Examination of Witnesses (Questions 100
- 119)
WEDNESDAY 12 APRIL 2000
PROFESSOR STEPHEN
GLAISTER, MR
DECLAN GAFFNEY
AND DR
JEAN SHAOUL
Chairman
100. Good afternoon. Can I welcome you to the
Committee and ask you first to identify yourselves for the record.
(Dr Shaoul) My name is Jean Shaoul and I am from Manchester
University, the School of Accounting and Finance.
101. Thank you.
(Mr Gaffney) My name is Declan Gaffney
and I am from the School of Public Policy, University College
London, research fellow at the Health Policy and Health Services
Research Unit
(Professor Glaister) I am Stephen Glaister, Professor
of Transport and Infrastructure from Imperial College London.
You should know that I was a member of the London Regional Transport
Board from 1984 to 1993 as a Non-Executive Director.
102. Can I thank you for that. Does anyone want
to open the batting by making one or two general remarks or are
you quite happy to go to questions.
(Dr Shaoul) Go to questions.
103. Just to questions. The other thing I would
say to you is where you agree perhaps silence will be taken as
consent and where you disagree if you would indicate where you
would like to make a comment, that would be helpful. Should the
PPP be abandoned at this stage because there are better and cheaper
options for funding London Underground?
(Professor Glaister) Let me start, chair. Whether
it should be abandoned at this particular juncture is a particularly
difficult question. As Members will know, for some considerable
time we have been arguing in several publications that there are
better options for reasons no doubt we will explore. We are at
a difficult place in the proceedings because the first bids have
come in and it would make sense to assess what those bids are
before we go any further. At the same time with the arrival on
the scene of an elected mayor very soon it will be somewhat problematic
to wait until the full appraisal of those bids has been made which
I believe will not actually happen until about this time next
year.
104. This time next year? So we are talking
about the spring
(Professor Glaister) April 2001. That is my own view.
Perhaps the London Underground people can appraise you more accurately
about that. There is a long way to go I believe in this process
because the bids have come in. From those are selected two preferred
bids. Then there is a negotiation. Then they put in their best
bid for real, as it were. Then the finally selected bidder has
to prove financial ability to support it and then there is the
signing of the contract. I think there is a long way for that
process to take. It would be possible for the government, if they
were to choose to do so, to say, "Let's pause for a moment,
hand this whole thing to the mayor"—because in my view
it is the mayor's affair—"Let he or she decide what
to do next including the possibility of carrying on with the PPP
process," but of course there are other options from that
point.
105. Dr Shaoul, would you want to comment on
that?
(Dr Shaoul) Yes, I am extremely concerned about the
PPP. First of all, I think it does not do what the public think
it is going to do. It is not going to provide substantial new
investment for the Underground. At best all it is going to do
is the day-to-day maintenance, the £1.2 billion backlog and
some minor upgrades. So in other words it really does not resolve
the problems confronting the Tube. It is merely going to stop
it from collapsing. That is fine. Clearly we want that, we do
not want it to collapse but it does mean you are looking then
at a very small aspect of what needs to be done and the particular
proposals that involve dividing and fragmenting the London Underground
into effectively four units which will have very complex legal
arrangements between them and London Underground and between each
other is going to make it very, very difficult to carry out the
real investment programme that is needed, new lines, extensions
of existing lines. How are they to be managed given the "ownership
rights" that will have to be given to the PPPs to carry out
the maintenance programme? If, on the other hand, they go to the
PPP companies as first bidders, then they have got London Underground
over a barrel. So I really feel that they have created very difficult
circumstances for other work to go ahead. I am also extremely
concerned because the division of the Underground into these four
separate units ahead of whether they have determined whether the
PPP is in fact good value for money effectively has pre-empted
that decision and it is going to make planning and co-ordination
and, above all, safety extremely difficult. By way of example,
Members, I should tell you that we asked the simple question,
"Can you tell us how many escalators are out of order?"
and we were told that it was difficult to get this information
because it meant going to three companies. I rest my case.
106. Who told you that?
(Dr Shaoul) It was asked of London Underground.
107. Management?
(Dr Shaoul) Yes.
108. I think most users of London Underground
would be able to tell you exactly the number of escalators that
are out of order. Supposing it was decided to implement a revenue
bond scheme, how long would that take. Professor Glaister?
(Professor Glaister) I do not imagine any of us are
precisely expert about the legal implications of that but my guess
would be that it is really a matter of will. If the government
really wanted to do it they could do it quite quickly. In the
paper we have published just today we have suggested exploring
the existing arrangements for trusts because we believe you do
need a watertight legal structure for the issuance of these bonds
and for the control and due diligence. The American model is called
the public benefit corporation and is well established. In British
law there are of course very long-standing arrangements for keeping
money in trust and raising money. Indeed, it was done in the 1930s
by London Transport. As far as I know the legal powers still exist
and anyway I think the local authorities have the power to issue
bonds, it is just a matter of getting permission from the Treasury
to do so. The government found ways of allowing bonds to be issued
for the Channel Tunnel Rail Link when it suited the circumstances.
My guess is (without being expert) that if the Government wished
to do it they could do it quite quickly.
109. How strong is the case for funding Underground
infrastructure entirely from either local or national taxes or
a combination of both?
(Professor Glaister) The traditional route in London
in recent years entirely has been through the Exchequer, through
national taxation. There is an issue of course as between national
taxpayers versus local London taxpayers and I think there is a
very strong case for London taking this into its own hands to
some extent. One of the reasons we have got imperfect transport
infrastructure in London is because the national taxpayer has
not been willing to provide adequate funds and I believe the truth
is we will not get that until Londoners are willing to pay for
what they want.
(Dr Shaoul) I feel there is a case for public funding.
Nowhere in the world are railway systems or metro systems able
to generate the fares that cover the full cost of both passenger
services, the infrastructure and the rate of return on capital
employed, ergo it has to come from some public subsidy.
The question that you ask is in fact, is it local or is it national?
In the case of the London Underground I would say there is a strong
case for some element of national funding, because this is an
asset that serves not just the people of London, but a much wider
ridership and a much wider public, as well as the question of
any possible integration into a national railway system at some
future date.
(Mr Gaffney) Can I add to that? On this question about
local taxation with regard to London, if one looks at the New
York and Paris systems, one sees clearly that the public element
of the funding of those systems is divided between national taxation
and local taxation, and this used to be the case in London. The
loss of that source of revenue to London Transport reflects the
centralisation of local taxation powers as a result of a long
war against local authorities.
110. We do not want to get off on that, Mr Gaffney,
or we will lose sight of our objective.
(Mr Gaffney) I simply make the point that the fact
that it is now funded through national taxation reflects the centralisation
of tax revenues.
Chairman: We understand that. Thank you.
Miss McIntosh
111. In a Sunday newspaper report this last
weekend there was a report that bonds could no longer be used
to finance the new metropolitan system. I do not know whether
that is because of the debt that has accrued on the amount of
bonds which have been issued. Why then should bonds be deemed
to work in this country if they do not work where they already
use them?
(Professor Glaister) That story in Sunday's Independent
was very, very close to a much longer and more substantial story
in the New York Times on 3rd April, and I suggest that
people who are interested should follow that story up. My understanding
is that what we are reading about is a regular five yearly debate
that happens in public, and in my view it is a very sensible and
mature debate about where they go for the next five years. It
is about what to do next and who is going to pay, whether it should
be the fare-payer or the City, State or the Federal Government.
The existing bond issue is not affected in any way. That is, as
far as I know, absolutely secure. What you see, in my view, in
this debate are all the elements that we should be having here
about a public agreement about what to do next, and you see audit
and comptrol going on. The audit and comptrol officials are making
sure that the public finances—the historical debt issue—is
not being compromised by what may be proposed for the future.
There has been a particular problem, which was reported, because
the State Governor has changed the commitment that has been made
in the past to put in State support and has basically withdrawn
that for the future. That is why there has been a big story in
my understanding. There is almost an element of negotiation going
on for the five year future funding. The City and the State are
both running quite substantial financial surpluses, mainly because
of the amount of wealth generated in New York City, and the MTA—Mass
Transit Authority—are trying to negotiate part of that surplus
for their benefit and they are saying that unless they get that
money they will not be able to fund what everybody wants.
Chairman
112. Your view is that it is a negotiation and
it is also a normal open debate?
(Professor Glaister) Every five years with a five
year planning process.
Miss McIntosh
113. If it does not work there, why should it
work here? Can I just carry that one step forward? If a bond system
was proposed and there was a shortfall between what the bond system
raised and what fares came in as revenue, what would your proposals
be to bridge that gap?
(Professor Glaister) I just want to answer directly
your very first question. It does work in New York. It has worked
spectacularly well in New York and continues to do so. They have
issued over $20 billion in the past to re-build their subway and
that is not in question.
(Mr Gaffney) The story in the Sunday Independent
I thought was providing a very partial account of what is happening
in New York and was really simply directed towards what is happening
in London rather than what is happening in New York. What it does
do, I suppose, is draw attention to the question of the underlying
sources of funding that are required for any financing mechanism,
whether that be a bond issue or the Government's PPP proposals.
It is not the case that in New York the entire cost of investment
is financed through bonds which are secured against fare box revenue.
A proportion—about 50 per cent of the bonds which are issued—are
secured against fare box revenue. The rest are secured against
hypothecated local taxation and quite a considerable amount of
the capital expenditure is funded directly by grants from state
and Federal authorities. What it draws attention to is the question
of what underlying sources of funding exist to back up any kind
of bond issue. When it is applied to London it may be quite easy,
from a legal point of view, to establish the kind of institutions
that would be able to undertake the borrowing, or even to undertake
borrowing under existing powers. The question of steady, stable,
predictable sources of funding to actually underwrite those loans
is something which is much more politically fraught because it
will require somebody, either government or the GLA, to say effectively
that subsidy will be provided to meet any shortfall.
(Dr Shaoul) I would like to make the point that those
issues will arise whether it is bond financing or the PPP, or
indeed normal government procurement, because the PPP implies
an affordability gap that will have to be bridged. Somebody is
going to have to make a commitment for 30 years to fund this,
because it cannot come out of the fare box. Secondly, irrespective
of the public sector comparator and the agreements, you should
be aware that although the agreement is for 30 years there is
a provision to renegotiate the infrastructure charge every seven
to eight years. If there is a failure to agree it—because
it is going to be the subject of negotiation—it goes to
the arbiter who under the Act is charged to consider the ability
of the companies to make an adequate rate of return, the agreed
rate of return. To me that means that effectively they will have
to see that in effect prices continue to rise. So whether it is
bond or whether it is the PPP, you are going to have an affordability
gap and you are going to have a running commitment that will have
to be made for the duration of 30 years.
Mr Forsythe
114. Does the Government's recent announcement
that the public sector comparator will be checked by the National
Audit Office reassure you that the PPP will be implemented only
if it is cost effective?
(Mr Gaffney) As I understand it the National Audit
Office will check the public sector comparator after the event,
after the contracts have been signed in the normal way. There
have been calls also for the National Audit Office to be brought
in at an earlier stage, before the contracts are signed, in order
to validate the exercise before commitments are entered into.
There are a couple of points about the role of the National Audit
Office in these exercises. First of all, it is not generally the
role of the National Audit Office to question government policy,
it is the role of the National Audit Office to check that government
policy has been implemented with efficiency and economy and so
on. The way in which the public sector comparator exercise is
carried out involves making assumptions regarding the interest
rates and regarding how you should deal with risk, which are themselves
to a large extent government policy. These assumptions, which
are what are likely to lead to criticisms of the public sector
comparator after the event, are precisely the kind of assumptions
that the National Audit Office is less likely to wish to address.
So I think the extent to which a National Audit Office evaluation
after the event will reassure people is limited for that reason.
The other point is that they do tend to agree their reports with
all the parties. They tend to seek the agreement of all the parties
before actually issuing a report. So the report would be likely
to be produced by consensus among the various interested parties.
115. Should the comparator test be published
before the PPP is awarded?
(Dr Shaoul) Absolutely. I would like to see it published
in advance. In my experience, I have never seen a PSC comparator
that in effect was not used to rationalise a decision. It is not
used as a decision-making tool. It is one of a number of criteria
that are used for PFI/PPPs. But the difference between this criteria
and all other possible ones is that it does give one numerical
number which therefore makes it easy to say yes or no, whereas
most of the others, to some extent at least, are qualitative judgments.
But there are other criteria—affordability, stakeholder
agreement, clear benefits to the users and so on and so forth,
so it is only one of a number but unfortunately it is the one
that has attracted most of the attention. As far as I can see
the most clear cut one was in the case of the Passport Agency
where it was very clear that the numbers of passports was 5.1
million, they had a contract for 4.4 million passports, the risk
analysis went up to 4.8. They made the point the higher the number
of passports the better value for money it was for the public
sector comparator but despite that and despite the fact it was
less than the 5.1 they had been dealing with for several years
they went for a PFI. That could only have been because it was
the only game in town.
Chairman: We do not want to get too involved
in that. First Mr Stevenson and then Dr Ladyman.
Mr Stevenson
116. I would like to examine the credibility
of London Transport's position here and start off with a question
to you all, namely will the PPP be capable of producing the cost
savings with the introduction of private sector efficiencies that
are claimed for? I have two or three questions that will follow
on from that but that is the first one I would like to put to
you.
(Professor Glaister) If I may link my answer to the
previous one. That is one of the judgments which is so important
to be done in the public sector comparator. It is absolutely critical.
That is why I would not myself worry too much about this being
done in public but that it should be done independently. The Government
have published their methodology for doing that in the last week
or so and I very much welcome that. It is a good document. It
seems to say the work will be done by London Transport and their
advisers and it will be audited by KPMG as an external group.
I would like to see the work done by an independent group because
of all these judgments we have been talking about. The particular
question you address, whether the cost savings will be delivered,
is a judgment. We all agree, certainly I agree that there is a
lot of cost to come out of London Underground. The question is
how best to do that. One of the questions for the comparator to
decide on is will these contracts-if they are signed-be enforceable?
As Jean has said, will it in fact come to pass that the cost reductions
will come out? On the other side of the same coin, if it is left
in the public sector why could not the public sector get a large
proportion of those costs through aggressive and repeated competitive
procurement? We all forget that London Buses have been competitively
procured since 1985 and it has been a phenomenal success in terms
of reducing cost.
Chairman: They have certainly been walloping
up their fares.
Mr Stevenson
117. In the light of time, I realise that time
is getting on, and I did say I wanted to get your view about the
credibility of London Transport's position in this vital area
because you have used the words it is a "matter of judgment"
and you would like to see it "independently assessed".
Let me pull a couple of points out of the information we received
from London Underground that bother me particularly in this vital
area. They have said that in terms of developing their PPP work,
the value of splitting infrastructure management from operations
has taken on a greater significance. Having each side of the business
focused on its key tasks of customer service and operation and
whole life asset management for infrastructure improves both performance
and efficiency. That may be a statement that sounds like motherhood
and apple pie, but I am just wondering how much credibility it
has and whether or not we are witnessing here a changing scene
in terms of London Transport's approach to this vital area.
(Mr Gaffney) One of the striking things is that this
has been going on now for nearly two years. The best evidence
in support of these cost savings that have been presented by London
Underground and its financial advisers was the rather slim document
issued by PricewaterhouseCoopers in December of last year which
simply asserted efficiency savings on the part of the private
sector without making any attempt whatsoever to prove they were
going to happen or suggest why they should happen.
118. That is very helpful.
(Dr Shaoul) Can I answer your point. You are saying
that London Transport have said that submitting the operations
into passenger service and infrastructure delivers the goods.
It is quite clear, because they admit it in the document they
produced ten days ago, that actually it has created additional
costs both in operational costs and it is going to create huge
extra costs in monitoring.
119. I have two quick points before I am stopped
to develop this very briefly. Another quote from their correspondence
to us: "We previously assumed that the majority of efficiency
benefits would be attributable to stable funding and an end to
annuality. We now think this is less significant and more benefit
will come from integrated whole life asset management. "As
a lay person I read that and think it sounds very comforting but
I wonder how credible it is. Whilst I am at it, so I am not stopped,
they also say: "We assumed in our report, in common with
many commentators, that the cost of capital was higher in the
public sector" and then they go on to indicate why apparently
it is cheaper in the private sector. I would put those two questions/observations
together to you.
(Professor Glaister) I fully accept the argument that
whole life costing is sensible and will save costs and many of
the features London Transport mention in the letter I fully accept.
The question is whether you cannot get that equally well in some
other way. What the PPP does is to bundle all of this into a single
set of agreements lasting 30 years. What I think would be much
more flexible and sensible and what any commercial business would
do is to separate the raising of the finance from the letting
of the contracts. You let the contracts for whatever length is
appropriate for that particular piece of work. You get your whole
life costs. That is what PFI is all about and I am not at all
opposed to PFI. It has been very successful in the right circumstances.
PwC and the government have produced the evidence that you tend
to get about 20 per cent cost savings from PFI. I fully agree,
but only if you have repeated competitive tendering and freedom
in labour markets.
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