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The use of
Private Finance Initiative (PFI)
Public Private Partnerships (PPPs)
in Northern Ireland
The use of
Private Finance Initiative (PFI)
Public Private Partnerships (PPPs)
in Northern Ireland
Mark Hellowell, David Price and Allyson M Pollock,Centre for International Public Health Policy,
University of Edinburgh
This report was commissioned by NIPSANorthern Ireland Public Service Alliance, 54 Wellington Park, Belfast BT9 6DP
i
Index
Page(s)
Executive Summary ................................................................................................1
Introduction .............................................................................................................2
i What is PPP? ......................................................................................................2
ii Financing and funding in the public sector ..........................................................3
Section 1: The use of PPP in NI - current scale and plans for expansion ........4
1.1 Capital investment through PPPs signed and in procurement ........................4
1.2 Government departments involved in PPP ......................................................5
1.3 The impact of PPP on NI revenue budgets ......................................................6
1.3.1 Actual commitments on signed schemes ...............................................6
1.3.2 Estimated future payments for schemes in negotiation .........................7
1.4 Plans for PPP from 2012 onwards ...................................................................7
Section 2: Shifting rationales - a decade of PPP policy development in NI .....8
2.1 The embrace of PPP - first period of devolution (1999-2002) ........................8-9
2.2 Putting the PPP structures in place - direct rule (2002-2007) .......................9-10
2.2.1 A new policy rationale during direct rule ...............................................10
2.3 Devolution restored .........................................................................................11
Section 3: Evaluation of the arguments for PPP ................................................12
3.1 Does private finance provide ‘additional’ resources for public services? ........12
3.1.1 Capital and revenue resources in NI..................................................12-13
3.1.2 Changing accounting practices .............................................................13
3.2 PPP as a means of rebalancing the economy .............................................14-15
3.3 PPP and value for money ...............................................................................15
3.3.1 Financing costs in PPP ......................................................................15-17
3.3.2 The evidence: the public sector comparator ......................................17-18
3.3.3 The evidence: time and cost overruns ..................................................18
Conclusion ..............................................................................................................19
References ...........................................................................................................20-22
ii
Foreword
NIPSA has campaigned against the use of Private Finance Initiative (PFI) and Public
Private Partnerships (PPPs) since these policies were first introduced by the
Conservative Government in the 1990’s. Despite the mounting evidence of PFI and PPP
failures, however, the UK Government and the NI Executive continue to advocate the use
of PFI/PPPs to provide essential public service infrastructure and deliver public services.
NIPSA therefore decided it was essential to provide Ministers, MLAs and the public in
Northern Ireland with an independent and rigorous analysis of the use of PFI/PPPs in
Northern Ireland. Professor Allyson Pollock’s team at the University of Edinburgh was
commissioned to undertake this work – the University’s Centre for International Public
Health Policy is widely recognised and respected as an expert authority on the issues
involved.
We believe this is a landmark report on PFI/PPPs in Northern Ireland. It provides stark
facts. The unitary charges to fund agreed and projected PFI/PPP schemes is going to
cost a staggering £10 billion plus if the devolved administration adheres to current plans.
These costs will have to be met from Northern Ireland’s public expenditure budget. Public
services will suffer not benefit as a consequence.
It is now time to stop PFI/PPPs in Northern Ireland. A switch back to conventional
procurement for all future public capital projects can only help local companies in the
current financial climate. As the report highlights, PFI/PPPs freeze out local companies in
favour of large multinational corporations.
The Centre’s report now provides the clear and compelling evidence for the change of
policy on PFI/PPPs that is so desperately needed. NIPSA commends the report for
detailed consideration by Northern Ireland’s Ministers and MLAs.
JOHN COREYGeneral SecretaryNIPSA
1
Executive Summary
• Theuseofpublicprivatepartnerships(PPPs)InNorthernIrelandhasdramaticallyincreasedsincethelate1990s.AsofMarch2008,contractsfor35PPPprojectshadbeensigned,representingprivatefinancingof£1.29billion.Afurther13projects,withacapitalvalueof£1.94billion,arenowbeingnegotiatedwithprivatesectorbiddersandareduetosignbefore2012.
• Privatefinancecreatesapublicdebt.ThepublicbodiesinvolvedinPPPshavetopayannualpaymentstotheprivatesectoroveralongperiod,often30years.Thefuturepaymentsonschemessignedtodateamounttosome£4.7billion.Astheprojectscurrentlyinnegotiationaresignedoff,theliabilitiesaccruingtoPPPcontractsinNorthernIrelandwillrisetomorethan£10billion.
• DifferentrationaleshavebeenusedtosupportPPPinNorthernIrelandinthelastdecade.ThefirstdevolvedadministrationregardedPPPasameansofgenerating“additional”investment.However,thisrationalewasbroadenedduringdirectrule,whenPPP(bynowthe“preferred”methodforcapitalinvestment)wasembracedaspartofwidermeasurestoreducethesizeofthepublicsector.
• Infact,neitherrationaleisvalid.The“additionality”ofprivatefinanceisillusory–anaccountinganomalywhichdistortsfinancingdecisions.Similarly,thenotionthatPPPcanhelptorebalancetheeconomyisamisconception.Thisisapolicythatwillchannelworktolarge,overseascompaniesattheexpenseofdomesticproviders,curtailingprivatesectorgrowth.
• Inreality,thelegitimacyofPPPstandsorfallsonitscost-efficiencycredentials:i.e.whetherthepolicyisbettervaluethanthealternatives,suchasdirectborrowing.Theevidencedemonstratesthatfinancecostsarehigherfortheprivatesector,andthis,combinedwithanexcessiverateofreturnoncapital,hasledtoveryhighcostsforthepublicauthoritiesinvolvedincontracts.
• Thesecostsareincreasingfornewschemesduetothecreditcrunch,whichhaseliminatedbonds-thecheapestsourceofprivatefinance-andsignificantlyincreasedthemarginsonbankfinance.
• Newaccountingregulationswilladdresstheanomalywherebydebtraisedthroughaprivatesectorintermediaryisnotrecordedonthepublicsector’sbalancesheet.ThiswillremovethecentralattractionofPPPforthepoliticalpartiesofNorthernIreland.Withdevolutionrestored,thereisaclearneedforafull,independentreviewofcapitalinvestmentpolicyinNorthernIreland.
2
Introduction
UnderthePrivateFinanceInitiative(PFI),thepublicsectorentersintolong-termcontractswithprivatesectorcompaniestodesign,build,financeandoperateanewfacilitysuchasahospitalorschool.ThepolicywasintroducedbytheConservativegovernmentintheautumnbudgetstatementof1992and,sincethen,ithasaccountedforasignificantproportionoflarge-scaleinvestmentprojectsinareassuchashealth,education,defence,transport,councilhousing,waterinfrastructureandwastemanagement(HMTreasury2008).AsofMarch2008,627PFIschemeshadbeensignedintheUnitedKingdom,representingprivatelyfinancedinvestmentof£58.2billion.
InNorthernIreland(NI),privatefinancehasbeenusedasamethodofincreasinginvestmentinpublicservices,whicharewidelyperceivedtohavesufferedfromunder-fundinginrecentdecades.TheuseofPFIprojects,orpublicprivatepartnerships(PPPs)astheyaremorecommonlyknowninNI,hasincreasedsincethelate1990s.AsofMarch2008,therewere35PPPcontractssignedinNI,providingprivateinvestmentof£1.29billion.Afurther13contracts,withacapitalvalueof£1.94billion,arebeingnegotiatedwithprivatesectorbiddersandwillbesignedby2012.
i. What is PPP?
APPPisalong-termarrangementbetweenapublicauthorityandagroupofprivatesectorfirms,inwhichthelatterisresponsibleforfinancingthedesignandbuildofnewfacilities,andthenprovidingcertainserviceswithinthemoncetheconstructionworksarecompleted.Forexample,inahospitalPPP,anNHSbodywillcontractwiththeprivatesectortodesign,buildandfinanceanewhospital.Oncethehospitalbuildingisdelivered,theprivateoperatorwillmaintainthefacilityanddeliverarangeof“non-core”services-suchascateringandcleaning-foraperiodof25-30years.
WhenundertakingaPPP,apublicauthoritycarriesoutacompetitiveprocurementprocess,withanumberofprivateconsortiabiddingagainsteachotheronthebasisofpriceandqualitytoundertaketheproject.Eachconsortiuminvolvesamixofinvestors,suchasconstructionandfacilitiesmanagementcompaniesandprivateequityinstitutions.Onsigningthecontractfortheprojectwiththepublicauthority,themembersofthewinningconsortiumcreatea“SpecialPurposeVehicle”(SPV)-anewprivatesectorbusinessthatexistssolelytodelivertheproject.
TheSPVentersintosub-contractswithoneormorefirms(usuallyitsownshareholders)todelivertheproject.Financeisalsoraisedfromtheshareholders,and‘seniordebt’israisedfrombanksorthecapitalmarkets.InthestandardSPVfinancialstructure,seniordebtwillprovide90%ofthefinancerequired,withloansandequitycapitalfromtheshareholdersmakinguptheremaining10%.ThepublicandprivateorganisationsinvolvedinatypicalPPP,theirrolesintheprojectandthefinancingarrangementsbetweenthem,areillustratedinFigure1below.
3
ii. Financing and funding in the public sector
WhilePPPprovidesfinanceforinvestmentinnewfacilitiesandinfrastructureinNI,itdoesnotprovidefunding.Itisamethodofaccessingcapital,likedirectborrowinganditcreatesalong-termfundingrequirementforthepublicsectorinmuchthesameway.AnnualunitarychargesmustbepaidthroughoutthelengthofthePPPcontract,providingareturnontheprivatesector’scapitalandfeesfortheservicesitprovides.Thus,increasinginvestmentthroughPPPrequiresanincreaseinfunding–andthiscanonlycomefromtheUKTreasury,higherregionaltaxationorusercharges.
However,undercertainconditions,usingPPPratherthanborrowingdirectlycancircumvent(oftenstrict)constraintsoncapitalinvestment,andthishasbeenoneofthecentraldriversbehinditsuse.
ThisreportprovidesanoverviewandanevaluationoftheuseofPPPinNorthernIreland.Itisorganisedinthreesections:
Section 1:illustratestheincreasingsignificanceofthePPPmethodinNI,alongwiththeimplicationsforfuturepublicexpenditure.
Section 2:summarisesthemaindevelopmentsinPPPpolicyinNIoverthelastdecade,describingtheembraceofa“limited”PPPprogrammebythedevolvedadministrationof1999-2001;andtheexpansionofthepolicyanditsrationalesunderthesubsequentperiodofdirectrule.
Section 3:providesanevaluationofPPPagainstthethreemainrationalesfortheuseofPPPinNI,focusingonclaimsofPPP’sabilityto:provideadditionalresources,addressmacro-economicimbalances;anddeliverhigherefficiency.
Public sector body/ users
Private sector
‘Special Purposes’
Construction company
Facilities manager
Equity investor
Debt provider (bank)
Facilities managerBuilder
Services delivered
fee paid
Figure 1 The contractural structure of a typical PPP project
Share-holder capital
debt
typically same firm
sub-contractors
4
Section 1: The use of PPP in NI - current scale and plans for expansion
ThissectionexaminesthescaleofprivatelyfinancedinvestmentcommittedasofMarch2008,andprojectionsofadditionalinvestmentupto2012.Italsooutlinesthelong-termcosttothepublicsectorofthecontractssignedtodate,andprovideanestimateofthelongtermcostofprojectsthatarecurrentlybeingnegotiated.ItisdemonstratedthatcapitalinvestmentthroughPPPissettoincreasesignificantlyoverthecomingyears,atrendmirroredbyincreasesinthepublicliabilities.
1.1 Capital investment through PPPs signed and in procurement
AsofMarch2008,therewere35signedPPPcontractsinNI,withacombinedcapitalvalue1of£1.29billion.Thisrepresentscapitalexpenditureof£758perheadoftheNIpopulation–asignificantfigure,thoughstillabout£250lessthantheequivalentcalculationfortheUKawhole(ONS2008).ThisreflectsthefactthatprivatefinancewasusedtoamuchlesserextentinNIthanintherestoftheUKuntilrecentyears.Figure2illustratesthis,plottingthestarkincreaseinthecapitalvalueofprojectssignedpercalendaryear,fromjust£8millionin1997to£444millionin2007.
Figure2alsoshowsthatthecapitalvalueofsignedPPPswillincreasesignificantlybetween2008and2011,asthe13contractsfortheschemesnowbeingnegotiatedaresigned.Thevalueofcontractsisprojectedtoincreasefrom£353.6millionin2008to£630millionin2011.ThiswillincreasethevalueofPPPcontractsfrom£1.29billionasofMarch2008,to£3.22billionbythestartof2012,andtaketheamountofprivatefinanceperheadofpopulationto£1,138–higherthanthecurrentUKlevel.
Source: OFMDFM (2008)
1‘Capitalvalue’isanestimateoftheamountofcapitalinvestmentrepresentedbyagivenPPPcontract.
Figure 2. Actual value of projects signed between 1997-07 and estimated value of schemes projected
to sign between 2008-11
5
1.2 Government departments involved in PPP
ThePPPmodelhasbeenusedacrossawiderangeofNIpublicservices,providingnewgovernmentaccommodation,roads,waterinfrastructure,wastefacilities,hospitals,schools,collegesandlibraries.ThetablebelowillustratesthesectoralbreakdownofPPPinvestmentcommitteduptoMarch2008,andprojectionsforschemesnowinprocurement.Onexistingschemes,threeNIExecutivedepartments-RegionalDevelopment(responsibleforwaterandroads);Education;andHealth,-havebeenthemaincommissioningauthorities,accountingforover90%ofthecapitalvalueofcontractssigned(thelargestofwhicharehighlightedinBox1).Goingforward,however,PPPinwaterandroadsisdiminishing(alongwiththeenvironment,socialdevelopmentandenterprisesectors),whileitcontinuestohaveamajorroleineducation,healthandfinanceandpersonnel.
Actual value of Projected value ofNI Executive department schemes signed (£m) schemes in procurement (£m)
1. Social development 26.5 0
2. Regional development 586.2 0
3. Environment 25 0
4. Health 167.05 1,087
5. Finance and Personnel 47 450
6. Enterprise, Trade and Investment 25 0
7. Education 344.6 309.6
8. Employment and Learning 62 88
9. Culture, Arts and Leisure 13.9 0
Total 1297.25 1,935
Source: OFMDFM (2008)
6
Figure 3. Total unitary charges to be paid on schemes signed as of March 2008
Unitary charges (£m)
Box 1 Signed PPP schemes worth more than £50 million in capital value
Regional Development• a£118millionroads package,signedinFebruary2006.Totalunitarychargestobepaid
onthisschemeare£508.29millionbetween2006/07and2035/36.• afurtherroadspackagewithacapitalvalueof£224million,signedinDecember2007.
Totalchargestobepaidonthisschemeare£1004.59millionbetween2010/11and2037/38.
• the£110millionAlphawater schemefortheNIWaterService,signedinMay2005.Totalchargestobepaidonthisschemeare£506.86millionbetween2008/09–2031/32.
• the£122millionOmegawaterschemefortheNIWaterService,signedinMarch2007.Totalchargestobepaidonthisschemeare£640.14millionbetween2007/08–31/32.
Healthcare• a£98millionmanaged equipmentPPPfortheBelfastHealth&SocialCareTrust,
whichsignedinMay2007.Totalchargestoonthisare£132.93millionbetween2006/07and2021/22.
Education• the£104millionClassroom2000schemeforpost-primary and special schools,signed
inMarch2003.Totalunitarychargestobepaidare£116.11millionbetween2002/03to2010/11.
• the£58.2millionClassroom2000networkscheme,alsosignedinMarch2003.Totalunitarychargesare£120.16millionbetween2003/04to2011/12.
Source: www.hm-treasury.gov.uk
1.3 The impact of PPP on NI revenue budgets
1.3.1 Actual commitments on signed schemes
Asexplainedintheintroduction,thecapitalinvestmentcommittedbytheprivatesectorhastoberepaidwithinterest,alongwithpaymentsforservices.Theseunitary chargesarepaidbytheNIExecutivetotheprivatesectoroverthe25-30yearlengthofPPPcontracts.Asnoted,capitalinvestmentthroughPPPnowequals£1.29billion.Figure3(below)plotstheprofileofthe£4.7billionofunitarycharges(innominalterms)thataccruetothe35contractssignedbyMarch2008.Thesepaymentsrisefrom£1.5millionin1997-08toreachapeakof£167millionin2010-11.
Source: www.hm-treasury.gov.uk
7
1.3.2 Estimated future payments for schemes in negotiation
Clearly,thescaleofpaymentswillincreaseasmoreprojectsaresigned.However,itisimpossibletoestimatewithanycertaintywhatthepublicsectorcostswillbewhentheschemescurrentlyinprocurementarecompleted.Onecrudemethodistoexaminetheratioofcapitalvaluestolong-termunitarychargesonschemesthataresigned.Asnoted,thevalueofschemessignedasofMarch2008is£1.29billion,andpublicsectorliabilitiesontheseschemesare£4.69billioninnominalterms,givingaratioof3.64.Addingtheprojectedvalueofschemescurrentlyinprocurementproducesatotalcapitalvalueof£3.22billion-andmultiplyingthisby3.64yieldsthefigure£11.73bn.
Giventhenumeroussourcesofmeasurementbias2,thisfigureisnotverymeaningful.Perhapsallwecancurrentlysayisthat,by2012,thetotalcostofPPPsinNIwillbeintherangeof£10-15billion.
1.4 Plans for PPP from 2012 onwards
TheInvestmentStrategyforNorthernIreland2008-2018(OFMDFM2008)identifiessome£20billionofnewinvestmentinthe10yearsfrom2008butprovidesnoinformationonwhatrolePPPwillplayindeliveringthis.Indeed,theterms‘publicprivatepartnership’and‘PPP’donotappearinthedocument.Itisunclearwhetherthisomissionistheresultofpoliticalmanagement–thatis,adesiretoobfuscatethetruescaleofPPPplans,orwhetherthecurrentExecutiveisgenuinelyunsurewhatthefutureholdsforprivatefinanceinNI.Whatisclearisthatthereareanumberofprojectswhich,byvirtueoftheirlargecapitalinvestmentrequirementsandlong-termnature,areoncurrentguidance(HMTreasury2003)likelytoproceedasPPPs.Theseinclude:
• ArapidtransitsystemfortheGreaterBelfastarea.TheISNIstates:“Thepotentialtoleverinprivatesectorfundingwillbeanimportantingredient”
• SignificantinvestmentinNI’smotorway/dual-carriagewaynetwork(partoftheTrans-EuropeanNetwork)andupgradestoselectedlinkcorridorsandtrunkroads
• AnewBelfastCentralLibraryopenby2015
• Deliveryofupto10,000newsocialhomes
• Significantincreasedinvestmentinwasteandwastemanagementfacilities,inabidtomeetEUtargetsonwaterqualityandlandfill.
2Forexample,pastexperienceshowsthatbothcapitalandcontractcostsonPPPsincreaseduringtheprocurementprocess,soitcannotbeassumedthatthecurrencyquotedcostsareaccurate.
8
Section 2: Shifting rationales - a decade of PPP policy development in NI
Priortothefirstmodernperiodofdevolution(1999-2002),PPPhadmadebarelyanyimpressioninNI,despiteitsgrowingsignificanceintherestoftheUK.ThecapitalvalueofPPPschemessignedinNIbetween1992/93and1999/2000waslessthan£100million,comparedto£4billioninGreatBritain(HMTreasury2008).However,intheearlydaysofdevolution,NIpoliticalpartiesbegantoregardPPPsasapotentiallyimportantmeansofincreasinginvestmentinpublicinfrastructure.
2.1 The embrace of PPP - first period of devolution (1999-2002)
InJuly2001,theNIAssembly’sCommitteeforFinanceandPersonnelpublishedareportonPPPs,arguingthatprivatefinancecouldprovideadditionalresourcestotheamountfundedbyTreasurythroughtheblockgrant.Itstatedthat,“whilethepreferredsourceoffinanceispublicfinancebecauseitcanbeprovidedatlowerinterestratesthanprivatefinanceandensuresthatresponsibilityforprovisionofpublicservicesremainswithinthepublicsector”,PPPswouldhavetoplaysomeroleininfrastructuredeliverysince“theTreasuryisunlikelytomeetalloftheoutstandingfinancialneedsofNIfromincreasedpublicexpenditureintheshorttomediumterm”(CFP2001,p.5).
UsingPPPtodeliveradditionalfinancewassubsequentlyadvocatedbyMarkDurkan,theNIfinanceministerinthefirstdevolvedadministration.HetoldtheAssemblythat:“wedonotwishtousepublicprivatepartnershipassomeformofprivatisation.Theaimistoensurethatwemaximiseourpublicinvestment...inourcircumstancetherulesareclear:ifweborrow,thefullamountisdeductedfromourpublicexpenditureblock-wedonotgettheadditionalexpenditure.”3HeaddedthatrulingoutPPPwouldbe“doctrinaire”asitwould“limitouropportunitiestoprovideservicesofamodernstandardinthesortoffacilitiesthatpeoplehaveeveryrighttoexpect”(NIA,2001).
Tounderstandthisargument,itisnecessarytobrieflyoutlinethecapitalfinancesysteminNI.MostpublicexpenditureinNIisfundedundertheAssigned Budget,4whichissetbyWestminster,undertheBarnettFormula.ThisadjustsfundingtoreflectchangesinpercapitaexpenditureinEngland.TheAssignedBudgetprovidesfundsforspendingonservicessuchastransport,healthandeducation(i.e.thosethatareadministeredbytheNorthernIrelandExecutiveindevolution,andtheNorthernIrelandOfficeduringdirectrule).Itiscomposedofacapital budget(moneyforinvestmentinbuildingsandequipment)andarevenue budget(moneyfortheprovisionofservices).
Underthissystem,capitalspendingfundedthroughtheuseofNIresourcesorthroughdirectborrowingistightlyconstrained.ThecapitalusedwillcountagainstNI’s(verylimited)capitalbudget,reducingthescopeforalternativeexpenditure.Inaddition,there
3UndertheReinvestmentandReforminitiative,agreedwithHMTreasurin2002,an(initiallylimited)powertoborrowwasprovided,solongasthiswaspaidforoutoflocally-raisedtaxation(Heald2003).4ThisistheblockgrantfromHMTreasuryandaccountsformorethan90%oftotalexpenditureinNI.
9
areongoingcapitalchargesontheinvestmentthatwill,alongwithdepreciation,countagainsttheNIrevenuebudget.5
Incontrast,undercurrentTreasuryrules,solongasaPPPisoff-balance sheet(i.e.theprojectisrecordedasacontractforservicesratherthanafinancialleaseinthepublicsector’saccounts),therewillbenodirectimpactontheNIcapitalbudget,whileannualchargescountagainsttherevenuebudgetastheyareincurred.Theeffectofthisisthat,whilecapitalspendingfacestwoconstraints,onbothcapitalandrevenuebudgets,projectsfinancedthroughPPPfaceonlythelatter.Thisisthesourceoftheclaimthatprivatefinancecandeliver“additional”publicsectorinvestment.
InlinewithCFPrecommendations,aninter-departmentalworkinggroupwasestablishedandareportissuedforconsultationinMay2002.ReflectingthethemesoftheCFP’swork,thereportadvocatedlimiteduseofPPPsforthepurposeofincreasinginvestment,withasocialpartnershipapproachinvolvingtradeunionsandthevoluntarysectorinprojectdecisions(OFMDFM,2002).
2.2 Putting the PPP structures in place - direct rule (2002-2007)
InOctober2002,responsibilityforthedevelopmentofinvestmentpolicyinNIpassedtoWestminsterwiththere-impositionofdirectrulein,whichwastolastuntilMay2007.PerhapsthefirstsubstantiveactofdirectruleministersinNIwastolaunchaStrategicInvestmentProgramme,aspartoftheBudgetannouncementinDecember2002.Thissetoutplansforaround£2billionofinvestmentoverthefive-yearperiodto2007-08,including£725millionthroughPPPand£400millionofdirectborrowing,withtheremainderfundedthroughtheblockbudget.
ItwasunderdirectrulethatministersfinalisedthepolicyframeworkfortheuseofPPPinNI,andthebureaucraticinfrastructurewasestablishedtodeliverit.Thisframeworkwasoutlinedinthedocument,Working Together in Financing our Future(OFMDFMandDFP2003)whichstatedthattherewouldbea“strongpreference”forPPPininfrastructureandaccommodationprojects.Thiswasincontrasttothe“limited”roleforPPPthathadbeenenvisagedintheworkinggroupreport,suggestingthattheroleofprivatefinancewouldbeexpandedstillfurtherunderdirectrule.
This“strongpreference”wasreflectedinthestaffingofthenewStrategicInvestmentBoard(SIB),theexpertprocurementbodyoriginallyadvocatedbytheCFPandsupportedintheworkinggroupreport.TheSIBwasestablishedasanindependentgovernmentagency,butwasstaffedbyindividualsfromthePPPindustry,andheadedbyAndyCarty,adirectorofPartnershipsUK(PUK),thehalf-public,halfprivatebodythatisboththeUKgovernment’sexpertbodyonPPPandthepolicy’smainadvocate.ThechoiceofCarty(andhissuccessorDavidGavaghan,fromDavidWyldeProjectFinance)reflectedthecentralityofPPPtotheinvestmentplansofdirectruleministers.
Long-termplansforinvestmentinNIwerepublishedbytheSIBInDecember2004,inadraftinvestmentStrategyforNI,settingoutapotential£16billionprogrammeofinfrastructureinvestmentforthetenyearsto2015,withthepriorityonschools,hospitals,
5PublicentitiesmustpaytheTreasuryfortheuseoftheirbuildingsthroughannualcapitalcharges.
10
housingandwaterinfrastructure.Thefinalised“InvestmentStrategyforNorthernIreland2005-2015”waspublishedinDecember2005,andspecifiedthat23%oftheprogramme–thepartofitdealingwithlarge-scaleinfrastructureandaccommodationprojects-wouldcomethroughPPP.
InWorking Together,directruleministersmaintainedtherhetoricof“socialpartnership”thatwasacorethemeintheCFPandworkinggroupreports.However,thenew“strongpreference”forPPP,andthekeyrolenowbeingplayedbypractitionersandadvocatesofPPPwithintheSIB,renderedmeaninglessthiscommitment.
2.2.1 A new policy rationale during direct rule
Whiletheallegedabilityofprivatefinancetodeliver“additional”resourceswas,asshownabove,thecentralmotivebehindPPP’sexpansionduringdevolution,therationalewasbroadenedunderdirectrule.Working Togetherhadsignalledthischangeinemphasis,stressingtheabilityofPPPproviderstointroduce“reformandchangemanagement”inthepublicsectorsoastodevelop“newworkingpracticesorlessbureaucraticprocedures”(p.3).Combinedwiththe“strongpreference”forprivatefinance,thissetthestageforthemajorexpansionofPPPoutlinedinSection1ofthisreport.
Theimportanceofthisnewrationalegrewduringtheperiodofdirectrule,andmirroredreformsinEnglandwheretheprivatesectorwasencouragedtoplayalargerroleinthepublicservicesdelivery.However,thisagendahadadistinctroleinNIwherePPPwasregardedasplayingaroleinawiderattemptto“rebalance”theNIeconomyinfavouroftheprivatesector.DirectruleministersarguedthattheNIpublicsectorwastoolarge;thatthelevelofapublicexpenditureperheadwashigherthantheUKasawholeandthatitneededtobereduced;andthateffortshadtobemadetostimulatetheprivatesector,includingthroughtheuseoftax-fundedservices(Hain2006).
TheReview of Private Services in NI(NIERCandRegionalForecasts2004),commissionedbytheNorthernIrelandOffice,suggestedthatthe“DirectRuleAdministrationpromoteprivatisationofappropriateorganisationsstillinthepublicsector”(p.9).Privatisationshouldinclude“wholeorganisations”butalso“individualgovernmentactivitiescouldbehivedofftotheprivatesectortoagreaterextentthanatpresent”(p.115).Inresponsetothis,theNIOsaiditwould“lookatareaswherepublic/privatepartnershipsincapitalprojectscanhelpleverinprivatefinancetoGovernmentprojects”and“continuetoexplorehowtheprivatesectorcanbemosteffectivelyengaged”(p.6).
Similarly,theEconomic Vision for NI(DETI2005)saidthegovernmentwoulddeliver“areformedpublicsectorwhichisinbetterproportiontothesizeoftheprivatesector”and“exploitgreaterpartnershipbetweenthepublicandprivatesectorsforthedeliveryofservicesandfacilities”(p.9).ThisstoodincontrastwiththestatedpreferenceoftheCommitteeofFinanceandPersonnel’sforretainingserviceswithinthepublicsector;andthestatementsofdevolvedministersthatPPPswereaboutincreasingpublicinvestment,andwerenotintendedtoresultinanyprivatisation.
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2.3 Devolution restored
Withdevolutionrestored,thereisevidencethattheNIExecutiveismovingawayfromthismacro-economicagenda.TheExecutive’s2008-11NIBudget,forexample,contestedtheclaimthattheProvince’spublicsectoristoolargeandneededtobereduced.However,undercurrentconstitutionalarrangements,WhitehallmaintainsstrongleverswithwhichtoinfluencepolicyinNI.Forexample,theTreasurycontinuestoapplypressureontheExecutivetoreducethesizeofthepublicsector,andhasidentifiedtheuseofPPPwasoneimportantmeansofdoingso.
TheTreasury-commissioned‘VarneyII’report(2008),forexample,states:“Onewaytoincreasethevalueformoneyofthepublicsector,andtohelpstimulatetheprivatesector,istoincreasetheroleoftheprivatesectororthirdsectorindeliveringpublicservices”(P.109).InformationonthefutureroleofPPPinNIishardtoaccessduetothelackofdetailinthelatestNorthernIrelandInvestmentStrategy.However,thereisnoevidenceatthemomentthattheNIExecutiveisreviewingtheuseofPPP.
Figure 4 A chronology of PPP policy development in NI
July 2001CFPbacksuseofPPPfor
investment
May 2002Review of
Opportunities published,
backingPPPsforadditional investment
February 2003Working Together
outlines“strongpreference” forPPP
December 2004
SIBlaunchesdraft
InvestmentStrategy
February 2005
Economic Vision for Northern Ireland
published
May 2006NISecretaryPeterHaincallsforneweconomic
balanceinNI
May 2007Devolutionrestored
January 2008New
investmentstrategylaunched
October 2001
Devolutionabandoned;DirectRulerestored
April 2003SIBformallyestablished
December 2005
SIBlaunchesInvestmentStrategyNI2005-2015
April 2008Varney
recommendsusingPPPtoshrinkthepublicsector
2001 2008
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Section 3: Evaluation of the arguments for PPP
ThissectionexaminesthetwocentraldriversbehindtheuseofPPPinNI,outlinedinsection2:namely,theclaimthatprivatefinancecandeliverextraresourcesforpublicinvestment;andthatitcanenhancethemacro-economicvalueofNI.Theargumentispresentedthattheserationalesarewithoutmerit:theonlycrediblerationalefortheuseofPPPisthatitiscapableofdeliveringprojectsandserviceswithgreaterefficiency,or“valueformoney”,thanthealternatives.Thefinalpartofthissectionprovidesareviewoftheevaluativeliteratureontheissueofvalueformoney.
3.1 Does private finance provide ‘additional’ resources for public services?
3.1.1 Capital and revenue resources in NI
Asnotedinsection2,underthecurrentNIfundingregime,capitalspendingfinancedthroughthedirectuseofresourcesorconventionalborrowingistightlyconstrained.ThecapitalusedwillcountagainstthealreadylimitedNIcapitalbudget,therebyreducingthescopeforotherprojects,andcapitalchargesanddepreciationcountagainsttheNIrevenuebudget.6Incontrast,theupfrontcostsofoff-balance sheetPPPshavenoimpactonthecapitalbudget,andonlytheannualchargesappearonthepublicsector’saccounts.Thismeansthat,whileconventionalcapitalspendingisconstrainedbycapitalandrevenuebudgets,onlythelatterimpactsonmostprojectsfinancedthroughPPP.
ThisprovidesNIadministrations–whetherdevolvedorWestminster-based-withanincentivetousePPP,asitappearstoprovidescopeforinvestmentthatisadditionaltowhatcouldbeprovidedthroughconventionalcapitalspendingorborrowing.7BecausecapitalbudgetsaresolowinNI,andthepowertoborrowistightlyconstrained,thisincentiveoperateseven where the revenue impact of private finance is greaterthanalternativemethods.Section2ofthisreportshowsthattheNIExecutivewas–quiteopenly-respondingtothisincentivewhenitchosetoexpanditsuseofPPP,withboththeCFPandthefinanceministeremphasisingPPP’s‘additionality’.NIOfficeministersalsofacedtheseconstraintsduringdirectrule,andthereforeoperatedunderthesameincentive.
AstheInternationalMonetaryFund(2004)notes,the“off-balancesheet”statusofPPPsintroducesan“unwarrantedbiasintheirfavour”,providinga“superficial”relaxationofbudgetconstraints.Therelaxationis“superficial”becauseinvestmentthroughPPPhasexactlythesamerevenueeffectasconventionalcapitalspendingordirectborrowing.ThispublicsectorcoststhatPPPgivesrisetocanonlybemetthrougharedirectionofrevenuefromotherpartsofthepublicsector,increasedtaxationor,forsectorslikeroadsandwater,higherusercharges.ThebudgetaryadvantageofPPP–thatwhiledirectborrowingcountsagainstthecapitalbudget,borrowingthroughaPPPintermediarydoesnot-istheconsequenceoffinancialreportingstructuresdevelopedbytheTreasury,anddoesnotreflectanyeconomicdifferencebetweenalternativeformsoffinancing(Heald1997).
6PublicentitiesmustpaytheTreasuryfortheuseoftheirbuildingsthroughannualcapitalcharges.7BecauseEnglandusesPPPtofinancemostofitslarge-scalecapitalinvestment,thecapitalbudgetforNImaybesetlowerthanitwouldotherwisebeundertheBarnettformulaforterritorialrevenueallocation.TheincentivetousePPPisparticularlystrongfordevolvedgovernmentsintheUK,sincenotusingprivatefinanceimpliesalowerlevelofcapitalexpenditurethanEngland,whichmayhavepoliticalconsequences.
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IfPPPcannotprovideadditionalresourcestodevolvedadministrations,whymighttheTreasurywishtogiveministersabudgetaryincentivetouseit?ThereasonisthattheTreasuryfacesaverysimilarpoliticalincentivetotheoneoutlinedabove,largelybecauseofself-imposedfiscalconstraints.
AcrossEurope,financeministriesareinterestedinPPPbecauseofitsabilitytodeliverinvestment,theupfrontcostsofwhichdonotcountagainstmeasuresofpublicsectordebt.AllEUmemberstatesaresubjecttofiscalconstraintsundertheMaastrichtTreaty,whichrestricts‘grossgovernmentdebt’to60%ofnationalGrossDomesticProduct(GDP).IntheUK,thefiscalrulesarelessflexible.Since1998,theLabourgovernment’s‘sustainableinvestmentrule’hasimposedaceilingof40%ontheratioof‘publicsectornetdebt’(PSND)toGDP,whichisconsistentwithamuchlowerdebt-to-GDPratiothanthatspecifiedintheEUStabilityandGrowthPact.8
Aslongasprivatelyfinancedinvestmentisrecordedoffthepublicsector’sbalancesheet,thenitdoesnotcounttowardsthePSND.9And,asthesustainableinvestmentruleisanimportantbenchmarkoftheTreasury’seconomicprudence,ithasanincentivetoencouragetheuseofprivateratherthanpublicfinancefornewinvestment,evenwherethepresentvaluecostwillbehigher.
3.1.2 Changing accounting practices
TheNIExecutive’sabilitytokeepprivatefinanceoffbalancesheethasbeenreducedoverrecentyears.10ThisabilitywillbereducedevenfurtherwhentheUKgovernmentmovestoInternationalFinancialReportingStandards(IFRS)from2009/10.Underthissystem,itislikelythatPPPswillbeaccountedforinaccordancewithIFRIC12,anInterpretationofIFRSissuedbytheInternationalAccountingStandardsBoardandstronglysupportedbytheFinancialReportingAdvisoryBoard(FRAB),towhichtheTreasuryisaccountable.Thisdeclaresthatprivateoperatorsshouldnotrecordtheup-frontcapitalcostofPPPprojectsontheirbalancesheetsifoverallcontroloftheassetconcernedisnotintheirhands–andthisisthecaseforthevastmajorityofPPPprojects.
UnderpressurefromFRAB,theTreasuryhasacceptedthata“mirror-imagetreatment”ofIFRIC12isappropriateforthepublicsector(Heald2008).ThismeansthatinvestmentsunderPPPwillhavetoberecordedonthebalancesheetofthepublicsector,therebyscoringagainstthebudgetsofdepartmentsanddevolvedadministrations.Itisalsolikelythat,from2009/10,manyPPPswillalsoscoreagainstPSNDand,unlessitisreformulated,thesustainableinvestmentrule(ONS2007).
Fromafinancialtransparencypointofview,themovetoIFRSwillbewidelywelcomedifitremovesperverseincentivestousePPP.Ontheotherhand,withtheaccounting-drivenadvantageofPPPeroded,itisessentialthatministersconsiderhowinvestmentbydevolvedadministrationsistobefundedifshortfallsincapitalinvestmenttobeavoided.ItremainstobeseenwhethertheTreasurywillintroducenewregulationsthatwillallowtheNIExecutivetomeetitsinvestmentneeds.
8ItislikelythatthisratiowillbechangedintheforthcomingAutumnPre-Budgetreport,duetoneweconomiccircumstancesandrisingpublicdebt.Whateverceilingisimposed,theTreasurywillretainanincentivetocircumventitifitcanachievepoliticallydesirableresults–e.g.higherlevelsofinvestment–bydoingso.9Forexample,theTreasury’sseminalstatementonitspolicytowardsPFIstatesthatprivatefinance“canrelievethepressureonpublicfinances”(HMTreasury2000;p.13).10Some60%ofthefinancecommittedtosofaronsignedPPPsinNIisoff-balancesheet(HMTreasury2008)
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3.2 PPP as a means of rebalancing the economy
AsdiscussedinSection2,duringdirectrulePPPwasadvocatedasonewayofrebalancingNI’seconomyinfavouroftheprivatesector,andtheTreasuryhascontinuedtolobbyforthispolicytobepursuedduringthecurrentperiodofdevolution(e.g.Varney2008).
This“macro-economic”rationalefortheuseofPPPisproblematicforthreereasons:
(1)TheargumentthatthepublicsectoristoolargeinNIisanoversimplification.ItisthecasethatNIhasahigherlevelofpublicexpenditureperheadthaninGB(Mcleanetal2008).However,animportantpartofthisisconnectedwithsocialsecuritypayments.ThesearemuchhigherthaninGB,notleastbecausethenumberofbenefitclaimantsis50%higherthanonthemainland.Relatedly,certaingovernmentreforms,forinstanceontaxcredits,haveinflatedthe‘subvention’toNI(GudginandGibson,2008).ThepublicexpendituredifferentialbetweentheNIandGBisthereforelargelyafunctionoftransferpaymentsanddoesnotimplyhigherspendingonpublicservices.
Intermsofemploymentshare,NIhasahigherpercentageofindividualsinthepublicsectorthantherestoftheUK-estimatedat28%inNI,comparedto20%(NIExecutive2008).However,whenthesizeofthepublicsectorismeasuredintermsofpublicemploymentasaproportionofpopulation,NIissimilartootherpartsoftheUK.Whatthissuggestsisthattheprivatesectorafterdecadesofunder-investmentduringTheTroublesistoosmall,notthatthepublicsectoristoolarge.Inthiscontext,acrudeattempttoreducethesizeofthepublicsectorcouldhaveseriousconsequencesfortheeconomy(GudginandGibson,2008).
(2)AsignificantimplicationofprocuringthroughPPPs,ratherthanconventionalprocurement,isthefreezingoutoflocalcompaniesinfavouroflargemultinationalcorporations,whichcanbetterhandlethetransactioncostsinvolved.TheaveragebiddingperiodforPPPschemesisaroundthreeyears,requiringsignificantlegal,financial,andtechnicaladvisorycostsforbothsectors(NationalAuditOffice2007).Becauseofthis,authoritiestendto‘batch’individualconstructionschemesintolargerunitsinordertocreateeconomiesofscale,11withtheresultisthatmostprojectsareintherangeof£50-£250millionrangeintermsofcapitalvalue.Together,thesefactorsareknowntodetersmallandmediumenterprises(SMEs)frombiddingforPPPs(Ezulikeetal1997).
ThisislikelytohaveanegativeimpactoneconomicgrowthinNI,aregionthathasarelativelysmallnumberoflarge,high-turnovercompaniesandanimportantSMEsector.AccordingtoVarney(2008),theProvincehasonly45businesseswithmorethan500employees,comparedto4,510intheUKasawhole-adifferenceofahundredfold,eventhoughtheUKpopulationisonlyaround34timeshigherthanthatofNI.EvenifthefewlargeNIfirmswereabletofindtheresourcestobidforthiswork,itisunlikelytheywouldbecompetitive.EstablishedPPPfirmsfromtheUK,EuropeandtheUShaveabsolutecostadvantagesoverpotentiallocalbidders,sincebankfinancerateswillbeunfavourableforconsortiawithlimitedexperienceofPPP(StandardandPoors2004).
11Indeed,Treasuryguidanceissuedin2003expresslyforbidsPPPsunder£20millionincapitalvalue.
15
Tothisextent,theprioritisationofPPPoverotherformsofpublicprocurementactuallyrunscountertotheprojectofstimulatinggrowthinthedomesticprivatesector.ItalsorunscountertooneoftherecommendationsoftheVarneyreviewtotheNIExecutive:toensurethat“governmentprocurementcanplayanimportantroleindrivingSMEinnovationandgrowth”(p.109).
(3)Thesuggestionthatshiftingaservicefromthepublictotheprivatesectorcould,inandofitself,addvaluetoaneconomyisamisconception.MovingagivenservicefromthepublictotheprivatesectorhasnoimpactonGDP,norontheunderlyingworthoftheeconomy.ServicestransferredtotheprivatesectorthroughPPPwillstillbetax-funded.Allotherthingsbeingequal,PPPdoesnotimplyanyreductioninpublicspending,oranyrelaxationofthepublicsector’sbudgetconstraint.
AnargumenthasbeenmadethatpublicservantsaretoohighlypaidinNI’spublicsector,andthisis“crowdingout”theprivatesector,wherewagesaresome20%lower.Thisargumentisstronglycontestedbypublicsectortradeunions.Inanycase,underTUPEandrelatedUKgovernmentregulations,stafftransfersthroughPPPscannotresultinlowerwagesorpensions,soPPPisirrelevanttothisissue.Inanycase,Heald(2003)suggeststhatthepublicsectorinNInowcompetesformanpowerandskillswiththeRepublicofIreland,wherepublicsectoremploymenthasgrownrapidlyinrecentyears.AnyattempttoradicallyreducewagesintheNorthislikelytoleadtonetout-migrationofmobile,well-qualifiedstaff(GudginandGibson2008).
3.3 PPP and value for money
PerhapsinrecognitionoftheweaknessoftheargumentsforPPPthatareoutlinedandcritiquedabove,thepolicyisalsojustifiedoncost-efficiencygrounds.Atfirstblush,thevalueformoneycaseforPPPappearsweaksincepublicfinanceischeaperthanprivatefinance.Thisisbecauselendingtogovernmentisextremelylowrisk-publicbodies,unlikeprivatecompanies,areunlikelytogobankruptanddefaultontheirpayments.Thetransactioncostsofgovernmentfinancingarealsolowandthemarketingovernmentdebtisusuallyliquidandefficient(Yescombe2007).
3.3.1 Financing costs in PPP
InitsexaminationoffinancingcostsforScottishschoolsPPPs,AuditScotland(2002),foundoverallratesofreturnonprivatefinanceintherangeof8-10%ayear,some2.5%to4%higherthanapublicauthoritywouldpayifithadborrowedmoneyonitsownaccount.Similarly,inastudyofthefirst12PPPhospitalprojectsinEngland,Shaouletal(2008)foundprivatefinancecostsofabout8%-wellinexcessofthe4.5%availableonpublicfinanceintherelevantperiod.FinancingcostsmatterinaPPP,justastheydoinprojectsfundedthroughdirectborrowing,astheyarepartofaproject’scostsandtoalargeextentdeterminetheleveloftheannualpaymentsthatthepublicauthoritymustfund.TheFreedomofInformationActhasenabledindependentscrutinyofPPP‘financialmodels’,documentswhichcontainestimatesofaproject’sprofitability.CuthbertandCuthbert(2008)lookedatthecostoftwocompletedhospitalschemesinScotland,theEdinburghRoyalInfirmaryandHairmyres,andcomparedthiswithanestimateofwhattheseprojectswouldhavecosthadpublicfinancebeenused.Todothis,theycomparedforeachschemethenetpresentvalue(NPV)12ofreturnstoinvestorswiththeamountofprivatecapitalraisedtofinancetheconstructionwork.12Basedonadiscountrateof5%-theNationalLoanBoardrateatthetimetheseprojectsreachedfinancialclose.
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OntheEdinburghRoyalInfirmaryscheme,theyfoundthecashvalueofthereturnsonprivatecapital(excludingpaymentsforoperations,maintenanceandserviceprovision)was£760million.Thiswasthendiscountedat5%-therateofinterestthatwouldhavebeenpaidbythesehospitalsonpublicfinanceatthetimetheircontractsweresigned–togivethefigure£416million,morethantwice(2.04)the£181millionofcapitalraisedbytheprivatesectortobuildthehospital.Thesameanalysiswasappliedtothe£68millionHairmyresscheme,generatingasimilarratio(1.97).Althoughtheyareestimates,theseratiosprovideanindicatorofthecostofthesefacilitiestotheNHS,relativetowhatthecostwouldhavebeen,hadtherequiredfinancebeenaccessedthroughdirectborrowing.TheauthorsconcludedthatPPPisa“onehospitalforthepriceoftwopolicy”(p.5).
TheTreasuryarguesthatthehighercostofprivatefinanceissimplyafunctionoftheriskofinvestmentbeingexplicitlypriced(HMTreasury2003).Onthisanalysis,whengovernmentfinanceisusedforaproject,therisksassociatedwiththeinvestmentarethesameasinaPPP,butanyadditionalcosts(e.g.duetotimeandcostoverrunsinconstruction,orproblemsinoperation)arepassedontocurrentandfuturetaxpayers.Incontrast,inaPPP,theseprojectrisksarebornebyprivateinvestors,ratherthantaxpayers,andarepricedaccordingtostandardmethodologies.
Theclaimthatthecostofprivatefinanceissimplythecostofpublicfinance,plusa“riskpremium”,isthereforefundamentaltothemicro-economiccaseforPPP.Ifthecostofprivatefinanceisthesameaspublicfinanceafterallowingforrisk,andtheprivatesectorisabletomanagethisriskanddeliverprojectsmorecheaply,thenthetotalcostofaPPPcouldbelowerthanapublicproject.
However,theavailableevidencesuggeststhatthisisnotthecase.ResearchcommissionedbytheOfficeofGovernmentCommerce(OGC),andcarriedoutbytheaccountingandmanagementconsultancyPricewaterhouseCoopers(2002),showsthatprivatefinancecostsaresignificantlyhigherthanispredictedbytheTreasury’sclaim.PwCanalysed64PPPsthatweresignedbetween1995and2001,comparingforeachprojecttheprojectedrateofreturnoncapitalwithabenchmarkdesignedtoreflectthereturnthatshouldbeexpectedonthescheme,givenitscostsandrisks.
Thestudyfoundthatprojectedratesofreturnexceededthebenchmarksbyanaverageof2.4%.13Whilethismayappeartobeanarrowmargin,itrepresentsasubstantialamountofmoneyoverthelifeofacontractof25to30yearsormore.WhatPwCcalls“excessreturns”ofaslittleas1%couldleadtoanincreaseinoverallcoststothepublicsectorof10%overthetermofa30yearcontract.
Thecreditcrunchisincreasingthecostofprivatecapitalrelativetopublicfunding(Hellowell2008).Investorsinpublicprojectshavebeenhitbytheshortfallinbankliquidityinmuchthesamewayashomebuyersandbusinesses,withfinancenowbeingrationedandcreditmarginsincreasing.Theimpactofthisistwo-fold.First,bondfinance,hithertomuchthecheapestformofseniordebtfinanceforPPPs,isnolongeravailable.ThisisbecausetheUS‘monoline’insurers,suchasAmbacandMBIA,losttheirtriple-AcreditratinginthewakeoftheUSsub-primecrisis.Theseinstitutionsplayedakeyroleinthe
13AccordingtotheNationalAuditOffice(2007),thelevelofcompetitionislowinthePPPmarket,anddeclining.Between2004and2006,only67%ofPPPprojectsreceivedthreeormorebidders.Onethirdofprojectsattractedonlytwobiddersatthepointatwhichdetailedbidsweresubmitted.
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commercialbondmarket,guaranteeingrepaymentstobondholdersinreturnforafee,reducingoverallfinancingcosts,inparticularformanylargerPPPprojects.
Second,inthebankfinancemarket,nowtheonlysourceofseniordebtforPPPinvestors,liquidityhasreduceddramaticallysinceJuly2007and,wherecreditisavailable,thecostisveryhigh.Thisispartlybecausethebanks’owncostofcapitalhasincreasedduetothefactthatbanksarenolongerwillingtoprovidecreditexceptathighinterestrates.Inaddition,theshortfallinliquidityhasreducedcompetitionintheseniordebtmarket.Ratherthanlendingindividually,banksarenowlendingascartels,or“clubs”,andasaconsequenceofthis,creditmargins(theinterestratesabovethebanks’owncosts)havedoubledinthelastyear.Pre-creditcrunch,creditmarginsonsimpleaccommodationschemeslikeschoolsandhospitalswerebetween60-80basispoints(0.6-0.8%)abovethebank’sowncostofcapital.Thishasnowincreasedto100-150basispoints(PricewaterhouseCoopers2008).
ItissignificantthattheUKgovernment’sownevidencebasesuggeststhereare“excessreturns”toinvestors.Thisisaparticularcauseforconcerngiventhatprivatefinancecostsarenowincreasingtohistoricallyhighlevels.Thisimpliesthat,tobevalueformoney,theprivatesectormustbesomuchmoreefficientthanthepublicsectorthatitcanmore than offset itshighercostoffinancethroughbeingmoreableandbetterincentivisedtomanagerisk.Inprinciple,itispossiblethatthisisthecase,butthereisclearlyahighburdenofproofgiventheevidenceofexcessiveprofitability.Asweseebelow,novalidevidencehasbeenprovidedbythegovernmentissupportofitsassertions.
3.3.2 The evidence: the public sector comparator
UnderTreasuryrules,publicauthoritiesmustsubjecttheirprivatefinanceplanstoavalue-testingexercise,partofwhichisbasedonapublic sector comparator(PSC)–anestimateofwhattheprojectwouldcostunderpublicfinance.Intheory,whereaPSCconcludesthatprivatefinancedoesnotrepresentvalueformoney,apublicprocurementmethodshouldbechosen.Inpractice,PPPalmostalwayscomesthroughthePSCexerciseasthemoreefficientoption,andthishasbeenpresentedbytheTreasuryasgoodevidencethatthemodeliscost-efficient(HMTreasury2000).
SincethelogicofPPPisthatitleadstogreatercostefficiencythroughtheprivatesectormanagingmoreeffectivelyprojectrisk,theprincipleisthatriskshouldbeaddedtothePSCtomakethiscomparablewiththecostofPPP.However,thisprocesshasbeenfundamentallydiscreditedbyacademicsandauditors(Gaffneyetal1999;PriceandGreen2000;NAO1999),whopointoutthattheaccounting-drivenadvantagesofPPPstriptheseappraisalsofanyobjectivity.
Forexample,Gaffneyetal(1999)note“atendency”forpublicauthoritiesengagedinthePSCprocesstoascriberiskstoPPPconsortiathattheywillneverinfactbeaskedtobear,andtherebyartificiallyinflatethecostofthePSCrelativetothePPP.Forexample,ononehospitalproject,oneoftheriskssupposedlytransferredtotheprivatesectorwasthattargetsforclinicalcostsavingswouldnotbemet.Thecostofthisriskwasestimatedat£5millionandaddedtothePSCfigure.However,theconsortiumhadnoresponsibilityforensuringsuchsavingswouldbemade,andfacednopenaltyiftheyweren’t.TheauthorsconcludethatthePSCprocesswas“oftenspurious”.
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JeremyColman,formerdeputygeneraloftheNationalAuditOffice,thesupremepublicsectorauditinstitutionintheUKoutlinedasimilarconclusionincommentsmadetotheFinancial Times(sinceconfirmedbyColmaninapersonalcommunicationwithoneoftheauthors).MrColmannotedthatmanyappraisalswereguiltyof“spuriousprecision”,basedon“pseudo-scientificmumbo-jumbo”.Henotedtheperverseincentivefacingauthoritiestomanipulateappraisals,inacontextinwhichprivatefinanceisusuallytheonlyfundingsourceavailable:“Iftheanswercomesoutwrongyoudon’tgetyourproject.Sotheanswerdoesn’tcomeoutwrongveryoften”(Timmins2002).
3.3.3 The evidence: time and cost overruns
MorerecentgovernmentattemptstojustifythedominanceofPPPinlarge-scalecapitalinvestmenthavefocusedonthemodel’sabilitytodeliverprojects“ontimeandtobudget”.Forexample,theTreasury(2003)states:“[our]researchintocompleted[PPP]projectsshowed88%cominginontimeorearly,andwithnocostoverrunsonconstructionbornebythepublicsector.Previousresearchhasshownthat70%ofnon-PFIprojectsweredeliveredlateand73%ranoverbudget”(p.43).
AfterrepeatedFreedomofInformationrequestsfortheTreasury’sworkoncostandtimeoverruns,officialsconfirmedthatnoresearchreportexists.Accordingly,the88%figurequotedabovecannotbevalidated.Meanwhile,the“previousresearch”notedreferstotworeportsfromtheNationalAuditOffice,Modernizing Construction and PFI Construction Performance.Butneitherofthesestudiescomparesrelativeperformanceunderdifferentprocurementroutes.Thefirstisbasedoninterviewswithindustryaboutthescopeforimprovedconstruction.Thesecondisacensusof38projectmanagers.Indeed,thelatterreportstates:“itisnotpossibletojudgewhethertheseprojectscouldhaveachievedtheseresultsusingadifferentprocurementroute”(NAO2003).
Inanycase,comparingPPPandnon-PPPprojectsforpost-contractualpriceincreases(whattheTreasuryappearstomeanby“timeandcostoverruns”)isnotavalidmethodfortestingoverallvalueformoney.UnderaPPP,theriskofcostandtimeoverrunsistransferredtotheprivatesector,soithaslittleflexibilitytoincreaseitspriceduringcapitalworksunlessmajorproblemsemerge.Instead,underPPP,theprivatesectorincreasesitspricebeforecontractsaresigned.Itisassistedindoingsobythepreferred bidderstage-apost-competitivephaseofPPPprocurementinwhichthepublicauthorityentersintoalongandexclusivenegotiationprocesswithasingleconsortium.14
Duringthisperiod,theprivatesectorcan‘hold-up’thepublicauthority,usingitsadvantageousbargainingpositiontoincreasepricesandreducetheextentofrisktransfer.Meanwhile,thescopeforpublicauthoritiespullingoutofsuchnegotiationsislimitedbythenon-availabilityofotherfinancingroutes.Inproposingthatpost-contractualpricecertaintycanbetakenasanarbiterofoverallefficiency,theTreasuryissettingupacomparisonwhichisboundtofavourthePPPmethod.Aprojectthatisdeliveredtotimeandtobudget(inpost-contractualterms)mayrepresentverypoorvalueformoneyifthepricepaidfortherisktransferthatledtothatoutcomewastoohigh.
14AccordingtotheNationalAuditOffice(2007),theaveragelengthofpreferredbiddernegotiationsforprojectsthatsignedbetween2004and2006was15months.
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Conclusion
ThereasonsfortheadoptionandexpansionofPPPunderdevolutionstemfromanaccountingregimethatdoesnotreflecttheunderlyingeconomicreality.UsingPPPallowsthescoringofinvestmenttobepostponedagainsttheAssignedBudget,creatinganincentivetopursuethismodelevenwhenthelongruncosttotaxpayerswillbehigher.ItisclearthattheNIExecutiveandtheNIOfficewererespondingtothiswhenformulatingcapitalexpenditurepolicyinthelate1990s.
Underdirectrule,PPPwasseenasawayof“rebalancing”theeconomythroughtransferringservicesfromthepublictotheprivatesector,shrinkingtheformerandexpandingthelatter.However,theargumentthatthepublicsectoris“crowdingout”theprivatesectorispoorlyevidenced,andthefundamentalcharacteristicsofPPPareactuallylikelytoreducethecapacityofgovernmentactiontostimulateexpansionintheprivatesector.Thenotionthatanyvalueisaddedtotheeconomysimplythroughtransferringservicesfrompublictoprivateisamisconception:theonlywaysuchatransfercanbebeneficialifitbringsaboutimprovementsinproductiveefficiency,or“valueformoney”.
ThefinalsectionofthisreportlooksattheevidenceonPPP’seconomiccredentials.WhilePPPinNIisduetoberadicallyexpandedbetweennowand2012,thereisnocredibleevidencebasethatsupportsthispolicy.Itwouldappearthatthecapacityforanyimprovementsinefficiencyiserodedduetotheexcessiveprofitabilityofcontractsforinvestors.Theevidenceshowsthatratesofreturnarewellinexcessofmarketnorms,suggestingthepricebeingpaidforrisktransferistoohigh.
Atthecurrenttime,thecostofprivaterelativetopublicfundingisrisingsignificantlyduetothecurrentfinancialcrisis.Thishaseliminatedthebondfinancemarket–previouslythecheapestsourceofprivatefinance-andcurtailedtheavailabilityofbankfinance.Inturn,thishasfurtherreducedthedegreeofcompetitioninthemarketforfinance,andallowedbankstodoubletheircreditmargins.
ThechangefromBritishtointernationalaccountingstandardswillremovetheNIExecutive’sreasonforusingPPP–itssuperficial‘additionality’advantage.Atthesametime,theeconomicslowdownmeansthatNIwillreceivelowerincreasesinfundingfromtheTreasurythanhasbeenthecaseinthelastdecade.Inthiscontext,thehigh(andincreasing)costsofPPParelikelytoputpressureontheNIExecutivetoincreaseregionaltaxationanduserchargesinareassuchaswater.
We suggest that the time is right for an independent review of capital investment policy in NI, and we recommend a moratorium on the further use of PPP until this is completed.
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