State would do well to embrace PPPs

Comment: Public/private partnerships (PPPs) should not be dismissed as a remnant of Thatcherite dogma. The model has been taken up in Norway, Sweden, Denmark, the Netherlands, France, Germany and Canada - hardly bastions of right-wing orthodoxy. PPPs should also be embraced wholeheartedly in the Republic because they work.

PPPs are partnerships between the public and private sectors. The public sector contracts for a road, school or hospital and the private sector agrees to ensure it is available for service at an agreed price. While this may not seem like much, one need only consider the delays and cost overruns in infrastructure build to consider that a new way forward is warranted.

The State is by no means unique in struggling to provide infrastructure efficiently. Endemic cost overruns and long delays in public sector construction contracts provided Margaret Thatcher with the impetus to introduce PPPs in Britain.

Britain's National Audit Office report in 2003 showed how successfully PPPs can deliver better value for money. They reduced the percentage of projects delivered late to the public sector from 70 per cent to 22 per cent (with only 8 per cent more than two months late). PPPs also reduced the number of projects that ran over budget from 73 per cent to 24 per cent. Price increases in those cases were due to design changes requested by the public sector. This success can be repeated here.

PPPs work because they change the nature of the relationship between the contractor and the public sector client. Traditionally, the contractual relationship between public and private sectors was adversarial, with each side focused on protecting its legal position. Tightening specifications merely changed the focus from final outcome to how the job was done. Greater control did not incentivise speedy completion nor did it align the interests of contractor and public sector client in delivering the infrastructure.

PPPs, on the other hand, emphasise the common goal of timely asset completion and align the long-term interests of both parties on service delivery. This is done by a clear delineation of responsibilities and risk. The essence of PPPs is that the private sector takes on construction risk and is incentivised to increase returns through early delivery, efficient operation and design innovation.

Unfortunately, significant opposition to PPPs has emerged in some Government Departments. There appears to be a belief in these Departments that "design, build and operate" (as opposed to the normal PPP model of design, build, finance and operate) contracts will generate the same level of risk transfer without the need for private sector finance. Without the discipline and economic incentives of having the contractor's (and the bank's) money at risk, it is difficult to see how this works in theory let alone in practice.

The Minister for Finance, Mr McCreevy, at a recent PPP conference outlined his Department's proposal to use National Treasury Management Agency (NTMA) and National Pension Reserve Fund (NPRF) to replace bank lending. This proposal ignores the core rationale for PPPs - risk transfer. It puts the State back in the firing line for all risks and cost overruns.

Undoubtedly, private sector finance is more expensive than State funding. However, in exchange for a financing premium, the risk of failure is transferred to private sector construction companies, financiers and banks, all of whom have a long track record of successfully managing this risk. A rough calculation shows that the weighted average cost of capital for recent PPP pilot transactions is approximately 6.8 per cent - only 1.7 per cent greater than NTMA/NPRF financing on a similar basis. This is way short of the 15 per cent cost of capital touted in some recent speeches.

Eurostat has outlined a transparent basis for determining how PPPs are to be treated in Government accounts. Subject to two simple tests - which mean that the private sector must assume a significant portion of the "risk" - PPPs will be classified as "off balance sheet". This means that the cost of infrastructure can be spread over the life of the asset instead of being charged to the Government accounts in the year of construction.

The proposal to use the NTMA and the NPRF is likely to cause spending on infrastructure to be charged immediately to the Government accounts (unless real charges pay for at least 51 per cent of the costs). This means that Ireland could potentially breach the terms of the Stability and Growth Pact unless it holds down spending on infrastructure unnecessarily.

The Government proposal for a Critical Infrastructure Bill restores the balance between the common good and individual rights, and could remove planning delays for key infrastructure. This development to speed up infrastructure may well be undone by the proposal to use NTMA and the NPRF funding and the consequent effect on budgetary arithmetic.

The ESRI has calculated that the returns on infrastructure investment to the economy can be as high as 14 per cent per annum. Following the Eurostat ruling, the Government is in a position to increase its spending on infrastructure without any danger of infringing the 3 per cent deficit limit imposed by the stability pact. All that remains is for the Government to recognise this and put the financing where it belongs - with those who have a track record in delivering. If they do, projects are much more likely to be finished sooner and within budget.

Cormac O'Rourke is director, structured finance in Goodbody Stockbrokers. In his former banking career, he financed PPPs in the UK and Europe..