Examination of Witnesses (Questions 120
- 126)
WEDNESDAY 12 APRIL 2000
PROFESSOR STEPHEN
GLAISTER, MR
DECLAN GAFFNEY
AND DR
JEAN SHAOUL
Chairman
120. You are saying neither of those will apply?
(Professor Glaister) Correct.
Chairman: Thank you. Dr Ladyman?
Dr Ladyman
121. Two questions, the first one to Dr Shaoul
and Mr Gaffney. In your supplementary evidence to the Committee
you seem to indicate that the distorting factor in the public
sector comparator is being removed by the fact that it is going
to be a comparison against bond issue with the revenue being spread
over a period of time. That seems to me a positive statement about
the fairness of the public sector comparator, which is later contradicted
by pretty much everything else you say. Would you clarify your
position on that.
(Mr Gaffney) I do not think it is contradictory. What
we said was "subject to the reservations below", is
the phrase we use in the note, that this did remove a distortion
from earlier public sector comparators. The technique used in
all economic appraisal of PFI schemes is one which is based on
discounted cash-flow analysis where expenditure which is scored
in later years counts for less than expenditure which is scored
in earlier years. By convention public sector procurement capital
costs tend to be allocated to years in which the expenditure actually
occurs rather than treated as being spread out. Basically you
assume that government or the public sector cannot spread its
costs through borrowing and when it comes to, for example, NHS
hospitals where you might have costs of £100 million in the
first two years with the public sector contract which are spread
out over 30 years of a PFI contract, those two things together
constitute a distorting mechanism. You front load the public sector
expenditure and then discount it at a discount rate which is also
regarded by many people as being far too high anyway. The reservations
to that were, first of all, that there would be a lot of subjective
elements in the assessment of the cost and risk, and this has
been another major distorting factor in previous PFI economic
appraisals. A major reservation, which related to an ambiguous
passage in the document issued last week concerned the cost of
finance under the bond issue where the authors of the document
say that the interest rate on a bond issued by London Underground
could be expected to be at a certain level. However, it implied
that this did not capture the full cost of capital in that instance
and, therefore, that they should use a different rate, which would
have been up to 2.5 per cent higher, in order to fully reflect
the cost of capital. I cannot see in that document any argument
which would support raising the interest rate in this way. It
is implied that this is to take account of the cost of government
guarantees on any bond issue by a public authority. As far as
I can see, there is no extra cost which would justify raising
the interest rate in that way, and that is a major reservation.
122. Professor Glaister, we have just been through
a fairly traumatic experience with the Jubilee Line, where the
cost was much higher than expected and the project took a lot
longer than it was hoped. To what extent is it reasonable to assume
that the PPP would eliminate, or have eliminated, that sort of
cost over-run and time over-run? Therefore, to what extent can
we learn from the Jubilee Line experience what assumptions are
appropriate when we do our public sector comparator?
(Professor Glaister) There are a lot of issues in
that question. The first observation I would make is that the
Jubilee Line Extension was finally sorted out by the employment
of Bechtel as independent management consultants. That is exactly
the kind of procurement of service within the public sector which
I would see being perfectly available to a Mayor if the whole
thing stayed within the public sector. Secondly, there were all
sorts of reasons why the Jubilee Line Extension over-ran. One
of the difficulties was that that was a big contract where the
contractors were not able to deliver what they promised, for all
sorts of reasons, and they were in a very strong position to extract
more money from the public sector to finish the work. I see that
as being precisely the kind of position that the PPP would risk
putting the Mayor and the Assembly into with a 30 year contract,
with a first review only after seven and a half years. It would
be very difficult to enforce these contracts rigorously were the
contractor to fail to deliver. So, yes, I think that there are
things to learn from the Jubilee Line Extension and I do not think
it is all one way, it is a lesson on both sides of the argument.
(Dr Shaoul) I would like to get you to consider that
the finance initiative has had similar problems and yet the contractual
relations are very similar for the PPP. You have only to think
of the Benefit Agency contract where Andersons Consulting ended
up with a fine of £3.9 million, and yet the Government is
out of pocket to the tune of hundreds of millions of pounds. It
is not at all clear to me—and I have looked at some of the
legal contracts and legal issues—that these contracts are
going to be enforceable.
Chairman
123. I do not want to go backwards. I think
we have a clear picture now.
(Dr Shaoul) The answer to the question as well is
that the Jubilee Line was concerned with very difficult tunnelling
work and most of these tunnelling projects face problems. You
have got to remember the PPP. We are talking about a large number
of relatively small scale projects which are quite different to
manage.
Dr Ladyman
124. Are you saying that the sort of practical
experiences that people like Professor Currie are using in order
to back up assumptions for the PPP are not real factors that we
ought to be considering and that there is nothing that we can
learn in that way in order to build in those assumptions?
(Mr Gaffney) You referred to what we can learn from
the JLE with regard to the public sector comparator. I have a
grave concern that when it comes to design the PSC, London Underground
will learn far too much from the JLE. We have seen this already
in the NHS where assumptions on cost over-runs, which were supposedly
based on historical cost over-runs in the NHS, have the effect
of bumping up the price of public sector comparators to quite
outrageous levels. Trusts were regularly making use of assumptions
that all NHS capital projects over-ran by figures between 17 and
25 per cent. These figures were actually imaginary, the real figures
were closer to 6 per cent. This then led to over-valued public
sector comparators which, therefore, made greater spurious value
for money on the PFI side. If the JLE is used as an example to
work out the kind of historical cost over-runs which should be
used in assessing the risk under the PPP contract, there will
be a serious distortion.
(Professor Glaister) You said, "Should we ignore
Lord Currie's evidence?" No, we should not. It is well established,
but you must look at the assumptions and look at the circumstances
in which those 20 per cent cost savings were got historically.
It is repeated competition with open labour markets, it is not
a one off thing with protection for the transferring employee,
which is a different game.
Mr Donohoe
125. When you were answering a question earlier,
you indicated that there were better options than the PPP. What
would you say they were?
(Professor Glaister) My fundamental difficulty with
the PPP is this inflexibility with a 30 year contract, and even
with a first review after seven and a half years. I would look
for a way of getting cost savings from private sector involvement,
which is much quicker and more flexible and which divorces the
raising of finance from the commissioning of the work. I think
one that would be worth looking at is leaving it in the public
sector, a funding trust to do the funding with revenue bonds to
raise the finance, but not necessarily government backed, and
then letting out the Underground lines on a line by line basis
for a period of five or seven years. You keep those as integrated
businesses, you have management contracts and you compete for
those just as they did with the buses. Basically it is by direct
contract managing, and it was a very successful experience on
London Buses. I hope that will be used in the comparator.
126. It is possible that the proposals for the
PPP as they are, are going to come up against the buffer because
of the fact that they have to do the calculations on the basis
of the fares and the increasing number of usage, when in fact,
if anybody uses the underground, they will know that it will be
almost impossible at peak times to get any more passengers on
board. Do you think that is a problem in its own right as well
in terms of the basic undertaking that has been taken?
(Professor Glaister) That is a kind of engineering
and economic judgment that one would want to look at. On the face
of it, it does seem strange that you can get 40 per cent more
passengers onto the existing system. You would certainly get more
through it if it worked more reliably. If it is a problem, it
faces any of these solutions. The future revenues over 30 years
are very, very hard to predict and the shortfall will fall on
the Mayor and the London Assembly whichever way we do it.
Chairman: I am very grateful to you. You have
given us a lot to think about. Thank you very much indeed for
coming this afternoon.
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