Public Private Partnerships no ‘magic pudding’

In the heyday of the Kennett government in Victoria 'Public Private Partnerships' were promoted as the 'debt free' way to fund public infrastructure. Although the idea that the public can get 'something for nothing' through these partnerships has now been widely discredited, most Australian governments still find the idea of shifting debt 'off balance sheet' attractive. The current Victorian government in particular, working in the shadow of alleged financial mismanagement by past Labor governments, seems to fear a backlash if it should run a budget deficit, or even fail to run a substantial surplus. Public Private Partnerships (PPPs) are therefore seen as a way to produce larger surpluses and win kudos for good financial management. Economist John Quiggin has referred to this mentality as: ' [the] idea that financial innovation represents some sort of magic pudding.' It is now accepted, he argues, that any apparent reduction in debt from the implementation of PPPs is illusory:

'However it is represented in the official accounts, a liability to make a stream of payments into the future is, in economic terms, a debt. There is no 'magic pudding' providing infrastructure services with no corresponding cost to the public.'

For those living in the shadow of PPPs the real cost of government debt-shifting soon becomes apparent. In the case of the Cross-City Tunnel, the NSW government responded to public disquiet over high tolls by reopening routes that had been closed in order to guarantee the profits of the private operator. Predictably, this has led to the private operator demanding substantial compensation.

Another case in point is Victoria's Scoresby Freeway. Although the original cost of building the road was estimated at $2.5 billion, the cost


of 'buying out' the project, including financial costs, so as to make the project 'toll free', was put at about $7 billion – the cost of compensating the private investor for foregone profits. This places the estimated value of tolls over the life of the project at almost three times the original cost of construction.

While the tollway may have created the illusion of a debt free project, the reality is that the accumulated cost of tolls over the lifetime of the project is the equivalent of perhaps as much as $7 billion of debt: or, alternatively construed, as a regressive 'flat tax' on Victorian motorists amounting to approximately $7 billion over the life of the agreement.

Public Private Partnerships leave a trail of scandal

The new County Court building is yet another controversial Public Private Partnership which has become a public relations headache for the Bracks Labor government. While it only cost about $135 million to construct, the building will be leased back to the government over 20 years by the Packer family for about $533 million, and even then will not revert to public ownership.

As Ken Davidson argues, ' At the end of the lease period, the Government will have nothing. If the Government in 2022 decided to buy an equivalent building, it would cost about $500 million, given the inflation in land and building costs.'

Meanwhile 'the private partner (project financier ABN Amro) was given a 99-year lease on the site on the corner of Lonsdale Street and William Street for a peppercorn rental of $1 for 99 years.'

In the face of arrangements that fleece Victorian taxpayers of hundreds of millions of dollars, the Opposition has been conspicuously silent, with Shadow Treasurer Robert Clark acquiescing to the removal of the most damaging section of a recent Public Accounts and Estimates Committee report on PPPs. Davidson argues that the ' lazy, mushroom-like acquiescence of the committee members, makes a mockery of the (report's) recommendation on governance, evaluation and accountability arrangements'.

Benefits of private versus public finance considered: can 'risk' be transferred?

One of the main arguments against PPPs is the fact that public finance is cheaper than private finance. As Davidson notes, 'even the least credit-worthy government could borrow money more cheaply than Australia's most credit-worthy corporate borrower'.

This difference alone adds around 20% on average to the cost of PPPs. On top of that, Davidson explains, 'the merchant banks who create the financial vehicles for PPPs [expect]…..a 25 to 100 per cent return on equity.'

This impost is further exacerbated by the participation of those who ACTU Secretary Sharan Burrow has described as 'the 5 per cent club'. In an article for the Evatt foundation, Burrow lists the institutional investors, lawyers, accountants, merchant bankers and others who 'take what could be a public sector infrastructure project and turn it into a private sector commercial venture, in order to both provide the infrastructure and make a quid'.

The end result of all these additional costs is that the public ends up paying more for a PPP than a publicly financed enterprise, whether that takes the form of tolls or regular public payments.

Answering the prevailing orthodoxy

What, then, does the current orthodoxy have going for it, that such arrangements continue to be made?

Many of the claims are dubious at best. Some revolve around essentialist arguments regarding the virtues of the private sector; its capacity for innovation and a supposed propensity to provide projects 'on time' and 'on budget'. Private sector innovation can be captured, however, through competitive tendering – without any need for private finance and its consequent inefficiencies.

The most common claim, though, is that Public Private Partnerships involve a transfer of 'risk'. Again, despite these claims, the reality is different.

As the examples of the Sydney Harbour Tunnel and the Victorian 'Citylink' project show, many PPPs still make governments bear the risk that the project will fall short of expected earnings, even to the point where governments are expected to eliminate the 'competition' (e.g. by closing off publicly financed roads). Should a government break a contract which guarantees the closure of said routes, then it becomes liable for the loss of projected earnings.

The bottom line, however, is that the public expect their governments to provide services and infrastructure in health, education, ports, roads, rail: and this responsibility cannot be outsourced to the private sector. If a PPP fails, governments are held responsible, and they inevitably have to pick up the pieces, either by bailing out the private providers or otherwise financing the continued provision of essential infrastructure and services.

As the example of public transport franchisees Connex and Yarra Trams in Victoria shows, governments can be driven to subsidise private providers to the tune of hundreds of millions in order for services to remain viable. In this instance the Victorian State government, failing to take said services back into public ownership, agreed to subsidise these firms to the tune of $580 million.

Is there a better way?

Earlier this year the Construction, Forestry, Mining and Energy Union (CFMEU) released a report on Public Private Partnerships. Titled Reform of Public Private Partnerships: How to Harness Private Capital To Genuinely Work In Partnership With The Public Sector, the report argues the case for a new organisation: a 'National Infrastructure Finance Corporation' (NIFC). The idea of such a body, to be financed jointly (on a 50/50 basis) by government through the Future Fund, and by pooled superannuation funds, is to provide a means of funding essential infrastructure while bypassing some of the common pitfalls associated with PPPs.

Certainly there is an urgent and demonstrable need for greater investment in public infrastructure, and the idea of an NIFC is one innovative response to a crisis that has been looming for quite some time now. The report argues that in the areas of electricity, gas, rail, road and water, there is underinvestment to the tune of almost $25 billion. This is without even considering the backlog of investment in schools, universities, hospitals, public housing and aged care facilities. According to the report, broader estimates of the backlog of infrastructure investment, taking into account the inability of current infrastructure services to meet future demand, put the cost of necessary infrastructure investment at $150 billion.

The report recognises that objections to deficit financing are irrational and based on 'intellectual fashion' rather than substance. Nevertheless, its authors accept that the current intellectual climate, fostered by a media that responds with alarmism to anything short of a substantial surplus, is 'unlikely to change in the short term'. To some this may seem a 'cop-out', but in this argument the authors are working within the accepted wisdom prevalent in Labor circles at the moment.

The report sees a National Infrastructure Finance Corporation as having two main advantages over other forms of private finance.

To begin with, such an organisation would address the problem of the high cost of private sector borrowing. Because the Commonwealth would be an equal stakeholder in such a corporation, the body would benefit from competitive interest rates available to the Federal Government. Furthermore, the authors of the report foresee that pooled superannuation funds could provide debt capital to the NIFC at rates 'much closer to the Commonwealth bond rate for investment into infrastructure projects', and at rates 'lower than would be [achieved] through normal PPP channels.'

In essence, it is argued, superannuation stakeholders would enjoy a stable and fair return on investment, while the public would benefit from the lower levels of interest paid by the Federal Government: even compared to the State and Territory governments.

Additionally, the report envisages that a National Infrastructure Finance Corporation would address the problem of 'supernormal returns that can accrue to private equity investors in some cases.'

Controversially, however, the report's authors foresee that generous tax concessions may be necessary as a spur for superannuation funds to invest heavily in appropriate infrastructure.

As John Sutton, National Secretary of the Construction division of the CFMEU, argued in The Age earlier this year,

'Targeted tax breaks would be a further way to entice super money into the projects Australia needs. Taxes on super funds are relatively low but the Government could allow tax exemptions for dividend earnings from investments in qualifying projects, and reduce or abolish the tax on capital gains from them.'

The long term cost of tax cuts for superannuation funds (an effective subsidy) would need to be worked into any overall calculations as to the efficiency and value for money provided by any National Infrastructure Finance Corporation.

Certainly, pooled superannuation funds represent a broad cross-section of the Australian populace. According to the report's authors there were some 10 million superannuation members as at June 2004; roughly the number of Australian taxpayers. Unfortunately though wealthier fund members inevitably hold more substantial fund holdings that those who have laboured on low incomes, or in part-time or casual work. It follows, then those on higher incomes will benefit proportionately more from the (subsidised) earnings of a National Infrastructure Finance Corporation, reflecting the flaws of the superannuation system in general.

That said, the NIFC option certainly seems attractive when compared to the scenarios that have emerged from PPPs in Victoria and New South Wales. The ability of the Commonwealth to borrow at a lower rate than the States, in particular, is a drawcard that heightens the appeal of the overall package.

However, despite the assumption of the CFMEU report that pure public finance of major infrastructure projects is unviable because of a popular aversion to public debt of any form, this ought not be accepted fatalistically. Fashions come and go, but in the public sphere we must continually struggle to construct what is perceived as 'common sense'. If purely public finance remains a more competitive way of building infrastructure then we ought to be struggling to win recognition of this reality as the 'common sense' of our age. And we should not forget that dividends from publicly-owned assets can themselves be used to finance further infrastructure development.

Finally, there also remains the option of 'wage earner funds' along the lines imagined by eminent economist Rudolf Meidner in Sweden. If implemented along the lines suggested by Robin Blackburn in New Left Review: a levy of 10% on corporate profits – to be issued as shares, this could result in a substantial pool of capital to be controlled by communities and unions in partnership. This is a more modest proposal than the 20% levy originally proposed by Meidner. Nevertheless, such a proposal still represents a radical option for economic democratisation: opening the way for regional funds to trade existing shares and plough the proceedings into local infrastructure projects. Such funds would provide an unprecedented avenue for popular participation in economic decision making in Australia.

The CFMEU's offering has pushed the debate forward: beyond the scandalous fleecing of taxpayers that some of our politicians would like to portray as 'responsible economic management'. Nevertheless, when compared to traditional methods of public finance, and when considering the cumulative cost of any tax incentives, governments still need to decide whether or not a National Infrastructure Finance Corporation would provide better value than traditional public finance.

For those who care, contributing in the public sphere towards a movement that seeks to challenge and reconstruct the 'economic common sense' of our age is a valuable mission that impacts on all of us as citizens, consumers and taxpayers. As economists and journalists such as John Quiggin and Ken Davidson remind us, though, it is a debate that is far from over.

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