Build now, pay heavily later

One of the chief misconceptions about public-private partnerships is that they somehow mobilise extra financial resources for projects that would otherwise have to wait several years to be implemented. This irresponsible claim encourages decision-makers to carry out projects that may not be affordable - and it is usually several years before anyone realises the damage done.

Already before the economic crisis, our 2008 study showed the dangers for public budgets that hide behind PPPs. Download the study as pdf.

When Bankwatch released its 2008 analysis of PPPs, Never Mind the Balance Sheet (pdf), this threat was still largely being swept under the carpet. However, once the financial and economic crisis struck, it became all too real for countries like Hungary, Portugal and the UK, with Portugal and Hungary placing a moratorium on new PPPs and reviewing existing ones, and the UK slashing its PPP Building Schools for the Future Programme and reviewing its PPP policy.

So how can this happen?

A report commissioned by the European Bank for Reconstruction and Development has summed it up nicely:

"The particular time schedule of investments and payments in PPP contracts - with payments typically starting only after the completion of infrastructure, several years after signature of contracts - implies that these contracts, if improperly dealt with, are a powerful instrument for keeping public expenses out of the books, for under-evaluating them and for biasing decisions in favour of PPP schemes that accelerate investment and delay payments by the public sector to the private partners. This creates the possibility of undertaking inefficient projects, or efficient projects that are too much of a burden for future generations to pay, future generations that were not included in the decision process.”

The paradox of PPPs is that since they are extremely complicated, it does not necessarily make sense to do just one or two, and many PPP advocates have aimed to gain experience through increasing the ‘deal flow’ of PPP projects. This ‘quantity brings quality’ theory is at odds with minimising the cumulative impacts of PPPs on public budgets and with ensuring that PPPs are only used where they really bring benefits.

Example: Hungary

With around 100 PPP projects, Hungary is a typical example of a country which undertook numerous PPPs most likely due to the attraction of their promise of “Build now, pay later”. However as early as 2005, analysts were warning about the burden caused by its road PPPs:

“as in other countries, PPPs seem to be motivated by fiscal constraints while they should be pursued only if they offer value for money... without properly appraising and prioritising projects and analysing solutions for the whole road network, Hungary may be embarking on a too ambitious road sector development programme, thereby burdening future government budgets with large contingent liabilities.”

Once the financial and economic crisis set in, the Hungarian government finally recognised the problem, declared a moratorium on new PPPs, and started to review existing contracts.

Example: Portugal

The story is similar in Portugal. Starting in the mid-1990s, the Portuguese authorities signed tens of PPP contracts up until 2010 (exactly how many is surprisingly hard to pin down).

However as part of its drive to cut expenditures and qualify for assistance from the IMF and EU, in early 2011 the government announced a freeze on PPPs and a review of existing contracts. By the end of the year it had reviewed 36 contracts, committed to renegotiate some of them, and promised to publish all PPP contracts on the Ministry of Finance website (pdf) (albeit excluding some confidential clauses).

Example: United Kingdom

The situation in the UK has been less dramatic, but critics, including the House of Commons Public Accounts Committee among others, have long warned that the Private Finance Initiative (PFI) PPP model that has seen more than 700 projects signed since 1992 does not necessarily offer good value for money and that long, inflexible contracts are storing up problems for the future.

A change of government in 2010 prompted a noticeable drop in enthusiasm for the PFI, and in summer 2011 slashed plans for the PPP Building Schools for the Future programme, as well as kicking off a review of PFI in general.

In particular difficulties have been noted with capital costs commitments in the health sector. The money that UK hospital trusts receive from the government includes

“an element for capital costs based on 5.8% of trust income. However, the capital costs of trusts with PFI schemes average 8.3%, with the result that they are under-funded. The problem is even more serious for trusts with large or multiple schemes. Trusts with operational PFI schemes with capital values of over GBP 50 million have average capital costs of 10.2% - a shortfall in income of 4.4%. This under-funding has created serious financial difficulties for many trusts, which can only be reconciled by further service reductions.”

This is echoed by the Commons Public Accounts Committee:

“Contracting for a relatively fixed price for many years ahead can also create financial pressures for public authorities at times when financial cuts are needed. Under the PFI model, each year's payments is determined in advance, except for the effects of inflation which have to be adjusted for annually. NHS [National Health Service] Trusts in particular are finding it very difficult to meet their PFI liabilities out of their resources. An example of budgeting difficulties is the Queen Alexandra PFI hospital, Portsmouth where the NHS Trust, in seeking to manage annual hospital running costs of £40 million, has cut 700 jobs and closed 100 beds.”

Various methods for carefully accounting total long-term government commitments have been proposed. Yet the questions remain:

• How much future commitment of funds is too much?
• Is it justified to commit other people to pay significant sums of money for the next thirty years on something they might never have considered a priority?

Although financing projects always leads to some commitments, the time period in question is generally much longer for PPPs than for normally procured public sector projects, with a corresponding greater potential for today’s decision-makers to create a long-lasting burden.

An additional issue was created by the credit crunch during recent years, when it became extremely difficult to attract financing from private banks for PPPs.

In the UK, this led to the bizarre solution of setting up a GBP 2 billion public infrastructure fund for PFI projects. This has meant that the public sector has been financing the private sector - for whom borrowing is more expensive than for the public sector, thus adding to the cost of projects - to do works that the public sector supposedly didn't have money to do.