What New York Can Learn from Britains Rail Fiasco
Public-private partnerships have real benefits, but theyre no substitute for government competence.
13 January 2013
When an American state or city wants to build or run a commuter-rail service or toll road, it usually does the job itself, with some help from Washingtons coffers. But in Albany, the states political leaders havent controlled their spending enough to make enough room in the annual budget for investing in roads, bridges, and transit. The states quasi-independent public agencies also lack the money to do this work. Over the next two decades, the state and local agencies responsible for New Yorks transportation assets face $89 billion in capital shortfalls, the state comptroller reported last month. With the state itself facing a nearly $1 billion budget gap next year and a gap of $3.6 billion, or 5.5 percent of spending, the year after that, road and transit users can hardly expect the state to increase infrastructure spending.
Thats why some state politicians, including Governor Andrew Cuomo, are looking to public-private partnerships. More common in Europe than in the U.S., such partnerships represent a departure from how America traditionally builds and operates its physical assets. The arrangements require, for example, that private-sector firms take some long-term responsibility for an infrastructure project. A private company may contract to build, maintain, and operate a toll road for 30 years, shouldering the risk, say, that shoddy construction work generates high maintenance costs, or that lower traffic numbers result in lower revenues.
Most important from cash-strapped states perspective, private-sector partners usually raise their own money to build or upgrade projects, avoiding official government debt. In New York, state senator Charles Fuschillo, Jr., a Republican from Merrick and head of the state senates Transportation Committee, rolled out a bill a year ago to legalize public-private partnerships, citing the states multi-billion-dollar budget deficit and deteriorating transportation infrastructure. The bill, which would allow the state to enter long-term partnerships, has support from the states business council, contractors doing business in the state, and the operating-engineers union.
Though Cuomo hasnt supported specific legislation, he said last year that he would endorse public-private partnerships to leverage capital investment—twenty private-sector dollars to every public dollar to improve or replace bridges and roadways. The Port Authority, which can operate without state legislation, likely will rebuild its Goethals Bridge working with a long-term public-private partnership, partly because its up against the limits of its own ability to borrow. Its certainly worth seeing if the Port Authority can save money through this arrangement, with a private operator of a new Goethals spending less money per year to operate the bridge once its completed, for example.
But before New York goes all in on these partnerships, legislators should take note of the potential problems, so as best to prevent them. Britains latest fiasco with its privatized passenger-rail system offers a case in point. Last August, the British government announced what seemed like a dream come true: it had found a private-sector company, First Group, willing to pay the equivalent of $8.8 billion over a 13- to 15-year contract to provide new trains, better service, and upgraded stations for the busy rail line that runs down the U.K.s West Coast from Scotland to Central London—and all for lower anytime fares, too. This new franchise will deliver big improvements for passengers, said Theresa Villiers, Prime Minister David Camerons rail minister.
But one losing bidder wasnt having it. Virgin Trains, run by Richard Branson of hot-air balloon and Virgin Atlantic airline fame, claimed that the government had made serious errors in its selection process. Bransons main complaint was that First Groups estimates of revenues, based on growing numbers of business-class travelers, were unrealistic. Thus, there was a risk that First Group, in a few years time, would have no choice but to default on the contract, leaving the government in limbo. Indeed, as Branson pointed out, another big operator had done just that in 2009, with an earlier contract for the main East Coast rail line, as did one large private operator of the Tube in 2007.
A month and a half later, the government conceded that Branson was right. In October, the transportation ministry abruptly announced that the contest results were cancelled following the discovery of significant technical flaws in the way the franchise process was conducted. The secretary of transportation, Patrick McLoughlin, apologized for his departments deeply regrettable and completely unacceptable mistakes. McLoughlin promised to reimburse the bidders $64 million. He also promised to conduct multiple internal and external reviews.
The problem, it seems, is that government bureaucrats screwed up their calculations. Bidders are supposed to put up a bond to reduce the governments costs in the case of default. But transportation officials may have misjudged the risk level of the winning companys bid and thus miscalculated the amount of money the company would need to provide up front. Allowing the bidder to put up less cash thus improperly favored its bid. Or, as the Daily Mail put it, civil servants . . . realised their computer models were wrong. The ministry cannot even find some crucial supporting documents.
Everyone makes mistakes, but the experience points up a truth about public-private partnerships: they dont obviate the need for government competence. In fact, the model requires more government competence. The private sector is efficient because competition weeds out inefficient players. A solitary rail line, however, faces no competition, so the government must ensure that passengers get the bang for their buck by writing up hundreds of pages of specifications. Indeed, the Cameron government defended itself from criticism, as the Mail reports, by saying that the model used by officials was incredibly complex and it is totally unrealistic to expect [high-level] ministers to have grasped that level of detail.
In a contract spanning more than a decade, lots can go wrong, because little mistakes in forecasting compound over time. Further, the government cutbacks that privatization encourages can work against good contracting, as fewer experts are working for the public rather than its partner. A private-sector company cant print money or make a rail route profitable when it isnt. The higher the bid, the higher the fares for passengers, as Branson pointed out. The government takes some of the money that bidders on profitable lines pay and uses it to help subsidize bidders on unprofitable lines—just as, in America, Amtraks profitable northeast corridor helps subsidize money-losing rail service elsewhere.
The no-free-money maxim holds true for roads as well as rail. Last month, George Osborne, Britains chancellor of the exchequer (roughly the equivalent of the U.S. Treasury Secretary), said informally that he wanted private companies and investors to upgrade Britains motorway system. The catch? The government would start charging drivers to use currently free highways. Cameron hasnt yet embraced the idea; senior political leaders rightly sense that voters would view the new fee as yet another tax.
Opacity and complexity, too, can breed media complacency. Britains financial media, for one, mostly dismissed Bransons initial concerns about the rail bid, accepting the governments implicit suggestion of its complicated, so trust us. In response to Bransons careful analysis of the flawed bid process, the Financial Timess editorial page tagged him a sore loser who was seeking to have the rules redrawn retrospectively so as to give Virgin a second bite at the cherry. The FT didnt admit it was wrong until after the government had canceled the deal. Absent the force of someone like Branson, whose fearlessness has extended to taking on British Airways, Britains national-champion airline, its easy to imagine that the government would have gotten away with the bad deal it signed for passengers and taxpayers. Large companies are often wary of taking on a government with which they hope to do future business.
As New York and other states plunge into public-private partnerships, they should take away a few lessons. First, the longer and more complicated a deal, the more room for error. Thats why, for example, Nassau Countys recent privatization of its bus service—formerly provided by the MTA—to a French company, Veolia, is a better deal than the British rail franchise. Nassau County is hardly known for government excellence, but under a five-year deal in which the government takes little risk, the worst that can happen is that Veolia performs poorly and Nassau comes back to the MTA. Second, beware of a winning bidder that all but promises to solve your problems. Like anything else, if it looks too good to be true, it probably is.