The end of Public Private Partnerships?

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In the months after the collapse of the dotcom boom in early 2000, publishers continued to pour out a stream of books, commissioned during the mania, promising to show readers how to make their fortunes in e-commerce. It seemed, one reviewer quipped, that the publishers’ presses lacked a ‘Stop’ button. Much the same can be said of the National Public Private Partnerships (PPP) Guidelines issued by Infrastructure Australia in October 2008.
The guidelines are an attempt to harmonise the policies (broadly similar, but differing in significant details) adopted by State governments and embodied in instrumentalities such as Partnerships Victoria. These state policies were designed to replace the deal-driven, case-by-case approach to private infrastructure projects adopted, with generally unsatisfactory results, in the 1990s.

In general, it might be reasonable to treat the development of such guidelines as a long-term project, and to disregard short-term developments in financial markets. However, in the context of the current global financial crisis, which had already reached the point of systemic meltdown by October 2008, such an approach is detached from reality.

The reality is that the flow of PPP projects has come to a halt, and is unlikely to be revived.
Major participants such as ABN Amro, Babcock and Brown and Transfield have suffered severe financial setbacks, and many are likely to disappear or be broken up. The resulting ‘firesale’ of assets provides an attractive alternative to participation in new projects for those infrastructure businesses that have so far survived the crisis.As the global economic crisis deepens, this dynamic will only intensify. Construction firms and service providers will be eager to participate in public infrastructure projects, since private investment is collapsing. But equity investment and bank lending for such projects will be unavailable except on very expensive terms.

Admittedly, given a sufficient ideological commitment, it will be possible to maintain the appearance of private participation. The same British government, which has nationalised or bailed out large parts of the banking sector is now suggesting that banks may be forced to lend to public projects under the Private Infrastructure Initiative. In effect, the government will be lending money to itself, while paying the costs of a series of complex transactions (some of them highly vulnerable to exploitation) along the way.Meanwhile, governments are able to borrow at very low rates of interest, and in some cases at zero or even negative rates. Under such circumstances, the idea that private investors could offer a competitive financing package is out of the question.

Even when some form of financial normality is restored, PPP deals of the kind seen in the past are unlikely to return. The risk premium for corporate equity has risen dramatically, and is likely to remain high for decades to come. Thus, the cost of resorting to private finance, rather than public debt serviced from user charges or general revenue, is likely to be prohibitively high for most public sector projects.

Furthermore, the complex financing structures (glowingly referred to in the bubble era as ‘financial engineering’) that characterized most PPP deals, and proved immensely profitable in an environment of rising asset prices, have proven to be disastrous. Many of these devices will be unavailable in the future as a result of regulatory and accounting changes that will be needed to prevent a recurrence of the current crisis. The end of the PPP model that has prevailed for the last decade does not mean the end of partnerships between the public and private sector. Indeed, just about any form of economic activity involves both public sector and private sector contributions of some kind. The public sector contributes the basic legal and property rights structure within which all private sector activity takes place and much of the physical infrastructure on which economic activity depends. The private sector contributes a vast range of goods and services necessary to any kind of economic activity, public or private. The question is not whether to engage in partnership but what form that partnerships should take.The experience of the PPP era suggests that the optimal arrangement for most public projects will involve private sector firms tendering for construction at a fixed price, with transfer of ownership to the public sector on completion. The contract may also involve maintenance for a fixed period after completion to ensure high quality of construction work. The operational activities of public sector assets such as schools and hospitals should be under public control, but many inputs will be provided by private sector enterprises through contracts, tenders or market purchases.

One common, though rarely acknowledged, motivation for the use of a PPP project has been the desire of governments to avoid levying user charges for public infrastructure assets such as roads. The spurious transfer of ownership to a private firm has made it possible to conceal the reality that governments are in fact levying such charges.

In the post-crisis environment, such evasions will no longer be possible Governments will need to increase revenue substantially to meet the costs of their expanded role, and to service the debt associated with the large deficits and capital expenditures required to resolve the crisis. In these circumstances, it will be necessary to apply user charges for public assets such as roads. The required charges should reflect the social cost of road congestion, and the need for a continuing return on capital assets and should not be related to the construction costs of recent additions to the road network.

Similarly, governments should seek to earn socially appropriate returns to public investments in network infrastructure assets such as electricity and telecommunications networks, ports and so on. The large-scale privatisation of such assets is likely to be reversed in coming years as heavily-geared asset owners default on their debts and private buyers are unwilling to invest except at fire-sale prices.

The experience of the PPP era shows that many different structures for the provision of goods and services, spanning the range from private corporations to direct government provision are possible and may be appropriate in different situations. The range of possible alternatives includes statutory authorities, government business enterprises, not-for-profit corporations and a range of structures combining public and private contributions.Rather than refining the details of a model that is now primarily of historical interest, Infrastructure Australia should be exploring how these possibilities can be exploited in the post-crisis environment.

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