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Are ‘Public Private Partnerships’ the only way to boost capital spending on infrastructure?

Posted on April 21, 2017 by Tom Healy

Tom Healy, Director NERI
Tom Healy, Director NERI

Public-Private Partnerships (PPPs) were much in vogue across Europe for many years especially prior to the Great Recession of 2008-2012. The essential idea behind PPPs is that the State commissions a private company to undertake some or all of the following: part-fund, design, build, operate and maintain a facility (it could be a motorway, a school, a hospital, a social housing scheme, etc).  The State may pay a fee on an on-going basis to a private entity while the latter may, depending on the nature of the product or service, charge a fee to those using the product or service in order to recoup the costs of running the service.  One rationale – but not necessarily always the main one – is that such arrangements involve less initial outlay of spending by public authorities. This point has particular currency ...

...as many Governments across Europe and the world seek to avoid raising taxes to pay for growing populations or more complex and resource-intensive health systems.  There is also the matter of the European Union ‘fiscal rules’.

A number of PPP models exist including ‘ Unitary Payment Projects’ where the State makes regular payments to the private sector partner subject to satisfactory performance.  ‘Up-front Capital Projects’ (such as in wastewater projects) involve an upfront capital investment by the State but procured on a DBOM basis (Design, Build, Operate and Maintain).  ‘ Concession Projects’ (such as tolled motorways) involve payment of a user charge to the private operator.  ‘ Asset-based Schemes’ involve provision of a public asset (such as publicly owned land) on which private developers undertake investment (such as in social housing).

In a NERI Working Paper in 2013, Vic Duggan has discussed some aspects of PPPs in Ireland [ Ireland’s Investment Crisis: Diagnosis and Prescription Victor Duggan June 2013 NERI WP 2013/03 ].  The Department of Public Expenditure and Reform has a dedicated website http://ppp.gov.ie/ while the Department of Finance in Northern Ireland has a special page here .

Are PPPs ‘good value for money?’ Even if PPPs were a way to reducing initial cost on the part of central or local government do they save money in the longrun?  There is growing literature on various funding models including PPPs (or Public Finance Initiatives as they are called in the UK).  The evidence that PPPs save the taxpayer money in the longrun is underwhelming. In a paper given at a NERI seminar in 2013, Dr Eoin Reeves of the University of Limerick has drawn attention to the hidden costs as well as the explicit or implicit transfer of risk to the State [ Public-Private Partnerships in Ireland: A Review of the Experience ].  He drew attention to the lack of transparency around contracts, value-for-money analyses and governance oversight.  Reports of the Office of the Controller and Auditor General (C&AG) in the Republic of Ireland have drawn attention to liability issues for Government.

The C&AG Report on the Accounts of the Public Services 2011 has noted:

Significant costs have been incurred on cancelled PPP projects. Some of this expenditure is sunk cost that has delivered no effective benefit. In other cases, assets have been acquired that may be usable in the future if projects recommence.

The C&AG goes on to recommend that:

Evaluations of the value for money expected to be achieved through procurement of projects by means of PPP should be published.

A detailed review for the Northern Ireland Public Service Alliance, NIPSA, of PFI/PPPs in Northern Ireland over a ten-year period [ The use of Private Finance Initiative (PFI) Public Private Partnerships (PPPs) in Northern Ireland ] by researchers at the Centre for International Public Health Policy in the University of Edinburgh do not mince words in the following:

Private finance creates a public debt. The public bodies involved in PPPs have to pay annual payments to the private sector over a long period, often 30 years.

The “additionality” of private finance is illusory – an accounting anomaly which distorts financing decisions. Similarly, the notion that PPP can help to rebalance the economy is a misconception. This is a policy that will channel work to large, overseas companies at the expense of domestic providers, curtailing private sector growth.

The evidence demonstrates that finance costs are higher for the private sector, and this, combined with an excessive rate of return on capital, has led to very high costs for the public authorities involved in contracts.

The sums involved in Northern Ireland are not trivial.  The Northern Ireland Audit Office in its 2014 report, The Future Impact of Borrowing & Private Finance Commitments stated that:

" Total estimated PFI committed payments relating to the 39 PFI contracts in Northern Ireland is £7.2 billion, with the current cost of PFI contract payments approximately £250 million per annum".

That translates into £4,000 per capita in Northern Ireland.  The capital value of PFI projects in Northern Ireland was £1.9 billion.

In a report by the UK Office for National Statistics [ Wider Measures of Public Sector Debt by Hayes, Moskalenko and Bailey] the extent of UK on-balance sheet PPPs is highlighted:

As at March 2015, the National Accounts and Public Sector Finances debt measures included approximately £5 billion in finance lease liabilities relating to on-balance sheet PPPs. By contrast there were estimated to be approximately £31 billion in off-balance sheet PPP liabilities at the same point in time."

 

There is no corresponding esetimate for Northern Ireland but it is likely to run to many hundreds of milions of pounds.

A Guide to the Statistical Treatment of PPPs produced by the European PPP Expertise Centre (EPEC) with assistance from EUROSTAT provides detailed information which may be of assistance in helping Member States to obtain ‘off-the-books’ solutions to their fiscal challenges (although this is not the purpose or aim of the publication).  Some sense of the challenge in meeting the fiscal rules may be given in the following revealing answer to a Parliamentary Question recently [ Social and Affordable Housing ]. EUROSTAT offers advice to Member States on various matters of statistical classification at this website here (although such advice has only recently become generally public so there may be cases where advice against placing PPPs on the books is not shown). Not all cases of PPPs go ‘off-the-books’. See, for example, this case which arose in Lithuania.

It must be emphasised that Public Private Partnerships are a domestic policy choice.  It is striking that comparisons of EU Member States (see below) show variation in the use of PPPs. In the UK, according to Eurostat data, ‘Adjusted capital value of off-balance private-public partnerships (PPP)’ was estimated by Eurostat as £31.5 billion. In the Republic of Ireland, the figure was €2.3 billion in 2015. Chart 1, below, presents the information as a % of GDP (for 2014 instead of 2015 because of the very unusual surge in GDP in the latter year in the case of Ireland). Clearly, the Republic of Ireland along with the UK, Hungary, Slovakia and Hungary is a big fan of PPPs. However, Germany and France have no recourse to PPPs whatsoever (Chart 1). It is sometimes claimed or suggested that without recourse to PPPs Governments will spend less on capital investment. This is simply not the case.  The UK and Ireland are big users of PPPs and yet both countries spend relative little on capital investment from public sources.  Sweden spent twice as much on capital investment from Government sources in 2014 as was the case in Ireland (Chart 2). Yet, PPPs are unknown in Sweden as in many other EU Member States. PPPs are a policy choice and not a policy inevitability because of fiscal rules.  The argument used in support of PPPs by some policy makers and politicians that they provide a way of circumventing the EU fiscal rules on government spending, deficits and debt does not hold up. 

 

EUROSTAT, the European statistical agency which has responsibility for overseeing (and ultimately approving) national classifications of economic activities according to ‘General Government’ or market corporation has been taken a much more rigorous approach to the interpretation of the statistical rules than heretofore.  The European Commission and Member States make or interpret the EU fiscal rules. However, Eurostat along with national statistical offices decide how various entities or activities are classified with regards to being ‘on-the-books’ or ‘off-the-books’. In other words, they get to decide if an entity such as Irish Water or the Strategic Banking Corporation of Ireland or the various Approved Housing Bodies are to be treated as ‘on-the-books’ or otherwise. The criteria used in making these decisions are based on typical or expected commercial revenue flows together with explicit or implicit state subsidies as well as the governance and purpose of any particular entity. 

In a Note published, last year, by Eurostat Eurostat clarification note The statistical treatment of PPP contracts the following paragraph is crucial to a proper classification of assets of PPP’s:

It is recalled that, for the asset in a PPP project to be classified in the balance sheet of the private partner, the majority of risks and rewards must be carried by the private partner. In this case, the PPP contract may sometimes mention financial advantage and disadvantage compensation clauses which would bring the availability fee (and hence the profit of the private partner and the costs for government) to a more “normal” level (specified in the contract at the outset) through adjustment of the availability or demand fee. These clauses are incompatible with the classification of the assets in the balance sheet of the private partner, as they have the effect, in practice, of capping risks and rewards for the private partner.

See also “ Frequently asked questions on Public-Private Partnerships (PPPs) and their statistical treatment in national accounts (ESA2010)

The widespread belief that PPPs are:

  1. A sure way of avoiding EU fiscal rules by shifting activity to the private sector and facilitating a low-tax regime; and/or
  2. The only way of so doing

…is very much open to question. In the first place, PPPs are coming under increased EUROSTAT scrutiny with cases of projects failing the private corporation test. In the second place, examples of possible ‘off-the-books’ public corporations involving full public ownership and control of assets ‘off-the-books’ are provided by Cost-Rental Models used for public housing in various European countries and reviewed in the recent NERI Working Paper [ Ireland’s Housing Emergency - Time for a Game Changer ] .  Those in the private sector advocating PPP’s as a sure or only way of avoiding necessary public investment in economic and social infrastructure should face the ‘burden of proof’ test to demonstrate that

  • PPPs will remain off-the-books using Eurostat classifications and recent precedents
  • Alternative models of publicly owned entities cannot work just as well and deliver better value for money in the short and long-run.

Ultimately, all concerned must face the truth that public investment in economic and social capital investment is well below what it needs to be. Public capital investment is funded from taxes or from borrowing (which is deferred taxation generated by higher economic growth).  No amount of creative book-keeping and institutional engineering involving cash cows that deliver more to corporations than the general public can get around this fact.

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