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The Magic of Public-Private Partnerships: Really?

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Last week I was visited by election campaigners who wanted to sell me on the merits of their party for the upcoming Victorian election. I may be strange, but I actually was happy to be visited by door-knockers so I could ask them some questions. The Victorian election has been fought on competing infrastructure projects but there didn’t seem to be clear details on how the projects would be funded. Being fiscally responsible, I wanted to know how these projects would be funded. So I asked the door-knockers the question. And the answer I got was: “through the magic of PPPs [public-private partnerships].”

I was quite frankly stunned that someone in our digital world still believes in magic! And in such a brutal arena as politics, it was great to see that innocence wasn’t dead. Then the implications hit me: what kind of magic are we talking about here? White or black magic? Then you get into finer categories such as illusionism, sorcery and necromancy. If it was necromancy, this would have major implications for workplace relations. Would the government use zombies to build the infrastructure? There will be huge cost savings from using the undead. But you need to feed zombies brains which may pose a public safety issue to live humans. Furthermore, the building unions probably wouldn’t be happy that their members’ jobs will be stolen by zombies. I can see why the issue of infrastructure financing is hard to explain to voters.

Unfortunately, I had something on the stove so I had to cut the chat short. Nevertheless, the answer has been eating away at me I had to investigate it. Much to my disappointment, very little has been written on the intersection of magic and PPPs. Even more tragic, nothing has been written about zombies and infrastructure financing. Instead, I found all these papers on the legal and financial issues of PPPs. Fortunately, I still found these interesting and I think they may have provided a better answer to my question on how these major infrastructure projects could be financed.

One paper I found very useful and accessible for non-lawyers and finance types is a paper written by the law firm, Clayton Utz. It provides a good explanation on how PPPs work. Essentially, a PPP is a contract between the government and the special purpose vehicle (SPV) responsible for building and managing the infrastructure. PPPs can be for government-funded or user-funded infrastructure. User funding can be raised through tolls or fees. PPPs indeed do have some magic-like properties in terms of being more likely to be completed on time and fewer delays. But this is explained by the clever structuring of incentives where debt financiers (i.e. banks) are involved to monitor the progress of the build because they have skin in the game. But this didn’t necessarily answer my question, how do PPPs help finance major infrastructure projects?

Not all PPPs magically produce funding for infrastructure. Government-funded PPPs are, as their name implies, are funded by tax-payer. User-funded PPPs on the other hand do not require tax-payer contributions. Instead users are charged for using the infrastructure. So, PPPs aren’t really that magical – you pay either way. So while the government may be able to shift the funding burden onto the private sector through a user-funded arrangement, there is nothing magical about how the money is raised to finance the project.

That isn’t to say that PPPs aren’t useful. They certainly provide a useful tool for governments, but only for specific circumstances. If the government are clear on the requirements of the infrastructure and the management services required, PPPs are great for creating a financing arrangement to ensure the delivery of this project. If a specific risk (e.g. demand risk) cannot be shifted to the private sector through other financing arrangements, PPPs may be your only option. Also, if the project is complex or unique, such as a tunnel under Sydney Harbour, PPPs may be a good option because it can allow for innovation by the designer and the builder. Finally, PPPs should only be used for major projects (i.e. at least $100 million) because of the high transaction costs involved.

So, while PPPs can help governments ‘magically’ overcome funding constraints by transferring the financing burden to the private sector, magic – or zombies – aren’t involved. Unfortunately, we will have to find magic in our lives some other ways.


2 Comments

  1. dixie65 says:

    Good one Barefoot. So those transaction costs: don’t they justify the government taking it on themselves and saving the transaction costs for…saving. There’s a couple of guys in the Age who always ‘bang on’ about the government’s lower borrowing costs. Is that a furphy or hard to explain to people cos they’re still adding to the government’s (DON’T SAY IT) debt (ouch).

    Cheers Simon

    • arthurchha says:

      Hi Simon, thanks for your comment. While PPPs may have higher transaction costs, these are associated with more rigorous due diligence by government and the bank. PPPs requires governments to be clear on what they want from the project so governments spend more time planning and defining the project. Also, banks are keen to make sure the project is technically and financially feasible so they also spend significant resources on monitoring the project. So these transaction costs actually help reduce the risk of cost blow-outs. Other forms of infrastructure funding don’t require such rigorous planning. But in theory, there is nothing stopping governments going through the same process. So, PPPs could actually turn out to be lower cost than traditional forms of infrastructure financing. So the transaction costs may actually be justified by reducing risk. The results quoted in the Clayton Utz paper certainly suggests that.

      As for borrowing costs and PPPs, it depends if the PPP is government- or user-funded. If government-funded, debt would probably be used to finance the project. Conversely, if user-funded, the users pay for it. A government’s borrowing costs depends on their credit rating, which in turn depends on their debt level and future fiscal situation. So, a PPP may help preserve a good credit rating if it is user-funded. But if a PPP is government-funded, a good credit rating may be under threat if the PPP requires taking on relatively high debt to revenue. So, it depends on how the PPP is funded that determines the impact on the government’s borrowing costs.

      I think it is clear that PPPs are definitely not a magic bullet for infrastructure financing. The taxpayers eventually end up paying for it. The only thing that changes is how the cost burden is spread through the community and over what time horizon.

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