Date created: 28 November 1996
Last modified: 18 November 1997
Maintained by: John Quiggin
John Quiggin

Public pays price for private infrastructure

The Age<

Nov 22 , 1994

The Kennett government's recent announcement that private developers are to be permitted to charge tolls on existing public roads marks both an inevitable development in the push towards privately-owned infrastructure and the collapse of the last credible rationale for that policy. The initial claim associated with BOOT (Build, Own, Operate and Transfer) projects was that the public sector would get 'something for nothing' in that there would be no public input, but the public would eventually get ownership of the project. The reality, as is now being discovered, is that BOOT projects require either massive transfers up-front or expensive public sector rescue packages.

The policy shift from pure BOOT projects to publicly subsidised pseudo-private infrastructure is inevitable simply because very few road projects can be successfully financed by tolls, unless the scope of the toll is extended to cover existing elements of the road network. This is because much of the benefit of any new road accrues to users of the existing network. As traffic is diverted on to the new road, congestion on the existing network is reduced.

In addition, the very act of charging a toll reduces the benefits of the project. Drivers will be willing to take longer and more congested routes to avoid the toll, and the new road will be underused. Thus, the toll itself is a further source of inefficiency. Except in the case of congested bridges and tunnels, tolls are an inefficient and wasteful method of financing road expenditure.

The difficulty of toll-financing a road is greatly increased in the case of private sector infrastructure projects. This is because the rate of return demanded by private sector investors is about twice the rate at which the government can borrow. Hence, the toll must be twice as large to cover costs, with the result of more diversion of traffic onto alternative routes and further reductions in the benefits of the project.

Taking all these factors into account, a genuine BOOT project would only be feasible for projects with a (conventionally-assessed) benefit/cost ratio in excess of four to one. Not surprisingly, such projects are very rare and most of them have already been undertaken. As a result, private infrastructure projects throughout Australia have been characterised by covert or overt handovers of public assets.

How does this fact affect the case for private infrastructure? The simplistic rationale for privately financed infrastructure is that it permits the development of projects that could not be afforded by the government because of the danger of excessive public debt. It is now generally recognised that this argument is simply smoke and mirrors. An infrastructure project will have essentially the same macro-economic effects whether it is publicly or privately financed. Moreover, it is ultimately impossible for the government to avoid bearing much of the risk associated with these projects. For these reasons, the NSW Auditor-General has recently insisted that the State government admit ownership of pseudo-private infrastructure such as the Sydney Harbour Tunnel.

The next claim made in favour of private infrastructure is that the superior efficiency of the private sector will lead to cost savings. There is little doubt that a fixed price contract is more efficient than the old method of construction by day labour. However, governments have realised these cost savings for many years by putting construction projects such as roads out to competitive tender. Once an infrastructure project such as a road has been built, public ownership is cheaper than private. This is because the main cost associated with ownership is the riskiness of returns. The public sector with its large and diverse portfolio of assets is much better placed to bear these risks than is any private sector corporation. This is reflected in the 'equity premium' between the rate of return demanded by equity investors in private corporations and the bond rate at which governments can borrow.

BOOT projects face even greater difficulty. There is no reason to expect that a company that is expert in road construction should also be expert in risk management. Furthermore, much of the risk regarding traffic flows is associated with government policy decisions regarding land development and the planning of other parts of the road network and competing public transport. Because of these risks, private firms can be induced to invest in BOOT projects only if they are given either very high returns or assurances that future government policy will put their interests ahead of those of the public at large. Both options are very costly.

The remaining rationale for private infrastructure projects is that, since such projects will only be undertaken if they are profitable, private sector involvement is a guarantee against the occasional tendency of transport ministers and other politicians to wasteful monument-building. The government's recent announcement explodes this rationale. Once private sector developers are allowed to collect taxes on existing public sector assets to finance their projects, there is no guarantee that the benefits of these projects will exceed the costs. Furthermore, the secrecy associated with these projects (particularly in Victoria) and the replacement of open competitive tendering with deal-driven preferential treatment is a virtual guarantee of poor decisions, as well as an open invitation to corruption.

In NSW, which took the lead in private sector infrastructure, some of the first of the inevitable disasters are already coming to light. Like most 'something-for-nothing' deals, BOOT projects will prove very profitable for their promoters and very costly for the Australian public.

John Quiggin is Professor of Economics at James Cook University and author of Great Expectations: Microeconomic reform and Australia, published by Allen & Unwin.

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