The UK’s deficit in infrastructure is vast; it requires private-sector capital and expertise to join with the public sector.
Over the past 20 years concessions in the form of private finance initiatives (PFIs) and public-private partnerships (PPPs) have enabled many new public buildings and services to be delivered. The UK alone has 1,000 PPP concessions. Furthermore, PPPs are one means of renewing infrastructure in an era when capital constraints mean that public finance is not always freely available.
The PPP framework can be a significant, beneficial tool for government procurement. For our future economic success we need to put well-framed critical infrastructure at the heart of the political agenda and create a new paradigm, where our decision-makers lay the national infrastructure foundations needed for the economy and its growth to be secure for future generations. Leveraging private investment will be vital, but doing so requires an informed and engaged approach.
Unfortunately, there is a mismatch between political attention spans and infrastructure investment timeframes
Unfortunately, there is a mismatch between political attention spans and infrastructure investment timeframes. This is particularly so for large, high-profile infrastructure projects. The public sector, and the public more widely, rarely understand the techniques and skills required to evaluate a PPP concession. Certain concepts are vital, such as the time-value of money and nominal versus real cash flows and the rate at which these are discounted. This skills shortage reduces the ability to properly compare the value for money of different procurement approaches and weakens the oversight needed to review such decisions appropriately.
More than just getting the lowest bid price or transferring the most risk, it is essential to meet project requirements in the broadest sense. To address this, there is a comprehensive list of issues that need to be evaluated: transparency; urgency; accountability; risk transfer; budget; specification; flexibility; project complexity; and market competition. Not all infrastructure should use PPP frameworks, nor necessarily private investment at all: understanding when to seek private funding is as important as how to go about doing so.
One of the important procurement tools for the public sector is through the granting of infrastructure PPP concessions. Straightforward and commoditised procurements do not necessarily benefit from the rigours of the private finance approach. Similarly, where projects get too complex and specifications grow unwieldy, the constraints of private finance can undermine the quality delivered. Concessions rely on clear, upfront specification in order to optimise a series of asset management and investment trade-offs. This means that a concession tends not to be suitable where substantial flexibility is required, as in IT procurement.
Moreover, concessions are rigid and prevent governments from changing their budgets on a regular basis. Surprisingly, this can be a benefit masquerading as a cost. In most instances it would be perverse to suggest that deviations should be made from an optimally planned infrastructure maintenance regime. To argue for short-term budget flexibility is to saddle future taxpayers with a disproportionately higher backlog of maintenance work.
There is a crucial middle ground, wherein the involvement of private finance delivers substantial additional value to infrastructure investments.
For a concession to be efficient, both the specifications and project risks must be clear. Then the mix of private and public finance brings rigour, value and efficiency. Concessions generally take a long time to negotiate, which is partly due to their commercial complexity, but is also explained by the need for clear specification at the outset. The public sector needs to understand this in order for private finance to support the development of crucial infrastructure in the UK.
Concessions offer cost and project transparency and enable the public sector to enter into commitments with its eyes wide open. For example, building a new school is a financial commitment as well as a commitment to a community, and whereas under a concession the costs of the school are defined, conventionally the long-term costs of the commitment to the community are unknown. PPP concessions in general include not just the initial construction spend but all future operating, maintenance and life-cycle costs. Such transparency also enhances accountability; across much of the world concessions are promoted as a route to tackling corruption.
Whole-life costing, asking contractors and their lenders to put their money behind their forecasts for a concession, brings rigour and discipline to the procurement process. Addressing the life cycle of a project can reduce the need for ongoing investment and save substantial costs down the line. Properly developed and deployed, the private sector’s higher cost of capital can be more than justified on the basis of risk transfer, enhanced planning, accountability and risk management.
Public- and private-sector actors are both needed if the UK’s infrastructure requirements are to be met. The crucial question is not whether to use private finance, but rather how it can be involved most efficiently. That begins with recognising where PPPs can add most value, understanding the constraints and opportunities over the whole lifetime of a project, and developing the necessary skills on the public-sector side so that the UK’s infrastructure can be procured effectively. This must be a key priority for the recently launched National Infrastructure Commission.
This article was originally published http://www.eiuperspectives.economist.com/economic-development/vibrant-economy/blog/financing-uk%E2%80%99s-infrastructure-private-and-public-gains 19 April 2016 on the Economist Intelligence Unit perspectives.com