In the United Kingdom, the private finance initiative (PFI) has become an important part of the public investment process. PFIs use PPPs to build and operate assets such as hospitals, schools, and other infrastructure regulatory projects. As of September 2009, the total estimated capital value be illustrated of these projects across the United Kingdom was £55.1 billion.7 The United Kingdom is the most important international test bed for PPPs, given that 667 projects have been signed as of 2009, 599 of them operational; their diversity is shared among transport, education, health, prisons, defense, leisure, housing, courts, technology, government offices, and other projects.
In 2002, the U.K. government's treasury conducted a sample study of 61 projects, out of 451 operational projects at the time. The conclusions were positive. First, the percentage of projects that were late was much lower than the percentage under public provision, both in studies by the National Accounting Office and by the U.K. Treasury.8 Furthermore, the Treasury reported that there were four bidders, on average, for each project, signaling healthy competition. The Treasury claimed that there were no excess costs in PFI projects, but it did not include excess costs associated to changes in the specifications-that is, those whose contracts were renegotiated. In fact, according to the figures presented in the report, in 22 percent of projects there were increased costs due exclusively to changes in the specifications.
An additional problem, described in the report, were the long lead times necessary for PFI projects, which averaged twenty-two months (though there is no public sector comparison). However, it must be noted that similar long delays would also occur under the traditional provision approach if the project were as carefully designed as it was under a PFI. The only delay that can be unambiguously assigned to PPPs is that delay caused by arranging private financing. Also, because of high contracting costs, the United Kingdom considers PPP contracts only for large projects (£20 million minimum).
A further topic of interest is the issue of contract flexibility. The government keeps the right to change any aspect of the building or service, subject to agreement with the contractor on cost. If the change exceeds £100,000, competitive tendering is required, but this occurs in only 29 percent of cases. It is also interesting to observe that 20 percent of the changes requested by the public sector correspond to the reinstatement of requirements that had been excluded from the initial contract due to their cost. The Treasury's report is correct in indicating that it is not appropriate to eliminate items at the competition stage and then reinstate them when the project has already been awarded.
In retrospect, it seems clear that the original motivation for the introduction of PPPs in the United Kingdom was to have a source of of-budget public investment. Only 23 percent of capital costs of 599 PFI projects up to April 2009 are on-balance sheet, which explains why The Economist wrote, "cynics suspect that the government remains keen on PFI not because of the efficiency it allegedly offers, but because it allows ministers to perform a useful accounting trick" (The Economist 2009). Since the United Kingdom faced no rationing in the credit markets, using PPPs to provide more funds for public investment served no social purpose, but did help the government comply with the debt limit of the Treaty of Maastricht.
Also, some of the problems faced in the United Kingdom have been exacerbated by the extensive use of availability contracts, in which user fees (if they exist) pay only for operations and maintenance costs, and not for capital costs. When users pay fees (especially when those fees are sufficient to defray the capital costs of the project), they are less willing to accept cost increases and quality reductions. There is a tendency to renegotiate contracts during the construction process, leading to cost increases in 35 percent of projects. And, as we have already mentioned, in a substantial number of projects requirements were dropped at the bidding stage and were again included after award of the franchise.
There is a tendency to renegotiate contracts during the construction process, leading to cost increases in 35 percent of projects.
BOX 1
The Chicago Skyway
The Chicago Skyway is an eight-mile six-lane median-divided toll road in Chicago that links downtown to the Illinois-Indiana state line. (Much of the material for this box appears in Cheng 2010.) The Skyway was initially developed by the city of Chicago in 1959, with bond financing linked to toll revenue. However, the city was unable to raise tolls enough to service the debt and had to be ordered by the courts to do so. Even then, the first principal payment (after paying of all due interest) only came in 1991, when the financial situation of the project improved due to congestion in untolled alternative roads. After retiring the original bonds in 1994, the city made no further toll adjustments until leasing the project in 2005.
From this point on, the city started using the revenue from the Skyway to fund other transportation projects and to anticipate the revenues from the Skyway by issuing bonds in 1996 for the same purpose. In 2004, the city issued a request for qualifications that led to five qualified bidders for a ninety-nine-year lease on the Chicago Skyway. The bidders competed for the operations and maintenance of the highway in exchange for future toll revenues according to a predetermined toll schedule.
There were three active bidders, and an undisclosed reservation price estimated to lie in the range of $700 million to $800 million. The winning bid of $1.83 billion was submitted by Cintra-Maquarie. The other two bids were more than $1 billion smaller, providing some indications of the winner's curse. Cheng (2010) estimates that under all reasonable demand scenarios, Cintra-Maquarie paid too much for the project.
There are a few issues to note in this case. First, major toll increases were pushed into the future, past the time of retirement of the then-current mayor. Moreover, before leasing the Skyway, the city procured an exemption from leasehold tax for the facility, thus raising its current value at the expense of future revenues. Finally, the original lease was for fifty-five years, but the final lease was extended (at the insistence of the firms) to ninety-nine years, an extension that might loom large in future renegotiations, but whose current present value is just $3 million.
Cheng (2010) shows that the PPP was financially convenient for the city, because only under implausibly optimistic expectations of traffic growth and a so-far unobserved ability to raise tolls would it have been able to generate the amount of discounted revenue it received from the winning bid. There are other potential efficiency gains from private management (more efficient maintenance and operations), but their impact is relatively minor (operational costs fell by 11 percent, a gain of $1 million per year). Thus, efficiency gains should have a correspondingly small impact on the overall valuation of the facility.
The short-term political benefits of the program were important. Part of the debt was used to retire Skyway bonds and city debt; $500 million went into a long-term reserve; and the remaining $475 million remained in discretionary funds, of which the city had spent 83 percent as of 2010.