A notable feature of the international landscape over the last two decades has been the increase in the use of public-private partnerships (PPPs). These PPPs typically involve the government using the private sector to build and, in some cases operate and own for a defined period, basic infrastructure facilities. In return for building, managing and/or maintaining the assets, the private partner (or consortium of private firms) receives a regular payment from the government and/or charges for the users.
 

More than 90 countries are now using PPPs in areas as diverse as designing and building roads and schools, constructing and running prisons, and designing, building and operating water and wastewater treatment facilities. Amongst the most active countries using PPPs have been the United Kingdom, Australia and Canada, countries we have much in common with.
 
But just because just about everyone else is doing it doesn't necessarily make it right. The real question is do such PPPs work?
 
The formal studies that have been undertaken generally provide a qualified “yes” to that question. I say qualified because the PPPs don’t always work. And even when they do work, the PPPs are by no means perfect.

A study by the UK National Audit Office (refer the table below) provided one of the most comprehensive independent evaluations of PPPs. That study found PPPs had their flaws: of the 37 PPP projects evaluated, 9 of the projects (24%) were late and the projects incurred cost-overruns, on average, of 22%. But the experience in the public sector was a lot worse: 70% of the projects were delivered late and the cost overruns averaged 73%.
 

An important additional benefit of PPPs identified in some studies is the benefit that can arise from opening the public sector up to competition. For example, where prisons were able to be run by the private sector, the performance of the state-run prisons also improved – perhaps because of the spur provided by competition or because the public prisons now had benchmarks with which to compare themselves.
 
Why is it that PPPs can work better than traditional public-sector methods? A major factor is likely to be that PPPs reward people for performance – something that it is difficult to do within the public sector.By providing financial rewards for good performance (and financial penalties for poor performance), PPPs seek to harness the innovation and creativity of the private sector.
 
Should we be concerned if the private sector profits from PPPs as long as the government is getting a better service and better value for money? Profits provide the incentive for people to perform better and to innovate – two things that are much needed if New Zealand is to grow and prosper.
 
That is not to understate the challenges that can arise in designing well-constructed PPPs. Contracts have to be crafted carefully to target the right outcomes.  In addition, measuring the performance of the contractors is not always straightforward. But much has been learnt over the last twenty years about how to best allocate project risks and about where PPPs work best.
 
It is sometimes argued that PPPs are not appropriate because the government can finance the project more cheaply. Certainly the government can almost always borrow more cheaply than the private sector. But that doesn’t mean the government should necessarily finance a project. If that logic was correct, the government would end up funding all the riskiest activities in the economy. Why not have the government fund property development or own football teams if all that mattered was access to cheap finance?  Higher private sector rates allow for risk, but the true cost of government borrowing is higher than it appears - the risk element is often only recognised when taxpayers end up bailing out unsuccessful projects.
 
There have been some high-profile collapses of companies involved in PPPs in Australia in recent years. For example, the consortium behind the Cross-City Tunnel underneath central Sydney went bankrupt, largely because of its over-optimistic projections of traffic volumes. Much the same happened with the Brisbane and Sydney airport rail links.  Does that mean the PPPs failed? There was no loss of service – the tunnel and rail links remained open – and the taxpayer didn’t lose out. Those who lost their money were the private investors who took the risk. Another road PPP, Melbourne’s Citylink freeway, has been highly successful, and when there were problems with one of the tunnels the entire rectification cost was borne by private parties with no call on taxpayers.
 
What we should be wary of is using PPPs where the government simply won’t allow the company to fail. Take, for example, the government buyout of Toll NZ’s rail operations where the taxpayer ended up paying hundreds of millions of dollars for a business that was not commercially viable. The reality is that if the government won’t allow a private company to go under, it makes little sense to use the private sector in the first place. The taxpayer simply ends up both paying for the profits and carrying the losses.
 
It is sometimes claimed that PPPs are not-well suited to the social sector. This can be true where it is difficult to specify and measure performance. But it is by no means always the case. Governments in the UK and USA are introducing innovative means of raising private finance to tackle some of their country’s thorniest social problems. The Cameron coalition government has launched what it calls Social Impact Bonds to fund schemes run by charities to reduce the reoffending rate amongst criminals. If the re-offending rate falls far enough, investors can earn up to a 13.5% annual return. But if there is no improvement, investors could lose all their money. The Obama government is looking to introduce a similar mechanism with what it calls “Pay for Success” bonds.  At a more everyday level, PPPs have been used or planned in Australia for building and maintaining courthouses and schools.
 
New Zealandhas been slow to use PPPs to address its many infrastructure and other public sector needs. With the Christchurch earthquakes the country’s need for innovative solutions to building and funding infrastructure is all the more pressing.The government has recently said that PPPs must be considered for central government projects over $25m. Having a minimum size for PPPs is wise – it is simply not worth incurring the legal, administrative and monitoring costs that PPPs involve for small-scale projects. And making a PPP an option – and not compulsory – is also wise. PPPs have been shown to work well in many circumstances. But they do not always work. Astute use of PPPs by central and local government could make a significant contribution to New Zealand’s economic development.
 
Philip Barry is a principal of Taylor Duignan Barry Ltd, an economic and corporate finance advisory business. He is a former Counsellor Economic at New Zealand's Delegation to the OECD.