The Great Divide

1 March 2017 There remain questions over where responsibilities lie between public and private sectors when planning and investing in infrastructure. Paul Jarvis investigates

“I’ve had a roomful of engineers agreeing that the markets don’t work in energy and that it all needs a major rethink.”

That is the view of a highly respected industry professional, who has worked in the infrastructure arena – on both the public and private sector side – for several decades. “In the UK, because of the political theology, anyone who refers to ‘limits to markets’ is assumed to be a crypto-communist.”

In fact, the question over where the public and private sectors interact is not something that should fall along political lines of ‘right’ or ‘left’. Rather, it needs to consider more fundamentally who is best-placed to take on the burdens associated with developing that infrastructure and delivering the services out of it.

Where responsibility lies has long been an issue in PPP contracts, and has perhaps never been more salient in the sector than at present. In our last issue, Partnerships Bulletin explored the continued loss of confidence in PPP among the general public.

Whether it is trees being cut down in the UK via a PFI contract, or concerns over the ‘privatisation’ of water infrastructure in Canada, the fear over a lack of public accountability for infrastructure is gaining traction.

Much of this, in the end, comes back to the amount of control that the public and private sectors have – and are perceived to have – over infrastructure.

“Although 60% of infrastructure in the UK is owned or operated by the private sector, it is not clear who is responsible for driving forward investment and for sorting out problems,” explains James Stewart, chairman of global infrastructure at KPMG.

This manifests itself in a variety of ways – from the continued questions over value for money in PPP contracts, to the breakdown in relationship between operator and unions at Southern Rail.

“The UK is at the sharp end of the debate over who is responsible for infrastructure,” says Stewart.

So how did the UK get to this point? Mark Hellowell, academic at Edinburgh University, points to the need to increase investment and improve service levels in the nationalised industries from the end of the Second World War. “The performance of the privatised industries since the 1980s is generally seen to be good. Customer service has greatly improved. The level of investment has been reasonable, set against changing needs and expectations.”

And then, of course, there are the benefits to the way in which the public sector operates. “We are coming from a place where the public sector was not in a position to procure effectively,” says one source.

Identification questions

As is well-documented, it is with this background of a lack of procurement nous and effective long-term infrastructure planning that PPP was developed.

“Now, there is a far more coordinated and organised public sector,” says an investor. “We are seeing good people working in the public sector more and more, not just in central government but also at local council level.”

“The rationale for outsourcing the construction phase has gone down,” adds Stewart. “We are seeing this in Canada and other mature markets, as well as the UK.”

PPP may have played its part in this, but it has not managed to emphatically resolve the question of where responsibilities lie in each contract.

“In the vast majority of cases, identifying where the risk should sit is relatively straightforward,” says Alison Fagan, partner at law firm DLA Piper. “So many of these are working well and it is clear where the risk balance is positioned.”

However, this is not always the case. Fagan points to obligations involving statutory compliance that have been passed to the private sector. “The contract might push a health and safety duty onto the private sector, but the statute will say that both the private partner and the public authority are the responsible bodies,” she explains.

This can lead to complications and can quickly become a source of tension between parties – especially if the two sides have not been keeping a close eye on their contracts. “The risk balance in contracts is negotiated to the letter, but sometimes the contracts get put in a drawer and forgotten about,” says Fagan. “So it is about making sure the actual risk balance that is agreed in the contract is consistently applied throughout the life of the contract.”

Amar Qureshi, chief executive at advisers Agilia, agrees. “There is no point in having a clear contract, which when it is actually implemented, responsibilities become vague or diluted.

“But this in itself isn’t enough: people at the end of the day make and implement projects – and we need to get a better appreciation of the behavioural dynamics at the delivery stage and ensure that these are properly reflected in the contracts we develop. Complicated contracts will be forgotten about when it comes to delivery.”

Furthermore, a contract that is set up for running a piece of infrastructure over the longterm is not always able to deal effectively with major shocks or crises. Hellowell points to recent problems in health PPP contracts around fire stopping, and the issues faced by the Edinburgh schools PFI programme, where a wall collapsed at one of the sites.

“Standard PFI contracts have been shown to be better in dealing with the routine – processes of ensuring availability and the operation and maintenance of the asset – than they are at dealing with extreme circumstances, especially those that seriously threaten service delivery,” he explains.

On the Edinburgh schools situation, though, Hellowell questions the publicprivate relationship. “The great unknown is whether there is something PFI-specific about this, or whether we might expect a similar incidence of the problem across the public procurement space. Because with the former you are transferring to the private sector the responsibility to define the output specification, and inevitably you lose some control of the inputs – does that make it more likely that this will happen?” he asks.

The inquiry into the issue confirmed the view that it was the quality assurance processes that were inadequate. Although the report suggested this is likely to be an issue across the construction industry, it is not necessarily clear that the PFI model didn’t play a part in some way.

“Is that because the inspectors weren’t as hands-on because it was a private sector responsibility to ensure these buildings were fit for long-term use?” asks Hellowell. “We have not got to grips with that yet.”

Planning problems

Tim Stone, a former global chairman of infrastructure at KPMG, who has lectured on this issue over recent years, suggests that markets can work well in the exploitation of infrastructure during its operational phase but before its eventual decay. But for the start and end (or renewal) of a piece of infrastructure’s life, he suggests there needs to be more onus on public sector investment.

“The government still has a big role to play even in privately run infrastructure,” points out Stewart. “In infrastructure planning, what are government’s levers? What does the private sector do and what does the public sector do?”

Long-term planning has been a key focus for many governments over recent years, but there are constraints around how they can deliver new infrastructure when most of the assets they are dealing with are controlled by the private sector.

“In privatised companies the responsibility lies with the private sector to deliver or engage with government to identify the best way to deliver,” says Qureshi. “Government’s role is strategic and as a facilitator.”

Stewart agrees. “Government is the master planner,” he says. In social infrastructure, this means it is up to ministers to decide where, how many and how big facilities such as schools should be. He points out that one of the reasons Infrastructure UK was created was because of the realisation by government that it needed a planning function other than just for PPP projects.

There is one recent example in the UK that could provide a model that begins to answer this question. The Thames Tideway Tunnel PPP not only attracted private finance, it also managed to attract something even more hard to come by: political support from then-Chancellor George Osborne, who described it as a model of how such deals should and could be done.

“The model was smart – the private sector was bidding on the cost of capital not the overall construction of the project,” explains one source who remains involved in the scheme. “The government support package helped reduce the cost significantly.

“It used to be the private sector on the hook for everything. Now, the risks are placed appropriately between partners.”

Qureshi, who worked at Thames Water to develop the Tideway project, points out that the relationship between Tideway and Thames Water is one of ‘sister utilities’, whereby the two companies are not allowed – except in limited circumstances – to sue each other.

“That’s one of the drivers to the two companies working effectively together. Crucially, having seen the implementation of the project, I know that all involved in the project are adopting the essence of the model, which is highly collaborative, to make it a reality.”

Stewart agrees that this is a step in the right direction. But he also points out that the government was reluctant to take on responsibility for the project originally. He points to similarities with the Battersea regeneration project in London, where potential investment was delayed for decades by a succession of governments reluctant to support it.

In areas such as airports or ports, where the markets are largely in control, Stewart explains that governments need to be ready to step in and invest. “The focus of the private sector is to make returns, so if their airport is running at 100% capacity, they will be making healthy returns,” he says. “The government will judge airport development on the economic benefit to the region, which is a completely different point of view from the private sector.

“There is no modus operandi for dealing with these situations. The natural inclination of government is to sit back and have no involvement at all.”

Fearing failure

Qureshi suggests: “At its highest level it can be put fairly simply – if the private sector wins then so do customers. If the private sector is in pain then customers also share. But it’s the deterrent of pain which is the financial incentive that helps ensure we have measures in place so we don’t get in that zone.”

But this is not the case when it comes to failure.

“You can’t outsource failure,” says Stewart. “If the private sector fails to invest, it is at worst a lost opportunity for investors, but it is a serious failure for government.

“When constructing PPP contracts, you are seeking to transfer enough risk to incentivise the private sector. But you must recognise that if those risks materialise, the private sector will take a hit but can then walk away, and it falls back to the public sector.”

“That is why I don’t refer to risk ‘transfer’,” adds Hellowell. “There is risk ‘bearing’ by the private sector because of the payment mechanism, and that creates a useful set of incentives for good project delivery. But the ultimate responsibility for providing public services rests with the public sector. The incentive that the private sector has to avoid limited financial losses is less salient than the risk that the public sector faces of service failure. That risk cannot be transferred whatever is in the contract.”

So is a fundamental rethink needed in the relationship between public and private sectors in infrastructure?

“I’m not sure,” says Hellowell. “Investment is only one side of the coin. You have to think about the right structure of the economy. There are many people who would see problems with having large chunks of infrastructure in the public sector.”

Fagan argues the best way to tackle this issue would be to start collating the lessons learned from the problems cropping up in contracts all the time. “The industry needs to learn from the issues,” she says. “Wider opportunities for information sharing are needed throughout both the public and private sectors.”  

This page was last updated on:
2 May 2017.

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