macquarie Base Hospital, for example, nurses called on the State government to investigate the hospital's staffing practices, including its decision to stop rostering theatre nurses on weekends, which they claimed were cost-cutting exercises that put profits before human life. ²⁵ As noted above, the hospital was later rated worst in the State, based on Department of Health performance indicators.

Who is accountable under PPPs?

PPPs can also be heavily criticised for the lack of accountability to the community. Access to the details of contractual arrangements is often denied on 'commercial in confidence' grounds. Hence, "there is no accountability for the spending of public funds, and no independent evaluation in which there is access to adequate information".²⁶

The above concerns indicate that PPPs are a hazardous road to travel further along. We should be seeking alternatives.

Government provision of infrastructure and services

There is a growing volume of evidence that most people think infrastructure and services traditionally provided by governments should still be provided publicly rather than by private enterprise. For example, the 2003 Australian Survey of Social Attitudes (AuSSA) showed widespread support for this position for a range of services, including health services, child care and aged care.²⁷ Considering the growth in private provision of social services, this suggests that Australians are already getting "a more privatised welfare state than they want".²⁸ . ..Direct public provision can be funded by a number of means. Increasing taxation revenue is the most obvious. Australia is already a low-taxed country in comparison to the OECD average.²⁹ As well as indicating that Australians would prefer more social spending by governments, the recent AuSSA showed that most Australians are willing to pay more taxes in order to fund publicly provided services. Research into these findings suggests that these sentiments have become increasingly widespread since the election of the Howard government, reflecting growing dissatisfaction with changes to the provision of health services and public education.³⁰ The Sydney Morning Herald economics editor Ross Gittins draws similar conclusions, arguing that not only do governments provide services better, but to go further down the path of privatisation would fundamentally change Australian society in ways he believes most Australians would not want.³¹

The principle alternative to infrastructure funded through taxation is public debt. It is negative attitudes to the role of public debt that have been a principal driver of the push to PPPs. The recent Ministerial inquiry into sustainable transport in NSW (the Parry Inquiry) recommended that "public debt should only be considered as a funding source when other more desirable funding options [including PPPs] have been fully explored".³² One can argue equally strongly for the reverse presumption, that is, we should only have recourse to PPPs if more public debt is unacceptable. In practice, and contrary to what is often heard from politicians at both State and Federal levels, there is no pressing need to reduce public debt. Since the Coalition came to power in 1996, it has reduced Federal government debt from 19% of GDP to a budgeted 2.9% for 2004-05.³³ This compares to an average for OECD countries of 50%.³⁴

Many of the conventional arguments for debt-reduction are deeply flawed. They reflect a myopic concern with 'balancing the books' that ignores the needs of future generations. To invest in infrastructure today is a prerequisite for a more prosperous future. If this is not done through public debt, the effect is to shift the burden to private debt. Public housing provides an illustrative case in point. The run-down of investment in public housing, now dwindling to less than 5% of the housing stock, puts more pressure on the private housing stock, adding to the inflationary processes that have been so evident in recent years. So private mortgage debt increases. In effect, the squeeze on public debt shows up in the form of growing private debt. Public frugality and private indebtedness are two sides of the same coin.

For the financing of public infrastructure the public debt option is preferable. After all, the future economic prosperity of the nation, as well as the quality of our environment and the adequacy and reliability of our public infrastructure, is at stake. The shift to PPPs is part of the process whereby such collective and long-run concerns are marginalised by the short-term fetish with elimination of public debt. As Professor John Quiggin argues, "in retrospect, many of these [PPP] projects have been shown to have reduced the net worth of the public sector... The superficial appeal of such projects as a way of reducing public sector debt has been shown to be an illusion generated at high social costs."³⁵

Alternative funding -There is a wide range of options for funding public infrastructure in practice. Savings bonds, for example, can be used to facilitate community investment in infrastructure provision.³⁶ The Australian Greens are currently advocating specifically earmarked 'Green Bonds' as the key part of a plan to invest $35 billion over 10 years to boost public investment in social, environmental and economic infrastructure. This would increase public infrastructure spending in line with the current rate of GDP growth.³⁷

Other possibilities include financing infrastructure by drawing on the massive pool of savings currently held by superannuation funds. The super funds could be required by the Federal government to channel part of their expenditures into infrastructure investment, through holding public infrastructure bonds as a significant component in their portfolios. If they were required to hold 5% of their total capital in this form it would amount to over $27 billion. Requiring the super funds to invest part of their capital in this way might raise fears about whether such a regulation would result in any substantial lowering of the rate of return and therefore of the value of workers' retirement incomes. This is an important concern. However, to the extent that improved infrastructure underpins national economic productivity, increased investment in infrastructure would enhance the financial rate of return on other assets held by the funds. So there need be no trade-off between infrastructure investment and the rate of return achieved by the funds in the medium term. Moreover, any balanced portfolio needs some high security, low risk components. In this case infrastructure bonds, with a steady rate of return and underwritten by government, could impart an element of greater stability into an otherwise uncertain investment environment.

Conclusion

The costs of providing infrastructure and services can be expected to increase into the future. This is partly due to demographics and the ageing of the population, but it is also due to increasing costs of health care, education and repairing the environment.³⁸ Ross Gittins has pointed out that for the most part we should be happy if this occurs: it is indicative of improved environmental protection and increasing investment in health and education as people live longer and increasingly seek to undertake education and training. ³⁹

The key question is how we are to fund and manage these aspects of economic and social progress. The role of public goods is paramount, and their public provision is as important to the economic and social wellbeing of

Australia today as it has ever been. There are economically viable and socially desirable alternatives to PPPs - it is time to start talking seriously about the various combinations of taxation, public debt and

superannuation that could best suit this purpose. Where there's a will there's a way...

Frank Stilwell is Professor of Economics at Sydney Uni - and Kirrily Jordan is a Research Assistant.

(Editor: This article was first published in Arena in 2004. Since 2004 there have been further PPPs. Due to lack of space the detailed reference list has been omitted. Email pandbtoms@bigpond.com for it to be sent to you.)