Date created: 15/11/08 3:02 PM Last modified:15/11/08 3:02 PM Maintained by: John Quiggin John Quiggin
21 June 2007
With state treasurers around the nation announcing plans for large-scale infrastructure programs, the role of public-private partnerships (PPPs) has once again become the focus of attention. The keenest interest is in toll roads, because, in the words of US bankrobber Willie Sutton, ‘that’s where the money is’. Toll road PPPs are appealing to politicians and financiers alike, because of the large and long-lasting flows of cash they generate.
For politicians, this means more than the spurious appealing of packaging costly infrastructure projects as if they are free. As was shown by the Cross-City Tunnel project, there is ample room to treat part of the cash flow as a source of funds independent of the usual budgetary processes. For private investors, the appeal is even greater. A PPP project yields payoffs to financiers far greater than the boring, but cheap, option of financing projects by the issue of government bonds, serviced with tax revenue or user charges.
However, there is wide agreement among economists that such projects are particularly inappropriate areas for private provision of infrastructure.
Toll roads are, in most cases, a bad idea, regardless of their ownership. As Andrew Leigh pointed out recently, tolls based on construction cost typically bear no relationship to an economically sound system of road pricing, based on congestion Pay a Fee or Pay the Toll, AFR 14/6/-7. The fact that so many tolls are locked into long-term contracts is a major obstacle to rational road pricing.
Second, as the Productivity Commission has pointed out, PPP financing of toll road projects violate the fundamental principle of contracting, that risk should be allocated to the party best able to manage it. The main risk associated with ownership of a toll road is traffic volume, mainly determined by factors like urban development patterns, that are outside the control of the road owner, but subject to the effects of government policy.
With public scepticism about PPP toll roads increasing, attention is turning to social infrastructure such as hospitals. Australia had some early, and unfortunate, experience in this field with governments being forced to bail out, and eventually repurchase, hospitals at Port Macquarie in NSW and Robina in Queensland.
Rather than dwell on, let alone learn from, these failures, PPP advocates have focused on the British Private Finance Initiative which is claimed to do much bette. Here too, there were plenty of early failures. The first PFI hospital, in Cumbria, was the subject of a series of damning reports. But the claim is that all these teething difficulties have been worked out, and that things will run smoothly from now on.
It appears, though, that the opposite is the case in important respects. The longer such projects operate, the greater is the disadvantage to the public partner from being locked into a contract with a term of many decades, and the more the contractual terms turn out to benefit the private partner.
Hidden time bombs keep re-emerging. One relates to the highly profitable business of refinancing. An intangible risk that can be shifted back to the public allows a refinancing with higher gearing and a massive increase in the return to holders of equity. In some British projects, the investor rate of return rose from 15 to 70 per cent after refinancing. As the House of Commons Public Accounts Committee noted recently, ‘Some of the locally negotiated refinancings have produced very high investor returns and increased risks for the public sector such as higher termination liabilities and longer contract periods.’
Even more striking are recent disclosures about termination clauses. These should provide a way for the public sector to get out of contracts that are unbalanced or inappropriate to changing circumstances. But years after the contracts were drawn up, the Daily Telegraph has discovered clauses stating that, in the event of termination, the private parties get to keep, and redevelop land worth hundreds of millions of pounds, under leases that in some cases extend into next century.
This is unsurprising, given the incentives. The politicians and bureaucrats who negotiated the deals for the public have, predictably, moved on by now, so it is unsurprising that they were more concerned with initial impacts than with long-term effects. Meanwhile the professionals on the other side of the table had strong incentives to insert such clauses.
The proponents of PPP financing have had at least 15 years to get things right, but we still keep hearing the same excuses about teething problems and the need for better contract design. Perhaps it’s time for a moratorium.
John Quiggin is an Australian Research Council Federation Fellow in Economics and Political Science at the University of Queensland.
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