Public Private Partnerships - A formula for excess profits and failure

Common Weal Policy

Top statistician reveals link between PFI’s excessive profits and project failures and backs National Infrastructure Company

IN A NEW REPORT for Common Weal, former Chief Statistician for the Scotland Office has uncovered how the makeup of PFI/PPP (private finance initiatives) deals link “excessively high returns” to private investors and a higher risk to infrastructure projects compared to publicly run alternatives. This new report comes with the news that 2162 jobs have been lost due to the collapse of Carillion which dealt with many of the PFI/PPP contracts across the UK.

Jim Cuthbert’s new report can be read here.

The new paper, entitled Public Private Partnerships: a formula for excess profits and failure explains that the spread of excess risk payments to PPP companies across the life cycle of a public building contract (usually about 30 years) means that the money is usually not immediately available for the PPP company to spend in the event of a failure: like a school wall falling down.This, according to the report, means that “the substantial extra cost margin in PFI/PPP projects which the public sector pays for risk transfer does not actually provide meaningful insurance against failure”.

The report also considers the further layer of instability that is built into the PFI/PPP system. Current accountancy rules mean that PPP construction contactors can face an almost immediate black hole in their balance sheet if their ability to sell their equity on the secondary market is hit by events such as construction failures. If the price in which they can sell their equity at goes down, or in other words if private investors deem the PPP equity to be too risky to buy, the value of the entire private company will go down. This mechanism played a large part on the collapse of Carillion as “£375 million of the hole which suddenly emerged in its balance sheet arose from writing down the value of its equity holdings in PFI/PPP contracts”.

Report author Jim Cuthbert said:

"What the paper identifies is an inherent problem implicit in conventional PFI/PPP, which arises from paying the risk premium to the equity investors in such schemes over the extended life of the project. On the one hand, paying the risk premium for equity investors in a PFI/PPP scheme over the 30 year life span of the project opens up the potential for equity investors to pocket excess returns immediately after the construction phase of the project – provided construction appears to have been completed satisfactorily.

But on the other hand, the same mechanism actually also contributes to the high rate of PFI/PPP failure. Paying the risk premium late in the life of the project means that, if things go wrong, the risk premium is not actually available when it is needed, thus increasing the likelihood of failure.

The Common Weal proposal for a Scottish National Infrastructure Company, with finance provided by the new Scottish National Investment Bank, would get round this problem completely. Under the proposed public/public type of partnership, there would be no need for the expensive, and wasteful, payment of long term risk premiums to equity investors."

Common Weal’s head of policy and research Craig Dalzell also commented on the report and the proposal for a Scottish National Infrastructure Company:

"There are many reasons why PFI has been a disastrous failure for Scotland and for the UK as a whole and this new report highlights yet one more. This type of scheme is fundamentally and systemically flawed and Scotland should move beyond it as quickly as possible. The welcome announcement by the Scottish Government of the adoption of Common Weal's policy of forming a Scottish National Investment Bank is a very welcome step towards this goal. The next step is to replace the failed model of companies like Carillion with a Scottish National Infrastructure Company which can support the sustainable development of Scotland's economy."