It is time to count the real cost of public money?
Published 23rd August 2012
Anyone looking for proof that buying water is a better deal for the public sector than buying water infrastructure should look at the story on the cost over-run of Spanish water infrastructure in this week’s briefing.
On average the winning bidders for water infrastructure projects were able to earn an additional 30% on top of the value of their bids by piling on the costs after the contracts were signed. It is a game all construction contractors play given the chance: bid low and make a margin by over-pricing any contractual variations which may become necessary after the deal is signed. The 30% extra paid in Spain is probably low by international standards. Some commentators believe that the figure for the US may be over 50%. The design-bid-build model they use is tailor-made for expensive changes after the contract is signed.
Imagine now what would have happened if the Spanish used private finance for their infrastructure. Instead of buying the desalination plants and other assets with their own (or the EU’s) money, they would have bought just bought the water and paid per cubic metre for what was delivered. The private contractors would have had to take the construction risk, and you can be absolutely sure that they would not have allowed such massive cost over-runs.
The main reason why people in the US and elsewhere argue against the private finance model is because they think that public money is cheaper than private money. Private companies have to pay more to borrow and they need a margin of profit for their investors. Public bodies by contrast get low interest rates and are not required to make a profit.
What they don’t realise is the extent to which the public sector gets taken for a ride by private contractors anyway. The public sector still needs private contractors to build the infrastructure, and those private contractors make their margin through contract variations.
Private finance puts the lid on that kind of behavior for two reasons. First, because private contractors tend not to take themselves for a ride: if the same company is involved in the EPC (engineering, procurement and construction) contractor and the finance of the project any required variations are settled at the minimum possible cost. Second, because the scope for a contract variation on a large water infrastructure project is much greater than the scope for a contract variation on a cubic metre of water for the simple reason that a large infrastructure project is a lot more complicated than a cubic metre of water.
The other side of the issue is the real cost of public finance. Public money is cheap to raise because it comes with a sovereign or quasi-sovereign guarantee. That means is that it is backed by investors (i.e. taxpayers) who are locked in to paying their dues by law. Private money is more expensive because shareholders are not locked in by law. If they don’t like the way their investment is going they can sell their shares and walk away. This may make public money cheaper than private money in the technical sense, but when you consider the anger of the tax payers who are locked in to paying for it, it doesn’t look cheap at all.
In fact if politicians around Europe and North America had realized the real cost of “cheap” public debt, the world might be a much happier place today.