Why Sydney’s global infrastructure hub should be wary of PPPs

A global infrastructure shortfall looms - but governments need to carefully assess the merits of private capital. Flickr/Trey Ratcliff, CC BY

While in Davos representing Australia at the World Economic Forum, Assistant Treasurer Josh Frydenberg has enthusiastically extolled the virtues of the Global Infrastructure Hub as a way of funding an infrastructure shortfall, particularly in developed nations.

Frydenberg told the ABC:

“There is a great deal of interest here at Davos in what Australia is doing because essentially this infrastructure hub is a knowledge sharing platform. It is about sharing best practice across the funding of infrastructure, the construction of infrastructure and the prioritising of infrastructure. It is estimated there is a $50 trillion deficit in infrastructure over the next decade and Australia had a real strength in this area.

In Brisbane last November, G20 countries endorsed the idea of the establishing the hub and agreed to establish it in Sydney to harness perceived Australian expertise, especially in Public Private Partnerships (PPPs).

I am not ideologically for or against PPPs and can see the case for them every time I visit a developing country to give governance advice and walk through a brand new terminal that cannot be the most important priority for limited government capital in poor cash-strapped states. But I am arithmetically opposed to PPPs which do not add up, cautious about self-interested spruiking, almost as leary of private monopolies as Adam Smith and concerned about the governance issues associated with PPPs.

Australia’s experience

Australia does have experience of PPPs from which the world can and should learn. But we may offer as many lessons in what not to do as what should be done. Brisbane is the city of bankrupt PPP tunnels and Sydney is the place where huge fees were generated even in projects that spectacularly failed or succeeded by extracting monopoly rents from privatised monopolies.

Melbourne’s Citylink innovated by including agreements to restrict competing routes (for instance, reducing the lanes on busy arterial Toorak Road and banning a Tullamarine rail-link) - measures that profit the contractor but limit the increase in total capacity by less than the capacity of the new road. When similar lane closing measures were included in Sydney’s cross city tunnel, the public outcry led to the cancellation of those measures. Sydney’s bankrupt Cross-City and Lane Cove tunnels were joined by two in Brisbane where "optimistic” traffic flow projections also led to bankruptcy (of the tunnel companies, not the scheme promoters).

For supporters of PPPs, this just showed that governments should take some of the core risks so that investors could enjoy more secure returns (suggested by experts at the B20 to be 7% real return). Accordingly, the new model has the government providing some of the funding and paying “availability fees” to the contractor.

An equally good example of value for money conundrum was the now-dumped East-West link in Melbourne. This involved government providing the bulk of the funding (A$4 billion), with the contractor providing A$2 billion, construction management and ongoing maintenance worth less than A$5 million per annum (based on a much larger contract for maintaining two bridges and 20km of motorway in Brisbane for 14.5 years cost $80 million).

At the end of the 25 years, the tunnel would have reverted to the government. This was, in essence, a very expensive hire purchase agreement. If the money had been borrowed at the Commonwealth’s 15 year bond rate Victoria could have paid for the maintenance and applied the rest of the A$340 million to paying off the loan in 13 years rather than 25 (leading to the state being better off by more than $4 billion).

To the extent that the undisclosed escalation clause increases the A$340 million, the disparities merely increase. The difference between the two represents the higher costs of borrowing by the contractor, the profit and the fees. Ironically, one of the problems with the East Link project was that it was hard to see value for money (VFM). If the government had chosen a less expensive means of funding, it might have come much closer to VFM standards.

Economics of PPPs

This raises a more general question about the economics of PPPs. Economist Nick Gruen demonstrated that “hard” infrastructure projects, such as roads and water projects are inherently more expensive as a result of higher interest rates, transaction costs and the need to make a profit. He estimated that, even after adjusting for risk, NSW is A$4.6 billion worse off for having chosen PPPs for some of its motorways.

Why should governments choose more expensive infrastructure? Expensive infrastructure is a problem for growth, not a solution. It raises the costs of other businesses and also raises the cost of capital for exporting and import competing businesses by providing such good returns on less risky investments. Business should be careful not to promote the interests of some businesses that would make money out of more expensive infrastructure for business in general.

The irony of arguments from the banking and finance sector that infrastructure should be funded from more expensive sources is that much of the extra expense is generated by the profits they demand and the fees they extract. Where a government ends up paying A$340 million per annum in “availability payments” instead of A$65 million in interest and maintenance - preventing the state paying down an extra A$4 billion debt - the argument is intellectually bankrupt.

Governance issues

The Global Integrity summit considered infrastructure governance issues in some detail. Here’s the World Bank’s Vice President in charge of integrity, Leonard McCarthy:

“At their best, PPPs can provide rapid injections of cash from private financiers, delivery of quality services, and overall cost-effectiveness the public sector can’t achieve on its own. But at their worst, PPPs can also drive up costs, under-deliver services, harm the public interest, and introduce new opportunities for fraud, collusion, and corruption.