||Issue No. 150||30 August 2002|
Shut It Down!
Interview: Australian Worker
Unions: Morning Ambush
Cole-Watch: Grumpy Old Men
International: Arrested (Sustainable) Development
History: Illegal Alien
Economics: The Trouble With PPPs
Poetry: Is This 'My Country'?
Review: Garage Days
The Locker Room
Week in Review
The Trouble With PPPs
'There is no clear evidence from experience that the investment which is socially advantageous coincides with that which is the most profitable.' - John Maynard Keynes
The first thing anyone can notice about so-called 'public-private partnerships' -- or 'PPPs' -- is that the subject presents itself as both exceedingly complicated and very boring; so complicated and boring that even editors with the Australian Financial Review have complained to me at times about being 'PPPed out'. Indeed, the topic can be so complicated and boring that one suspects this is a deliberate part of the political marketing strategy adopted by the advocates of these policies. If the editors of the Fin find the topic tedious, what hope can critics have of raising public awareness and debate about this direction?
Let me try to cut through some of the complexity, even if I cannot promise to be entertaining. Actually, when preparing this paper I spent some time searching cyberspace for some jokes about PPPs, without any luck. I naturally thought this was because the topic is so dry and complex that it simply doesn't allow for humour. But, on second thought, it occurred that the reason no one bothers to think up jokes about PPPs is because the policy-makers have already done the job for us.
The first joke in all the policy papers that have been released by our State Labor governments is an insistence that PPPs are not privatisation. The Western Australian PPP paper, for example, states in the opening paragraph of its introduction that the government 'has a clear policy position that it does not support privatisation'. Likewise, the NSW document says that the policy 'does not mean privatisation of public services'.
These statements must be a joke, because all the papers are all about, and all of them are only about, privatisation. No, this does not mean that the policies are about 'privatisation by stealth' -- the promoters of these policies don't really mind them being described as 'privatisation by stealth', since it helps them to keep up their running joke, which is that these policies are not about privatisation, pure and simple.
Let me insist, and we all should insist, that they are about privatisation, no more no less. This point must be hammered. A close reading of the PPP policy documents reveals that the only public activities that they all exclude from privatisation are school teaching and clinical services within hospitals. Mind you, the schools and hospitals can be privatised, but the governments have generally promised that they will still continue to employ the teachers, doctors and nurses who work in them. Some governments have gone a little further. The Victorian government has also ruled out privatising the judges within the court system, as has the Western Australian government, which has also ruled out privatising the police and 'offender management'.
This then is the first important point to be made. Read at their widest, the policies that have been represented as PPPs amount to a New Right Utopia. There is no barrier within these policy papers that can prevent State governments being reduced to the point where they own nothing, and their sole direct tasks will be teaching school children and tending the sick. In Victoria and Western Australia, they will also continue to employ our judges. Bravely, Western Australia also promises to continue to employ police and manage 'offenders'. Let's be clear: these policy papers supply no other limits. Beyond these slender commitments, PPPs amount to open slather for privatisation.
I lie. The truth is that the policies don't even supply these slender limits. A close reading of the Victorian policy, for example, reveals that the government has only promised to remain directly responsible for 'core' services. The problem here is that, when we go to the definition of 'core', we find that this does not necessarily even include education and hospital services. The policy does not make a clear statement that these are core services, and that they are therefore not subject to the PPP policy. Rather, what the policy says is that these tasks 'are widely regarded as core services'. Note, the policy does not say that the Victorian government regards these services as 'core', only that others do. Given that the paper also explicitly states that the definition of core services will be decided on a 'case by case' basis, strictly, the policy remain utterly open-ended.
This is, perhaps, a form of stealth. Yet it is not 'privatisation by stealth'; rather, it is pure and simple, in your face privatisation, plus a good deal of 'stealth' in defining the real limits of the policies. This is true of all the States. Despite their qualified allusions to protecting so-called 'core' services, all the policies emphasise their open-ended scope. The Western Australian government's policy is perhaps the most explicitly open-ended. In contrast to the vagaries employed to describe the very few functions that the government intends to keep, the policy paper presents an explicit list of areas that the West is actively seeking to privatise. These are: transport and port facilities, health facilities, education facilities, water supply and waste water treatment, electricity generation, transmission and distribution, gas supply and distribution, housing development and new housing estates, land development, and major construction processes. This list, the paper emphasises, is 'non-exclusive'.
So this is the first Orwellian-style joke that the State Labor governments are enjoying at the expense of their citizens. In the tradition of 1984's Big Brother, who insisted that war is peace, that freedom is slavery and that ignorance is strength, our State governments have all released policy papers that set out privatisation policies, which they insist are not privatisation policies. Again, let's be clear. Privatising water, electricity and transport can only mean privatising water, electricity and transport, regardless of whether the government does or does not continue to directly employ judges and police. Likewise, privatising school and hospital facilities, which presently appear to be at the front-line of the PPP policies, can only mean privatising school and hospital facilities, regardless of whether the government does or does not continue to employ schoolteachers and nurses.
Of course, the reasons why our State Labor governments are refusing to say that their privatisation policies are privatisation policies are plain enough. Despite the fact that the Australian public has been barraged by 20 years of bi-partisan pro-privatisation rhetoric, accompanied by a privatisation program valued at around $120 billion -- a program that has placed Australia at the top of the world privatisation rankings -- the public has remained implacably opposed to the policy. Opinion surveys always show - always show -- that between 60 and 70 per cent of Australians are opposed to privatisation; an opposition that stretches across all demographics and voting intentions. So entrenched is the public's opposition that even the majority of Telstra shareholders are opposed to the further privatisation of Telstra.
Given the unpopularity, our politicians have simply removed the word; they have scrubbed out 'privatisation' and replaced it with a new descriptor called 'partnership', and continued to advance their privatisation policies under this new banner. We will come to the new banner, and then to some of the issues that arise under the new policies. But first, let me quote from a speech made by the Australian Auditor-General in April, which goes to the most general concern about the cheap assurances the State governments are issuing about so-called 'core' services and the continuing privatisation of the nation's public sector:
Outsourcing and privatising areas traditionally considered public sector activities indicates that the size of the core is shrinking. A broader issue is whether, over the longer term, the public sector might diminish to a point at which it no longer constitutes a credible, effective or viable arm of sound governance.
This brings us to the second running joke in these policies, which is the insistence that they are not promoting privatisation, but 'partnerships'. Now we all know what partnerships are. We have tennis partners, marriage partners, bridge partners, business partners and so on, and in every case -- in all conventional contexts -- if the term is to have a distinct meaning, 'partnership' must carry connotations of equality, with both parties working toward a joint goal.
The truth is that almost nothing in these latest privatisation policies can be fairly described as providing for the formation of partnerships, apart from the frequent rhetorical assertions that the policies do have this aim. On the contrary, almost all the detail of the policies testifies to the fact that they primarily aim to establish long-term commercial contracts, provided these represent so-called 'value for money'. This is made unequivocal by the universal stipulation that private firms will only be contracted to supply specified 'outputs'. This automatically necessarily means that the governments will remain solely responsible for the 'outcomes' from the deals. The inescapable conclusion is that the policies thus provide for the establishment of asymmetric business relationships; relationships so starkly asymmetric that they cannot be defined as 'partnerships'. In fact, the policies amount to nothing more than conventional principal-agent contract relations, and principal-agent contract relationships are not, and cannot in any reasonable sense, be described as 'partnerships'.
Thus, it seems obvious that the role of the 'partnership' rhetoric is simply to hide the unpopularity of privatisation behind a term that implies equality, and therefore evokes a friendly glow. There are dangers in this policy marketing rhetoric that go beyond just fooling poor old dumb Joe Public. The danger is that the terminology will also fool the governments themselves. The risk is that the positive connotations of equality and joint goals that are associated with the rhetoric of partnership will confuse and tend to disarm the governments and their officials. There are places for genuine partnerships with government. But falsely characterising garden variety principal-agent contracts as partnerships only encourages institutional capture, allowing select private firms privileged access to market and political intelligence and generally interfering with the necessarily hard-headed and unprejudiced evaluation of whether or not the proposed privatisations are socially beneficial.
Costs and Benefits
Given that in discussing PPPs we are actually talking about various forms of privatisation, what can we say about the costs and benefits? Let's leave aside the actual open-ended character of the polices, and assume for the moment that we are just talking about the present agenda to privatise schools and hospitals. The first thing to say is that it is mistaken to think that private provision will bring additional funding for these facilities. On the contrary, privatisation is merely a more expensive alternative to funding the infrastructure through public borrowing in the traditional way.
There is some inescapable arithmetic here. Irrespective of whether the infrastructure continues to be collectively funded through the public sector, or is funded by select private firms, there is no doubt about where most of the money will come from: it will be borrowed from the managers of the nation's swelling superannuation funds. The inescapable arithmetic is that the funds will lend money to the government by purchasing bonds for a return of less than 4 per cent, whereas they demand an additional risk premium of 6-8 per cent from consortia that offer private infrastructure bonds.
Moreover, with private firms, someone must also fund the additional cost of raising the capital, involving the structuring of the projects, undertaking risk evaluation, carrying out debt and equity placement, and so on, which is usually 3 to 4 per cent of the total cost. Further, although this is rarely mentioned, we must remember that additional costs also arise because, unlike State governments, private firms must pay tax. While quasi-taxes or tax equivalents may theoretically be applied to the 'public sector comparator' (in the name of 'competitive neutrality' - yes, the national competition policy lurks behind PPPs), this does not remove the private tax disadvantage; it merely transfers its manifestation from the comparator to the Treasuries.
The inescapable arithmetic therefore is that the cost to the public of capital under privatisation is at least double the cost of raising the funds directly through the public sector in the traditional way: instead of the government rate of less than 4 per cent interest on the capital; private consortia must receive between 9 and 16 per cent. In turn, this means that the only way that PPPs can be profitable to private firms is if the service quality is dramatically reduced, the taxpayer gets severely gouged, or large-scale efficiency gains can be found.
It beggars belief to imagine that large-scale efficiencies can be found by privatising social infrastructure such as schools and hospitals. The most likely prospect is that the services will decline. In the UK, where private financing has been operating for some years now, the diversion of funds to cover the additional costs for private hospital development has led to a 30 per cent reduction in bed capacity and a 20 per cent reduction in hospital staff. An extensive study of the record was also undertaken last year by Tony Blair's favourite think-tank, the Institute of Public Policy Research. Although heavily criticised for being a deeply interested attempt to 'talk out' the policy's opponents, the report nevertheless found that the British results showed no significant efficiency gains in hospitals and schools.
This stands to reason, for it has long been recognised that the major opportunity for capturing efficiencies in this area is in the construction phase, which is already conventionally put out to private tender. Conceivably, there may also be some gains to be made by tendering for maintenance, or bundling the maintenance task with the construction tender, although these gains are only likely to be small and they are, in any event, hotly contested in the literature. Regardless, there is no need to flog private ownership rights or long-term private franchises for schools and hospitals in order to capture these gains.
So how do the policies justify the additional costs? The magic pudding that bridges the cost gap is referred to as 'risk allocation'. We don't really have the space to delve into the infinite complexities of risk allocation, but let me make some quick points.
Firstly, the idea that substantive risk transfer occurs in these deals is another PPP joke. As mentioned, construction risks, the major risks in physical infrastructure, have already been privatised. And as has also been mentioned, the policies explicitly stipulate that the governments will remain fully and solely responsible for the outcomes in all the privatised policy areas, with the private firms only being responsible for so-called 'outputs'. In other words, if the privatisation of schools and hospitals has adverse impacts on education and health, the governments will continue to carry the can.
And the major risk that all normal private firms face, the risk that actually gives an authentic meaning to the notion of private enterprise, is non-existent in these cases. This is, of course, the risk that there will not be sufficient demand for a firm's product, or that it will be undercut by competition. In the case of PPPs, this risk will be completely born by the governments, since they have all undertaken to guarantee demand for 25-30 years. It is this remarkable government guarantee that underwrites all PPP policies. This is the river of gold for which the private consortia are bidding. Note the contrast between the extraordinary 25-30 year public income security that is to be granted to the new owners under the privatisations and the receding security it entails for Australian workers? From this perspective, we can say not only that PPP policies are about privatisation; we can also see that, in the most vital sense, they are not about private enterprise.
If none of the major risks are transferred under the policy, how can risk be used to justify the policy? The answer is that the State governments have adopted an idiosyncratic definition of risk. Ever since Frank Knight (1921), conventional economic literature has defined risk as an actuarial concept, applying to randomness that may affect returns that can be specified in terms of specific insurable numerical possibilities (as with the likelihood or rain, or lottery tickets). Beyond, this strict definition, the probability of random occurrences affecting returns is a matter of subjective belief, or the concept shades into the broader concept of 'uncertainty'.
The widespread use of subjective risk assessment, defined in a way as to include any and all possible imaginable uncertainties, is cause for serious public suspicion. A major study of risk allocation in the UK, for example, found that risk transfer was the critical element in proving the 'value for money' case for privatising public hospitals. For the six hospitals subjected to the study, the value of the allocated risk varied by between an extraordinary 17.4 and 50.4 per cent of total capital costs, yet, as it happened, in each case this just amounted to a cost that was sufficient to close the gap between private and public options, often favouring the private proposal by less than only 0.1 per cent. Since there is no standard method of measuring the values of non-calculable risk, and the UK government has not published the methods it uses to arrive at its figures, the study concluded that the 'value for money analysis seems to be no more than a mechanism that has been created to make the case for using private finance'.
The final point on the costs and benefits of the policies is that we should appreciate that PPPs also create new and potentially very costly risks. Given that the policies cannot, and explicitly do not, transfer the residual risks to the private firms, this means that the governments are automatically exposed to moral hazard -- or the practice of regulatory gaming in order to shift any unspecified or unanticipated costs back onto the public.
Opportunities to exploit moral hazard are encouraged by the unavoidable and therefore inevitable reduction in public accountability that comes with the attribution of private rights in public infrastructure. This follows by definition, since the public monitoring of private performance, including 'step in rights', can only ever amount to partial supervision; that is, if monitoring is not less than partial, than the government would effectively still remain the manager, or a shadow manager, of the infrastructure -- a costly duplication that would, of course, completely destroy any possibility of efficiency gains. The incentives thus encourage partial monitoring. And to the extent that monitoring is partial, private firms capture opportunities to exploit the government's continuing responsibility for the actual policy outcomes.
Aside from the risks that come with moral hazard, the arrangements also create new technical risks. Anyone who has read my book on the failures in the Sydney and Adelaide water infrastructure, or who has been following the corporate crisis in US, will know that there are many ways in which firms can increase their earnings without enhancing productivity by exposing the public to additional risks. Many of the technical and accounting risks that comprise the actors in Water's Fall are applicable within privatised public schools and hospitals, where we can also find other specific risks.
In hospitals, for example, the current proposals will divide the ownership and control of the buildings from the clinical services, yet there is an obvious relationship between the two, since the level of building hygiene is a direct cause of hospital-acquired infections. This introduces a direct conflict. It will be in the new operators' interest to minimise expenditures in all areas, but it is in the public interest for investment levels to be technically optimised. Assuming the private operators are risk-neutral rational-maximisers, as PPP policies themselves generally do, at the least, this ensures service losses at the margin. In the UK other risks have also emerged. At the privately financed Darent Valley Hospital in Dartford and Gravesham, nurses have complained that the design was not conducive to effective care, and equipment was not working properly when the hospital first opened. At the new Princess Margaret Hospital in Swindon, the recovery room is located 80 metres from the operating theatre.
Similar risks will be opened up in schools. In the UK, where the Blair government is openly subsidising school privatisation, last month one school discovered that, at the urging of the UK Treasury and education department, its new 25-year contract didn't include the cost of 'furniture and equipment', 'access for wheelchair users', or 'cabling and IT provision'. Nor was provision made for the costs of emptying the classrooms, storing equipment, or replacing it after refurbishment. Other hidden additional costs have also been discovered in the UK's schools. For example, the classroom size set out in the contracts is now too small for the curriculum needs in at least three schools.
The necessary variations that must be made to the original UK contracts will now add substantial new costs on to the schools, which reminds us that among the real risks created by the polices here are those which are presently unforeseeable, since they relate to the continuing development of educational and health standards. Remembering that the policies involve 25 to 30 year contracts, we must also remember that, as standards change which require changing building space or servicing requirements, governments will have to deal with today's competitive private provider, who by virtue of the contract will have automatically become tomorrow's private monopoly exploiter.
Why have governments gone this way?
If all of this is true, if the policy is nothing but virtually open slather for privatisation, which is deeply unpopular within the community, more costly, leaves all the substantial and residual risks with the governments, and creates new risks, we are left with one question, which is why on earth have the State Labor governments gone this way?
There appear to be two interlocking reasons. The first is simply the opportunity PPPs present to exploit an accounting quirk, whereby the liabilities incurred are entered into the public accounts as expenses rather than debt. Here it is important to appreciate that all the fiscal characteristics of the PPPs are exactly the same as public debt, except these funds are more expensive and less flexible. While strictly this means that they increase the exposure of the governments to financial risk compared with debt, they are not accounted for in the same way and therefore do not incur the same scrutiny or criticism.
The contemporary refusal of the States to maintain let alone increase public borrowing has thus opened up the way for PPPs. Let me stress that the present zero public debt policies are driven by nothing but pure populism, or economic irrationalism. There is no reputable rationale in any economic theory for our State governments not to borrow. Australia's public-debt to GDP ratio is ridiculously low, at 6 per cent compared to an OECD average of 40 per cent. There is no microeconomic or macroeconomic justification for eliminating this remaining skerrick of debt. Leaving aside empty populist blather about mortgages, bankcards and baby boomers, the common justification that gets trotted out by grown-ups in this area is that public borrowing 'crowds out' more valuable private borrowing by raising interest rates. This is an entirely irrelevant consideration in this case, and it is theoretically wrong in any event.
As John Quiggin has pointed out, the macroeconomic effects of infrastructure investment will be exactly the same whether the investment is made collectively through the public sector or by select private firms. This is to say, whoever does the borrowing, the effects on firms outside the infrastructure sector will be identical. And as Kenneth Davidson has recently reminded us, in any event public borrowing levels do not determine Australia's interest rates. Rather, in globalised financial markets, interest is determined in relation to the world rate, with adjustments for inflation and currency risks. This is an easy point to demonstrate. While Australia has one of the world's lowest levels of public debt, our interest rates are among the world's highest. By contrast, Japan has the world's lowest interest rate, yet at 135 per cent of GDP has one of largest public debts. Likewise, the US has lower interest rates, but carries three times the level of public debt. Plainly, there is no straightforward relationship between public debt and interest rates.
Thus, the only available conclusion is that, effectively, our States have become imprisoned within their own populist anti-public debt rhetoric. Under the present circumstances, where pressure for public infrastructure investment is intense, PPPs are attractive because they offer the governments a way to take on debt-equivalent obligations, while avoiding the appearance of having done so.
This motivation dovetails with second reason why the States have gone this way, which is that the policies are simply a consequence of the direct political pressure from vested financial interests on the current Labor premiers. PPPs are attractive to the politicians as a way of pacifying or buying off the local lobbies, which, of course, are simply seeking secure public rents. Labor Premiers always seem to be vulnerable to these kinds of pressures from the so-called 'big end of town'. This stems from the somewhat absurd but nevertheless lingering idea that Labor is somehow anti-business, or a poorer economic manager than the conservative parties. Labor governments always dread local business charges that lead to headlines like 'the go-slow state', the 'shut-down state', and so on, and hence they are always keen to prove their business credentials.
All this is to say that, as far as can be divined, the policies have not been driven by the State Treasuries. This follows because PPPs deeply offend one of the most basic of Treasury operating principles: the law against hypothecation. All Treasuries hate hypothecation, or the ring-fencing of parts of the annual budget to particular areas. There are two levels of objection. The first and milder objection is to using hypothecation to raise additional money. This is bad, but not so very bad as the second objection, which is to hypothecate existing moneys.
It is not difficult to understand the Treasury objections. The more of a budget that gets immunised from annual management, the less room they have to move and the harder their annual budget task becomes. The more that certain areas are walled off from discretion, the less room they have to adjust for annual variations, and - by definition - the more that the pressure will fall on the remaining parts of the budget. This is an important point to appreciate, and is not well understood in the general community. To restate, the more public money that is hypothecated (tied) to the operation of physical infrastructure, the more that pressure will be automatically placed on the funds that are provided for the remaining services. And when we come to PPPs, we are talking hypothecation big time, since we are talking about hypothecating funds for the operation of the infrastructure for periods of up to 30 years. The value of the fixed-capital stock in NSW schools alone is some $17 billion. By definition, the continuing hypothecation of budget funds to pay expensive rents to private firms for this infrastructure must continuously mount the pressure on the remaining service areas. In this sense, PPPs are analogous to those smart bombs that preserve buildings but kill people.
So if we can assume that the professional Treasury officials are opposed, or at least policy neutral, we must look to the political pressure that has been placed on the premiers by the business lobbies for the second part of the policy rationale. And of course there are no mysteries about why lobbyists are pushing so hard for the policies. Private consortia will always seek to purchase the benefit of a very secure income stream, with risk characteristics similar to a government security, but higher returns. And who can blame business for chasing the security of government contracts, as they always have?
For business, PPPs amount to a form of corporate welfare, which brings us to my final point, which is to recall, as one of my economist colleagues has recently reminded me, that the ideology of private enterprise originated specifically in opposition to governments allocating private monopolies. This historical perspective lends a sense of perspective to the objections to PPPs raised in this paper, which are scarcely radical. To insist that private firms should stick to private enterprise is to insist on nothing more than a policy that has historically been most strongly advocated by Adam Smith. In The Wealth of Nations, Smith explains why governments, as masters, cannot turn over exclusive responsibilities to private commercial servants:
The real interests of their masters ... is the same as the country... But the real interests of the servants is by no means the same with that of the country, and the most perfect information would not necessarily put an end to their oppressions ... Such exclusive companies, therefore, are nuisances in every respect ...
This paper was presented at an Evatt Foundation Seminar on 16 August 2002
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