P3s for Dummies: Part I: Protecting against giant Gila monsters

We’ve noticed that our posts about P3s – public-private partnerships – tend to be of less interest than others. We hope it’s not because our readers are less interested in how billions of dollars are being squandered at a time when front line health care workers are facing layoffs, but because your head goes numb around all the technical mumbo jumbo from issues of risk transfer to value-for-money comparisons. Trust us, slogging through this stuff is hardly fun for us either.

So, we thought, better make it fun and educational because these P3s are eventually going to come around and bite us all on the bum as they presently are in Britain. Ouch!

Here is our sly attempt to describe in really basic terms what’s going on and why we should all be concerned.

What is a P3?

This is the first problem with P3s – there is no hard definition of one. Just to confuse the heck out of everybody, Ontario decided they weren’t doing P3s at all, rather they were engaged in Alternate Financing and Procurement (AFPs). It occurred to them that some people might put together all these news stories about P3s gone wrong and start to question why Ontario is still charging ahead with them, especially when Dalton McGuinty and company actually campaigned against two Tory-inspired P3 hospital deals in 2003. Whoops! Just to make matters even more confusing, in Britain, the birthplace of such schemes, they call them PFIs – private finance initiatives. At least the Brits had the decency to realize there’s not much public about these projects.

P3s are essentially the privatization of public infrastructure. Of course the Conference Board of Canada insists this is a myth, that the public technically still owns these structures (even if they don’t fully control them) or if they don’t, will get back ownership of these building after the contracts are up and the buildings are towards the end of their useful life. How reassuring! Then, of course, they can be P3’d all over again!

The Conference Board even goes so far as to suggest we can get out of these P3s at any time, but omits what the financial penalties would be.

P3s usually involve private financing, which everyone admits is much more expensive than what government pays to borrow money. Imagine what a 1 per cent difference on your mortgage would look like. Now imagine a mortgage on a $700 million dollar building. You get the idea. Hands up all those who believe we should pay a higher rate of interest on the mortgage of our public infrastructure? Okay, all you bankers, put your hands down now.

The Risk of Giant Gila Monsters

The pro-P3 business community love P3s because it makes them very rich, but they have a problem. When you compare the costs, the P3 method always end up costing much more. So they invented something called “risk transfer.”

Risk transfer works something like this:

You want to buy a $35,000 car that will take four months to be delivered from another country. The dealer quotes you a price, but suggests it may not be the final price. You might, for example, change your mind and decide to have leather seats rather than vinyl, or a GPS installed, or a radio that gets the AM frequency. Or maybe dingle balls! That would be extra and could raise the cost of your final car. The foreign exchange rate could also vary, the rise or fall of the Canadian dollar determining the final price. These and other costs are unknown and the dealer doesn’t want to assume them if they come to pass.

Along comes a private business person and says “pssst, hey kid, I can give you a guaranteed price on that car, and not only that, but we’ll guarantee you’ll get it in four months. We’re offering you price security.”

You remembered that it cost you more than you were counting on last time and your spouse got quite cross with you. “This has potential,” you think.

The person tells you for $70,000 his business consortium will guarantee both the price of the car and the delivery.

“But that’s double the cost!” you protest. “How can you possibly justify that?”

“Well kid, you have no idea of the risks,” the business person says, twirling his black mustache. “The Canadian dollar could rise, workers at the factory could go on strike, the price of steel could swing upwards, or a giant Gila monster could rise and eat your car before it ever arrives. Who would pay the cost? You!”

“I’ve heard of those giant Gila monsters,” you say, rubbing your chin.

“The cost of all that risk is $50,000 – it says so right here,” he says tapping a sheet of paper, “by a bona-fide company we hired to say so right here. So the car is actually much cheaper this way. This is far more efficient. Not only that, but we’ll manage the car for you, all you have to do is drive it.”

“I bet my spouse doesn’t know about the giant Gila monster problem,” you say. “This looks good.”

Four months later the car doesn’t arrive. You call the guy.

“Well you did order the air freshener after the deal was made,” that delayed the project, especially after we had to spend weeks resolving the cost of that air freshener with the lawyers,” he says.

“But Shoppers Drug Mart had a sale on air fresheners,” you say. “I don’t know why I couldn’t have just gone out and bought one myself.”

“You can’t do that!” shouts the business person, “You signed a contract with us and we control all aspects of that car. Our contract says you are only allowed to drive it.”

“Oh yeah, right,” you say in a deflated tone.

Two weeks later you get a call from the business person.

“Bad news,” he says. “A giant Gila monster ate a whole boat load of these cars, and we can’t afford to cover the loss. The good news is we have sold the contract we signed with you to another business consortium, and they’ll take care of you. It’s out of our hands.”

“But what about my car?” you ask.

“It’s over there, albeit we had to provide you with the smaller model. Couldn’t be helped. Gosh those external factors!”

“But that’s a Lada,” you say.

Think this is a bit far-fetched? This is exactly how the P3 process is justified.

The Conference Board of Canada, which is pro-P3, had to acknowledge that the first wave of P3 projects did not turn out so well.

Regarding risk, this is what they had to say (warning: some mind-numbing language ahead): “Some first wave P3 deals did not succeed in fully transferring financing risk to the private consortium, although the projects in question relied on private financing (eg. Confederation Bridge). In such cases, the public sector owners incurred the higher cost of private financing (relative to public sector debt financing) without arguably enjoying its full benefits.”

Not only that, but the other big justification for these projects, that it would take the costs off the government books, turned out not to be true. Somebody should tell this to Kingston MPP John Gerretsen, who still believes such schemes are the only way to afford public infrastructure.

Again, this is what the pro-P3 Conference Board had to say: “First, the off-balance-sheet treatment of public sector liabilities was a widespread practice in the first wave P3 projects. The Confederation Bridge and Highway 104 (Nova Scotia) projects are two prominent examples of such public sector accounting treatment. However, this practice reduces the transparency of public sector accounts and provides no economic value. (emphasis added) Further, the extra effort required to structure an off-balance-sheet transaction arguably leads to higher transaction costs and thereby destroys value. Fortunately, this accounting practice has been abandoned in the second wave of P3 transactions.”

Don’t worry, says the Conference Board, because we’re now engaging in “P3s phase two.” In other words, now that provincial and federal governments have set up their own biased pro-P3 infrastructure agencies, we’ve figured this all out now. Criticism of the first batch may have actually turned out to be startling accurate, but trust us now. Is that Lada really so bad?

Part II next week! P3s versus the public interest

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