March 7, 2017 10:00AM

Public‐​private Partnerships: a Cautionary Tale from the UK

Given the administration’s plans are still as clear as mud, yesterday’s Cato event on infrastructure was necessarily wide-ranging. Panelists welcomed Trump’s desire to harness more private sector involvement, but there are many different forms policy to support this could take, from removing regulatory and user pricing barriers, right through to the distortionary tax credits proposed by his advisors Wilbur Ross and Peter Navarro.

One possibility is greater use of public-private partnerships. These entail agreements between government and a private contractor for the building, financing or operation of infrastructure with the aim of passing on substantial risk to the private sector. They can take different forms, from simply transferring management responsibilities to a private sector firm, right through to integrated contracts that incorporate the design, build, maintenance and operation of the infrastructure (for example, toll roads.)

In terms of results, types of PPPs are not created equal. As Randal O’Toole noted, “demand risk PPPs,” where a private company builds and then runs, say, a toll road for a set period of time, allow the expansion of capacity with incentives for the private firm to control long-term costs (including considering future maintenance needs) whilst alleviating taxpayers of the usage risk. Yes, there are still political risks that governments will renege on agreements, but when there are obvious cash streams from the investment linked to usage, beneficial investment can be forthcoming. Chris Edwards has previously pointed out the success of the Capital Beltway project in Virginia, for example.

Other types of infrastructure, not least provision of loss-making modes or those with no user fees, are more difficult. In these cases, public-private partnership contracts have and can be designed such that private investors build, operate and maintain an asset with a stream of tax revenue payments from the government instead.

Sadly this “availability payment” model, as Randal calls it, where the private contractor gets paid irrespective of usage, is less likely to curb costs. In fact, the UK made extensive use of this type of agreement in the building of hospitals and schools through the 2000s, and the results have been disappointing.

Success in road schemes and a number of privately-owned prisons in the early 1990s (with a much higher proportion delivered on time and on budget than through traditional procurement) led to a huge expansion of PPPs. By 2003/04 they accounted for 39 percent of capital spending by UK government departments, and there were over 500 in operation by 2008, including in the building of schools, hospitals and public transport (especially rail). Britain led the world in their use.

This expansion of PPPs though is now associated with high lifetime costs for taxpayers, not least arising from badly negotiated bundled contracts with private contractors. Many hospitals face huge deficits. Any benefits arising from the privatization of risk and on-time and on-budget delivery of projects was eclipsed by higher borrowing costs coupled with the costs of consultants and lawyers in drawing up the contracts. Furthermore, the opacity of the liabilities for taxpayers has proved very unpopular, with significant attempts to renegotiate contracts.

What went wrong? First and foremost, the government was often a poor client. As Jesse Norman MP wrote for the Centre for Policy Studies:

These were generally huge one-off projects agglomerating very different skills, services and expertise, from construction to IT to facilities management. They were laden with social, bureaucratic and political prestige, creating external interference and a demand for expensive “signature” buildings with unknown future costs. Often the clients were dominated by producer interests, overspecified the projects, changed the specification en route, lacked the necessary commercial or negotiation skills to manage the procurement, were naïve about using external professional advice, and did not adequately understand the risks involved, the likely future costs or the relevant financing models.

In other words, many of the failures of traditional government infrastructure projects merely arose at the contract negotiation stage. Another problem was inability to assess risk, something noted by Bent Flyvberg in his exceptional book Megaprojects and risk. That lots of the infrastructure built was regarded as “essential” or politically contentious meant that in reality taxpayers still faced most of the risk.

Several major projects in the UK saw the government step in, for example, after the private sector company was unable to fulfil the contract after mispricing (more details here).  Contracts were often overly inflexible too and the whole process dogged by political interference, even at the development stage. The main reason for the use of this type of arrangement was that the New Labour government wanted to see huge upfront investments without the capital expenditure being on the public balance sheet.

When trying to generate up to a $1 trillion of new investments here, it might be convenient for the Trump administration to play the same trick. Indeed, it could help fulfil the promise that taxpayers won’t fund new projects directly. But what really matters is lifetime costs, and whilst these types of PPPs can work in some scenarios, the UK model suggests caution about widespread roll-out or using them as a substitute for areas ripe for genuine privatization.

Of course, in policy we should not allow the perfect to be the enemy of the good. The failures of other traditional procurement methods are well-known, and in other countries such as Canada and Australia the record of PPPs seems more positive. At best though, the UK experience shows they are no panacea. If the public sector is bad at delivering infrastructure, it can be bad at contracting for it too.