PPPs: The existential crisis (part I)

If I was a public relations specialist and my new client was called Public-Private Partnership, I would be seriously concerned about the damage being done to its reputation, at least in Europe.

Take the very public collapse of the PPP to refurbish London’s underground train network (known as the tube) , which played out prominently in the pages of the free newspapers read daily by the majority of the tube’s passengers.

If your first contact with the concept of a PPP came from this saga, your working definition of it might be something like this: a PPP is a “Byzantine structure” that allows the private sector to waste “hundreds of millions of pounds of public money” and engage in what would be called “looting in other countries”.

These words came from London Mayor Boris Johnson in his unrelenting campaign to convey the message that the London tube PPP was too expensive and did not offer good value for money to taxpayers.

Worse, the tube PPP committed what is possibly the most egregious crime in this era of austerity: it allowed the private sector to profit handsomely from it, to the tune of “a 26 percent return on equity,” Johnson said. Unsurprisingly, it collapsed in May (perhaps under the weight of criticism), seven years into a 30-year contract.

Inflated cost

Travel eastwards in September and you’d have encountered similar sentiments being expressed by the Slovakian government (albeit in less emotive language), after it cancelled a €3.1 billion PPP contract to build a stretch of its D1 highway:

“We have nothing against PPPs, the problem is that the cost of the ones done so far have been terribly inflated,” claimed deputy transport minister Ivan Svejna.

And that, in a nutshell, is how PPPs risk being increasingly portrayed by cash-strapped European governments: as an overpriced mechanism used by prior governments  (note the point-scoring opportunity) to build infrastructure. As Goldman Sachs adviser James Wardlaw stated in an autumn 2009 report by British think-tank Policy Exchange:

“Essentially, the key question for a procuring authority is ‘what are we getting for the incremental cost of financing over and above the cost of government borrowing gilts?’ This was a much easier question to answer when the differential was 60 basis points per annum [i.e. 0.6 percent above the cost of long-term gilts] than when it is 250 basis points or higher.”

The benefits procuring authorities get from PPPs are many – although, sadly, they rarely get a decent airing whenever there is a public discussion regarding their use. To name just one, PPPs effectively transfer risks to the private sector, putting an end to the sort of construction delays and cost overruns that are notorious with publicly procured infrastructure.

It’s not that public authorities are not aware of these benefits – they clearly are. The question nowadays is whether these benefits are worth the premium they carry and, also, how big should that premium be? Procuring authorities are not ignorant of the private sector’s need to profit from these arrangements. But in the post-Lehman Brothers era, the persistent question is: how much is too much?

This question is not new, having been under discussion within the industry since the financial crisis changed the rules of the game in late 2008. At an industry event held around this time last year, Richard Abadie, a partner at financial services firm PriceWaterhouseCoopers had the following to say:

“If the [UK] government is concerned about the cost of finance and how it is performing, let us regulate it. Let us not throw the whole system out the door,” he urged.

Abadie’s appeal for a systemic change to PPPs has never been more urgent, as debt-stricken European governments increasingly question the mechanism’s  raison d’être. The consequences of ignoring the problem are obvious:  unless the current PPP system changes, there is a serious risk that it will not survive in the long term.

To find out what solutions might be implemented to avoid throwing the baby out with the bathwater, check out Part II in the December/January 2010 issue of Infrastructure Investor.