Jane Kelsey: The folly of using private companies for public services

Bill English. Photo / Mark Mitchell

There is a wise saying that if it sounds too good to be true, it probably is too good to be true.

That certainly applies to the Government's announcement taxpayers will get better value for money if public agencies have to consider using private firms for major new public investments.

Public Private Partnerships - more properly, but less attractively, called Private Finance Initiatives or Build Operate and Transfer schemes - are the current fashion in privatisation.

Internationally, private consortia are being contracted to deliver almost every conceivable public service, including hospitals, schools, water supply and prisons.

Finance Minister Bill English says private finance initiatives are only appropriate for some projects, but he doesn't say which. The previous Labour Government rejected this private model for years but eventually adopted it for the Waterview Interchange.

The National/Act Government has now added the private model to a policy platform that is increasingly redolent of the disastrous early 1990s.

It is not surprising that English announced the policy at a symposium organised by the New Zealand Council for Infrastructure Development, which includes numerous Australian and US-affiliated firms. The council was formed in 2004 to lobby for the use of public finance initiatives in New Zealand and will be the prime beneficiaries of the policy.

Governments find them attractive for two reasons. First, they avoid paying for new public assets up front.

But, in fact, they commit the government to a stream of payments to the contractor for the lifetime of the project, just as debt would. Treasury acknowledges this in its National Infrastructure Unit PPP guidelines.

Instead of payments on debt, the rent paid over the life of private finance contracts in Britain is estimated at four or five times the cost of construction. This reflects higher interest rates for private sector borrowing, even when backed by guaranteed income, and the payment of dividends.

The private finance arrangement allows a government to claim fiscal responsibility even though it is incurring debts that will be a public liability for the next 20 to 30 years and will often have first call on the public purse.

Second, the contract purportedly transfers the major risk of the project from the government to the private contractor, which absorbs some of the costs of construction over-runs, adaptation to new technologies, repairs and maintenance.

This assumption is usually factored into the comparator that public agencies must use to decide if private firms would give better value for money.

The real policy impact of private finance initiatives is quite simple - they are creative accounting exercises that disguise a massive transfer of wealth to private consortia that receive guaranteed returns with minimal accountability.

The state enters a long-term contract for a private company to design, finance, construct and/or operate a facility for public use. The standard contract gives the company the right to own and manage the facility, usually for between 25 and 40 years.

They receive a guaranteed annual fee and/or the right to levy user charges and profit from other commercial use of the facilities for the term of the contract.

The assets are often transferred to the state at the end of the contract, but not always.

A standard private finance contract will usually include a service agreement with the state's purchasing agency that sets the performance standards for running the school, hospital, prison, roads or whatever.

Because both sets of contracts are commercially sensitive, most of their terms and assessment of performance remain secret, even from Parliament.

The contract is almost always with a "special purpose vehicle" - a shell company with minimal capitalisation that is owned by a consortium of a construction company, a facilities management company and a finance arm, whose investors are usually highly leveraged investment banks, private equity firms, pension funds and insurance companies.

The scope for profiteering can be staggering. Contracts routinely include rights to profit from third party use of facilities like schools, and from the sale of surplus assets, including land.

Companies claim tax losses by generating massive income against which they offset equally massive operating expenditure, described as a "management fee" paid to the parent company.

The original contracts are increasingly traded on secondary markets to investors that demand an even higher and faster return from a government-guaranteed investment.

There is a second objection to this form of privatisation. The private finance model reduces public services to a purely commercial venture that is detached from their social purpose.

The largest British private finance investor, little-known company Innisfree, has shares in 269 schools and 28 hospitals, covering over 132,000 pupils and 13,000 hospital beds - more than anyone but the British state. Its other projects span transport, waste to energy, the Ministry of Defence, courts and water treatment.

Far from transferring risk, private finance initiative contractors with their shell companies know that the government retains the political or reputational risk as provider of last resort.

If contracts collapse, or if companies go bankrupt or abandon an unprofitable project, the state is expected to step back in. There are many instances around the world where that has occurred.

English's speech promised to improve the quality and transparency of his Government's long-term asset management. But harnessing its future investment to contracts that commit public bodies to payments from government revenue for 25 to 35 years may have exactly the opposite result, with future generations paying the price for this latest wave of privatisation.

* Professor Jane Kelsey teaches law and policy at Auckland University.