Bill Rosenberg is the Economist and Policy Director for the NZ Council of Trade Unions. This is the paper he presented to a July 2014 Christchurch seminar on PPPs. Ed.

In papers from the 2013 Budget, Treasury says that: “The Minister of Health has indicated that no additional capital funding will be made available in the 2013 Budget other than for the Canterbury District Health Board’s redevelopment and public private partnerships (PPPs)” (1). Considerable credit is due to local Canterbury DHB staff in exposing the rorts that PPPs can be. In August 2013, Treasury’s head of PPPs, John Park, told the New Zealand Council for Infrastructure Development (NZCID), which is the main lobby group for private involvement in public infrastructure and services, that it was looking at further PPPs in prisons, education, health and transport (2). We know the Government is considering PPPs for schools in Christchurch (3). It is using one for the Transmission Gully highway development in Wellington. There is an existing PPP at Mt Eden prison, the new men’s prison at Wiri will be a PPP and Auckland Prison’s maximum security wing will be designed, rebuilt, financed and maintained using a 25-year PPP. Other local governments are also looking at PPPs – the Wellington City Council is considering a convention centre proposed by a local property developer which would cost the Council $92 million over 20 years (4).

What Are PPPs?

PPPs take a variety of forms, but in general they hand over some or all of the financing, design, construction, maintenance and operation of a public facility to a private consortium, often including banks, construction companies and services operators (like Serco which runs some prisons in New Zealand and many elsewhere), but may also include law and accountancy firms, architects, engineers and various other professional consultants. Because in general they have to be large they are frequently overseas owned.

A PPP can also be seen as a form of funding that replaces capital raised by the Government raising from its own revenue or borrowing, something I’ll return to later. What “operation of facility” means can vary. So for example, although a health PPP may provide services that are in theory not related to health, leaving health professionals and managers to provide the medical services, it is often difficult to draw hard lines. Cleaning, catering and orderly services can all have important impacts on patient health, safety and recovery for example. PPP operators often control retailing and vending machines in the building, with implications for advertising and the health impacts of food and other goods sold. There are similar considerations for the running of schools and other social facilities. In schools there will be issues regarding out of hours access to facilities under the control of the PPP operator. The school may want to have them available for sports or cultural activities or for community education; the operator will see hiring them out as a way to make more money.

Experience In The UK

There are far too many horror stories about PPPs for me to cover. I will just give a few examples from the UK because it is in a sense the home of the current PPP model. PPPs have been hugely controversial there where they are often referred to as “PFIs” or “Private Finance Initiatives”. Introduced in large numbers into many areas of the public sector including health, education, social services, prisons, courts and roads by Tony Blair’s Labour government, it is significant that they are now being severely criticised by conservative politicians and media as a waste of public funds. The conservative Daily Telegraph reported in December 2011 for example (5) that Andrew Lansley, the Health Secretary in the Conservative-led government, had complained that hospitals are “being forced to spend extortionate sums on private contractors rather than spending that money on helping sick patients get better”. The Telegraph reported that: “Official figures show that taxpayers are committed to pay £229 billion for new hospitals, schools and other projects with a capital value of just £56 billion. Much of the additional spending goes on expensive maintenance contracts”. It gave examples: “North Staffordshire National Health Service Trust paid £242 to put a padlock while North Cumbria University Hospitals NHS Trust paid £466 to replace a light fitting and £75 for an air freshener. A trust in Salisbury paid £15,000 to ‘install a laundry door following feasibility study’”.

Unfortunately, these are by no means unique. There has been a series of critical investigations by the Public Accounts Select Committee of the UK Parliament. In 2011 it reported that: “In the present public expenditure climate there are legitimate concerns being expressed about the continuing financial cost of PFI for public organisations such as NHS Trusts. Some of Government's case for using PFI has not been based on robust analysis, but on ill-founded comparisons and invalid assumptions… At present, PFI deals look better value for the private sector than for the taxpayer”. (6) Margaret Hodge, the MP who chairs the Public Accounts Committee, has spoken of “an absurd situation where you had a company seemingly lying about what it was doing, but there was nothing in the contract that could allow you to terminate it – indeed, they still appeared to be eligible for their bonus payments”. (7)

The Treasury Select Committee reached similar conclusions and found that: “We have not seen clear evidence of savings and benefits in other areas of PFI projects which are sufficient to offset this significantly higher cost of finance. Evidence we studied suggests that the out-turn costs of construction and service provision are broadly similar between PFI and traditional procured projects, although in some areas PFI seems to perform more poorly. For example, we heard that design innovation was worse in PFI projects and we have seen reports which found out that building quality was of a lower standard in PFI buildings”. (8)

A study of roading PPPs in the UK and Spain concluded that: “While the use of private finance has proved expensive for both the taxpayers and road users, it has been beneficial for the construction industry, road operators and their financial backers… In other words, the use of private finance in roads can be viewed as a classic example of ‘privatising the benefits and nationalising the costs’”. (9) A 2012 Nuffield Trust report looking at the financial pressures on the UK National Health Service, “Can NHS Hospitals Do More With Less?”, noted the inflexibility of PFIs: “PFI schemes can commit trusts to substantial annual payments for up to 30 years… There is relatively little flexibility in PFI contracts, and because of this it has been suggested that there will be pressure to concentrate hospital activity on PFI sites at the expense of non-PFI sites if there is contraction”. (10)

Monopoly

This last point is a poignant one. PPP contracts are typically for 25-30 years. They give the PPP private consortium a 25-30 year monopoly over the operation of the facilities which may enable it to charge extraordinary amounts for minor changes requested after construction has been completed. The Government is legally obliged to pay regular instalments on the contract in the same way as a household must pay interest on a mortgage. During recessions such as the recent one, Governments try to cut spending by reducing maintenance and closing or making more efficient use of underused facilities. However PPP contracts are in effect privileged: payments cannot reduce, leaving less Government revenue available for other services.

Even if there is no longer a need for a facility, payments must continue. According to another UK newspaper investigation in 2010: “Balmoral High School in Belfast closed six years after it was built, when pupil numbers halved. However, the Northern Ireland Department of Education owes the contractor £370,000 a year for the next 18 years” (11).  As the UK government makes severe cutbacks, privatises increasing parts of the health services and moves care out of hospitals,  the Telegraph says: “Experts fear that PFI-built hospitals could be left half empty while trusts still have to pay millions every year in interest payments on the ‘mortgages’” (12). The profitability of these operations to their private operators provides evidence of the monopoly position they are in. “The average annual return on the sale of equity in UK PPP project companies was 29% between 1998-2012 – twice the 12%-15% rate of return in PPP business cases at financial close of projects”, according to the European Services Strategy Unit which maintains a database on PPPs (13).

Risk

One of the advantages of PPPs is said to be that the risk of building and owning facilities is shifted to the private sector. As has been seen, it may shift some of the risk around availability but not all risk. In any case, ultimately all risks in practice remain with the Government which cannot simply walk away from the failings of what remains in the public’s eyes a public hospital, road or school. The Government will be forced to intervene as it did in New Zealand in failed privatisations such as rail, Air New Zealand and banking, which were similarly supposed to transfer risk to the private sector. The more risks that are anticipated in negotiating the PPP legal contracts, the more complex and expensive the contracts become, and the higher the charges exacted for the PPP itself become as the private operators shift the cost of the risk back to the Crown in their charges.

Matthew Ryan, Associate Professor of Economics at Auckland University, points out that what in fact can happen is that risks and the likelihood of Government bailout becomes the subject of cold calculation by PPP operators:

“When the Government procures a private partner for a 25-year contract, it is not buying the completed job – it is buying some probability of completion. The winning bid reflects not only the efficiency or innovative spirit of the winning bidder, but also its estimated default probability and expectation of any Government bailout. Inefficient or financially fragile firms, which hope to make money when the going is good but default on obligations when times are tough, can afford to make attractive-seeming bids. The presence of such firms forces higher quality bidders to reduce their performance expectations in order to compete effectively on price. The result may be a ‘market for lemons’”. (14)  He concludes: “A positive case for private finance has yet to be made”.

To use a hospital as an example, over a three-decade contract, the risks of underuse or major change of use are high because changing medical practices, technology, demography and local health and population pressures change the nature and size of facilities that are needed. In addition, while a force majeure such as the 2010/11 Christchurch earthquakes may be insured against and provided for in PPP contracts in a general sense, it is almost impossible to anticipate and provide for all consequences such as the loss of population from Christchurch, and the change in its distribution. A Government could be left paying the cost of a hospital facility which is being used far below its planned capacity – or have little choice but to increase the capacity of a hospital controlled by a private operator.

New Zealand Experience

We have some of our own experience over the longer term. Novopay* is a PPP for school pay systems. You may have followed the intensely divisive debate over the ruinous financial position the Kaipara District Council has got into. It was the result of another form of PPP that went disastrously wrong. Serco’s management of the Mount Eden Prison has never been far from problems. The Sky City Casino convention centre deal is a PPP in a different form. *The Government has since terminated the contract with Australian company Talent 2, which operated Novopay, and has taken back responsibility for operating the teachers’ pay system. Ed.

Undoubtedly we will be told that in future we will learn from previous mistakes. It is extraordinary vanity that politicians think New Zealand with its small size and shortage of expertise and resources can do better than the hugely experienced UK when both Government and public there are clearly heartily sick of the scandals and looking desperately for ways to extricate themselves from expensive 30 year contacts. But in addition to their complexity and pitfalls, the evaluation of PPP deals in New Zealand is biased toward private provision. In comparisons of public versus PPP provision, the cost of public provision is required to be based on private sector interest rates (which are much higher than those available to the Government) in the cause of so-called “neutrality”, and public provision has an additional cost loading (usually 20%) for so-called “deadweight costs” of raising taxes, regardless of whether the public is happy with paying taxes for good public services (15). Thus, when we are told that the saving on the PPP for the Hobsonville School was “an upfront cost saving of 1.7% over the Public Sector Comparator” it is likely that in practice the PPP will be significantly more expensive (16).

In any case, 1.7% of a contract of this size and duration is well within the margins of error of estimating costs and is highly sensitive to assumptions such as the discount rates used. Even taking it at face value, 1.7% of the estimated cost of $111.1 million (in net present value terms) is $1.9 million. That is likely to be well below the cost of setting up the PPP. The Ministry of Education budgeted $2.5 to $3.5 million a year from 2010 to 2013 for “Detailed Business Cases” for and “Investigations into” PPPs for new school properties. Over the five years to June 2018 it is budgeting a further $31.6 million for these costs – more than the $29.8 million being budgeted in operational expenses to pay for the Hobsonville PPP itself. (17) The consultancy Castalia, the self-described “pioneer in PPPs” (18) which recommended PPPs in New Zealand schools, says the cost of setting up a school PPP could be as high as $6 million. (19)

PPP contracts can be designed to anticipate many possible contingencies, and we would hope they do learn from international experience. However because of the complexity of the facilities being created and the very long period of the contract, they are hugely complex contracts. The new PPP prison in Auckland, at Wiri, will cost $21 million before construction even begins, (20) and the PPP for Transmission Gully $30.7 million (21). A PPP for the London Underground which ultimately failed to get underway cost £445 million in negotiating the contracts(22). Indeed because of the large overhead costs, Castalia advised – and the Government has accepted – that PPPs in schools are not worth doing unless the PPP consortia are assured of several such projects. So we have the absurd situation of the overhead costs of these agreements being used as a reason for having more of them. Lawyers, accountants and financiers clearly are winners in these negotiations. But ultimately, everything cannot be anticipated, there will be loopholes, unforeseen circumstances and difficulties in enforcement.

In fact many of the cost savings in the UK have been due to lower pay for staff. The Centre for Public Services in the UK found that staff in private prisons were paid 25% less on average than their State counterparts and had inferior non-pay entitlements(23). There are no minimum staffing levels stipulated in New Zealand PPP prisons and the Corrections Association says Serco’s staffing levels are below the minimum required to run Mt Eden Prison safely. Castalia said that they “assume a PPP contractor (in New Zealand schools) will improve the efficiency of caretaking and cleaning by 20% including through contracting out and stronger labour bargaining”.(24) Perhaps because cost savings are elusive and it is simply not possible to control for all risks, the Government is now saying that the benefit of PPPs is not so much cost savings, “but because we learn so much” from them, as Bill English argued in November 2013 (25). If the lessons are so worthwhile, it is hard to imagine why they cannot be acquired in less risky ways.

International Pressures

With large sums like these at stake, it should be no surprise that arrangements like PPPs will be encouraged by the Trans Pacific Partnership Agreement (TPPA) currently under negotiation between New Zealand, the US and ten other countries. A number of its provisions could affect our ability to control and back out of PPP arrangements in future. For example, PPPs are a form of Government purchasing and the Government procurement chapter would require us to allow any commercial operator in a TPPA country equal rights to run them. It would also prevent us placing conditions on operators such as preference for not-for-profit providers or having health and safety standards above the legal minimum. The Government is about to sign a Government Procurement Agreement under the World Trade Organisation with similar effects.

The US is also insisting that the TPPA contains enforcement processes that would allow investors to sue the Government if their profits were threatened. A PPP contract is regarded as an investment under the very wide definitions in the leaked text of the TPPA’s investment chapter. If a PPP began to go wrong – perhaps because a central or local government wanted to change the use of a PPP-run facility or strengthen controls on how it is run, or because of unforeseen demographic changes or natural disaster – the Government could be faced with hugely expensive actions against it before private international dispute panels of trade lawyers with potentially tens or even hundreds of millions of dollars at stake. PPP contracts could be litigated in such panels rather than in our local courts. Even the threat of such actions could “chill” governments’ willingness to take action in the public interest.

Conclusion

While such arrangements may appear superficially attractive to cash-starved local or central governments, future Governments and the public will in the longer run regret the waste, loss of flexibility and impact on other public services.