P3s – Use with Extreme Caution
April 15, 2013 Leave a comment
In Canada federal, provincial and municipal governments are turning more and more to public-private partnerships (P3s) to fund major infrastructure projects. P3s are suddenly in vogue. But are they a good thing?
Prime Minister Stephen Harper certainly thinks so, and his government is aggressively promoting them. Under new budgetary regulations any project having a total capital cost of over $100 million must be structured as a P3 to receive funding under the federal Building Canada Fund. Many local officials see this restriction as coercive and unwarranted.
What is a Public-Private Partnership?
A P3 is defined as a “long-term contractual arrangement between the public and private sectors where mutual benefits are sought and where ultimately (a) the private sector provides management and operating services and/or (b) puts private finance at risk.” (Garvin and Bosso, 2008)
To date, nearly 200 public-private partnerships have been approved in Canada totaling tens of billions of dollars. (Click here for an interactive display of all the P3 projects across Canada.) Nearly half of these projects are in Ontario, followed by British Columbia and Québec.
They span the entire country from PEI’s Confederation Bridge to British Columbia’s Sea-to-Sky Highway. They include projects to build schools and prisons, hospitals and sports arenas, power plants and waste treatment facilities.
The federal government claims, “By partnering with the private sector to manage many of the risks associated with the construction, financing and operation of infrastructure projects, governments [federal, provincial and municipal] can build public infrastructure faster and at a lower cost to taxpayers.”
But is this really so?
The Hidden Costs of P3s
As the Globe and Mail reported last fall, in a study of 28 Ontario P3 projects, researchers found that “public-private partnerships cost an average of 16% more than conventional tendered contracts.” This is largely because private borrowers typically pay higher interests rates for their financing than do governments.
For example, in the construction of the Cobequid Pass in Nova Scotia, private financiers put up $66 million. The government of Nova Scotia is reimbursing them more that $300 million over 30 years, paying them an effective interest rate of 10%. This is more than twice what the government would have paid in borrowing costs if it had financed the project itself.
P3s entail complex arrangements between consortiums of partners that can be expensive to negotiate. The transaction costs for lawyers and consultants alone can add 3% to the final bill. The complex nature of these negotiations can add delays in construction and completion of the projects. Private shareholders also expect a good return on their investment. The contract they negotiate will seek to lock in profits to the consortium over the length of the contract. The final price charged to the governments will include these costs.
Governments nevertheless continue to farm out infrastructure projects to P3s for two main reasons. First, they will not have to shoulder the full cost up front. Instead they agree to reimburse the P3 consortium a fixed amount each year over the lifetime of the contract – usually between 25 and 40 years. Such an arrangement can be politically attractive. It looks better to show a more modest expenditure on the books each year over the lifetime of the project rather than to show a large debt on the ledger that is gradually being paid down. But often it means taxpayers are getting a bad deal over the long term.
Second, governments say they like P3s because it frees them from bearing the risks of construction delays, cost overruns, correction of design flaws and future fluctuating revenues. Under the terms of P3s these risks are all to be entirely borne by the private partner so they are priced into the contract. In the study of 28 Ontario P3 projects mentioned earlier, this risk premium averaged an astonishing 49%.
In every single project approved so far as a P3 in Ontario, the costs would have been lower through traditional procurement if they had not been inflated by these calculations of the value of “risk.”
Getting Good Value
And speaking of risk, is the government ever completely shielded from risk in working through a P3? The facts say otherwise.
Evidence shows that governments, workers, and the public are left on the hook for cost overruns, bankruptcy, incompetence, and inefficiency. When 180 million litres of sewage backed up into homes and businesses in Hamilton, Ontario, the government and the public paid the cost of the clean-up, not the private partner.
Governments cannot transfer the responsibility for the public interest. When a P3 fails, the government must step in to secure important outcomes such as patient care, clean water, sufficient electricity, and safe roads. Corporations can just walk away, and they do – leaving behind debt and dysfunctional services.
Many P3 contracts also include a provision that, after construction is completed, the consortium will have the exclusive right to operate the facility on a long-term contract. The government will pay for this service in fixed annual fees. However, the long-term nature of these contracts excludes competition, diminishes accountability, and provides an incentive for the private partners to maximize profits while minimizing expenditures.
The evidence shows that P3s not only cost the public more but also deliver poorer quality services overall. Often they cut corners, reduce maintenance, defer repairs, lower staff ratios, cut back on training, diminish oversight, and provide lower pay and benefits to staff.
The tainted water tragedy in Walkerton, Ontario, is a stark example of what can go wrong when public services are in private hands and high quality service is compromised for profit.
The government of Canada continues to claim, “P3s have demonstrated their ability to produce value for taxpayers in the delivery of public infrastructure.” And, by partnering with the private sector in these infrastructure projects, “governments can build public infrastructure faster and at a lower cost to taxpayers.”
Instead, the overwhelming evidence is that:
• Private financing is more costly and risky than public financing.
• The private sector is worse at managing risk than the public sector.
• Risks can never be completely transferred through P3s.
• Additional and complicated P3 requirements lengthen the process and add to delays.
Public-private partnerships may appear attractive. They should be used with extreme caution.