Putting the Public First in Public-Private Partnerships

Putting the Public First in Public-Private Partnerships

Public-sector competence is needed to make sure citizens get a good deal—and private vendors are no substitute for adequate public funding.

April 26, 2018

This article appears in the Spring 2018 issue of The American Prospect magazine. Subscribe here

In a perfect world, a big-city mayor would not have to wrangle over how to finance a tunnel to the port. But Manny Diaz did not live in a perfect world: He lived in Miami. Port traffic clogging downtown was a decades-old problem. To realize his vision of a vibrant region showcased by a vital city center, Mayor Diaz had to get rumbling, port-bound 18-wheelers off downtown streets.

In 2007, with a plan and money on the table, the Florida Department of Transportation turned up the heat on the term-limited mayor to deliver the tunnel. So Diaz devised a strategy to gin up city and surrounding county support: He tossed a baseball stadium, museums, more funds for a performing arts center—and the tunnel—into one civic wish-list basket and made a successful appeal to regional pride for funding them all. Meanwhile, two multinational firms, Meridiam, a public infrastructure investor, and Bouygues Travaux Publics, a tunneling and engineering firm, arrived on the scene with the dollars to move the complex initiative forward after the Great Recession unspooled the original consortium. “It was perfect timing,” says Diaz.

More than a decade later, the Port of Miami Tunnel is the marquee example of a public-private transportation infrastructure partnership. The concessionaire’s financing sources totaled about $900 million. It gets back a revenue stream based on state and federal funding sources, so there are no tolls. The city now has several new amenities, as well as two tunnels with two lanes each that, shortly after opening, decreased the weekly average volume of all port-bound traffic in downtown Miami by 35 percent and reduced weekly commercial truck traffic by nearly 80 percent.

AP Photo/Steven Senne

When the public sector fails to transfer enough risk to private entities or fails in its own oversight obligations, a state can end up with a fiasco like the Big Dig. Here, activists in Boston protest fare hikes resulting from the project's cost overruns. 

But the tunnel’s success is deceptive, since the unique factors that converged in South Florida cannot be replicated everywhere. For every Port of Miami Tunnel, scores of ill-conceived projects dot the American landscape. The United States lags behind not only in basic maintenance of existing assets at the end of their life cycles but in building the next generation of roads, bridges, rail, tunnels, and aviation projects. With public funds scarce in a climate of tax-cutting and budgetary austerity, the risk is that the contactor/partner pays the up-front costs but sticks future generations of taxpayers and rate-payers with exorbitant charges.

That outcome can be the fruit of cynicism, corruption, naïveté, or fiscal desperation. But states and municipalities can learn to appreciate the differences between partnerships that put the public first and the rip-offs that erode public confidence in government and drain public coffers. A key is the competence of public officials to supervise private ones and negotiate smart contracts. That’s another basic public resource at risk in an age of fiscal scarcity.

In a sense, nearly all transportation projects are public-private partnerships. Public entities own most roads, tunnels, bridges, and subway systems, but private contractors invariably build them. The new wrinkle is the option of having contractors provide some or all of the up-front financing, often in exchange for either a long-term lease or a share of revenues.

The Trump administration’s version of an infrastructure initiative relies heavily on private financing, which may or may not materialize. Trump proposes to have the federal government contribute $200 billion, with the rest of the illusory $1.5 trillion coming from cash-strapped state and local governments and the private sector. This model is disingenuous, partly because not all public needs are profitable; partly because it also hides other cuts to the Highway Trust Fund, Federal Aviation Administration, Amtrak, transit programs, and other areas; and partly because state and local governments are strapped for funds to contribute their proposed share. But the Trump framework is only an exaggeration of recent trends.

At best, new fiscal pressures can lead public officials to get creative, seeking private partners who may bring superior engineering, financing, and legal expertise, and better attention to maintenance and operations. But private-sector involvement does not automatically mean a better outcome. Citizens and public officials often forget that the private sector’s prime motive is profit, not philanthropy. If a firm cannot clear a good return on an investment, either the deal will not materialize or the terms will be onerous to the public. Public debates can be marred by false expectations, and confusion or obfuscation of what distinguishes a good partnership from a rip-off.

 

A KEY QUESTION IS THE degree of risk assumed by the public sector or the private entity because of the unknown vagaries of construction. What would the unearthing of significant archeological artifacts do to a construction timetable? Who pays the cost if an underwater tunnel hits unforeseen obstacles? What happens if there is unexpected community opposition and litigation? These factors and dozens more pose risks that must be assessed and calculated in the early planning stages on both sides.

“A strong contract lays out the performance metrics: who is accepting what kind of risk and what happens each step of the way with the meeting of those metrics or the failure to meet those metrics,” says Jim Aloisi, who was Massachusetts transportation secretary under former Democratic Governor Deval Patrick.

Massachusetts is infamous for the cost overruns associated with the Big Dig, which included a new tunnel linking the Massachusetts Turnpike to Logan International Airport and put the major north-south highway bisecting Boston underground. The project came in more than $20 billion over budget counting interest on the extra debt. Public planners erred in contracting out the project design, construction, andmanagement. State lawmakers later intervened and turned management over to a public agency.

If it went massively over budget, it was no skin off the supervising contractors’ noses. Instead of performing its own inspections along the way and holding the multiple vendors accountable, government ended up paying for the overruns after the fact.

A public-private partnership is a hybrid that exists along a continuum of risks. In traditional procurement, the public sector assumes the greater risk, turning over the design and construction to the private sector or consortium while the public agency secures financing, operates, maintains, and owns the completed project. This model is known as design-build.

Further along the risk continuum are long-term leases, known as DBFOM arrangements (for design, build, finance, operate, and maintain). Typically, the private sector takes on all the risks associated with unforeseen engineering issues, cost overruns, legal entanglements, or other issues. Those details, of course, depend on whether government negotiates a good contract. The private partner provides the bulk of the up-front dollars, in effect a loan to the public sector. Taxpayers or toll-payers eventually pay the cost one way or another.

“The whole business has matured and has changed the way [the] private sector and the public sector thinks about it,” says Aloisi. “People like me who are progressive … have looked at the direction this has moved in and are much more sanguine about it. I have seen too many examples of the public sector failing. I don’t think it’s appropriate to adhere to strict ideology at this point. I’m more ‘show me the facts’: Where are the risks, incentives, and what are you paying labor?”

Some municipalities have moved to get out of the business of owning and operating assets like parking garages or local roads and are selling these public assets outright to private companies—these are usual smaller deals. Under leasing deals, arrangements can run anywhere from roughly 30 to 50 years with the public entity maintaining ownership, but ceding functions like operation and maintenance to the private partner. Many public officials take a dim view of ceding public assets like roadways that are integral to a transportation network for longer periods, since that means giving up public stewardship, which is needed to respond to changing traffic and housing patterns.

Despite Trump administration hyperbole about encouraging private-sector participation in the country’s infrastructure enterprise, the majority of transportation infrastructure projects do not interest the private sector, since they do not have an associated revenue stream, such as tolls, or offer any other attractive features to tempt investors, particularly in rural areas.

AP Photo/M. Spencer Green

Chicago’s 75-year lease for its 36,000 parking meters with a limited liability company headed by Morgan Stanley and others was one of the worst, if not the worst, P3 deal in U.S. history.

To attract private-sector interest in rural projects, Pennsylvania, for example, bundled some 560 rural bridge-replacement projects into a nearly $1 billion, 25-year maintenance package, contracting with a private consortium to provide the funds and do the work. In its analysis of the project, the Bipartisan Policy Center, a Washington research organization, noted that the consortium could increase its profit margins by skimping on longer-term quality. Which means that the Keystone State must have a strong inspection regime in place to monitor the spans.

When the public sector fails to transfer enough risk to private entities or fails in its own oversight obligations, a state can end up with a fiasco like the Big Dig. A key factor in a good public-private partnership, or P3, is whether the public entity has the expertise and integrity to keep the private partner honest.

Large P3s comprise only a fraction of the highway projects built in the United States. In the 23-year period between 1989 and 2012, 79 design-build transportation projects (the more public variant) budgeted at $50 million or higher were launched in the United States, according to the “Public Works Financing” newsletter. Of the more complex DBFOMprojects, only 13 projects of $50 million or more were built during that period. So P3s are no panacea, but just one tool among many.

A more fundamental problem is dwindling public capacity. For the past several decades, conservatives have so undermined citizens’ faith in the public sector and stripped it of resources that pursuing new taxes, tolls, or fees to build new bridges, tunnels, and subways can be a political nonstarter. But these attitudes could change, if voters realize that failure to countenance tax increases means many public agencies will no longer have the resources to hire well-trained planners and engineers to keep up with maintenance demands, or to build new roads and bridges, or to keep contractors from passing hidden costs to the public.

 

COMPLETED IN 2014, the $1 billion Port of Miami Tunnel involved a 35-year concession agreement. “When you have high-profile, expensive projects, you don’t have that kind of cash lying around,” says Diaz, now a senior partner at Lydecker Diaz, a Miami law firm. “But you do have the ability to raise that cash over time; so it’s almost like a long-term loan that gives you access to capital that allows you to do those major projects.”

Florida benefited from exceptionally strong technical, commercial, legal, and financial advisers who were well-matched to their private-sector counterparts. Today, most states know that they must have first-caliber in-house experts and consultants if they intend to partner with a private company on a major project. “But back then, a lot of times when people said ‘public-private partnership,’ a governor or a mayor would hire their brother-in-law’s accounting firm and say, ‘Figure out what this means for us,’” says Joe Aiello, a partner at Meridiam who helped steer the project. “But Florida and Miami-Dade [County] went out and got the best.”

Aiello concedes that it may “sound crazy” that an investor would prefer going up against seasoned public-sector officials who can pull together a solid procurement process. But he sees long-term benefits for the private partner. “We want these deals to be rock solid and well thought-out because we are going to be there for 35 to 40 years,” he says.

A well-executed contract gives a public agency leverage when things go wrong. As long as the tunnel adheres to performance standards specified in the contract, the consortium continues to receive “availability” payments from the state. “The investor-developer in the private sector [is] in the world of no-excuses … so that the government is getting [the] best possible price,” Aiello says. “This is what astounded everybody … especially public officials who didn’t realize that you could transfer so much risk, especially long-term, to the private sector at a fixed cost.”

How labor fares should be key, especially in a right-to-work state like Florida. Some P3 deals try to save money by avoiding union contracts that would be required on explicitly public projects, as mandated by federal or state law. Unions, including the International Brotherhood of Electrical Workers and the Laborers’ International Union of North America, worked on the tunnel. But a 2013 Center for American Progress report found that the union representing workers who operate heavy equipment did not participate in creating the project’s hiring program. One union official also claimed that Bouygues “wouldn’t talk to us.”

Union representation in these arrangements hinges on the state labor climate. When the Maryland Port Administration decided to modernize the container berth at the Port of Baltimore’s Seagirt Marine Terminal to accommodate Super Post Panamax cargo ships, using a $1.3 billion, 50-year P3 contract with Ports America to operate the facility, the company preserved all union jobs.

State enabling legislation, experienced public agency procurement teams, and brokering of regional buy-in were also features of the Denver area’s $2 billion Eagle P3 Project. Its Regional Transportation District brought in a private consortium to build commuter rail lines connecting the city’s Union Station to outlying areas as well as a maintenance facility. The 34-year deal (which also survived the Great Recession) relied on $1 billion in federal funding, a regional sales tax, and $450 million in capital from Denver Transit Partners, the private consortium. For that, the private entity gets payments linked to meeting performance, operation, and maintenance metrics and is responsible for keeping the commuter rail cars in good repair.

Colorado Governor John Hickenlooper recalls that when he was mayor of Denver during the initial phases of the Eagle P3 project, he had to quell the “Hatfields and McCoys”–style feuding between Denver and its suburbs (much like Diaz did in Miami and its environs) to smooth the way for expanding the regional transit system and to persuade voters to back the network with a 0.4 percent sales tax increase in 2004. The regional transportation agency laid out the performance standards it expected the concessionaire to adhere to in cost-effectiveness, performance, safety, rider experience, and reliability and prioritized those standards over design and other aspects of the project.

“The key there is if you run into trouble [or] if your concessionaire creates a problem, [you know] who pays the freight,” says Hickenlooper. Apportionment of risk to the concessionaire has already protected area taxpayers. When Denver Transit Partners determined that one of the bridges would not hold up to specified performance standards, the group demolished and rebuilt the span. The public Regional Transportation District was not liable for additional monies.

 

OF THE PITFALLS THAT DOOM partnerships with private vendors, the most damning is insufficient transparency. Ironically, when private contractors cheat the public, it is government rather than the privatization process that gets the blame—fueling a conservative narrative that the government is an unreliable guardian of public assets while corporations can parachute in better solutions. Some politicians feed this story when their desire for a quick cash infusion causes public officials to accept arrangements with little to no public oversight, unleashing a cascade of missteps that negate short-term fiscal benefits and reverberate years later.

Chicago’s 75-year lease for its 36,000 parking meters with a limited liability company headed by Morgan Stanley and others (among them a German financial firm and the government of Abu Dhabi) was one of the worst, if not the worst, P3 deal in U.S. history. The slipshod agreement dented residents’ already low confidence in the city’s leaders and undermined the city’s fiscal health for decades.

In 2008, Mayor Richard M. Daley rammed the $1.1 billion plan through a quiescent city council in three days, refusing to divulge the bidders or detailed financial analyses. No municipal transportation officials or lawmakers ever studied the agreement. A deeper analysis would have shown that the deal called for additional payments to the concessionaire if parking meters came out of service for street fairs, repaving projects, or traffic circulation improvements. Daley used lump-sum payments to plug budget deficits. Residents went ballistic as rates exploded. The city now has the highest on-street parking fees in the country.

The Chicago inspector general found that the meters were worth at least twice as much as the lump-sum payment the city received for transferring them to the private consortium. The city is stuck with the deal until 2083.

The current mayor, Rahm Emanuel, sided with the consortium in a 2014 lawsuit challenging the deal. The group’s lawyers had contributed to his re-election campaign. In 2018, along with turning over all of the revenue from the parking meters to the concessionaire, the city owes an additional $20 million, a nearly 20 percent increase over the previous year, to compensate for lost revenues from meters taken out of service.

The deal continues to undermine Chicago’s ability to plan for future transit improvements. Instead of being able to consider bus, rapid transit, pedestrian safety improvements, or other projects on their merits, planners must consider how many parking meters must be taken out of service (with the attendant uptick in additional payments to the vendor), which may doom some of those projects.

Public accountability has also gone missing in St. Louis, where city officials continue to debate a proposal to lease the city-owned and -operated Lambert International Airport, a plan championed by former mayor Francis Slay and his successor Lyda Krewson. The airport director learned about the plan after the application had been filed with the Federal Aviation Administration’s Airport Privatization Pilot Program in 2017. The city’s board of aldermen were not consulted.

Missouri billionaire and Republican political donor Rex Sinquefield steered the escapade. He funded the FAA application and will be reimbursed if an agreement is finalized, while his political action committee, Grow Missouri, advises the city on the agency’s process and pays the consultants. Meanwhile, the airport remains a valuable transportation asset, having retired and refinanced debt.

A recent In the Public Interest report, which conducts research on privatization and investigated the St. Louis plan, found: “The [request for proposals] for the advisory contract is structured in a way that will eliminate the city’s opportunity to fully evaluate options for the development of the airport. Since the contractor is only compensated if the airport is privatized, it will not be in their interest to provide full, independent and objective analysis that would benefit and serve the interests of the city. This contract should not be finalized under these conditions.”

AP Photo/J Pat Carter

The billion-dollar Port of Miami Tunnel is a successful public-private infrastructure partnership completed in 2014. Here, construction workers watch the official opening of the tunnel in 2014. 

“The advocates for privatizing the St. Louis airport are failing to heed important lessons from Chicago’s parking meter disaster,” says ITPI Executive Director Donald Cohen. “They aren’t doing a rigorous fiscal and financial analysis to compare public versus private options that cost Chicago $1 billion. And they aren’t thinking long-term about what decisions city leaders won’t be able to make because [those decisions could] hurt the private operator’s bottom line.”

 

WHEN A PRIVATE-SECTOR actor fails to live up to the role of turnaround artist, it falls to public entities to pick up the pieces. To acquire Stewart International Airport in Newburgh, New York, in 2000, the National Express Group (NEG), a British rail, bus, and coach transit company that expanded into airport operations in Great Britain, paid $35 million to the New York State Department of Transportation for a 99-year lease to operate the facility under the FAA’s 1997 Airport Privatization Pilot Program.

The hope was that the new operator could improve the facility and attract more passengers to the lightly used airport north of New York City. Metro New York has long sought a fourth airport. The premise unraveled as the fallout from September 11, 2001, rippled through the aviation industry. NEG also ran into legal opposition from local environmentalists opposed to the plan for a new access road to the airport.

NEG soon announced other priorities, and tried to relinquish the lease. But there were no offers. After seven years, the Port Authority of New York and New Jersey acquired Stewart for nearly $80 million. A 20-year plan to upgrade the airport included a name change, renovations, and better transit connections.

Of the 12 airports that have pursued privatization through the FAAprogram since 1997, only one, the Luis Muñoz Marín International Airport in San Juan, Puerto Rico, remains in the hands of a private operator. Currently, three airports (including Lambert) have submitted preliminary privatization applications. The FAA’s complex regulations make most privatization scenarios unappealing, especially since airlines have veto power over such transfers.

 

STATES AND LOCALITIES that pursue public-private partnerships must do their homework. Public officials must determine whether involvement of the private sector is cost-effective, and they must engage highly experienced professionals who can run a transparent procurement process, particularly in the case of projects that a private entity wants to finance, operate, and maintain. Purely political considerations, especially ones predicated on general budgetary pressures rather than on the needs of the transportation sector, should be resisted.

The temptation to look for private-sector rescues is understandable. The United States is trillions of dollars short in funding to build the next generation of megaprojects. The bill is past due for repairs to transportation assets of the past century.

Public-private partnerships can play a role, but no one should exaggerate what they can achieve. “P3s are a very effective tool that helps communities build critical infrastructure, not the solution,” says Governor Hickenlooper. “We as a society are fighting over whether it’s federal, state, or local money. We’ve got to resolve the bickering and say, ‘This is the real infrastructure that we need, we can afford it, so let’s build.’” 

 

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