Experience suggests that both the government and the private sector are, in reality, poor risk managers. First, despite considerable expertise in writing contracts, developing risk assessment frameworks and applying sophisticated evaluation concepts,338 'the perfect contract can never be written and even if it could, performance could not be perfectly monitored'.
One academic pointed out:339
… it seems there is a significant gap between current risk analysis techniques applied to public/private infrastructure and those recommended by researchers, mathematicians, and insurance firms. Despite the fact that the importance of risk is widely recognised, practical limitations such as time and lack of historic data appear to be very real limitations to the incorporation of rigorous and legal risk analysis into the investment decision process.
In other words, risk analysis is only as accurate as the assumptions made. And, as noted previously, the reality of real projects requires consideration of risks in both commercial and governance terms rather than in commercial terms alone. Ideally, risk bearing should be explicit and the costs involved clear, as well, as noted by Professor Hodge:340
… the concept of risks ought to be seen in a holistic manner covering both the commercial role of government (when it signs the contract) and its overriding 'governance' role (in which the polity protects and nurtures the public interest). After all, the public happily vote not according to whether they perceive good commercial contracts are being signed but whether they perceive the interests of the public are being properly met by government.
Evidence on the successful consideration and management of risks could be viewed in terms of policy rhetoric, the clauses in a legal contract, or the historical outcomes by observing actual behaviours of government and contractors. The most powerful of these is experience, given the potential for differences between contracts and behaviour.
Unfortunately, Australia's public sector expertise with risks in the PPP arena is not high. As Bob Sendt, (then) Auditor-General of New South Wales, advised the Committee:341
I think one of the key risks that seems to have come out of many of the projects in New South Wales is a lack of understanding within the public sector of what risk involves and how to appropriately assign risk between the parties.
In a similar vein, the then Commonwealth Auditor-General noted that the risks associated with purchasing services as a paradigm are real. Specifically, he noted that:
The concepts underlying the outsourcing of infrastructure such as information technology (IT) are conceptually similar to PPPs in that, under a PPP contract, the emphasis is similarly on the purchase of services rather than the procurement of an asset. Consequently, lessons learnt from outsourcing initiatives raise important issues to consider in the context of PPPs, particularly in relation to accountability for results achieved, or not achieved as the case may be.
As Dr Arndt points out, 'the real world is much more complicated than any theoretical framework or model, and gave the following examples of risk treatment in recent projects around Australia:342
• the New South Wales Government decided to remove tolls on the M4 and M5 motorways in Sydney, but was unable to cancel the contract. A system was then put in place where motorists had tolls paid refunded by the government. While this has increased use of the facility, it is also evident that parties to the agreement did not originally contemplate this occurrence, and importantly, taxpayers have paid not only for the tolls, but also for the extra revenue accruing to the road owners due to the increased patronage; and
• the water supplied by the Prospect Water Filtration Plant in New South Wales was contaminated by certain biological organisms, and customers were forced to boil water prior to drinking. It emerged that the initial BOOT contract did not specify that these organisms needed to be treated.
An academic in the United Kingdom suggests that despite the implicit assumption of much of the private financing literature, that no risks were transferred under traditional procurement, this is clearly not the case. While it is true that recent PFI contractors have borne a wider range of risks, traditional procurement did take on substantial risks and had penalty clauses as incentives for delays. He also made the comment that where changes were requested by a client in traditional projects, it was easy to quantify the additional costs required based on the detailed design information that already documents all elements of the job, and it was a straightforward exercise for government to see if it was being overcharged. In a PFI project without this breakdown in costs, however, it was more difficult to challenge figures that the PFI contractor might come up with, and this resulted, in his view, in a real danger of being overcharged.
Further, construction contracts have typically included a contingency of around 10 per cent, and this is likely not to have differed between privately financed projects and traditional ones. He suggests the major difference is that in traditional projects this contingency was at the client's disposal, whereas under a PFI project, that money does not appear to be explicitly catered for in the risk transfer calculations. Overall, he suggests that with risk being valued on a mostly subjective basis, this could lead to over estimation of risks, and hence over optimistic expectations of real benefits being achieved through such arrangements.
The influential Economist magazine noted that despite the United Kingdom Government embracing the idea of PPPs with enthusiasm,343
With the effective re-nationalisation of RailTrack this week, many are now asking if there are limits to the transfer of risk from public to private sector. In the wake of the RailTrack debacle, there is widespread concern that PPPs have not transferred risk to the private sector, and that the extent of the residual liability left on the government's books might not be obvious for several years.
The RailTrack case is complex but the important issue is that the House of Commons Public Accounts Committee decided there were limits to the transfer of risk from public to private sector, and described the rescue as a 'bail out'. The Committee 'condemned the fact that the taxpayer had been left to pick up the tab for a flawed deal that failed to transfer the risk'. Such judgements followed an earlier change in emphasis in Britain putting 344 'less emphasis on transferring risk to the private sector and stress[ing] instead the value of PPPs in mobilising public sector expertise for big projects'.
The Committee heard that the M2 contract in New South Wales (like Victoria's CityLink contract) 'precluded any government from taking action which reduces the flow of tolls, and compensation has to be provided'. And in contemplating the question of whether the costs of bearing such network risks are different if the government owns a road project compared with the private sector owning the project, it also heard that:345
For roads, I would argue that the risks that the government faces are lower because it controls the rest of the network. It can direct traffic 30 kilometres away, away from or towards the tollgate depending on signage, the length of stop lights, lane marking - all sorts of things. The private sector, knowing it cannot control the traffic flow as well as it should to be an owner of the road, charges for that risk.
see: http://courses.wcupa.edu/rbove/eco343/021Compecon/U.%20K/020326privat.txt , accessed 19 September 2006
The implication from this witness, therefore, was that too much had been paid for the decision for the private sector to inappropriately bear such network risks.
In the provision of vital services, for example, health, hospitals, education, prisons, courts, public transport, policing and water, risk cannot realistically be fully transferred because it is ultimately left with government. In the final analysis, the community and its citizens hold the government responsible for the provision of such basic human goods and services.
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338 J E de Bettignies and T W Ross, The Economics of Public-Private Partnerships, draft report, Vancouver: Sauder School of Business, University of British Columbia, 2003, p.12
339 Dr C Duffield, An Evaluation Framework for Privately Funded Infrastructure in Australia, PhD thesis, The University of Melbourne, 2001, p.100
340 G Hodge, 'Risky Business in Public Private Partnerships', Toward Public Value, conference paper, Melbourne, 24 November 2003
341 Mr B Sendt, (then) New South Wales Auditor-General, transcript of evidence, p.175
342 Dr R Arndt, Private provision of public infrastructure: Risk identification and allocation project, survey report, collaborative project, Department of Treasury and Finance, 1999, p.3
343 'Public v Private', The Economist Global Agenda, 26 March 2002
344 R Vincent 'New doubts over tube PPP uncertainty comes as Treasury shifts emphasis of PPPs away from transfer of risk', Financial Times newspaper, 28 October 2001, p.1
345 Mr T Harris, journalist and former New South Wales Auditor-General, transcript of evidence, p.133