October 2, 2005

The idea of Public Private Partnership

Posted in Politics · 3 comments ·
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The idea of �appropriate� owners is a strange one. Can one owner of an asset be more appropriate than another? Surely not. All owners, if they take the commercial risk, weigh up the alternatives and plunge in are �appropriate�. However, the news on Friday that the Minister for Education plans to use the public private partnership (PPP) route to finance schools, does raise a few crucial issues mainly around the �appropriateness� of new owners.

Before we begin, let us clarify that there is nothing ideological in the following argument. There is nothing whatsoever wrong, or inappropriate with the private sector investing in education. In fact, one of the greatest travesties in the past fifty years in Europe has been the dead-hand of the state weighing down on our education system, particularly at third level. For example, how many Nobel Prize winners lecture in European universities? Seven. There are eight on the staff in Berkeley, in California, a university that is not even in the US�s top ten. So the private sector in education works and works well. If you doubt this, just look at the popularity of our private grind schools.

That said, the half-way house of PPPs in education is unusual for a number of reasons. First, PPPs are not cheap. As the state can borrow cheaper than any individual or company, it would seem that using PPPs as a way of financing public infrastructure is more expensive than allowing the government to raise the cash itself. So the reason cannot be purely financial. The other typical incentive for involving the private sector is that there is a feeling that the management of the schools will be more professional under non-public service management. This may be the case, but as far as we know the new PPP-financed schools will still be under the department of finance�s remit. It is unlikely that management of schools will change.

So why is the department doing it? Well, there is always the worry that PPP is just another fad, a buzzword that generates fees for those paid to put the deal together. But, without ruling that out, let�s not be so cynical. Let us assume that there is another reason.

A few months ago, I attended an interesting conference on financing the future of our health service. Healthcare is now one of the sexiest areas in financial markets, particularly in the UK where PPPs have taken off. Investors thronged the room listening to English healthcare entrepreneurs wax lyrical about the opportunities for small and large investors. There were also hedge funds represented who had bought British nursing homes and were in the process of extracting as much yield out of these assets before floating them on the market. This is a nice term for flogging the assets on to the next punter. So much money was flowing into these specialist funds that they were hard pressed to find homes and clinics to buy, let alone hospital projects to build.

Looking around at the audience, there appeared to be a predominance of builders and land speculators. These people have made out like bandits in the great Irish land rush and now, sensing that the good times might be over are trying to diversify. There was a large sprinkling of men who own large land banks around our major cities that were not being rezoned for development and if they were rezoned for hospital use this would generate value for the owner.

For an investor like this, PPPs offer a risk free bet. In fact, it operates like an underwriting service. The investment via a PPP offers the investor a return well over the rate of interest. What is more, that return is guaranteed by the state for a defined period after which the investors will either get their cash back (plus a premium to take into account inflation) or be allowed to roll-over and invest again.

If you were sitting on a large profit from land deals and you had the choice either to pay tax (ie give the state money) or else invest it all in a PPP (ie get the state to give you an annual yield on the money you were supposed to pay in tax) what one would you choose? To some this could be regarded as government-inspired tax avoidance. However, this interpretation, although not entirely untrue, would be far too narrow.

But there is a problem with PPPs and it is the inappropriate owner problem. If new investors are former property players who want to diversify, they will have to get used to a world where yields are fixed and capital gain is modest. This is therefore a process of managing expectations downwards. Initially, this might be easy but over a few years the investors are likely to get restless. Anticipating this, the stockbrokers are likely to put together PPP closed-end funds that can then be traded. This liquidity allows the original investor to get out by selling units of the fund to the next guy. If the UK experience of the health funds is repeated here, the brokers simply design the �next big thing� and advertise it as a smart way to mop up your maturing SSIA windfall next year. The state simply end up paying out a yield over and above that which can be generated by the school in question. But wait a minute, how can a school generate a return if it is only half private?

And here is the inherent contradiction in PPPs, they aim to give private sector yields (over the rate of interest) for public sector (or no) risk. So the investor gets all the upside, the public gets none. In addition, where will the cash come from to pay the investor? Presumably, from the department of education�s budget. Will it therefore be redirected from school books, computers or relief teachers� salaries? Probably. So will we gain? The jury is very much out.

It would be far smarter to go the whole hog. If the state wants the private sector to be involved in financing schools, then – like the newly emerging private hospitals – these new schools should be entirely private. The investors therefore take normal commercial risk, for normal commercial reward. PPPs merely underwrite private money with public pledges which is not a good deal for the country. If we had all private schools, the pupils pay through the nose for their private education and the money saved is ploughed back into the state system. Half-baked ideas like PPPs rarely offer wholesome solutions. Given that the primary education system is so crucial for our society, a bit of basic joined-up thinking to go with the elementary joined-up writing is not too much to ask.


  1. Sean

    David,

    What educational benefits is there going to be for Irish
    kids if the government decides that the dept of education is
    going to be funded by PPPs?

    Funny that the land owners & builders are keen to get in the
    action, they’ve made a lot of money on the back of people’s
    basic needs to to have shelter, and now it seems that
    they’re keen on making a fast buck on the people’s
    necessity to be educated.

    I think it’s a bad idea where parents are going to have to
    fork out a fortune for an education for thir kids. The
    course material is going to suit the whims of the real
    investors in education. Who needs science & English skills
    when one needs a kiss up & kick down attitude to survive. A
    national school education is more than sufficient to be
    entertained by crazy frogs and Pop idol. Irish kids will
    need to be educated to a standard so that hey can compete
    with kids from India & CHina, For some reason I dont believe
    that the a free market in education is the reason behind the
    success of India & CHina.

  2. will

    David,

    I firmly believe in the introduction of ppps into the
    Irish education system.Especially at third level, as we
    have already seen the success of the private grind schools
    in Ireland, which continue to out score state run schools
    in the leaving certificate, and produce students for the
    top universities in the country. And if people were willing
    to invest in their childrens education and invest in the
    future of the economy, and have Irish universities compete
    with American universities on an international basis rather
    than have Irish students go abroad for further education
    and end up working abroad i.e. ‘brain-drain’ . It would
    evidently be a more costly system of education but in the
    long run be a more beneficial for Irish companies, and thus
    look to indigenous firms for future growth rather than
    again rely on American multinationals.So in the long run
    ppps are the way forward to higher education standard for
    Irish students.

  3. [...] David McWilliams had to say 12 months ago, 24 months ago and 36 months ago. October 2nd 2005: The idea of Public Private Partnership [...]

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