Children's hospital: A spectacular example of how things can go wrong

When the political cut and thrust over the spiralling children’s hospital cost ends lessons need to be learned.

Frustratingly, recent history shows Irish policy-makers are slow learners in this regard and there is little evidence past lessons from huge projects that ran over budget have been absorbed.

Cost control on large infrastructure projects in Ireland has been patchy at best and in a number of cases shockingly poor.

In this, Ireland is following the pattern of mistakes that bedevil most major state investment projects worldwide.

Cost overruns in children’s hospital damaged faith in Government, says Taoiseach

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Children’s hospital: The meetings, the memos and the Minister - who knew what when?

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Harris faces further questions on Children’s Hospital costs

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Harris says €1.4bn cost of children’s hospital ‘reasonable’

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But that is no excuse.

As we head into a major period of investment under the Government’s rebuilding plan, it is important Irish taxpayers receive value for money.

Here we examine what appears to have gone wrong with the children’s hospital project from an economic perspective, what this means for decision-makers when it comes to considering future projects, and what we can learn from international experience.

1. The initial underestimate

The key economic question is would the Government have decided to build the children’s hospital if the cost was €1.7 billion?

There is no question the hopsital is needed.

But would the Government have opted for a scaled-back model, or a different location, if it had known the true cost?

Minister for Health Simon Harris insists the hospital remains value for money.

But we have no public cost benefit study to support this value for money view and a huge hole in the ground and a political commitment to the project means there is no going back.

The scale of the cost increase has been remarkable. Following the abandonment of the original plan to build beside the Mater hospital - due to planning problems - at an estimated cost of €410 million, a subsequent plan from the St James’s Group estimated a €484 million cost for a new children’s hospital, including construction costs of €400 million.

This cost has since risen exponentially; to €636 million at the time of the final tender in 2017, to €983 million by April 2017, with construction costs then rising to €1.433 billion by last December.

The 'iron law' of public megaprojects is they are 'over budget, over time, over and over again'

Once in fit-out and other costs are added in the running total is now over €1.7 billion and there are fears the final bill could hit €2 billion.

However, massive overspending on big projects is not unusual internationally. Ireland also has form in this regard where the Luas, the early days of the road programme, the maternity and children’s hospitals and the likely final cost of the National Broadband Plan all saw overruns.

Nine out of 10 public major projects internationally have cost overruns, according to Bent Flyvbjerg, a professor at Oxford University who has researched "mega projects," the biggest investments often undertaken by governments.

Even allowing for inflation, overruns of 50 per cent are common, he found, and in many cases are higher.

He points to the Channel Tunnel where there was a cost overrun of 80 per cent.

In a paper on this subject he said the “iron law” of public megaprojects is they are “over budget, over time, over and over again.”

If people knew the likely final costs of projects, many would never get approval, according to Flyvbjerg.

But political considerations and a desire to do something “unique” lead time and again, for the cost at an early stage to be underestimated, to overestimate the benefits followed by a subsequent determination to keep going despite rising costs.

Flyvbjerg quotes a former mayor of San Francisco, talking about persistent overspending on major transport projects, saying “the idea is to get going. Start digging a hole and make it so big there’s no alternative to coming up with the money to fill it in.”

We are now at the “big hole” stage with the children’s hospital and PWC has been asked to examine how we got here.

There was a competition between sites to get the project and then between construction firms to build it. In both cases price was the key – though not the only – factor. Now we have a project where the final cost bares no relation to the basis on which these decisions were made.

So one of the key issues for the PWC review of the children’s hospital project cost will be how the initial estimates were developed.

2. The 'break-fix' moment of truth

For most mega projects the day of reckoning – a realisation of the full, eye watering cost – eventually arrives.

Typically this forces a decision when things have to be sorted, in terms of project design, financing and so on – what Flyvbjerg calls the “break-fix” moment.

“The fix often takes place at great and unexpected cost to those stakeholders who were not in the know of what was going on and were unable or lacked the foresight to pull out before the break,” Flyvbjerg says.

The economic problem is not just the immediate need for a huge amount of extra cash but also because it makes it impossible to know if the State’s limited resources are being allocated in the best way.

The initial decision, including any analysis of costs and benefits and a decision to proceed was based on a completely different, lower figure.

Once cost spiral opportunity cost comes into play: what projects will not now proceed due to the overrun? An extra €400 million on the children’s hospital means something else will not now be built, or will be delayed.

While “benefits” from a new children’s hospital are difficult to measure – as they are gains to wider society, rather than economic figures – there still has to be a basis to make the decision.

And projects can still make sense despite larger overruns.

Studies have suggested a significant payback on Ireland’s roads programme, for example, despite early overruns.

But proper ordering and assessment of infrastructure projects is impossible if the initial cost assessments are hopelessly incorrect.

In the context of Ireland’s infrastructure plan until 2040, to which around €116 billion has been committed, these initial estimates simply have to improve.

3. The questions

PWC will examine why the costs of the project have increased so dramatically. We already have some outline indications from Oireachtas committee hearings and memos published in the last few days,with increases identified in the cost of building, IT provision, fire safety and clear problem that while the price of materials was set at 2016 levels, the estimate then of the quantities required was way out.

Me Harris told a recent Oireachtas committee: “The cost of a widget is still at 2016, but they need a hell of a lot more widgets.” This was one reason why the price that fed into the initial contract after the tendering process was way too low.

A key job for PWC will be to look forensically at the reasons why this happened.

How much of the cost overrun is due to inflation? How much was due to the initial numbers being incorrect?

And what evidence is there of mismanagement of cost control?

A key point will be to examine events in the run up to the August 2018 memos estimating a €190 million overrun and a further €200 million claim from contractors BAM.

While the BAM figure was subsequently significantly pared back, the total overrun soon soared to €450 million.

How this happened needs to be explained.

On a wider level, despite three separate boards overseeing the project there are questions about the cost control and project processes and how the two-stage tender process was managed.

There has to be an objective of good value for money, rather than low price, and a means of comeback for defects

Flyvbjerg identifies typical problems as being an inefficient decision-making process, a drive to develop something “unique”, an over-commitment to a certain route from too early a stage, without proper analysis and a lack of experience among those planning the project.

4. Wider issues

With the State embarking on huge capital spending under the Project Ireland 2040 programme the children’s hospital is just the latest in the list of projects with costs problems over recent years. When these are examined some trends emerge.

One is delay. Planning,the legal system, bureaucracy and other factors mean projects are subject to seemingly endless hold-ups – just look at the National Broadband Plan, where a contract had still to be signed, or the two big hospital projects, the maternity and children's hospitals.

The specific problem here is that building these projects during the downturn, or even as we emerged from it, would have been much cheaper, even if exchequer cash shortages would have been a restraint.

Now wages and costs are much higher as the economy reaches full capacity. New fast-track planning processes are designed to speed new projects now, but many are still subject to legal hold-ups.

Then are also clearly issues with the State procurement process. Orla Hegarty of the UCD School of Architecture points out there have been three major construction procurement failures in the news in the last year – the other two being the Carillion collapse in the UK which caused problems for school projects it was involved with here and the structural and fire-safety problems in the rapid school-building programme.

“These points to wider issues in procurement policy, which is also very relevant to the housing programme and other capital projects,” she says. Central to procurement is balancing the money available and the project requirements and against prices in the market and quality control – and managing the various risks.

“There has to be an objective of good value for money, rather than low price, and a means of comeback for defects,” according to Hegarty.

“Ultimately, all risk comes back to the State if something goes wrong, so robust controls and means of intervention are needed in government departments and state agencies.”

Finally there are issues for the State control of major projects. That the 2019 Budget was completed without factoring in the children's hospital overrun, when senior officials were aware of it and Harris knew of a problem, raises serious questions about the process of control – or lack of it – for big projects and how public money is allocated.

IMF found Ireland has substantial scope for better policies including choice of projects, appraisal and management

What happened left the Government with a gun to its head over a €450 million plus overrun, approving the continuation of a project on a completely different basis that originally envisaged.

It was, effectively, flying blind in terms of the rationale for its decision.

In a study completed by the IMF for the Department of Public Expenditure and Reform in late 2017, the international body recommended a range of changes in the way investment projects here are managed.

It says Ireland manages infrastructure “relatively well” but that measured against best practice internationally there was an “efficiency gap” of 23 per cent, or 58 per cent when judged against advanced economies.

Ireland is a relatively high-cost economy, with rising wage costs, with high land costs

While Ireland was not too far out of line with the EU average, the IMF found “substantial scope” for better policies, covering, in particular, the choice of projects, their appraisal and managing them through the budgeting process to ensure that proper decisions are made based on accurate information.

The cost of failure in these – and other – areas are clearly evident in the children’s hospital project.

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The bottom line is Ireland is not alone in struggling with the management of major projects.

The children’s hospital is a spectacular example of how things can go wrong and the Government left with an impossible choice.

It raises worrying questions about the State’s competency to manage such projects as we face committing vast sums of public money on broadband and the new MetroLink and on public housing.

The economic background is Ireland being a relatively high-cost economy, with rising wage costs, with high land costs and a coterie of legal and professional services firms who typically charge large sums for their input.

Ireland badly needs infrastructure development and building at scale when the economy is growing means developments will not be cheap.

So the Government must ensure its capital spending is efficient and also show that it has learned from past mistakes.