Based on current examples, it is simply not possible to state that P3s are more cost-effective than traditional public capital and service provision.

While in a P3 the private partner is responsible for securing private financing, the government ultimately pays the entire cost of the project in the form of contractual liability. In short, P3s do not help government to avoid long-term financial obligation. The real issue is whether involving a private partner lowers the total cost of a project through enhanced efficiency and innovation.

Since P3s are for-profit deals, the government must cover the cost of the project itself and the private partner's profit margin. Governments borrow at cheaper rates than any private company. How, then, can a privately financed project be cheaper than traditional public financing?

Are P3s Cheaper Than Public Service Provision?

Evidence shows that P3s are simply more expensive than public projects.

There are numerous examples of P3s exceeding the cost of public development. The Confederation Bridge between New Brunswick and PEI was constructed under private financing, and the government will make payments of $41.9 million (in adjusted 1992 dollars) per year for 35 years. Canada’s Auditor General found that the bridge cost $45 million more than it would have if it had been built publicly.

Ottawa built two arenas using P3s four years ago. In April 2007, city management recommended a $1.2 million bail-out for the Bell Sensplex, a four-sheet rink, and termination of the City’s other partnership, the Ray Friel Recreation Complex, leaving Ottawa  with an additional $12 million in debt. The Sensplex project required additional subsidy despite the City having waived property taxes, guaranteed the construction costs, and purchased 2400 hours of ice time a year. Serco Facilities Management, which operated the Ray Friel Complex before it was taken over by the City, drastically underestimated its operating costs and told the City it required an extra $2 million a year. The unanticipated debt will cost taxpayers $2.4 million a year.

In 1998, Guelph entered a DBFO contract with Nustadia Developments to provide a downtown arena. In 2001, the City was forced to take over Nustadia's loan when the company was unable to make payments, at a cost of almost $4 million over four years. In 2005, Nustadia walked out on the deal completely, leaving Guelph with $9 million in unanticipated debt.

If a P3 contract is to provide an incentive for innovation and cost reduction, the deal must allow the private partner to retain a large portion of the cost saving. In other words, even if the private partner reduces costs considerably, the private sector retains most of the benefit. In 1994, Hamilton-Wentworth entered into a 10-year, $180 million P3 agreement with Philip Utilities Management Corporation (PUMC) for the management and operations of its water facilities. The contract stipulated that PUMC receive the first $1 million derived from any cost-saving measure, and 60% of additional cost savings. PUMC’s gross profits over the first half of the deal are estimated at $4.8 million per year. Hamilton-Wentworth did not renew the contract when it expired.

In Britain, P3 arrangements (called PFIs) have adopted periodic market testing and price benchmarking of services to stabilize and reduce costs. A recent report by the House of Commons Committee of Public Contracts shows that in fact, this process has in practice increased costs by an average of 14%.

P3s are also often accompanied by increased user fees, meaning that the cost to the public is even greater than the sum of the contract. It is often argued that user fees can improve financial flexibility by allowing service prices to reflect the actual  cost of service provision, and that it is fair for the users of a service to pay for its cost. However, such an argument is not appropriate for services like schools, major arterial roads, or community recreation centres, all of which should be freely accessible to all citizens.

P3 supporters argue that even if the cost of a P3 is higher, the government's payments are contractually fixed, meaning that the government has cost-certainty, and any unforeseen cost increases will be borne by the private company. In reality, however, in P3s it is still the government partner that bears the greatest risk. To learn more, click the link at the bottom of the page.

TD Bank admits that P3s are at face value more expensive than public provision, but argues that spending on P3s has a greater positive impact, because P3s provide a stable, high-return investment for pension plans. However, this obscures the fact that public sector projects may provide an equal or better investment. A recent Statistics Canada study indicated that spending on public infrastructure projects generates an average yearly return of 17% in savings for Canadian businesses, a rate better than the return on the vast majority of private projects.

How Do Private Partners Reduce Costs? P3s and Reduced Quality of Service

By entering into a P3, government surrenders immediate control over the quality of service provided. The challenge here is that there is a fundamental difference in the goals of the public and private sectors. Private partners can be contractually obligated to meet certain quality benchmarks, but their primary interest will always be to keep costs as low as possible, and governments have limited options if they are dissatisfied. When the service in question is a massive infrastructure project like a roadway, school or recreation complex, it is extremely difficult to replace a service provider, and therefore difficult to hold the private partner accountable.

The Hamilton-Wentworth water services P3 with PUMC was plagued by serious quality and accountability issues. In 1996, a major spill occurred at a PUMC pumping station, flooding 115 houses and businesses. The Regional Authority and external consultants all determined that PUMC was responsible for the spill, but the Regional Authority paid for all damages, deciding against a lengthy and expensive legal action against PUMC. PUMC also frequently failed to meet provincial water treatment guidelines.

The Audit Commission of England and Wales conducted a review of 17 P3 schools constructed in Britain since 2001, and found that P3 schools were of lower quality in terms of space, lighting, acoustics, heating and ventilation, and there is no indication that the P3 schools were delivered faster.

P3s are supposed to protect governments from cost overruns or labour shortages, but it is under precisely these conditions that private partners are most likely to provide low quality service. If at a certain point the private partner has recovered its initial capital investment, and current costs are higher than initially projected, the company may become reluctant to perform costly maintenance or capital upgrading. This means that when the infrastructure is transferred back to the government at the end of the contract, the public will be forced to meet these costs. It may even be advantageous for the private company to abandon the agreement, as occurred in Guelph.



More:

Risks to the Public Partner: P3s Are Not a Low-Risk Option

How P3s Erode Transparency and Accountability

Loss of Flexibility: P3s Reduce Public Control Over Services and Planning


Get Informed and Take Action

Current P3 Projects in Alberta: More Expensive, Less Effective