Building better public-private partnerships

By on 15/01/2018
Edinburgh’s PFI-built £184m Royal Infirmary, completed in 2002, was built at the height of Britain’s PPP investments (Image courtesy: Lisa Jarvis).

Since entering the mainstream as the UK’s Private Finance Initiative, public-private partnerships have had a mixed track record – and this week’s collapse of PFI construction firm Carillion has further turned the tide against them. But outside Europe, they’re increasingly popular: Gavin O’Toole learns the lessons of Britain’s experiences

“There are a lot of criticisms of public-private partnerships in the UK, but overall by European standards it’s a convincing story – the UK has taken on PPPs in a very significant way, and actually they have done a pretty good job,” says Guy Chetrit.

Chetrit, the principal adviser at the European PPP Expertise Centre (EPEC) – an advice agency hosted by the European Investment Bank – insists that attacks on these novel instruments of financing – in which the UK is seen as a regional leader – are often unfounded.

“Much of the debate in the UK has been heavily politicised,” he says. “Yes, there have been criticisms; yes, there have been a lot of news stories about this – but actually the political noise has been much bigger than the real issues.”

A tricky tool

Yet even Chetrit doesn’t argue that PPPs have always worked out well for the public sector, or present them as suitable for all forms of public infrastructure spending. This week’s spectacular collapse of construction and infrastructure business Carillion illustrates one of the key dangers – threatening to upset facilities management and building projects across the public sector. But there are other risks: UK public bodies have ended up paying high costs for finance, and found themselves bound into inflexible contracts which impose high fees for maintenance or unforeseen use of buildings and facilities. The challenge facing finance officials, Chetrit says, is to consider project by project whether it is “a valuable way of contracting compared to the alternatives.”

Britain – by far the largest user of PPPs in Europe – has spent years developing its approach to managing PPPs, slowly working out how to minimise the risks and avoid the traps. “The UK has been at the forefront of developing the PPP technique, and has been thinking of the issues at stake when you contract out public services and try to get value out of them for a long time,” Chetrit comments. “They have done a very good job by European standards, in terms of developing the technique, facing the issues – and finding solutions.” So the UK experience has much to teach other nations embarking on the same path – helping them to realise the potential benefits and, just as importantly, avoid the pitfalls.

The big picture

A public-private partnership is an agreement in which responsibility for the provision of a service remains with the public sector, but infrastructure is financed – and generally managed, under an agreement lasting for many years – by the private sector.

While research suggests that increased use of PPPs in developing countries stems from the desire of governments to create new public infrastructure without adding to public sector borrowing, this is nowadays widely seen as a weak argument for PPPs. Since governments can borrow more cheaply than private businesses, the cost of finance is typically higher in PPP schemes; and if governments wish to invest in public services, they should probably make the argument for higher taxes rather than hide liabilities in long-term finance agreements.

Yet there are more substantive arguments for PPPs, which can allow governments to access specialist professional skills, take advantage of economies of scale, and focus on their core role of public service delivery. How far has the UK realised these benefits?

High costs of finance

The UK government has been an enthusiastic champion of PPPs since 1992 under a programme it calls the Private Finance Initiative (PFI), with the most recent Treasury figures showing that there were 716 PPP projects with a total capital value of £59bn ($80bn, €67bn) up to March 2016. The UK’s National Health Service (NHS) has made considerable use of PPPs, and in 2017 there were 127 PFI schemes in the English NHS valued at £13bn.

However, despite their use under governments on both right and left, PPPs have become a source of political division in the UK. A recurrent criticism is that interest rates payable on the funds borrowed by PPP consortiums have been more expensive than on government borrowing – thereby costing the taxpayer far more than if the government had borrowed to finance new projects itself.

While the National Audit Office (NAO), the UK’s official spending watchdog, has found that most PPPs have met contractual deadlines and budgets, it has also expressed concern about how they are expensive compared to conventional procurement methods.

The World Bank’s Public-Private Partnership in Infrastructure Resource Centre (PPPIRC) concedes that development, bidding and ongoing costs in PPP projects are likely to be greater than for traditional government procurement.

Fuelling criticism of PPPs in the UK have been the large windfall gains made by some private investors when these assets are “refinanced” after construction through the sale of shares to institutional investors. In 2017 the Centre for Health and the Public Interest (CHPI) said the NHS is “leaking” money to private companies, which had made pre-tax profits of £831m in the previous six years.

And there’s more

Inflexible PPP contracts have been blamed for a decline in public services, as spending on variable costs such as staffing is reduced to meet inflation-linked debt repayments. Some hospitals have been locked into high facility-management costs for building maintenance. And schools have found themselves unable to provide services to the wider community – such as hosting voluntary groups or training activities in the evenings – because contracts permit providers to levy high fees for additional services.

Moreover, the refinancing of UK PPPs has often attracted infrastructure funds and investors located offshore in tax havens, contradicting an early argument in favour of PFI: that taxpayers would benefit from corporation tax on contractors’ profits. The European Services Strategy Unit, a think tank, says the five largest listed offshore infrastructure funds made a total profit of £1.8bn in the period 2011–15 but paid no tax.

PPPs have also faced a large number of contractual problems and have often been the target of buyouts. Contracts have been criticised for inflexibility and a lack of transparency, in some cases sparking protests. The high stakes of failure in this market have been underscored in recent weeks by debt problems at Carillion – a construction and outsourcing firm that derives a third of its revenue from public sector contracts and PPPs – which went into liquidation, leaving ministers scrambling to ensure that public services and contracts weren’t derailed.

In 2012 a review of PFI advanced reforms to address shortcomings, and the government created “PF2” to make contracts more flexible and ensure greater transparency.

Technical solutions

Over the years, the British government has managed to address many of these weaknesses. It did so, in part, by improving its skills in procurement and contract management – ensuring that it wasn’t out-negotiated by private providers as agreements are developed. “We definitely learned a lesson on having a central unit and on getting in quite a lot of private sector expertise,” one senior HM Treasury figure told Global Government Forum. “For us, that means paying wages that you wouldn’t normally pay in the public sector to get the right people in.”

Officials have also had to change the way assumptions around future economic conditions are built into contracts. “You want the contracts to turn on passing the risk to the private sector, but the danger is that actually they turn on the assumptions you’re making for exchange rates and future inflation,” the civil servant says. “We never envisaged interest rates and inflation at such low levels when signing contracts five, ten years ago, and that’s left some contracts that look pretty generous to the private sector.”

In agreeing IT support contracts for public bodies, the UK has changed the way it lets contracts – splitting up big, wide-ranging service provision deals, and letting much narrower, shorter-term contracts less likely to become a millstone around the neck of departments that want to launch new digital services or change their IT systems. “You try and break it up into smaller contracts, reduce the risk, and make those contracts more flexible and more closely reviewed,” says the Treasury official.

As Chetrit says: “PPP is a tool: it has merits and it has challenges, and I think people in the UK – especially at the Treasury level – understand both how useful the tool can be, and where it becomes very difficult to use. Mistakes have happened; but likewise, conventionally procured projects go wrong, a lot – and possibly more than with PPPs.”

And political reactions

Yet PPPs have become politically toxic in the UK, in part because the deals’ long-term nature means that many public bodies are saddled with poor agreements brokered in the early days of PFIs. The Conservative government makes little noise about its continuing use of the format, and the Labour Opposition has – in a move apparently designed to emphasise its break with the approach of former leader and PM Tony Blair – set its face firmly against them.

“The scandal of the Private Finance Initiative has resulted in huge long-term costs for taxpayers while providing enormous profits for some companies,” shadow chancellor John McDonnell said last September. “Over the next few decades, nearly £200bn [US$270bn] is scheduled to be paid out of public sector budgets in PFI deals. In the NHS alone, £831m [US$1125m] in pre-tax profits have been made over the past six years. Never again will this waste of taxpayer money be used to subsidise the profits of shareholders, often based in offshore tax havens.”

McDonnell’s pledge to take PFI contracts back “in-house” may prove unrealistic or unaffordable, but PPPs – despite their provision of hundreds of schools and hospitals – have a poor reputation in the eyes of the public.

Edinburgh Royal Infirmary Building, a PFI hospital/teaching complex at Little France (Image courtesy: Lisa Jarvis).

Growth outside Europe

Nonetheless, evidence suggests that PPPs are growing in use internationally. The World Bank lists 116 countries that have passed laws enabling PPPs, and the latest data for 2017 reflected a 24% increase in investment volume on 2016. In Turkey, the average number of new PPPs rose from six during 2000-2010 to over 20 in the years after 2011; the country now has over 200 contracts.

International experience suggests that enthusiasm for PPP in countries that lack mature infrastructure is commonly driven by a desire to supplement public investment – “additionality”. And this is certainly Turkey’s experience: a senior Turkish finance official tells Global Government Forum that using PPPs enables the government to keep its budget deficit below 1.5% of GDP.

Chetrit believes, however, that PPPs should not necessarily be seen as a way of overcoming budgetary limitations: they should instead be selected on per project basis where they’re the best form of funding. “PPPs are not going to sort out your funding and budgetary allocation issues,” he says. “You use the best tool in the circumstances, and governments are slowly are coming round to the idea of PPPs as just being one way of doing public investment, with challenges and with potential benefits.”

Getting it right

The Turkish government has been learning from the British experience, and building a single legal framework and a dedicated central unit to help civil servants avoid PPPs’ pitfalls. “We’ve seen in many countries high risks because the initial negotiation was not right, mainly because on the public side they didn’t have the right skills,” notes the Turkish official. “In some countries there’s a huge difference in maturity between the finance guys in the private sector side and those on the public sector side.” Those risks, he adds, have sometimes led to excessive pricing, poor quality delivery, and punitive costs for contract variations and additional services.

Perhaps in response to these threats, in Europe PPP investment has declined in recent years: in 2016, the value of PPP  transactions totalled €12bn (US$14.3bn), a 22% decrease from 2015. Chetrit adds that the decline may also reflect the consequences of decisions made 3–5 years ago after the financial and sovereign debt crises, when governments curbed public investment in general.

“On policy agendas, are PPPs flavour of the month? It really depends on where you go,” he says. “You have places like the Netherlands, for instance, Belgium, Spain, who are saying PPPs are going to be an important instrument going forward in certain sectors; and you have places like France, which in 2012 was the main PPP market in volume terms in Europe but has done very few PPPs over the last five years. So it really depends on where you are in the cycle and who is in power.”

Key lessons

So PPPs can help shift risk and borrowing onto the private sector – but a bodged contract can leave governments holding most of the risk, whilst paying over the odds for finance. And the only way to get it right is to build the right skills and capabilities in the public sector, enabling officials to properly assess proposals and secure good-value contracts.

This is the view of the World Bank’s PPPIRC, which says that given projects’ long-term nature and complexity, a key issue facing the public sector is the difficulty identifying all possible contingencies during contract negotiations.

To get it right, says Chetrit, civil service leaders must carry out extensive due diligence and recruit the right specialists. Strong institutions, effective legal and regulatory frameworks, and good accounting and reporting standards are essential, he adds; and when it comes to delivering value for money, robust performance evaluation and monitoring are fundamental.

“At the end of the day, a lot of it is down to how you have prepared your project in the first place, what kind of contract you have put in place, what kind of systems you have put in place, and contract management during its operation,” he concludes. “PPPs are not for everybody: they are a sophisticated and complex instrument, and it is very dangerous to put those complex instruments into the hands of governments that are not able to manage them.”

Note: this article has been edited to reflect events in the fast-moving story of Carillion’s collapse.

About Gavin O’Toole

Gavin O’Toole is a freelance writer and editor in London. He has written for leading newspapers, magazines, wire services and business schools about financial markets, business and regulation around the world. He has a particular interest in international relations, and a specialism in Latin American affairs. He has conducted research on this region’s political economy and has also published a number of books about its politics and natural environment. His latest title, Environmental Security in Latin America, will be published by Routledge in September 2017.

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