Why we need public spending, and why we don’t need PPPs

1. Why we need public spending, and why we don’t need PPPs By David Hall d.j.hall@gre.ac.uk Public Services International Research Unit (PSIRU) University of Greenwich, UK www.psiru.org February 2011

2. Acknowledgements

3. Economic role of public spending • Public spending and economic growth • Infrastructure, efficiency, equality, employment • Public spending and the crisis • PPPs • Some conclusions The presentation is based on PSIRU reports ‘Why we need public spending’, available from http://www.psiru.org/reports/2010-10-QPS-pubspend.pdf , and ‘More public rescues for more private finance failures’ http://www.psiru.org/reports/2010-03-PPPs.doc , commissioned by Public Services International (PSI) and EPSU.

4. The economic and social role of public spending • Public services/spending/workers presented as: • Parasitic on ‘real’ productive sectors of the economy • ‘luxuries’ to be sacrificed for general economic benefit • Inefficient compared with private/market provision • PPPs presented as part of solution • Private investment instead of public investment • Greater efficiency and reliability • Empirical evidence shows • Rising public spending is linked to economic growth • Productive benefits of health, education • Economic and social benefits of equality • No significant difference in public/private efficiency • PPPs relatively expensive, inflexible , and risky

5. Public spending as % of GDP (source: OECD stats http://stats.oecd.org/Index.aspx , PSIRU calculations)

6. Spending/GDP and GDP per capita, 2008, OECD

7. Long-term link between public spending and growthGovernment spending as % of GDP 1870-1996, ave of 14 countries

8. Recent trends: levelling-off or temporary dip?Government spending as % of GDP, USA, 1903-2010

9. Questions and issues • Explaining the positive links • Productivity gains from infrastructure, • Productivity gains from public health/education • Demand effects of equalising income distribution • Social benefits from greater equality

10. Infrastructure investment and growth 1991-2005Change in ave per capita growth between 1991-1995 and 2001-2005. Calderon and Serven 2008

11. Public and private capital spending on infrastructure USA 2007

12. Public healthcare is more efficient and effective • Life expectancy in USA is lowest in high income OECD, lower than Cuba • Infant mortality in USA is 2x the rate in Czech republic, Portugal, Japan

13. Public services and equality

14. Half the jobs in the world

15. Public spending and the crisis – in context Some factors in the crisis • Unsustainable banking practices (CDS etc.) • Unsustainable personal borrowing (sub-prime) • Unsustainable corporate borrowing (leverage) • Inequality (wages-profits shares, high/low incomes) • NOT excessive government borrowing or spending • NOT numbers or wages of public employees

16. Household and government debt in Eurozone

17. Response to crisis: public spending and borrowing • Bailout of banks • Overall, the total value of actual and contingent support in North America and Europe rose to over US$14 trillion, equivalent to about 50% of annual GDP in those economies’ (Bank of England 2009a, p.6) • This equates to over $2000 for every person on the planet • ‘Stimulus’ to boost demand through higher deficit • Least impact if used for tax reductions • Most impact if used for public spending or benefits • Automatic stabilisers absorb shock: tax down, benefits up • Also spending on public services stabilises • counteracts 16% of economic ‘shocks’ • Especially spending on elderly, health care

18. Crisis: cost of rescuing the banks- equals global revenue from 30 years of privatisation

19. Crisis: Economic stimulus as % of GDP 2009

20. Higher government debt levels Source: European Commission

21. Corporate profits now at record levels

22. Global political contests over public spending • Post-crisis global contests over public spending • Two key drivers, for IMF and some govts • curb growth of public spending on healthcare and pensions, ageing populations • But contrary to efficiency evidence on public healthcare • drive to cut stimulus packages • IMF concerned with lasting shift: why? • More upward pressures on public spending • climate change, broadband, development • Major political conflicts already especially in healthcare, pensions

23. IMF and politics: effects of crisis and IMF ‘exit’ plans

24. New demands: climate change • Global costs of measures required to cut carbon emissions between 1% and 3% of global GDP. • UN estimates about three-quarters of this will have to come from public finance. • So globally, public spending will have to be higher by about 1.5% of total GDP, just on account of actions to deal with climate change. • Problems with liberalised energy markets • “we should not accept the significant risks and costs associated with the current market arrangements… changes to the current arrangements are both required and inevitable.” (UK Committee on Climate Change, 2009 http://www.theccc.org.uk/reports/progress-reports

25. Broadband, housing • Other continuing needs for public investment • Broadband internet access • Telcos reluctant to invest in necessary networks, so governments have to raise public finance • Eg Portugal state provides 85% of the financing for a €1 billion investment programme. • Housing • Sub-prime crisis highlights role of public investment in affordable housing • Slum problems in developing countries requires public housing programme • General needs for investment in developing countries • Private sector does not invest any significant amount in infrastruicture in Africa, Asia, limited in Latin America

26. Private alternatives: PPPs • Different channels for using private sector • Privatisation by sale of enterprises • PPPs • liberalisation • Key questions for PPPs: • Comparative value for money (VFM) • cost of finance, efficiency, risk • Accountability, governance

27. PPPs, PFI and Ryrie rules • PPPs fail VFM tests • UK Ryrie rules in 1980s were about VFM, scrapped because no PFI proposal ever passed them “(i) decisions to provide funds for investment should be taken under conditions of fair competition with private sector borrowers; any links with the rest of the public sector, government guarantees or commitments, or monopoly power should not result in the schemes offering investors a degree of security significantly greater than that available on private sector projects; and (ii) such projects should yield benefits in terms of improved efficiency and profit from the additional investment commensurate with the cost of raising risk capital from financial markets” (Treasury, 1988, Annex; quoted in Heald 2003).

28. A VFM framework for PPPs • Cost of capital :always higher for private sector • Construction ‘on time’ :is costly ‘turnkey’ contract, for bankers’ benefit • No systematic efficiency savings (IMF: “the theory is ambiguous and the empirical evidence is mixed.”) • Real transaction costs and uncertainty • No reduction in public spending under PFI schemes: government pays

29. PPPs pay higher interest rates: UK data Govt bonds pay 4.5%, PPPs 6%, post-crisis 7% Source: PAC 2010 Cf Build America Bonds as successful public finance alternative

30. The high cost of private finance Source: PSIRU calculations, OFWAT, D Helm 2006 ‘Ownership, Utility Regulation And Financial Structures: An Emerging Model’ 14 January 2006 http://www.dieterhelm.co.uk./publications/OwnershipUtilityReg_FinancialStructures.pdf.

31. Efficiency, privatisation, PPPs • Empirical evidence does not support assumption that private sector will be more efficient • “While there is an extensive literature on this subject, the theory is ambiguous and the empirical evidence is mixed.”(IMF, March 2004) • Studies across countries and sectors find no consistent difference • UK privatisations in general: “little evidence that privatisation has caused a significant improvement in performance” (Martin and Parker 1997, Florio 2004) • Water and electricity: “no statistically significant difference in efficiency scores between public and private providers.” (Estache et al, 2005, Warner and Bel 2009) • Telecoms: global study comparing private and public companies found that “efficiency growth following privatizations…is significantly smaller than growth in public sectors.” (Knyazeva, Knyazeva and Stiglitz 2006) • Buses: no significant difference in efficiency between public and private bus operators, or mixed systems (Pina and Torres 2006) • Auditing: Australia: ‘outsourced audits are more costly’ (Chong et al 2009) • Prisons: “privately managed prisons provide no clear benefit” (Lundahl et al. 2009 ) • Airports: “Empirical evidence regarding the effects of privatization on the efficiency of airports is scarce and largely inconclusive (Bel and Fageda 2010)

32. Some efficiency references

33. More efficiency references

34. Even more efficiency references

35. Efficiency and liberalisation • Liberalisation expected to deliver efficiency via competition • Not found in EU liberalisation of network industries • “No evidence of consumer benefits from electricity/gas/telecoms liberalisation” (Florio et al, 2008) • USA unbundled electricity systems are less efficient: • electricity systems in deregulated states “have lower productive efficiency, and have also experienced decreases in efficiency over time. In particular, the vertical separation of generation, a hallmark of an effort to deregulate the industry, is associated with an adverse impact on productive efficiency” (Goto and Makhija 2009) • Deregulation halted in USA after California crisis 2000

36. PPPs/PFI: dynamic problems • UK cases • M25 motorway: worse technical option , financed by govt at private rates, long-term costs of £1billion • Major London Underground PPPs cancelled, = 25% by value of entire PFI programme • “we found no clear and explicit justification and evaluation for the use of PFI in terms of its value for money…The Department for Communities and Local Government has undertaken a limited analysis of capital costs on new build schemes but this did not take account of all project costs such as finance costs.” (HoC 2010) • “Many PFI housing procurements have taken very much longer, and cost a great deal more, than originally planned” (Hoc 2010) • Supporting PPPs post-crisis means that: “higher financing costs increased the annual charge of PFI projects by six to seven per cent and that between £500 million to £1 billion of higher cost has been built in over 30 years” • Refinancing advantages for companies, rarely an option for public authorities • Little evidence of learning process by government • Little monitoring of outcomes • high spending on advisers: “insufficient commercial and technical skills within the Agency. The Agency risks advisers controlling projects and having little incentive to transfer knowledge back to the Agency.” NAO 2010 • Same experience in France after decades of concessions

37. Risks • Risk transfer is not an objective in itself • Only if improves VFM • used to massage comparisons • Cannot transfer risk of public service delivery • Private sector indifferent to public service • Eg Brussels sewerage treatment PPP pollutes river for 10 days • PPPs create risks to other services, especially with proposed cutbacks • Eg UK spending cuts affect PFI hospitals more, due to contractually fixed expenditure on PFI

38. Public sector aid for PPPs • Post-crisis inability to finance for PPPs • cost of capital even higher, PPPs even more unpopular • VFM response should be: use public sector option • But massive efforts by public sector bodies to support, rescue and promote PPPs despite this • By governments – eg UK, France, India create special public financing mechanisms for private projects • By international institutions eg IFC creates special fund, UNECE et al create special unit to promote PPPs • By EU, with range of special propaganda and legal initiatives to support PPPs alone (Nov 2009 paper) • Misleading language of

39. Skewed choices and government deficits • Why so much effort for such poor results? • Avoidance of deficit rules key motive for PPPs • Note implication that infrastructure projects are more important than deficit rules • EU Deficit rules mean projects only allowable if ‘off-balance sheet’, hence importance of Eurostat rules • EIB/UK reports find 'there is no alternative‘ • Deficit avoidance now harder because • Statisticians in UK, EU, elsewhere rule must be on balance sheets (control, liability) • New international standards say on balance sheet • Greater public awareness and opposition

40. Conclusions 1: the summary failure of Metronet (London underground PFI) • “The return anticipated by Metronet’s shareholders appears to have been out of all proportion to the level of risk associated with the contract…” • “In terms of borrowing, the Metronet contract did nothing more than secure loans, 95% of which were in any case underwritten by the public purse, at an inflated cost…” • “Metronet’s inability to operate efficiently or economically proves that the private sector can fail to deliver on a spectacular scale..” • “The Government should remember the failure of Metronet before it considers entering into any similar arrangement again. It should remember that the private sector will never wittingly expose itself to substantial risk without ensuring that it is proportionally, if not generously rewarded. Ultimately, the taxpayer pays the price…” • “we are inclined to the view that the model itself was flawed and probably inferior to traditional public-sector management. We can be more confident in this conclusion now that the potential for inefficiency and failure in the private sector has been so clearly demonstrated. In comparison, whatever the potential inefficiencies of the public sector, proper public scrutiny and the opportunity of meaningful control is likely to provide superior value for money. Crucially, it also offers protection from catastrophic failure. It is worth remembering that when private companies fail to deliver on large public projects they can walk away—the taxpayer is inevitably forced to pick up the pieces.” (UK House of Commons Transport Committee January 2008)

41. Conclusions 2 • The economic, social, developmental and environmental role of public spending • General upward pressures on public spending: stimulus, infrastructure, healthcare, pensions, equality, climate change, broadband, development • Political conflicts, national and global • PPPs and privatisation not efficient alternatives • A world without PPPs is possible and viable

42. Affordable and fair taxation “our tax collectors are like honey bees, collecting nectar from the flowers without disturbing them, but spreading their pollen so that all flowers can thrive and bear fruit” Pranab Mukherjee India’s  finance minister, budget speech, July 2009