No such thing as a free road

By GEOFF CUMMING

Imagine if the Government had the money to free up Auckland's clogged arteries by building new motorways (just assume this would work), ease the crisis in health by building more hospitals, build more schools to cope with population growth and pour billions into sewage and stormwater systems to tackle pollution.

Now, imagine if it could finance these projects without borrowing and taxing the lifeblood out of you and me to pay for it.

Any Government would leap at the chance, wouldn't it? Well, the British Government certainly has and state governments in Australia are following to boot (as in build, own, operate and transfer).

Public-private partnerships, or PPPs, have replaced privatisation as the mantra of politicians and bureaucrats wondering how to pay for big infrastructure projects without racking up debts of Mexican proportions.

Such projects use private money to pay for public services, such as roads, hospitals, schools and prisons. In most cases, the state retains ultimate control but allows the developer to operate the service for several years to obtain a return on the investment.

For governments worried about debt ratios and ageing populations, a major attraction is that PPPs get big projects built while keeping the costs off their balance sheets. They also transfer many of the risks to the developer.

But after a decade of operating in Britain, Canada and Australia, PPPs remain hugely controversial, with claims that the public ends up paying much more for services that decline in quality as the private sector extracts its profit.

In this country, PPPs are touted as the key to beginning major roading projects that have been delayed by years of underfunding, but the Government has drawn the line at their use in health and education.

Private finance has been flagged for Auckland's proposed eastern corridor, the Hamilton-Pokeno motorway, Transmission Gully in Wellington and a link across the Weiti River to the Whangaparaoa Peninsula. Tolls are seen as a way to pay for them, although PPPs often require more direct government contributions.

The Government's land transport reform package, due to reach Parliament before Christmas, provides for both PPPs and tolls.

Disgraced former TVNZ chairman Ross Armstrong's championing of an infrastructure "think tank" to advance PPPs reveals the extent of behind-the-scenes manoeuvring ahead of the legislation. And the Government's reaction to the whiff of insider-preference highlights the sensitivity that surrounds the concept of private noses in public projects.

PPPs are the "third way" in action, and the Blair Government in Britain has embraced them to rescue rundown public services. Since 1997, private investment has helped to build hundreds of schools, hospitals, roads, bridges and prisons. Contracts worth more than £100 billion ($319.9 billion) are in force and the £13 billion ($41.6 billion) modernisation of the London Underground will be a PPP.

Big public schemes attract investors because they supposedly lack many of the risks inherent in private sector investments - governments are hardly likely to let public services such as hospitals and transport fail.

For the state, the trick is to negotiate a deal that ensures the costs, benefits and risks stack up when compared with traditional borrowing - but critics say it can be very hard to tell.

A major concern is that the public ends up paying far more than if the Government financed the project from its own accounts or by borrowing. Contract details are shrouded in secrecy, raising concerns about hidden costs, tax concessions and risks borne by the state and users of the service.

"It's like buying the television on hire purchase and trying to convince the public that it will be cheaper than buying it outright," says Kerry Jacobs, a senior lecturer in accounting at Edinburgh University.

Dr Jacobs, a New Zealander, says PPPs in Britain have not delivered value for money. "The system is structured to prefer the private option and the alternative of publicly funding the project is never really considered."

Opposition in Britain boiled over at this month's Labour Party conference in Blackpool, which passed a union-backed motion calling for a review of the programme. It was only the second time Blair has been defeated from the party floor during his premiership, but he has vowed to continue the programme.

Public sector unions fear that pay and conditions can be eroded while PPP developers operate services. Critics also accuse developers and operators of cutting corners and reducing service levels to protect their profits. Hospital projects have been dogged by design flaws, costly contract variations and claims of fewer beds as operational funds are diverted to pay the bills.

The most notorious rip-off, according to the Guardian newspaper, is the Edinburgh Royal Infirmary, where £900 million ($2.88 billion) will be paid over 30 years for a project costing £30 million ($96 million).

But a survey by PricewaterhouseCoopers concluded that PPPs were delivering the benefits that the public requires. "Most notable is the delivery of high-quality facilities and infrastructure as planned, on time and, as far as the public sector is concerned, to budget."

In Australia, motorway projects have required tax breaks and other subsidies for the developer, fuelling suspicions of wheeler-dealing. There have been notable flops, including a rail link between Sydney airport, the city and La Trobe hospital, which the Victorian Government was forced to buy back.

Auckland Mayor John Banks has a $7 billion wishlist of roadworks he wants completed within seven years and he says traditional funding won't pay the bills.

Banks says investors from Hong Kong, China, Britain, Germany and Australia are interested in the motorway programme. The eastern highway "may not stack up" for total private-sector ownership, but extension of the Mangere-Hillsborough motorway from Richardson Rd to the Northwestern Motorway, which could involve substantial tunnelling, is a "classic candidate" for a PPP.

But New Zealand unions remain sceptical about the need for private funding. Council of Trade Unions president Ross Wilson says Government debt is below target and it has plenty of scope to borrow. Other options are to issue development bonds - providing a vehicle for local investors - or to invest the superannuation fund.

Wilson says the Armstrong affair has highlighted the need for a robust state sector to control PPPs.

"It's vital that the public interest is safeguarded. We have seen with Tranz Rail the problems you can get into when profits are drawn out by private ownership.

"If it's a case of getting it off the Government's balance sheet, you have to know what is the cost-benefit of doing so. Is there a larger price to be paid that outweighs the benefit?"

The Green Party also questions the need for PPPs. "Our concern is that these things are being sold on the simplistic notion that the Government doesn't have the money and we can get something for nothing if the private sector builds it," says party co-leader Jeanette Fitzsimons.

"Whether it's public or private, they have to borrow [for such large projects] and the public sector can always borrow at a lower rate than private sector can."

The Greens oppose Boot (build, own, operate and transfer) arrangements, which effectively privatise assets for a time.

"The public pay for it one way or another," says Fitzsimons. "It's not at all clear that private financing can do it any cheaper."

But PPP disciples argue as passionately in justifying their use. Advocates include former National Party leader Jim McLay, now executive chairman of Macquarie New Zealand in Auckland. The firm is a subsidiary of Macquarie Bank in Australia, "the largest owner and manager of toll roads in the world".

McLay says PPPs are behind an enormous improvement in Sydney traffic flows in the past decade, with freeways including the M2, M4, M5 and eastern distributor. Their success has overcome doubts about relying on toll revenue to pay for such large projects.

McLay, who steered a roading review for the National-led Government in 1997, counters concerns about quality when public projects are handed to the private sector.

"Governments have never been particularly good at quality assurance on our roads. There is this glorious assumption that somehow governments are benevolent things that deliver good services all the time, when there is evidence to the contrary."

Stuart Lea, infrastructure specialist with Deutsche Bank in Sydney, says the private sector can bring design flair and innovation to public projects.

PPPs allow the state to transfer many of the risks, says Lea, who has worked on contracts in Britain and Australia. For instance, under a traditional design-and-build contract for a hospital, the Government may not factor in risks such as ground conditions, strikes, design faults and contract variations. With PPPs, these can be passed on to the private sector. "Yes, it costs more, but look at the risks being transferred."

Lea cites the Melbourne CityLink between the airport and city as a classic example of risk transfer working. When a leaking tunnel was closed soon after opening, the repair bill went to the developer.

On the other hand, the state Government had to compensate the developer when its own roading improvements reduced traffic volumes on the toll road. Similar arrangements will probably be negotiated if Auckland's proposed eastern highway is built as a PPP, with the developer wary of any improvements to the adjacent rail corridor, which may reduce commuter flows.

Mike Caird director of investment banking with ABN Amro, says it's important that the costs and benefits of PPPs are properly compared with traditional funding and that contracts minimise the risks to both sectors.

"Any individual project must stack up as better than the Government doing it itself," says Caird, whose firm is involved in the proposed toll road and bridge over the Weiti River.

He says New Zealand can learn from contract models developed in Australia and Britain."Where projects have failed, the public interest has usually been pretty well safeguarded. It costs the private sector money."

However, the New Zealand Government is ruling out using the Boot schemes of Britain and Australia.

Transport Minister Paul Swain says DBFO - design, build, finance and operate - arrangements are more likely here.

The land transport reform package's provision for PPPs and tolls will help to clear a logjam of transport projects that must be tackled if New Zealand's economy is to prosper, Swain says.

The legislation won't be prescriptive in terms of contract arrangements, but tolls will be allowed only where an alternative route is available, he says. Existing roads will not be tolled to pay for new roads.

"My view is we aren't going to have a flood of these kind of projects. There are some likely candidates but they are going to be rare."

Swain says officials have put a lot of work into PPPs, which will include complex checks and balances to safeguard the public interest. Hence the annoyance over the document that Armstrong sent out.

"The inference that somehow a group of people would have the inside running when it's simply not possible ... to think such a thing would get legs goes beyond belief."

Swain says the Government is taking a "cautionary" approach to PPPs.

"Borrowing is still an option and may become more attractive because the legislation allows a longer-term planning cycle. But sooner or later we have to front up to the fact that we can't fund all the things we need for New Zealand's development.

"PPPs represent an alternative funding mechanism and are certainly part of our policy platform."

Further reading
Feature: Getting Auckland moving

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