Public responsibility - public schools

It is time to re-examine the financial underpinnings of Public Private Partnership (PPP) ideology. Hot on the heels of Sydney’s Cross City Tunnel debacle, the New South Wales Auditor-General, Bob Sendt, has released a report that casts a very large shadow over the supposed economic benefits of privately financing and maintaining public schools.

It appears that the New South Wales Government does not know, with any degree of certainty, how much it would cost to perform the same function in the public sector. Any attempt to say that private sector control is cheaper is now fraught with danger.

Since bids for corporate control of new public school buildings and facilities were first sought in October 2001, contracts have been signed for nineteen New South Wales schools, with nine now completed and operating. Ten are in the planning or construction phase. The private enterprise operators are responsible for financing, building and maintaining these schools to performance standards specified in secret contracts. After 30 years of operation, the school buildings will revert to public ownership.

The argument for this radical departure from public responsibility for public school facilities is that the private sector can deliver outcomes more cheaply and can better handle the economic risks. This is counterintuitive given both the private sector’s higher cost of borrowing capital and the profits paid to shareholders. Nonetheless, it is the ruling economic orthodoxy in the New South Wales Treasury and in many other parts of Australia and the world.

At the heart of the argument is a financial model referred to as the Public Sector Comparator, which estimates the costs of publicly financing and maintaining schools over the 30-year life of the contract. This figure is then compared to the amount of money corporate bidders are asking to deliver the same service. Lower private sector bid costs are then used to demonstrate that PPP schools are cheaper than public sector ownership and maintenance.

Buried within the Auditor-General’s performance report The New Schools Privately Financed Report released on March 8, 2006, is an alarming analysis that exposes the Public Sector Comparator as unreliable and suspect.

The report shows that relatively small changes in assumptions produce massive variations in the estimate of public sector costs, suggesting that the model cannot make reliable predictions. Similar changes did not affect private sector bids to nearly the same extent.

This undermines the entire economic argument for PPP schools. A basic axiom of all mathematical modelling is that outputs should be robust to small changes in inputs. If this is not the case, then small but inevitable errors in forecasts of factors, such as interest rates, wage growth and insurance costs, will render meaningless any prediction made by the model. This is exacerbated by the long contract lives of PPP projects such as schools where predictions are being made 30 or more years into the future.

The Auditor-General observed that the “public sector comparator is very sensitive to the assumptions that are made”. Many of these “assumptions” are forecasts of factors affecting the costs of running a school over the lifetime of the contract. Any such forecast is inherently subjective and hence open to debate.

The Auditor-General compared the performance of the Public Sector Comparator for the two sets of public schools for which contracts have been let. While each contract was for nine similar schools, the Comparator estimated a cost for the second set that was $52 million greater than for the first.

The New South Wales Department of Education and Training attempted to explain this 36.7 per cent increase in estimated public sector costs in terms of factors such as “higher market volatility”, “higher risks associated with site investigations” and planning and insurance costs. The Auditor-General omitted to mention that these same factors would also equivalently affect the private sector but that the contract cost (that is, the amount paid to the private providers) only increased by 13.2 per cent between the two sets of schools.

The report also criticised the way in which the Comparator treated economies of scale. In particular, the methodology did not allow for any efficiency gains in maintenance costs that might be made within public sector management by bundling together facilities services for the nine schools.

The Comparator is thus highly biased towards the private sector. The Auditor-General came to the remarkable conclusion that this “made it unlikely that the public sector comparator would ever be lower than the private sector’s PFP [Privately Financed Project] bid”. In other words, the Public Sector Comparator is unreliable and biased towards private projects.

If the costs of building and maintaining a school in the public sector are unknown to any degree of certainty, then the comparison to the private sector bids is unreliable. It could well be that publicly financed and operated schools are cheaper in the long run. It could also be that the same problems beset motorways, public transport projects and hospitals, all of which are candidates for PPP projects. If that is the case, the community would have sacrificed the benefits of public ownership to dodgy modelling and discredited economic ideology.