Public Private Partnerships

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1 Revisiting the State and the Market The New Zealand Governance Centre The University of Auckland Friday 28 th October 2011 Public Private Partnerships Michael Regan Professor of Infrastructure Institute of Sustainable Development & Architecture Bond University, Gold Coast, Australia

2 Public Private Partnerships In the mid 1990s, traditional procurement methods were under review in the United Kingdom and Australia. The problems identified in a succession of public inquiries included: Low productivity, underinvestment in technology, innovation and training Late delivery, cost overruns Poor agency-contractor relations Inefficient, adversarial supply chains (Latham 1994; Levene 1995; Egan 1998; NAO 2001; Mott McDonald 2002) 2

3 A major reform agenda was implemented (OGC 2000, NAO 2003, 2004). The UK policy response was built on: Adoption of non-adversarial contracting principles (improved communications) Risk weighting to correct optimism bias Lifecycle costing Integration of design and construction services Introduction of the Gateway system of public procurement. 3

4 A more formal response occurred in 2001 with introduction of the UK Private Finance Initiative policy which included PPP procurement models. In Australia, the Government of Victoria introduced an Infrastructure Investment Policy in 1994 with the object of attracting private investment and management of infrastructure services. In 2001, the Gateway and Partnerships Victoria programs were introduced, setting a best practice standard for PPPs worldwide. 4

5 Public Procurement Reforms Microeconomic Reform Introduction of Gateway Programs IC-PC 1991 Aust Govt RC 2001 Introduction UK PPP Program Improvements in the science of public procurement Latham 1994 Levene 1995 Egan 1998 PPP Policies, Victoria, NSW IA Privatisation, Outsourcing & BOT methods Alliance Contracting Productivity Increased Inflation Declined Reduction in Public Debt, Fiscal Sustainability Full employment 5

6 The principle of private financing and management of economic infrastructure is not new. Ancient Greece, Rome in the time of Augustus, The East India Company, the industrial revolution in Britain and France in the 1930s provide examples of state outsourcing essential services to the private sector. Historically, the size of government was small compared to the statism the occurred in the post-world War II years. 6

7 1325 STATE EXPENDITURE AS GDP % Industrialised Countries Country Highest Current Country Highest Current Rate % Rate % a b a b Australia 40.2 (1985) 36.3 Luxembourg 51.9 (1981) 45.6 Austria 57.4 (1993) 50.4 Netherlands 58.3 (1983) 47.1 Belgium 63.8 (1983) 50.2 New Zealand 56.5 (1985) 38.6 Canada 52.6 (1992) 39.7 Portugal 46.5 (2004) 46.5 Denmark 61.3 (1993) 55.1 Spain 47.6 (1993) 39.0 Finland 64.8 (1993) 51.5 Sweden 73.0 (1993) 57.1 France 55.4 (1996) 54.0 Switzerland 34.8 (1998) 34.3 Germany 50.2 (1996) 47.5 UK 50.7 (1981) 44.1 Greece 52.0 (2000) 49.9 US 37.2 (1992) 34.3 Ireland 56.2 (1982) 34.0 Average Italy 57.7 (1993) 48.6 Euro Zone Japan 41.0 (1998) 38.6 Non-Euro OECD SOURCE Hauptmeier, Heipertz & Schuknecht 2007 NOTES a Year in parenthises; b

8 Today, State Interventions in the Market Economy 2011 UK US Spain Sth Korea Greece Germany France Denmark Canada Belgium Austria Australia Tax Burden GDP % Govt Expen. GDP % Employ't. Labour % Source: OECD 2011, Heritage Foundation

9 Why are western nations adopting policies to facilitate private provision of infrastructure services today? 1. Fiscal policy constraints 2. Innovation and new technology (the capital productivity challenge 3. Incentives matter with incomplete contracts 4. Greater science and certainty 5. to improve delivery performance. 9

10 What is a Public Private Partnership? A contract between the public and private sectors for the provision of goods and services to, or on behalf of, government. Characteristics: An output specification Long-term and privately financed Transfer of life cycle operational risk to contractor. 10

11 Projects are required to meet the gateway process for selection, analysis and appraisal (including preparation of a full business case). Bidders are selected against a public benchmark (public sector comparator or PSC) representing the most efficient risk-weighted agency procurement model The evaluation criteria employs quantitative and qualitative outcomes (value for money). 11

12 SIMPLE PUBLIC PRIVATE PARTNERSHIP MODEL THE STATE BUILDER FACILITY MANAGER EQUITY INVESTOR SERVICE PROVIDER PRIVATE CONSORTIUM Provision of user pays quasipublic good Franchise Regulation State pays for the provision of a public good on its behalf FINANCIER OR SYNDICATE OF LENDERS FINANCIAL INTERMEDIARY OR UNDERWRITER CONSUMERS CREDIT RATING AGENCY

13 PPPs are outsourcing contracts not privatisations. Assets and service delivery obligations return to the state at the end of the contract term. 13

14 PPPs account for around 10% of public capital procurement in Victoria, <5% nationally. Application limited to those projects that are best suited to PPP procurement That meet the value for money criteria To bring forward otherwise future state projects (RCH and Desalination in Victoria; Royal Adelaide Hospital in Sth. Australia). 14

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16 In a theoretical sense, PPPs challenge fundamental principles underpinning traditional state practices: The key role of incentives (agency and transaction cost theory) The science of lifecycle costing Adversarial v. collaborative contractual principles Recognition of ownership (control of outcomes) Incomplete contracts (& relationship between ex ante and ex post performance aspects of infrastructure projects) Responsive regulation & relationship management (Regan 2011a, 2011b). 16

17 TRADITIONAL CONTRACT OUTSOURCING/BOT PPP ALLIANCE Lowest asset price Lower lifecycle Value for money Optimal service cost Rigorous process procurement Control and Risk transfer Full risk transfer reponsibility & control & control retained by agency + + Lifecycle costing Lifecycle costing Aligned incentive Aligned incentive framework framework + + Regulation Relationship Joint management management and control + Service outcomes 2676b 17

18 Why do we need alternative procurement methods? 1. To introduce innovation and technology 2. Qualitative improvement in services 3. To correct systemic failures in public procurement: Home roof insulation program National broadband network The BER schools project Defence contracts (domestic and foreign). 18

19 1643 SURVEY OF PROCUREMENT OUTCOMES a On Budget On Time User Benefits b Traditional Procurement e 25% 34% 27% d 27% 30% 35% f 55% 63% 55% Gateway Programs d 69% 73% 65% Alliance Contracting e 77% 78% Refer notes PFI (UK) f 78% 76% n.a. PPP (Australia) g 79% 82% 74% UK Defence Contracts h 17% (14%) 8% (24%) Met requirements SOURCE MR 2008 NOTES a Sources as noted. Sample sizes vary. Parenthesis denotes average overruns for sample b Qualitative assessment from independent NAO 2004, 2006 reports. Defect reporting. d results: NAO 2001 Moderninsing Construction. Delivered on or under time and price. e 1999 results: NAO 2005 Improving Services Through Construction Part B f 2004 results: NAO 2005 Improving Services Through Construction Part A g Fitzgerald 2005; Audit Office Reports Victoria & NSW ; IPA 2007 h NAO 2004, 2006 MOD Defence Contracts 19

20 Bond-Aalto Procurement Review A review of the characteristics of major project procurement methods: Traditional procurement Relationship contracting PPPs Outsourcing BOOTs In-house provision. 20

21 Procurement Evaluation Criteria 1660d VfM Scope for innovation Process cost Lifecycle costing Delivery to expectation Marginal utility of investment Sustainability values Integrate design & construct Gateway PM process Project lead time Minimum project size 21

22 Elements of Procurement Evaluation PPPs BOOT Outsourcing Alliances Traditional In-House Form of 0specification20 40Process cost Risk 100transfer Lifecycle costing Marginal utility of investment Innovation & technology NPV investment Gateway PM process Project lead time Minimum project size Integrate design & construct Relationship status Sustainability values 22

23 Procurement Comparison PPPs BOOT Outsourcing Alliances Traditional In-House Performance Measure Non- Weighted Non- Weighted 23

24 The evidence suggests that project procurement involving private sector participation for lifecycle operation, extensive risk transfer and an output specification is the most effective form of procurement (PPPs, BOOTs and outsourcing) Incentives for long-term contractual performance and maintaining a high marginal return on investment is central to sustainable improvement in infrastructure service delivery. 24

25 Input Specification Output Specification Value for Money Inhouse Optimal risk transfer & private capital incentives Traditional Procurement Alliance Contracting Outsourcing BOO, BOT, BOOT Public Private Partnerships Risk Transfer 30 25

26 Criticisms of PPPs Lower cost of state debt Government best provider of public goods Disclosure and transparency Long lead time, high transaction costs Public sector comparator inadequate High failure rate... 26

27 Failure Rate In Australia, 59 PPPs transacted (including 3 BOT) Failure rate around 12% Administration and resale 2 (cum. <10%) Resumption with compensation 2 Resumption without compensation 2. 27

28 Causes of PPP Failure Operational performance (2) Legal disputes (3) Poor contracting framework (2) Poor governance (1) Unrealistic expectations (optimism bias) (1) Forecasting error (6)... 28

29 Project Failures Contract cancelled with compensation 2 Contract cancelled without compensation 2 Administration and resale (sold/pending) 3 Reasons for failure: Forecasting error a factor 6 Operational matter/legal dispute 2 29

30 Procurement Efficiency Index (Nominal) b Contributing factors: PPPs 1. BOOT Forecasting error (case mix or traffic Outsourcing flows) (90% of failures) Alliances 2. Operational failures (25% of failures) Traditional 3. Legal disputes In-House 4. Failure to meet expectations Form of specification 0 20 Process cost #REF! Risk transfer Poor agency contractual framework Lifecycle costing Marginal utility of investment Innovation & technology NPV investment Gateway PM process Project lead time Minimum project size Integrate design & construct Relationship status Sustainability values 6. Failed agency governance 30

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32 The Future of PPPs? Continued trend to the private production of public goods and services Lessons are being learnt, the model is evolving, public procurement performance is improving We can expect new forms of private participation in the (social) infrastructure sector 32

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Delivering Public Private Partnerships in PNG

Port Moresby Chamber of Commerce-INA Public Private Partnership Seminar Pt Moresby, 22 nd February, 2012 1.4 Delivering Public Private Partnerships in PNG Michael Regan Professor of Infrastructure Institute