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008

The use of

Private Finance Initiative (PFI)

Public Private Partnerships (PPPs)

in Northern Ireland

The use of

Private Finance Initiative (PFI)

Public Private Partnerships (PPPs)

in Northern Ireland

Mark Hellowell, David Price and Allyson M Pollock,Centre for International Public Health Policy,

University of Edinburgh

This report was commissioned by NIPSANorthern Ireland Public Service Alliance, 54 Wellington Park, Belfast BT9 6DP

i

Index

Page(s)

Executive Summary ................................................................................................1

Introduction .............................................................................................................2

i What is PPP? ......................................................................................................2

ii Financing and funding in the public sector ..........................................................3

Section 1: The use of PPP in NI - current scale and plans for expansion ........4

1.1 Capital investment through PPPs signed and in procurement ........................4

1.2 Government departments involved in PPP ......................................................5

1.3 The impact of PPP on NI revenue budgets ......................................................6

1.3.1 Actual commitments on signed schemes ...............................................6

1.3.2 Estimated future payments for schemes in negotiation .........................7

1.4 Plans for PPP from 2012 onwards ...................................................................7

Section 2: Shifting rationales - a decade of PPP policy development in NI .....8

2.1 The embrace of PPP - first period of devolution (1999-2002) ........................8-9

2.2 Putting the PPP structures in place - direct rule (2002-2007) .......................9-10

2.2.1 A new policy rationale during direct rule ...............................................10

2.3 Devolution restored .........................................................................................11

Section 3: Evaluation of the arguments for PPP ................................................12

3.1 Does private finance provide ‘additional’ resources for public services? ........12

3.1.1 Capital and revenue resources in NI..................................................12-13

3.1.2 Changing accounting practices .............................................................13

3.2 PPP as a means of rebalancing the economy .............................................14-15

3.3 PPP and value for money ...............................................................................15

3.3.1 Financing costs in PPP ......................................................................15-17

3.3.2 The evidence: the public sector comparator ......................................17-18

3.3.3 The evidence: time and cost overruns ..................................................18

Conclusion ..............................................................................................................19

References ...........................................................................................................20-22

ii

Foreword

NIPSA has campaigned against the use of Private Finance Initiative (PFI) and Public

Private Partnerships (PPPs) since these policies were first introduced by the

Conservative Government in the 1990’s. Despite the mounting evidence of PFI and PPP

failures, however, the UK Government and the NI Executive continue to advocate the use

of PFI/PPPs to provide essential public service infrastructure and deliver public services.

NIPSA therefore decided it was essential to provide Ministers, MLAs and the public in

Northern Ireland with an independent and rigorous analysis of the use of PFI/PPPs in

Northern Ireland. Professor Allyson Pollock’s team at the University of Edinburgh was

commissioned to undertake this work – the University’s Centre for International Public

Health Policy is widely recognised and respected as an expert authority on the issues

involved.

We believe this is a landmark report on PFI/PPPs in Northern Ireland. It provides stark

facts. The unitary charges to fund agreed and projected PFI/PPP schemes is going to

cost a staggering £10 billion plus if the devolved administration adheres to current plans.

These costs will have to be met from Northern Ireland’s public expenditure budget. Public

services will suffer not benefit as a consequence.

It is now time to stop PFI/PPPs in Northern Ireland. A switch back to conventional

procurement for all future public capital projects can only help local companies in the

current financial climate. As the report highlights, PFI/PPPs freeze out local companies in

favour of large multinational corporations.

The Centre’s report now provides the clear and compelling evidence for the change of

policy on PFI/PPPs that is so desperately needed. NIPSA commends the report for

detailed consideration by Northern Ireland’s Ministers and MLAs.

JOHN COREYGeneral SecretaryNIPSA

1

Executive Summary

• Theuseofpublicprivatepartnerships(PPPs)InNorthernIrelandhasdramaticallyincreasedsincethelate1990s.AsofMarch2008,contractsfor35PPPprojectshadbeensigned,representingprivatefinancingof£1.29billion.Afurther13projects,withacapitalvalueof£1.94billion,arenowbeingnegotiatedwithprivatesectorbiddersandareduetosignbefore2012.

• Privatefinancecreatesapublicdebt.ThepublicbodiesinvolvedinPPPshavetopayannualpaymentstotheprivatesectoroveralongperiod,often30years.Thefuturepaymentsonschemessignedtodateamounttosome£4.7billion.Astheprojectscurrentlyinnegotiationaresignedoff,theliabilitiesaccruingtoPPPcontractsinNorthernIrelandwillrisetomorethan£10billion.

• DifferentrationaleshavebeenusedtosupportPPPinNorthernIrelandinthelastdecade.ThefirstdevolvedadministrationregardedPPPasameansofgenerating“additional”investment.However,thisrationalewasbroadenedduringdirectrule,whenPPP(bynowthe“preferred”methodforcapitalinvestment)wasembracedaspartofwidermeasurestoreducethesizeofthepublicsector.

• Infact,neitherrationaleisvalid.The“additionality”ofprivatefinanceisillusory–anaccountinganomalywhichdistortsfinancingdecisions.Similarly,thenotionthatPPPcanhelptorebalancetheeconomyisamisconception.Thisisapolicythatwillchannelworktolarge,overseascompaniesattheexpenseofdomesticproviders,curtailingprivatesectorgrowth.

• Inreality,thelegitimacyofPPPstandsorfallsonitscost-efficiencycredentials:i.e.whetherthepolicyisbettervaluethanthealternatives,suchasdirectborrowing.Theevidencedemonstratesthatfinancecostsarehigherfortheprivatesector,andthis,combinedwithanexcessiverateofreturnoncapital,hasledtoveryhighcostsforthepublicauthoritiesinvolvedincontracts.

• Thesecostsareincreasingfornewschemesduetothecreditcrunch,whichhaseliminatedbonds-thecheapestsourceofprivatefinance-andsignificantlyincreasedthemarginsonbankfinance.

• Newaccountingregulationswilladdresstheanomalywherebydebtraisedthroughaprivatesectorintermediaryisnotrecordedonthepublicsector’sbalancesheet.ThiswillremovethecentralattractionofPPPforthepoliticalpartiesofNorthernIreland.Withdevolutionrestored,thereisaclearneedforafull,independentreviewofcapitalinvestmentpolicyinNorthernIreland.

2

Introduction

UnderthePrivateFinanceInitiative(PFI),thepublicsectorentersintolong-termcontractswithprivatesectorcompaniestodesign,build,financeandoperateanewfacilitysuchasahospitalorschool.ThepolicywasintroducedbytheConservativegovernmentintheautumnbudgetstatementof1992and,sincethen,ithasaccountedforasignificantproportionoflarge-scaleinvestmentprojectsinareassuchashealth,education,defence,transport,councilhousing,waterinfrastructureandwastemanagement(HMTreasury2008).AsofMarch2008,627PFIschemeshadbeensignedintheUnitedKingdom,representingprivatelyfinancedinvestmentof£58.2billion.

InNorthernIreland(NI),privatefinancehasbeenusedasamethodofincreasinginvestmentinpublicservices,whicharewidelyperceivedtohavesufferedfromunder-fundinginrecentdecades.TheuseofPFIprojects,orpublicprivatepartnerships(PPPs)astheyaremorecommonlyknowninNI,hasincreasedsincethelate1990s.AsofMarch2008,therewere35PPPcontractssignedinNI,providingprivateinvestmentof£1.29billion.Afurther13contracts,withacapitalvalueof£1.94billion,arebeingnegotiatedwithprivatesectorbiddersandwillbesignedby2012.

i. What is PPP?

APPPisalong-termarrangementbetweenapublicauthorityandagroupofprivatesectorfirms,inwhichthelatterisresponsibleforfinancingthedesignandbuildofnewfacilities,andthenprovidingcertainserviceswithinthemoncetheconstructionworksarecompleted.Forexample,inahospitalPPP,anNHSbodywillcontractwiththeprivatesectortodesign,buildandfinanceanewhospital.Oncethehospitalbuildingisdelivered,theprivateoperatorwillmaintainthefacilityanddeliverarangeof“non-core”services-suchascateringandcleaning-foraperiodof25-30years.

WhenundertakingaPPP,apublicauthoritycarriesoutacompetitiveprocurementprocess,withanumberofprivateconsortiabiddingagainsteachotheronthebasisofpriceandqualitytoundertaketheproject.Eachconsortiuminvolvesamixofinvestors,suchasconstructionandfacilitiesmanagementcompaniesandprivateequityinstitutions.Onsigningthecontractfortheprojectwiththepublicauthority,themembersofthewinningconsortiumcreatea“SpecialPurposeVehicle”(SPV)-anewprivatesectorbusinessthatexistssolelytodelivertheproject.

TheSPVentersintosub-contractswithoneormorefirms(usuallyitsownshareholders)todelivertheproject.Financeisalsoraisedfromtheshareholders,and‘seniordebt’israisedfrombanksorthecapitalmarkets.InthestandardSPVfinancialstructure,seniordebtwillprovide90%ofthefinancerequired,withloansandequitycapitalfromtheshareholdersmakinguptheremaining10%.ThepublicandprivateorganisationsinvolvedinatypicalPPP,theirrolesintheprojectandthefinancingarrangementsbetweenthem,areillustratedinFigure1below.

3

ii. Financing and funding in the public sector

WhilePPPprovidesfinanceforinvestmentinnewfacilitiesandinfrastructureinNI,itdoesnotprovidefunding.Itisamethodofaccessingcapital,likedirectborrowinganditcreatesalong-termfundingrequirementforthepublicsectorinmuchthesameway.AnnualunitarychargesmustbepaidthroughoutthelengthofthePPPcontract,providingareturnontheprivatesector’scapitalandfeesfortheservicesitprovides.Thus,increasinginvestmentthroughPPPrequiresanincreaseinfunding–andthiscanonlycomefromtheUKTreasury,higherregionaltaxationorusercharges.

However,undercertainconditions,usingPPPratherthanborrowingdirectlycancircumvent(oftenstrict)constraintsoncapitalinvestment,andthishasbeenoneofthecentraldriversbehinditsuse.

ThisreportprovidesanoverviewandanevaluationoftheuseofPPPinNorthernIreland.Itisorganisedinthreesections:

Section 1:illustratestheincreasingsignificanceofthePPPmethodinNI,alongwiththeimplicationsforfuturepublicexpenditure.

Section 2:summarisesthemaindevelopmentsinPPPpolicyinNIoverthelastdecade,describingtheembraceofa“limited”PPPprogrammebythedevolvedadministrationof1999-2001;andtheexpansionofthepolicyanditsrationalesunderthesubsequentperiodofdirectrule.

Section 3:providesanevaluationofPPPagainstthethreemainrationalesfortheuseofPPPinNI,focusingonclaimsofPPP’sabilityto:provideadditionalresources,addressmacro-economicimbalances;anddeliverhigherefficiency.

Public sector body/ users

Private sector

‘Special Purposes’

Construction company

Facilities manager

Equity investor

Debt provider (bank)

Facilities managerBuilder

Services delivered

fee paid

Figure 1 The contractural structure of a typical PPP project

Share-holder capital

debt

typically same firm

sub-contractors

4

Section 1: The use of PPP in NI - current scale and plans for expansion

ThissectionexaminesthescaleofprivatelyfinancedinvestmentcommittedasofMarch2008,andprojectionsofadditionalinvestmentupto2012.Italsooutlinesthelong-termcosttothepublicsectorofthecontractssignedtodate,andprovideanestimateofthelongtermcostofprojectsthatarecurrentlybeingnegotiated.ItisdemonstratedthatcapitalinvestmentthroughPPPissettoincreasesignificantlyoverthecomingyears,atrendmirroredbyincreasesinthepublicliabilities.

1.1 Capital investment through PPPs signed and in procurement

AsofMarch2008,therewere35signedPPPcontractsinNI,withacombinedcapitalvalue1of£1.29billion.Thisrepresentscapitalexpenditureof£758perheadoftheNIpopulation–asignificantfigure,thoughstillabout£250lessthantheequivalentcalculationfortheUKawhole(ONS2008).ThisreflectsthefactthatprivatefinancewasusedtoamuchlesserextentinNIthanintherestoftheUKuntilrecentyears.Figure2illustratesthis,plottingthestarkincreaseinthecapitalvalueofprojectssignedpercalendaryear,fromjust£8millionin1997to£444millionin2007.

Figure2alsoshowsthatthecapitalvalueofsignedPPPswillincreasesignificantlybetween2008and2011,asthe13contractsfortheschemesnowbeingnegotiatedaresigned.Thevalueofcontractsisprojectedtoincreasefrom£353.6millionin2008to£630millionin2011.ThiswillincreasethevalueofPPPcontractsfrom£1.29billionasofMarch2008,to£3.22billionbythestartof2012,andtaketheamountofprivatefinanceperheadofpopulationto£1,138–higherthanthecurrentUKlevel.

Source: OFMDFM (2008)

1‘Capitalvalue’isanestimateoftheamountofcapitalinvestmentrepresentedbyagivenPPPcontract.

Figure 2. Actual value of projects signed between 1997-07 and estimated value of schemes projected

to sign between 2008-11

5

1.2 Government departments involved in PPP

ThePPPmodelhasbeenusedacrossawiderangeofNIpublicservices,providingnewgovernmentaccommodation,roads,waterinfrastructure,wastefacilities,hospitals,schools,collegesandlibraries.ThetablebelowillustratesthesectoralbreakdownofPPPinvestmentcommitteduptoMarch2008,andprojectionsforschemesnowinprocurement.Onexistingschemes,threeNIExecutivedepartments-RegionalDevelopment(responsibleforwaterandroads);Education;andHealth,-havebeenthemaincommissioningauthorities,accountingforover90%ofthecapitalvalueofcontractssigned(thelargestofwhicharehighlightedinBox1).Goingforward,however,PPPinwaterandroadsisdiminishing(alongwiththeenvironment,socialdevelopmentandenterprisesectors),whileitcontinuestohaveamajorroleineducation,healthandfinanceandpersonnel.

Actual value of Projected value ofNI Executive department schemes signed (£m) schemes in procurement (£m)

1. Social development 26.5 0

2. Regional development 586.2 0

3. Environment 25 0

4. Health 167.05 1,087

5. Finance and Personnel 47 450

6. Enterprise, Trade and Investment 25 0

7. Education 344.6 309.6

8. Employment and Learning 62 88

9. Culture, Arts and Leisure 13.9 0

Total 1297.25 1,935

Source: OFMDFM (2008)

6

Figure 3. Total unitary charges to be paid on schemes signed as of March 2008

Unitary charges (£m)

Box 1 Signed PPP schemes worth more than £50 million in capital value

Regional Development• a£118millionroads package,signedinFebruary2006.Totalunitarychargestobepaid

onthisschemeare£508.29millionbetween2006/07and2035/36.• afurtherroadspackagewithacapitalvalueof£224million,signedinDecember2007.

Totalchargestobepaidonthisschemeare£1004.59millionbetween2010/11and2037/38.

• the£110millionAlphawater schemefortheNIWaterService,signedinMay2005.Totalchargestobepaidonthisschemeare£506.86millionbetween2008/09–2031/32.

• the£122millionOmegawaterschemefortheNIWaterService,signedinMarch2007.Totalchargestobepaidonthisschemeare£640.14millionbetween2007/08–31/32.

Healthcare• a£98millionmanaged equipmentPPPfortheBelfastHealth&SocialCareTrust,

whichsignedinMay2007.Totalchargestoonthisare£132.93millionbetween2006/07and2021/22.

Education• the£104millionClassroom2000schemeforpost-primary and special schools,signed

inMarch2003.Totalunitarychargestobepaidare£116.11millionbetween2002/03to2010/11.

• the£58.2millionClassroom2000networkscheme,alsosignedinMarch2003.Totalunitarychargesare£120.16millionbetween2003/04to2011/12.

Source: www.hm-treasury.gov.uk

1.3 The impact of PPP on NI revenue budgets

1.3.1 Actual commitments on signed schemes

Asexplainedintheintroduction,thecapitalinvestmentcommittedbytheprivatesectorhastoberepaidwithinterest,alongwithpaymentsforservices.Theseunitary chargesarepaidbytheNIExecutivetotheprivatesectoroverthe25-30yearlengthofPPPcontracts.Asnoted,capitalinvestmentthroughPPPnowequals£1.29billion.Figure3(below)plotstheprofileofthe£4.7billionofunitarycharges(innominalterms)thataccruetothe35contractssignedbyMarch2008.Thesepaymentsrisefrom£1.5millionin1997-08toreachapeakof£167millionin2010-11.

Source: www.hm-treasury.gov.uk

7

1.3.2 Estimated future payments for schemes in negotiation

Clearly,thescaleofpaymentswillincreaseasmoreprojectsaresigned.However,itisimpossibletoestimatewithanycertaintywhatthepublicsectorcostswillbewhentheschemescurrentlyinprocurementarecompleted.Onecrudemethodistoexaminetheratioofcapitalvaluestolong-termunitarychargesonschemesthataresigned.Asnoted,thevalueofschemessignedasofMarch2008is£1.29billion,andpublicsectorliabilitiesontheseschemesare£4.69billioninnominalterms,givingaratioof3.64.Addingtheprojectedvalueofschemescurrentlyinprocurementproducesatotalcapitalvalueof£3.22billion-andmultiplyingthisby3.64yieldsthefigure£11.73bn.

Giventhenumeroussourcesofmeasurementbias2,thisfigureisnotverymeaningful.Perhapsallwecancurrentlysayisthat,by2012,thetotalcostofPPPsinNIwillbeintherangeof£10-15billion.

1.4 Plans for PPP from 2012 onwards

TheInvestmentStrategyforNorthernIreland2008-2018(OFMDFM2008)identifiessome£20billionofnewinvestmentinthe10yearsfrom2008butprovidesnoinformationonwhatrolePPPwillplayindeliveringthis.Indeed,theterms‘publicprivatepartnership’and‘PPP’donotappearinthedocument.Itisunclearwhetherthisomissionistheresultofpoliticalmanagement–thatis,adesiretoobfuscatethetruescaleofPPPplans,orwhetherthecurrentExecutiveisgenuinelyunsurewhatthefutureholdsforprivatefinanceinNI.Whatisclearisthatthereareanumberofprojectswhich,byvirtueoftheirlargecapitalinvestmentrequirementsandlong-termnature,areoncurrentguidance(HMTreasury2003)likelytoproceedasPPPs.Theseinclude:

• ArapidtransitsystemfortheGreaterBelfastarea.TheISNIstates:“Thepotentialtoleverinprivatesectorfundingwillbeanimportantingredient”

• SignificantinvestmentinNI’smotorway/dual-carriagewaynetwork(partoftheTrans-EuropeanNetwork)andupgradestoselectedlinkcorridorsandtrunkroads

• AnewBelfastCentralLibraryopenby2015

• Deliveryofupto10,000newsocialhomes

• Significantincreasedinvestmentinwasteandwastemanagementfacilities,inabidtomeetEUtargetsonwaterqualityandlandfill.

2Forexample,pastexperienceshowsthatbothcapitalandcontractcostsonPPPsincreaseduringtheprocurementprocess,soitcannotbeassumedthatthecurrencyquotedcostsareaccurate.

8

Section 2: Shifting rationales - a decade of PPP policy development in NI

Priortothefirstmodernperiodofdevolution(1999-2002),PPPhadmadebarelyanyimpressioninNI,despiteitsgrowingsignificanceintherestoftheUK.ThecapitalvalueofPPPschemessignedinNIbetween1992/93and1999/2000waslessthan£100million,comparedto£4billioninGreatBritain(HMTreasury2008).However,intheearlydaysofdevolution,NIpoliticalpartiesbegantoregardPPPsasapotentiallyimportantmeansofincreasinginvestmentinpublicinfrastructure.

2.1 The embrace of PPP - first period of devolution (1999-2002)

InJuly2001,theNIAssembly’sCommitteeforFinanceandPersonnelpublishedareportonPPPs,arguingthatprivatefinancecouldprovideadditionalresourcestotheamountfundedbyTreasurythroughtheblockgrant.Itstatedthat,“whilethepreferredsourceoffinanceispublicfinancebecauseitcanbeprovidedatlowerinterestratesthanprivatefinanceandensuresthatresponsibilityforprovisionofpublicservicesremainswithinthepublicsector”,PPPswouldhavetoplaysomeroleininfrastructuredeliverysince“theTreasuryisunlikelytomeetalloftheoutstandingfinancialneedsofNIfromincreasedpublicexpenditureintheshorttomediumterm”(CFP2001,p.5).

UsingPPPtodeliveradditionalfinancewassubsequentlyadvocatedbyMarkDurkan,theNIfinanceministerinthefirstdevolvedadministration.HetoldtheAssemblythat:“wedonotwishtousepublicprivatepartnershipassomeformofprivatisation.Theaimistoensurethatwemaximiseourpublicinvestment...inourcircumstancetherulesareclear:ifweborrow,thefullamountisdeductedfromourpublicexpenditureblock-wedonotgettheadditionalexpenditure.”3HeaddedthatrulingoutPPPwouldbe“doctrinaire”asitwould“limitouropportunitiestoprovideservicesofamodernstandardinthesortoffacilitiesthatpeoplehaveeveryrighttoexpect”(NIA,2001).

Tounderstandthisargument,itisnecessarytobrieflyoutlinethecapitalfinancesysteminNI.MostpublicexpenditureinNIisfundedundertheAssigned Budget,4whichissetbyWestminster,undertheBarnettFormula.ThisadjustsfundingtoreflectchangesinpercapitaexpenditureinEngland.TheAssignedBudgetprovidesfundsforspendingonservicessuchastransport,healthandeducation(i.e.thosethatareadministeredbytheNorthernIrelandExecutiveindevolution,andtheNorthernIrelandOfficeduringdirectrule).Itiscomposedofacapital budget(moneyforinvestmentinbuildingsandequipment)andarevenue budget(moneyfortheprovisionofservices).

Underthissystem,capitalspendingfundedthroughtheuseofNIresourcesorthroughdirectborrowingistightlyconstrained.ThecapitalusedwillcountagainstNI’s(verylimited)capitalbudget,reducingthescopeforalternativeexpenditure.Inaddition,there

3UndertheReinvestmentandReforminitiative,agreedwithHMTreasurin2002,an(initiallylimited)powertoborrowwasprovided,solongasthiswaspaidforoutoflocally-raisedtaxation(Heald2003).4ThisistheblockgrantfromHMTreasuryandaccountsformorethan90%oftotalexpenditureinNI.

9

areongoingcapitalchargesontheinvestmentthatwill,alongwithdepreciation,countagainsttheNIrevenuebudget.5

Incontrast,undercurrentTreasuryrules,solongasaPPPisoff-balance sheet(i.e.theprojectisrecordedasacontractforservicesratherthanafinancialleaseinthepublicsector’saccounts),therewillbenodirectimpactontheNIcapitalbudget,whileannualchargescountagainsttherevenuebudgetastheyareincurred.Theeffectofthisisthat,whilecapitalspendingfacestwoconstraints,onbothcapitalandrevenuebudgets,projectsfinancedthroughPPPfaceonlythelatter.Thisisthesourceoftheclaimthatprivatefinancecandeliver“additional”publicsectorinvestment.

InlinewithCFPrecommendations,aninter-departmentalworkinggroupwasestablishedandareportissuedforconsultationinMay2002.ReflectingthethemesoftheCFP’swork,thereportadvocatedlimiteduseofPPPsforthepurposeofincreasinginvestment,withasocialpartnershipapproachinvolvingtradeunionsandthevoluntarysectorinprojectdecisions(OFMDFM,2002).

2.2 Putting the PPP structures in place - direct rule (2002-2007)

InOctober2002,responsibilityforthedevelopmentofinvestmentpolicyinNIpassedtoWestminsterwiththere-impositionofdirectrulein,whichwastolastuntilMay2007.PerhapsthefirstsubstantiveactofdirectruleministersinNIwastolaunchaStrategicInvestmentProgramme,aspartoftheBudgetannouncementinDecember2002.Thissetoutplansforaround£2billionofinvestmentoverthefive-yearperiodto2007-08,including£725millionthroughPPPand£400millionofdirectborrowing,withtheremainderfundedthroughtheblockbudget.

ItwasunderdirectrulethatministersfinalisedthepolicyframeworkfortheuseofPPPinNI,andthebureaucraticinfrastructurewasestablishedtodeliverit.Thisframeworkwasoutlinedinthedocument,Working Together in Financing our Future(OFMDFMandDFP2003)whichstatedthattherewouldbea“strongpreference”forPPPininfrastructureandaccommodationprojects.Thiswasincontrasttothe“limited”roleforPPPthathadbeenenvisagedintheworkinggroupreport,suggestingthattheroleofprivatefinancewouldbeexpandedstillfurtherunderdirectrule.

This“strongpreference”wasreflectedinthestaffingofthenewStrategicInvestmentBoard(SIB),theexpertprocurementbodyoriginallyadvocatedbytheCFPandsupportedintheworkinggroupreport.TheSIBwasestablishedasanindependentgovernmentagency,butwasstaffedbyindividualsfromthePPPindustry,andheadedbyAndyCarty,adirectorofPartnershipsUK(PUK),thehalf-public,halfprivatebodythatisboththeUKgovernment’sexpertbodyonPPPandthepolicy’smainadvocate.ThechoiceofCarty(andhissuccessorDavidGavaghan,fromDavidWyldeProjectFinance)reflectedthecentralityofPPPtotheinvestmentplansofdirectruleministers.

Long-termplansforinvestmentinNIwerepublishedbytheSIBInDecember2004,inadraftinvestmentStrategyforNI,settingoutapotential£16billionprogrammeofinfrastructureinvestmentforthetenyearsto2015,withthepriorityonschools,hospitals,

5PublicentitiesmustpaytheTreasuryfortheuseoftheirbuildingsthroughannualcapitalcharges.

10

housingandwaterinfrastructure.Thefinalised“InvestmentStrategyforNorthernIreland2005-2015”waspublishedinDecember2005,andspecifiedthat23%oftheprogramme–thepartofitdealingwithlarge-scaleinfrastructureandaccommodationprojects-wouldcomethroughPPP.

InWorking Together,directruleministersmaintainedtherhetoricof“socialpartnership”thatwasacorethemeintheCFPandworkinggroupreports.However,thenew“strongpreference”forPPP,andthekeyrolenowbeingplayedbypractitionersandadvocatesofPPPwithintheSIB,renderedmeaninglessthiscommitment.

2.2.1 A new policy rationale during direct rule

Whiletheallegedabilityofprivatefinancetodeliver“additional”resourceswas,asshownabove,thecentralmotivebehindPPP’sexpansionduringdevolution,therationalewasbroadenedunderdirectrule.Working Togetherhadsignalledthischangeinemphasis,stressingtheabilityofPPPproviderstointroduce“reformandchangemanagement”inthepublicsectorsoastodevelop“newworkingpracticesorlessbureaucraticprocedures”(p.3).Combinedwiththe“strongpreference”forprivatefinance,thissetthestageforthemajorexpansionofPPPoutlinedinSection1ofthisreport.

Theimportanceofthisnewrationalegrewduringtheperiodofdirectrule,andmirroredreformsinEnglandwheretheprivatesectorwasencouragedtoplayalargerroleinthepublicservicesdelivery.However,thisagendahadadistinctroleinNIwherePPPwasregardedasplayingaroleinawiderattemptto“rebalance”theNIeconomyinfavouroftheprivatesector.DirectruleministersarguedthattheNIpublicsectorwastoolarge;thatthelevelofapublicexpenditureperheadwashigherthantheUKasawholeandthatitneededtobereduced;andthateffortshadtobemadetostimulatetheprivatesector,includingthroughtheuseoftax-fundedservices(Hain2006).

TheReview of Private Services in NI(NIERCandRegionalForecasts2004),commissionedbytheNorthernIrelandOffice,suggestedthatthe“DirectRuleAdministrationpromoteprivatisationofappropriateorganisationsstillinthepublicsector”(p.9).Privatisationshouldinclude“wholeorganisations”butalso“individualgovernmentactivitiescouldbehivedofftotheprivatesectortoagreaterextentthanatpresent”(p.115).Inresponsetothis,theNIOsaiditwould“lookatareaswherepublic/privatepartnershipsincapitalprojectscanhelpleverinprivatefinancetoGovernmentprojects”and“continuetoexplorehowtheprivatesectorcanbemosteffectivelyengaged”(p.6).

Similarly,theEconomic Vision for NI(DETI2005)saidthegovernmentwoulddeliver“areformedpublicsectorwhichisinbetterproportiontothesizeoftheprivatesector”and“exploitgreaterpartnershipbetweenthepublicandprivatesectorsforthedeliveryofservicesandfacilities”(p.9).ThisstoodincontrastwiththestatedpreferenceoftheCommitteeofFinanceandPersonnel’sforretainingserviceswithinthepublicsector;andthestatementsofdevolvedministersthatPPPswereaboutincreasingpublicinvestment,andwerenotintendedtoresultinanyprivatisation.

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2.3 Devolution restored

Withdevolutionrestored,thereisevidencethattheNIExecutiveismovingawayfromthismacro-economicagenda.TheExecutive’s2008-11NIBudget,forexample,contestedtheclaimthattheProvince’spublicsectoristoolargeandneededtobereduced.However,undercurrentconstitutionalarrangements,WhitehallmaintainsstrongleverswithwhichtoinfluencepolicyinNI.Forexample,theTreasurycontinuestoapplypressureontheExecutivetoreducethesizeofthepublicsector,andhasidentifiedtheuseofPPPwasoneimportantmeansofdoingso.

TheTreasury-commissioned‘VarneyII’report(2008),forexample,states:“Onewaytoincreasethevalueformoneyofthepublicsector,andtohelpstimulatetheprivatesector,istoincreasetheroleoftheprivatesectororthirdsectorindeliveringpublicservices”(P.109).InformationonthefutureroleofPPPinNIishardtoaccessduetothelackofdetailinthelatestNorthernIrelandInvestmentStrategy.However,thereisnoevidenceatthemomentthattheNIExecutiveisreviewingtheuseofPPP.

Figure 4 A chronology of PPP policy development in NI

July 2001CFPbacksuseofPPPfor

investment

May 2002Review of

Opportunities published,

backingPPPsforadditional investment

February 2003Working Together

outlines“strongpreference” forPPP

December 2004

SIBlaunchesdraft

InvestmentStrategy

February 2005

Economic Vision for Northern Ireland

published

May 2006NISecretaryPeterHaincallsforneweconomic

balanceinNI

May 2007Devolutionrestored

January 2008New

investmentstrategylaunched

October 2001

Devolutionabandoned;DirectRulerestored

April 2003SIBformallyestablished

December 2005

SIBlaunchesInvestmentStrategyNI2005-2015

April 2008Varney

recommendsusingPPPtoshrinkthepublicsector

2001 2008

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Section 3: Evaluation of the arguments for PPP

ThissectionexaminesthetwocentraldriversbehindtheuseofPPPinNI,outlinedinsection2:namely,theclaimthatprivatefinancecandeliverextraresourcesforpublicinvestment;andthatitcanenhancethemacro-economicvalueofNI.Theargumentispresentedthattheserationalesarewithoutmerit:theonlycrediblerationalefortheuseofPPPisthatitiscapableofdeliveringprojectsandserviceswithgreaterefficiency,or“valueformoney”,thanthealternatives.Thefinalpartofthissectionprovidesareviewoftheevaluativeliteratureontheissueofvalueformoney.

3.1 Does private finance provide ‘additional’ resources for public services?

3.1.1 Capital and revenue resources in NI

Asnotedinsection2,underthecurrentNIfundingregime,capitalspendingfinancedthroughthedirectuseofresourcesorconventionalborrowingistightlyconstrained.ThecapitalusedwillcountagainstthealreadylimitedNIcapitalbudget,therebyreducingthescopeforotherprojects,andcapitalchargesanddepreciationcountagainsttheNIrevenuebudget.6Incontrast,theupfrontcostsofoff-balance sheetPPPshavenoimpactonthecapitalbudget,andonlytheannualchargesappearonthepublicsector’saccounts.Thismeansthat,whileconventionalcapitalspendingisconstrainedbycapitalandrevenuebudgets,onlythelatterimpactsonmostprojectsfinancedthroughPPP.

ThisprovidesNIadministrations–whetherdevolvedorWestminster-based-withanincentivetousePPP,asitappearstoprovidescopeforinvestmentthatisadditionaltowhatcouldbeprovidedthroughconventionalcapitalspendingorborrowing.7BecausecapitalbudgetsaresolowinNI,andthepowertoborrowistightlyconstrained,thisincentiveoperateseven where the revenue impact of private finance is greaterthanalternativemethods.Section2ofthisreportshowsthattheNIExecutivewas–quiteopenly-respondingtothisincentivewhenitchosetoexpanditsuseofPPP,withboththeCFPandthefinanceministeremphasisingPPP’s‘additionality’.NIOfficeministersalsofacedtheseconstraintsduringdirectrule,andthereforeoperatedunderthesameincentive.

AstheInternationalMonetaryFund(2004)notes,the“off-balancesheet”statusofPPPsintroducesan“unwarrantedbiasintheirfavour”,providinga“superficial”relaxationofbudgetconstraints.Therelaxationis“superficial”becauseinvestmentthroughPPPhasexactlythesamerevenueeffectasconventionalcapitalspendingordirectborrowing.ThispublicsectorcoststhatPPPgivesrisetocanonlybemetthrougharedirectionofrevenuefromotherpartsofthepublicsector,increasedtaxationor,forsectorslikeroadsandwater,higherusercharges.ThebudgetaryadvantageofPPP–thatwhiledirectborrowingcountsagainstthecapitalbudget,borrowingthroughaPPPintermediarydoesnot-istheconsequenceoffinancialreportingstructuresdevelopedbytheTreasury,anddoesnotreflectanyeconomicdifferencebetweenalternativeformsoffinancing(Heald1997).

6PublicentitiesmustpaytheTreasuryfortheuseoftheirbuildingsthroughannualcapitalcharges.7BecauseEnglandusesPPPtofinancemostofitslarge-scalecapitalinvestment,thecapitalbudgetforNImaybesetlowerthanitwouldotherwisebeundertheBarnettformulaforterritorialrevenueallocation.TheincentivetousePPPisparticularlystrongfordevolvedgovernmentsintheUK,sincenotusingprivatefinanceimpliesalowerlevelofcapitalexpenditurethanEngland,whichmayhavepoliticalconsequences.

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IfPPPcannotprovideadditionalresourcestodevolvedadministrations,whymighttheTreasurywishtogiveministersabudgetaryincentivetouseit?ThereasonisthattheTreasuryfacesaverysimilarpoliticalincentivetotheoneoutlinedabove,largelybecauseofself-imposedfiscalconstraints.

AcrossEurope,financeministriesareinterestedinPPPbecauseofitsabilitytodeliverinvestment,theupfrontcostsofwhichdonotcountagainstmeasuresofpublicsectordebt.AllEUmemberstatesaresubjecttofiscalconstraintsundertheMaastrichtTreaty,whichrestricts‘grossgovernmentdebt’to60%ofnationalGrossDomesticProduct(GDP).IntheUK,thefiscalrulesarelessflexible.Since1998,theLabourgovernment’s‘sustainableinvestmentrule’hasimposedaceilingof40%ontheratioof‘publicsectornetdebt’(PSND)toGDP,whichisconsistentwithamuchlowerdebt-to-GDPratiothanthatspecifiedintheEUStabilityandGrowthPact.8

Aslongasprivatelyfinancedinvestmentisrecordedoffthepublicsector’sbalancesheet,thenitdoesnotcounttowardsthePSND.9And,asthesustainableinvestmentruleisanimportantbenchmarkoftheTreasury’seconomicprudence,ithasanincentivetoencouragetheuseofprivateratherthanpublicfinancefornewinvestment,evenwherethepresentvaluecostwillbehigher.

3.1.2 Changing accounting practices

TheNIExecutive’sabilitytokeepprivatefinanceoffbalancesheethasbeenreducedoverrecentyears.10ThisabilitywillbereducedevenfurtherwhentheUKgovernmentmovestoInternationalFinancialReportingStandards(IFRS)from2009/10.Underthissystem,itislikelythatPPPswillbeaccountedforinaccordancewithIFRIC12,anInterpretationofIFRSissuedbytheInternationalAccountingStandardsBoardandstronglysupportedbytheFinancialReportingAdvisoryBoard(FRAB),towhichtheTreasuryisaccountable.Thisdeclaresthatprivateoperatorsshouldnotrecordtheup-frontcapitalcostofPPPprojectsontheirbalancesheetsifoverallcontroloftheassetconcernedisnotintheirhands–andthisisthecaseforthevastmajorityofPPPprojects.

UnderpressurefromFRAB,theTreasuryhasacceptedthata“mirror-imagetreatment”ofIFRIC12isappropriateforthepublicsector(Heald2008).ThismeansthatinvestmentsunderPPPwillhavetoberecordedonthebalancesheetofthepublicsector,therebyscoringagainstthebudgetsofdepartmentsanddevolvedadministrations.Itisalsolikelythat,from2009/10,manyPPPswillalsoscoreagainstPSNDand,unlessitisreformulated,thesustainableinvestmentrule(ONS2007).

Fromafinancialtransparencypointofview,themovetoIFRSwillbewidelywelcomedifitremovesperverseincentivestousePPP.Ontheotherhand,withtheaccounting-drivenadvantageofPPPeroded,itisessentialthatministersconsiderhowinvestmentbydevolvedadministrationsistobefundedifshortfallsincapitalinvestmenttobeavoided.ItremainstobeseenwhethertheTreasurywillintroducenewregulationsthatwillallowtheNIExecutivetomeetitsinvestmentneeds.

8ItislikelythatthisratiowillbechangedintheforthcomingAutumnPre-Budgetreport,duetoneweconomiccircumstancesandrisingpublicdebt.Whateverceilingisimposed,theTreasurywillretainanincentivetocircumventitifitcanachievepoliticallydesirableresults–e.g.higherlevelsofinvestment–bydoingso.9Forexample,theTreasury’sseminalstatementonitspolicytowardsPFIstatesthatprivatefinance“canrelievethepressureonpublicfinances”(HMTreasury2000;p.13).10Some60%ofthefinancecommittedtosofaronsignedPPPsinNIisoff-balancesheet(HMTreasury2008)

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3.2 PPP as a means of rebalancing the economy

AsdiscussedinSection2,duringdirectrulePPPwasadvocatedasonewayofrebalancingNI’seconomyinfavouroftheprivatesector,andtheTreasuryhascontinuedtolobbyforthispolicytobepursuedduringthecurrentperiodofdevolution(e.g.Varney2008).

This“macro-economic”rationalefortheuseofPPPisproblematicforthreereasons:

(1)TheargumentthatthepublicsectoristoolargeinNIisanoversimplification.ItisthecasethatNIhasahigherlevelofpublicexpenditureperheadthaninGB(Mcleanetal2008).However,animportantpartofthisisconnectedwithsocialsecuritypayments.ThesearemuchhigherthaninGB,notleastbecausethenumberofbenefitclaimantsis50%higherthanonthemainland.Relatedly,certaingovernmentreforms,forinstanceontaxcredits,haveinflatedthe‘subvention’toNI(GudginandGibson,2008).ThepublicexpendituredifferentialbetweentheNIandGBisthereforelargelyafunctionoftransferpaymentsanddoesnotimplyhigherspendingonpublicservices.

Intermsofemploymentshare,NIhasahigherpercentageofindividualsinthepublicsectorthantherestoftheUK-estimatedat28%inNI,comparedto20%(NIExecutive2008).However,whenthesizeofthepublicsectorismeasuredintermsofpublicemploymentasaproportionofpopulation,NIissimilartootherpartsoftheUK.Whatthissuggestsisthattheprivatesectorafterdecadesofunder-investmentduringTheTroublesistoosmall,notthatthepublicsectoristoolarge.Inthiscontext,acrudeattempttoreducethesizeofthepublicsectorcouldhaveseriousconsequencesfortheeconomy(GudginandGibson,2008).

(2)AsignificantimplicationofprocuringthroughPPPs,ratherthanconventionalprocurement,isthefreezingoutoflocalcompaniesinfavouroflargemultinationalcorporations,whichcanbetterhandlethetransactioncostsinvolved.TheaveragebiddingperiodforPPPschemesisaroundthreeyears,requiringsignificantlegal,financial,andtechnicaladvisorycostsforbothsectors(NationalAuditOffice2007).Becauseofthis,authoritiestendto‘batch’individualconstructionschemesintolargerunitsinordertocreateeconomiesofscale,11withtheresultisthatmostprojectsareintherangeof£50-£250millionrangeintermsofcapitalvalue.Together,thesefactorsareknowntodetersmallandmediumenterprises(SMEs)frombiddingforPPPs(Ezulikeetal1997).

ThisislikelytohaveanegativeimpactoneconomicgrowthinNI,aregionthathasarelativelysmallnumberoflarge,high-turnovercompaniesandanimportantSMEsector.AccordingtoVarney(2008),theProvincehasonly45businesseswithmorethan500employees,comparedto4,510intheUKasawhole-adifferenceofahundredfold,eventhoughtheUKpopulationisonlyaround34timeshigherthanthatofNI.EvenifthefewlargeNIfirmswereabletofindtheresourcestobidforthiswork,itisunlikelytheywouldbecompetitive.EstablishedPPPfirmsfromtheUK,EuropeandtheUShaveabsolutecostadvantagesoverpotentiallocalbidders,sincebankfinancerateswillbeunfavourableforconsortiawithlimitedexperienceofPPP(StandardandPoors2004).

11Indeed,Treasuryguidanceissuedin2003expresslyforbidsPPPsunder£20millionincapitalvalue.

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Tothisextent,theprioritisationofPPPoverotherformsofpublicprocurementactuallyrunscountertotheprojectofstimulatinggrowthinthedomesticprivatesector.ItalsorunscountertooneoftherecommendationsoftheVarneyreviewtotheNIExecutive:toensurethat“governmentprocurementcanplayanimportantroleindrivingSMEinnovationandgrowth”(p.109).

(3)Thesuggestionthatshiftingaservicefromthepublictotheprivatesectorcould,inandofitself,addvaluetoaneconomyisamisconception.MovingagivenservicefromthepublictotheprivatesectorhasnoimpactonGDP,norontheunderlyingworthoftheeconomy.ServicestransferredtotheprivatesectorthroughPPPwillstillbetax-funded.Allotherthingsbeingequal,PPPdoesnotimplyanyreductioninpublicspending,oranyrelaxationofthepublicsector’sbudgetconstraint.

AnargumenthasbeenmadethatpublicservantsaretoohighlypaidinNI’spublicsector,andthisis“crowdingout”theprivatesector,wherewagesaresome20%lower.Thisargumentisstronglycontestedbypublicsectortradeunions.Inanycase,underTUPEandrelatedUKgovernmentregulations,stafftransfersthroughPPPscannotresultinlowerwagesorpensions,soPPPisirrelevanttothisissue.Inanycase,Heald(2003)suggeststhatthepublicsectorinNInowcompetesformanpowerandskillswiththeRepublicofIreland,wherepublicsectoremploymenthasgrownrapidlyinrecentyears.AnyattempttoradicallyreducewagesintheNorthislikelytoleadtonetout-migrationofmobile,well-qualifiedstaff(GudginandGibson2008).

3.3 PPP and value for money

PerhapsinrecognitionoftheweaknessoftheargumentsforPPPthatareoutlinedandcritiquedabove,thepolicyisalsojustifiedoncost-efficiencygrounds.Atfirstblush,thevalueformoneycaseforPPPappearsweaksincepublicfinanceischeaperthanprivatefinance.Thisisbecauselendingtogovernmentisextremelylowrisk-publicbodies,unlikeprivatecompanies,areunlikelytogobankruptanddefaultontheirpayments.Thetransactioncostsofgovernmentfinancingarealsolowandthemarketingovernmentdebtisusuallyliquidandefficient(Yescombe2007).

3.3.1 Financing costs in PPP

InitsexaminationoffinancingcostsforScottishschoolsPPPs,AuditScotland(2002),foundoverallratesofreturnonprivatefinanceintherangeof8-10%ayear,some2.5%to4%higherthanapublicauthoritywouldpayifithadborrowedmoneyonitsownaccount.Similarly,inastudyofthefirst12PPPhospitalprojectsinEngland,Shaouletal(2008)foundprivatefinancecostsofabout8%-wellinexcessofthe4.5%availableonpublicfinanceintherelevantperiod.FinancingcostsmatterinaPPP,justastheydoinprojectsfundedthroughdirectborrowing,astheyarepartofaproject’scostsandtoalargeextentdeterminetheleveloftheannualpaymentsthatthepublicauthoritymustfund.TheFreedomofInformationActhasenabledindependentscrutinyofPPP‘financialmodels’,documentswhichcontainestimatesofaproject’sprofitability.CuthbertandCuthbert(2008)lookedatthecostoftwocompletedhospitalschemesinScotland,theEdinburghRoyalInfirmaryandHairmyres,andcomparedthiswithanestimateofwhattheseprojectswouldhavecosthadpublicfinancebeenused.Todothis,theycomparedforeachschemethenetpresentvalue(NPV)12ofreturnstoinvestorswiththeamountofprivatecapitalraisedtofinancetheconstructionwork.12Basedonadiscountrateof5%-theNationalLoanBoardrateatthetimetheseprojectsreachedfinancialclose.

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OntheEdinburghRoyalInfirmaryscheme,theyfoundthecashvalueofthereturnsonprivatecapital(excludingpaymentsforoperations,maintenanceandserviceprovision)was£760million.Thiswasthendiscountedat5%-therateofinterestthatwouldhavebeenpaidbythesehospitalsonpublicfinanceatthetimetheircontractsweresigned–togivethefigure£416million,morethantwice(2.04)the£181millionofcapitalraisedbytheprivatesectortobuildthehospital.Thesameanalysiswasappliedtothe£68millionHairmyresscheme,generatingasimilarratio(1.97).Althoughtheyareestimates,theseratiosprovideanindicatorofthecostofthesefacilitiestotheNHS,relativetowhatthecostwouldhavebeen,hadtherequiredfinancebeenaccessedthroughdirectborrowing.TheauthorsconcludedthatPPPisa“onehospitalforthepriceoftwopolicy”(p.5).

TheTreasuryarguesthatthehighercostofprivatefinanceissimplyafunctionoftheriskofinvestmentbeingexplicitlypriced(HMTreasury2003).Onthisanalysis,whengovernmentfinanceisusedforaproject,therisksassociatedwiththeinvestmentarethesameasinaPPP,butanyadditionalcosts(e.g.duetotimeandcostoverrunsinconstruction,orproblemsinoperation)arepassedontocurrentandfuturetaxpayers.Incontrast,inaPPP,theseprojectrisksarebornebyprivateinvestors,ratherthantaxpayers,andarepricedaccordingtostandardmethodologies.

Theclaimthatthecostofprivatefinanceissimplythecostofpublicfinance,plusa“riskpremium”,isthereforefundamentaltothemicro-economiccaseforPPP.Ifthecostofprivatefinanceisthesameaspublicfinanceafterallowingforrisk,andtheprivatesectorisabletomanagethisriskanddeliverprojectsmorecheaply,thenthetotalcostofaPPPcouldbelowerthanapublicproject.

However,theavailableevidencesuggeststhatthisisnotthecase.ResearchcommissionedbytheOfficeofGovernmentCommerce(OGC),andcarriedoutbytheaccountingandmanagementconsultancyPricewaterhouseCoopers(2002),showsthatprivatefinancecostsaresignificantlyhigherthanispredictedbytheTreasury’sclaim.PwCanalysed64PPPsthatweresignedbetween1995and2001,comparingforeachprojecttheprojectedrateofreturnoncapitalwithabenchmarkdesignedtoreflectthereturnthatshouldbeexpectedonthescheme,givenitscostsandrisks.

Thestudyfoundthatprojectedratesofreturnexceededthebenchmarksbyanaverageof2.4%.13Whilethismayappeartobeanarrowmargin,itrepresentsasubstantialamountofmoneyoverthelifeofacontractof25to30yearsormore.WhatPwCcalls“excessreturns”ofaslittleas1%couldleadtoanincreaseinoverallcoststothepublicsectorof10%overthetermofa30yearcontract.

Thecreditcrunchisincreasingthecostofprivatecapitalrelativetopublicfunding(Hellowell2008).Investorsinpublicprojectshavebeenhitbytheshortfallinbankliquidityinmuchthesamewayashomebuyersandbusinesses,withfinancenowbeingrationedandcreditmarginsincreasing.Theimpactofthisistwo-fold.First,bondfinance,hithertomuchthecheapestformofseniordebtfinanceforPPPs,isnolongeravailable.ThisisbecausetheUS‘monoline’insurers,suchasAmbacandMBIA,losttheirtriple-AcreditratinginthewakeoftheUSsub-primecrisis.Theseinstitutionsplayedakeyroleinthe

13AccordingtotheNationalAuditOffice(2007),thelevelofcompetitionislowinthePPPmarket,anddeclining.Between2004and2006,only67%ofPPPprojectsreceivedthreeormorebidders.Onethirdofprojectsattractedonlytwobiddersatthepointatwhichdetailedbidsweresubmitted.

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commercialbondmarket,guaranteeingrepaymentstobondholdersinreturnforafee,reducingoverallfinancingcosts,inparticularformanylargerPPPprojects.

Second,inthebankfinancemarket,nowtheonlysourceofseniordebtforPPPinvestors,liquidityhasreduceddramaticallysinceJuly2007and,wherecreditisavailable,thecostisveryhigh.Thisispartlybecausethebanks’owncostofcapitalhasincreasedduetothefactthatbanksarenolongerwillingtoprovidecreditexceptathighinterestrates.Inaddition,theshortfallinliquidityhasreducedcompetitionintheseniordebtmarket.Ratherthanlendingindividually,banksarenowlendingascartels,or“clubs”,andasaconsequenceofthis,creditmargins(theinterestratesabovethebanks’owncosts)havedoubledinthelastyear.Pre-creditcrunch,creditmarginsonsimpleaccommodationschemeslikeschoolsandhospitalswerebetween60-80basispoints(0.6-0.8%)abovethebank’sowncostofcapital.Thishasnowincreasedto100-150basispoints(PricewaterhouseCoopers2008).

ItissignificantthattheUKgovernment’sownevidencebasesuggeststhereare“excessreturns”toinvestors.Thisisaparticularcauseforconcerngiventhatprivatefinancecostsarenowincreasingtohistoricallyhighlevels.Thisimpliesthat,tobevalueformoney,theprivatesectormustbesomuchmoreefficientthanthepublicsectorthatitcanmore than offset itshighercostoffinancethroughbeingmoreableandbetterincentivisedtomanagerisk.Inprinciple,itispossiblethatthisisthecase,butthereisclearlyahighburdenofproofgiventheevidenceofexcessiveprofitability.Asweseebelow,novalidevidencehasbeenprovidedbythegovernmentissupportofitsassertions.

3.3.2 The evidence: the public sector comparator

UnderTreasuryrules,publicauthoritiesmustsubjecttheirprivatefinanceplanstoavalue-testingexercise,partofwhichisbasedonapublic sector comparator(PSC)–anestimateofwhattheprojectwouldcostunderpublicfinance.Intheory,whereaPSCconcludesthatprivatefinancedoesnotrepresentvalueformoney,apublicprocurementmethodshouldbechosen.Inpractice,PPPalmostalwayscomesthroughthePSCexerciseasthemoreefficientoption,andthishasbeenpresentedbytheTreasuryasgoodevidencethatthemodeliscost-efficient(HMTreasury2000).

SincethelogicofPPPisthatitleadstogreatercostefficiencythroughtheprivatesectormanagingmoreeffectivelyprojectrisk,theprincipleisthatriskshouldbeaddedtothePSCtomakethiscomparablewiththecostofPPP.However,thisprocesshasbeenfundamentallydiscreditedbyacademicsandauditors(Gaffneyetal1999;PriceandGreen2000;NAO1999),whopointoutthattheaccounting-drivenadvantagesofPPPstriptheseappraisalsofanyobjectivity.

Forexample,Gaffneyetal(1999)note“atendency”forpublicauthoritiesengagedinthePSCprocesstoascriberiskstoPPPconsortiathattheywillneverinfactbeaskedtobear,andtherebyartificiallyinflatethecostofthePSCrelativetothePPP.Forexample,ononehospitalproject,oneoftheriskssupposedlytransferredtotheprivatesectorwasthattargetsforclinicalcostsavingswouldnotbemet.Thecostofthisriskwasestimatedat£5millionandaddedtothePSCfigure.However,theconsortiumhadnoresponsibilityforensuringsuchsavingswouldbemade,andfacednopenaltyiftheyweren’t.TheauthorsconcludethatthePSCprocesswas“oftenspurious”.

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JeremyColman,formerdeputygeneraloftheNationalAuditOffice,thesupremepublicsectorauditinstitutionintheUKoutlinedasimilarconclusionincommentsmadetotheFinancial Times(sinceconfirmedbyColmaninapersonalcommunicationwithoneoftheauthors).MrColmannotedthatmanyappraisalswereguiltyof“spuriousprecision”,basedon“pseudo-scientificmumbo-jumbo”.Henotedtheperverseincentivefacingauthoritiestomanipulateappraisals,inacontextinwhichprivatefinanceisusuallytheonlyfundingsourceavailable:“Iftheanswercomesoutwrongyoudon’tgetyourproject.Sotheanswerdoesn’tcomeoutwrongveryoften”(Timmins2002).

3.3.3 The evidence: time and cost overruns

MorerecentgovernmentattemptstojustifythedominanceofPPPinlarge-scalecapitalinvestmenthavefocusedonthemodel’sabilitytodeliverprojects“ontimeandtobudget”.Forexample,theTreasury(2003)states:“[our]researchintocompleted[PPP]projectsshowed88%cominginontimeorearly,andwithnocostoverrunsonconstructionbornebythepublicsector.Previousresearchhasshownthat70%ofnon-PFIprojectsweredeliveredlateand73%ranoverbudget”(p.43).

AfterrepeatedFreedomofInformationrequestsfortheTreasury’sworkoncostandtimeoverruns,officialsconfirmedthatnoresearchreportexists.Accordingly,the88%figurequotedabovecannotbevalidated.Meanwhile,the“previousresearch”notedreferstotworeportsfromtheNationalAuditOffice,Modernizing Construction and PFI Construction Performance.Butneitherofthesestudiescomparesrelativeperformanceunderdifferentprocurementroutes.Thefirstisbasedoninterviewswithindustryaboutthescopeforimprovedconstruction.Thesecondisacensusof38projectmanagers.Indeed,thelatterreportstates:“itisnotpossibletojudgewhethertheseprojectscouldhaveachievedtheseresultsusingadifferentprocurementroute”(NAO2003).

Inanycase,comparingPPPandnon-PPPprojectsforpost-contractualpriceincreases(whattheTreasuryappearstomeanby“timeandcostoverruns”)isnotavalidmethodfortestingoverallvalueformoney.UnderaPPP,theriskofcostandtimeoverrunsistransferredtotheprivatesector,soithaslittleflexibilitytoincreaseitspriceduringcapitalworksunlessmajorproblemsemerge.Instead,underPPP,theprivatesectorincreasesitspricebeforecontractsaresigned.Itisassistedindoingsobythepreferred bidderstage-apost-competitivephaseofPPPprocurementinwhichthepublicauthorityentersintoalongandexclusivenegotiationprocesswithasingleconsortium.14

Duringthisperiod,theprivatesectorcan‘hold-up’thepublicauthority,usingitsadvantageousbargainingpositiontoincreasepricesandreducetheextentofrisktransfer.Meanwhile,thescopeforpublicauthoritiespullingoutofsuchnegotiationsislimitedbythenon-availabilityofotherfinancingroutes.Inproposingthatpost-contractualpricecertaintycanbetakenasanarbiterofoverallefficiency,theTreasuryissettingupacomparisonwhichisboundtofavourthePPPmethod.Aprojectthatisdeliveredtotimeandtobudget(inpost-contractualterms)mayrepresentverypoorvalueformoneyifthepricepaidfortherisktransferthatledtothatoutcomewastoohigh.

14AccordingtotheNationalAuditOffice(2007),theaveragelengthofpreferredbiddernegotiationsforprojectsthatsignedbetween2004and2006was15months.

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Conclusion

ThereasonsfortheadoptionandexpansionofPPPunderdevolutionstemfromanaccountingregimethatdoesnotreflecttheunderlyingeconomicreality.UsingPPPallowsthescoringofinvestmenttobepostponedagainsttheAssignedBudget,creatinganincentivetopursuethismodelevenwhenthelongruncosttotaxpayerswillbehigher.ItisclearthattheNIExecutiveandtheNIOfficewererespondingtothiswhenformulatingcapitalexpenditurepolicyinthelate1990s.

Underdirectrule,PPPwasseenasawayof“rebalancing”theeconomythroughtransferringservicesfromthepublictotheprivatesector,shrinkingtheformerandexpandingthelatter.However,theargumentthatthepublicsectoris“crowdingout”theprivatesectorispoorlyevidenced,andthefundamentalcharacteristicsofPPPareactuallylikelytoreducethecapacityofgovernmentactiontostimulateexpansionintheprivatesector.Thenotionthatanyvalueisaddedtotheeconomysimplythroughtransferringservicesfrompublictoprivateisamisconception:theonlywaysuchatransfercanbebeneficialifitbringsaboutimprovementsinproductiveefficiency,or“valueformoney”.

ThefinalsectionofthisreportlooksattheevidenceonPPP’seconomiccredentials.WhilePPPinNIisduetoberadicallyexpandedbetweennowand2012,thereisnocredibleevidencebasethatsupportsthispolicy.Itwouldappearthatthecapacityforanyimprovementsinefficiencyiserodedduetotheexcessiveprofitabilityofcontractsforinvestors.Theevidenceshowsthatratesofreturnarewellinexcessofmarketnorms,suggestingthepricebeingpaidforrisktransferistoohigh.

Atthecurrenttime,thecostofprivaterelativetopublicfundingisrisingsignificantlyduetothecurrentfinancialcrisis.Thishaseliminatedthebondfinancemarket–previouslythecheapestsourceofprivatefinance-andcurtailedtheavailabilityofbankfinance.Inturn,thishasfurtherreducedthedegreeofcompetitioninthemarketforfinance,andallowedbankstodoubletheircreditmargins.

ThechangefromBritishtointernationalaccountingstandardswillremovetheNIExecutive’sreasonforusingPPP–itssuperficial‘additionality’advantage.Atthesametime,theeconomicslowdownmeansthatNIwillreceivelowerincreasesinfundingfromtheTreasurythanhasbeenthecaseinthelastdecade.Inthiscontext,thehigh(andincreasing)costsofPPParelikelytoputpressureontheNIExecutivetoincreaseregionaltaxationanduserchargesinareassuchaswater.

We suggest that the time is right for an independent review of capital investment policy in NI, and we recommend a moratorium on the further use of PPP until this is completed.

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• PricewaterhouseCoopers(2002).Study into rates of return bid on PFI projects.WithFranks,J.CommissionedbytheOfficeforGovernmentCommerce.London.TheStationeryOffice.

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