Tuesday 11 December 2018

Costly lesson of private finance and public debt

Carillion's collapse shows the perils of private funding of major projects, writes Colm McCarthy

Burden: Giant UK construction and outsourcing company Carillion went into liquidation after running up debts of around £1.5bn. Photo: Getty
Burden: Giant UK construction and outsourcing company Carillion went into liquidation after running up debts of around £1.5bn. Photo: Getty
Colm McCarthy

Colm McCarthy

The bankruptcy of the giant UK building contractor and outsourcing company Carillion has produced some backwash in Ireland, where the company was involved in several school-building projects. The collapse has provoked politicians in Britain, on both left and right, to question anew the so-called private finance initiative (PFI) which has been used to fund many state investments in the UK since the early 1990s. It is identical to what we call public-private partnership (PPP) in this country. The politicians have a point, although not quite the point many of them have been making. Carillion's collapse was due only in part to its PFI activities, and the deeper criticisms of the PFI model have been around for a long time.

Finding money to finance public investment in schools, roads or hospitals before PFI came along used to require upfront public borrowing, with an immediate increase in the outstanding debt and deferred expenses for interest and maintenance. Around 1990, somebody invented a new model, the private finance initiative. The contracting firm will not just build the facility, they will raise the money on their own balance sheet and do the maintenance as well for 20 or 30 years with ownership eventually reverting to the State. Government needs to find no money in advance - the capital, interest and maintenance costs get rolled into a long-term annual fee arrangement. Since government accounts are not done properly, the deferred liability for these ongoing payments is not shown as a debt on the State balance sheet. It's a bit like the 100pc mortgage - no money up front, but plenty of costs (and risk) down the line.

So the finance minister can tell parliament that no, there has been no increase in State borrowing, we have cleverly mobilised ''private capital'' and can build more schools and roads. The national debt is unchanged according to the public finance accountants, including Eurostat, and future ministers are left to worry about the deferred costs. The whole approach could politely be described as an accounting trick.

In the Financial Times on Friday the doyen of British economic commentators, Martin Wolf, chose to abandon politeness. He wrote: ''A PFI contract creates a long-term contractual liability, just as government borrowing does. Accounting procedures that treat these two ways of financing services differently are fraudulent.'' He concluded: ''…PFI must not be used simply to shift a liability off the balance sheet. That is a swindle and, as such, quite disgraceful.''

Politicians are susceptible to anything that looks like a magic money tree and have responded as Oscar Wilde would have done: "The only way to get rid of temptation is to yield to it... I can resist everything but temptation."

Governments can usually borrow cheaply and getting the contractors to do it, at higher interest, will not deliver lower financing costs.

But PFI is supposed to offer other advantages - the private contractor may have better design skills and might do the maintenance more efficiently. The conventional public procurement model, where the State borrows the money and does the design and maintenance, relying on contractors only for construction, has produced plenty of disasters down the years. In Ireland, the Dublin Port tunnel ran well over budget and there was a major scandal about over-runs at a fertiliser plant in Cork in the 1970s. But Carillion is not the first failure of the public/private partnership alternative. The UK's PFI model has put some lipstick on the public accounts but there have also been spectacular operational failures, including huge over-runs on the Channel Tunnel.

So what extra light has the Carillion episode shone on all of this? Not very much really. The company employed 20,000 people in the UK and about the same number overseas, a reported 43,000 in total. It had some major outsourcing contracts with the UK government but also operated as a conventional building contractor. Five big projects seem to have gone sour, two hospitals in England, a motorway in Scotland, an offshore platform for Shell in the Gulf and a big job for the government of Qatar related to the 2022 World Cup. Construction work for this mega project, surprisingly awarded to the desert sheikdom, has seen numerous delays, cost over-runs and disputes about late payment.

Carillion appears to have made low-ball bids for these jobs when things were slack in the years immediately following the financial crash and the chickens have come home. Many smaller construction firms came unstuck in similar fashion. Carillion's demise does not seem to have been due to some specific flaw in its PFI activities and big losses, perhaps most, are down to failures in its bread-and-butter work as a building contractor. Builders uninvolved in PFI work, or any work at all for government, are exposed to these same risks.

Aside from its losses on big contracts Carillion appears to have mismanaged its liquidity, including on the PFI portion of the business, and the auditors have questions to answer. There will be parliamentary inquiries and the blame game has commenced.

Both the National Audit Office and committees of the UK parliament, as well as numerous economic and financial experts, have raised questions about the PFI model for decades. The first red flags appeared during the Tony Blair era and most of the outstanding liability for PFI contracts in the UK dates back to the period of Labour government. This naturally has not dissuaded the current Labour leadership from blaming the Tories.

In Ireland, successive governments have entered into PPP arrangements which entail annual payments over the next several years in the range €300m to €400m per annum. This can be thought of as akin to the annual debt service cost had the projects been financed in the conventional manner and corresponds to a capital value in the region of €6bn. This amount is, if you wish, airbrushed from the total of government debt as it is reported. The projects include schools, court buildings, roads, public transport and health facilities. Last June, the Minister for Finance Paschal Donohoe told Fianna Fail's Michael McGrath in the Dail that an expert group had been assembled to evaluate the PPP experience to date, apparently the first time such an overview had been undertaken.

Earlier this month, the Minister fielded a further query on the issue from Sinn Fein's Jonathan O'Brien. He informed the deputy that the work of this group is nearing completion and that it was his intention that its report will be incorporated into the 10-year capital plan, which apparently is due to be published during February. The Minister assured Deputy O'Brien that cost-benefit analyses for PPP projects would be prepared and published in future, as they would be for all projects, however financed, with a value of more than €20m. This requirement is already contained in the published public spending code and the Minister is no doubt aware that it has regularly been honoured only in the breach.

The best guarantee of value-for-money on capital spending would be to place on a statutory basis the requirement for advance economic evaluation of large projects, including any PPP projects. This would provide sanctions for politicians committing state funds to large unevaluated projects.

Sunday Independent

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