PPPs - The Next Big Thing, Or Big Mistake?

Author: Peter Fitzgerald is director of Growth Solutions Group and conducted the 2004 Review of Partnerships Victoria Provided Infrastructure

It was two years ago that I agreed to undertake a review of the State Governments PPP policy - Partnerships Victoria.

As a result I now get invites to address conferences every other month. I’ve been chased down by academics from the UK, Scotland, Brazil and a professor at JFK school of Government at Harvard has written a case-study of the review. The Brazilian said that my report was very brave and that no one in his country would have written anything like it. His words were in my ears when I was asked to address a Chinese delegation last week. Because the address was to be at RMIT and was part of the CommGames Management Area I would have had to get state permission to give an address - if it was likely to “disturb or annoy” other persons.

In any event I doubted my ability to provide a speech that would translate well into Mandarin- if addressed to a group of partisan communist bureaucrats about the doubts I have about the local propaganda on the merits of private capital. I might have to encourage the communists to behave more like socialists. I just didn’t think the nuances of my case would be picked up. Instead I’m here to talk to Fabians about a revolution not of the people’s making. And I hope I don’t offend anyone if I speak frankly

Starting firstly with the observation that PPPs are the next big thing; indeed the current big thing. The new tollway, the new convention centre, the Children’s Hospital, the Womens Hospital, the Spencer Street Station. Plus prisons, the new County Court, and a set of water and technology projects. Virtually the entire slate of major projects are there. With every likelihood of education PPPs for the first this year

The other BIG projects that are not PPPs were first examined for their potential as PPPs. Channel Deepening is one example and the Regional Transit links the other. The renewal of the Public Transport contracts, although not called PPPs, their structure is pretty close

But that brings up the definitional point: whats a PPP?

    • Typically a PPP involves infrastructure facilities that provide public services
    • Typically the private sector builds, finances and operates the facility
    • Typically there’s a consortium that splits out the various roles
    • Typically but not always there’s a transfer back to the state
    • Typically the entity is a special purpose vehicle that has no other business

Finally the state pays the PPP owner; its an exception that there are other revenue sources than the state. Tollways are the exception where the revenue comes direct from the consumer

So why have they become such a big big thing, and that will lead me into an evaluation of the reasons and the evidence.

There are around 6 reasons why PPPs have become so popular. My list of 6 comes from interviews and discussions across the government.

  • There’s a crisis of confidence with “traditional” procurement methods eg look at fed Square, look at the Regional Transit links
  • There’s the Industrial Relations issue - the placement of projects one step away from Spring St decisionmaking reduces the risk of the site become a showcase site for any IR campaign
  • There is the issue of “debt avoidance” issue ie large projects not funded by state debt.
  • There’s the “doing business with the big end of town” motivation; ie it must count for something that
  • There’s the Value for Money motivation
  • There’s the track record of success for PPPs

Of the six reasons I dont believe they are always based on facts; indeed the facts typically tell another story. But these motivations and reasons are heart-felt - particularly the internal crisis of confidence. Likewise the belief that PPPs are cheaper - is a belief that is held honestly - if mistakenly.

So the typical pitch after a PPP is announced sounds like this

    • The state has won private sector capital
    • To build a world class piece of infrastructure
    • The savings to the taxpayers will be at least 10 percent
    • The benefits to the state will be more than a billion dollars of economic impact
    • and more than 10,000 permanent jobs

My concern is that this formulation is often reverted to and usually or typically wrong in most respects . I’m reminded of the Woody Allen joke; Doctor doctor you’ve got to help me my brother thinks he a chicken. The doctor says -Well perhaps you should bring in your brother in. To which the man says - no we couldn’t do that - we need the eggs

I think its because we need the eggs that self-delusion typically occurs

Joan Didion developed a similar line of thinking in her book called Political Fictions. She had covered as a journalists a set of US presidential elections and noticed a set of things that other journalists refused to cover. What we now called spin she elaborated more as Political Fiction. She lamented that soundbites and even events were being contrived solely for media consumption. And a good deal of the entire political discourse was being presented through these contrivances

She used the example of the "tarmac arrival with ball tossing ." Presidential candidate Michael Dukakis arrives at the San Diego airport and brings out a baseball to throw it to one of his staffers. It appeared on the schedule as the fourth event of the day and, referred to as "tarmac arrival with ball tossing ." Dutifully the assembled media attributed concepts to the activities;Was Dukakis a man of the people; a regular guy. Was he tough enough?

No one actually reported that this was a contrived event to communicate just these points. Didion says that there was a “clear enough understanding” amongst the media and commentators and politicians that this was for them, and therefore not for journalists to question its contrived nature . "Tarmac arrival with ball tossing” is a media event and a contrived piece of communicated symbolism. It has no literal truth or factual basis other than as a contrivance.

The nature of Political Fiction is that it might be based on truth or fact or reality but not neccessarily so.

I have witnessed an annoying inventory of political fictions in Victoria, particularly for major projects. I’ll mention four:

1. Channel Deepening: In response to an FOI request I have a report that says the benefits of channel deepening might be $30m pa by 2030 . Compare this to the publicly available report that quotes $300m

An exaggeration of tenfold ie the benefits are actually one-tenth of the publicly quoted ones

2. CommGames: The Australian Open was evaluated at contributing $200m to the Victorian economy - with 600k attendances and 68k international and interstate visitors. The CommGames is likely to have been twice that size - 1.3 m attendances and 90k international and interstate visitors. Yet the quoted benefits are not double they’re said to be $1.5 billion . An exaggeration of perhaps threefold

3. Public Transport and the myth about National Express: The official statements quoted that National Express had made "losses of hundreds of millions of dollars". In the last two years of operation of its Melbourne Trams and Trains, National Express Group PLC declared to the London Stock Exchange profits in each year, totalling £9.5m.

National Express Group PLC told its London shareholders on March 13th 2003 that profits were made on Tram and Train operations in Australia (Melbourne) in calendar years 2000, 2001 and 2002. National Express probably over 200 million passenger trips over the last two years and made profits of 9.5m pounds or over A$25 million. Profits averaged over 10 cents per trip

4. Spencer Street Station: Ken Davidson of the Age wrote an article in 2002 suggesting that the payments to the developers of the Spencer Street Station were exceed one billion dollars. The Ministers subsequently wrote an article saying he didnt understand the deal and even with inflation it wouldnt exceed one billion. I have a copy of the State’s Financial Report - the total is now $1840 million - up $80 million on last years estimate. When I spoke to a hand full of public servants about the payment schedule - they said “so Ken Davisdon was right”. Actually the payments are 80 percent higher than he estimated. More than $1.8 billion so that the private sector can build us a nice roof?

My point is this - the standards of public discussion dont allow great nuance in presentation of matters financial or economic. Consequently there is a lot of shorthanding going on. However we tend to then go on and believe our own spin and create our own Political Fictions

    • Losses such as the National Express losses are sometimes entirely fictional
    • Benefits are exaggerated - typically by a factor of 3-10
    • Costs are typically expressed in economic terms rather than actual payments out of the state budget
    • The full payment stream is often missed or denied as is the case with Spencer Street
    • Costs are discounted in a way that creates false economic savings - that dont actually save money from the budget

And we do all this because we need the eggs

So I have a long list of myths about PPPs

    • They are the only way to avoid debt
    • They’re cheaper
    • They transfer risk
    • They allow a long-term view
    • They allow the state to access skills
    • It brings sophisticated risk analysis

I have evidence that makes me doubt the factual support for each.

But if I can elaborate on the use of the risk-adjusted discount rate. For me this is key because if its done badly counterfeit currency is created. This is a text book argument among financial academics.

It is based on the CAPM theory that says if you have a $10m flow of cash in perpetuity and long term bond rates are 5%

the bond market will value that at $200m if its backed by a sovereign body - a multiple of 20. However the stockmarket would say that it is going to be as volatile as the market and average $10m pa - then a discount rate will be applied and a multiple of say 12 might apply. The discount of one compared to the other differs between industries based on relative market risk.

This theory gives rise to a key methodology in PPPs called risk-adjusted discount rates. It is my contention in relation to the 8 PPPs that I evaluated that all of the benefits resulted from the use of a wrong discount rate. In my assessment the discount rate should have been 5.4% instead of 8.65%. The extra 3% was justified on the basis of “market risk” transferred in circumstances where I asked for details of this market risk I found nothing of substance.

As a result all of the benefits quoted would have gone to zero or negative if a proper approach had been used. In other words savings were being generated by the methodology; what I call counterfeit savings

I must say that had a great deal of self-doubt about whether I was right on the discount rate. Treasury took me task - saying of you take us on you’ll be taking on all 8 Treasuries across the country; a kind of CFMEU approach. Then they suggested lets cut the difference - on the basis that you can always argue about it

Ultimately I found that the UK had very quietly commissioned a report that said that of the PPPs that used a risk-adjusted discount rate only 10 percent of case actually had market risk transferred. They have moved to a rate that approximates my recommendations.

I have two final thoughts

We must get rid of the spin, the counterfeit dollars, the exaggerated benefits , political fictions about losses and costs and savings, and the sprinkle dust of risk transferred

If we cant do that we will also run the risk of bad money and bad projects crowding out the good ones. If we believe falsehoods about the Grand Prix, we might be tempted to provide public dollars to support it

Final thought - we must also accept that PPP’s whilst flawed under current approaches has enabled the Government to be bolder than it otherwise would be. Thats the one and only silver lining that can be eluded to. We must have a new RCH and RWH and all or some of the others

Heaven knows we need the eggs