Last month, London saw the failure of one of the two private-sector partnerships that have run its Undergrounds infrastructure for four years. The partnership walked away from hundreds of millions of pounds that its shareholders had invested, leaving the government holding the bag for nearly £2 billion ($4 billion) in state-guaranteed debt, plus billions more, possibly, in cost overruns on work that must be done before the 2012 Olympics. Londons subway debacle provides a useful lesson for the United States, where a recent bridge collapse in Minnesota has served as a reminder of public infrastructures fragility. While the private sector has a role to play in building, upgrading, and maintaining public infrastructure, it can never assume the public sectors ultimate responsibilityfinancial and otherwise.
The landmark Tube deals were the closest that any modern city has come to a full-scale privatization of its most complex public infrastructure, in that they theoretically transferred many public-sector risks to the private sector. A decade ago, the aging Tube needed billions in upgrades. But Prime Minister Tony Blairs audit office decided that the Undergrounds public-sector managers werent capable of managing efficiently and effectively the investment needed to improve and modernize the Tube. (Sound familiar, New York?) So starting in 1998, Gordon Brown, now prime minister but then in charge of the public purse, huddled with advisers to determine what London wanted from its subway system over the next three decades, including modern signals, tracks, and stations.
The government then called for bids from private-sector firms willing to take the risk of getting this work done right, on time, and on budget, and then maintaining their work for 30 years. Metronetmade up of five private-sector infrastructure giants, including Bombardierwon the biggest contracts, and thus responsibility for most of the Tubes assets. Another team that included San Franciscobased Bechtel won responsibility for the rest. (I discussed the deals somewhat favorably in a 2005 article, though I criticized their too-long and too-complex contracts and added that fobbing off responsibility for upkeep of the entire subway system onto the private sector all at once wasnt advisable.) If a firm ran over the costs that it had estimated at the beginning of the contract period, it would have to foot those costs. The companies would put up the cash for the work, and the government would slowly pay them back through regular infrastructure service payments, similar to how governments raise bonds for capital investment and then pay that debt back over time.
The government had to commit itself even beyond those payments, though, because a snag quickly emerged. The companies, and their shareholders, determined before they signed any deal that they would limit their risk by providing a finite amount of money for the projectmoney that they could afford to loseand borrowing the rest. But banks refused to lend the money without a government guarantee. That was no surprise. Lenders didnt feel comfortable taking on the risks inherent in a 100-year-old subway system full of decay and hidden defects. Nor did they want to take the chance that Londonwhose own government, led by mayor Ken Livingstone, was less bullish on the private contracts than was Blair, who held the purse stringswould cancel the contracts, leaving them in the lurch. So the British government directed Londons Tube to guarantee 95 percent of the debt, figuring that it was worth the management expertise and flexibility that the companies would provide. In 2003, after five years of planning and thousands of pages of contracts, the private sector took over.
And then things got really interesting. After a few years of work, Metronet decided that its contract with the government wasnt fair, since its costs were considerably higher than was anticipated by London Underground and Metronet at the time the contract was awarded. Metronet said, in essence, that it couldnt do the work the government wanted for what the government was payinga common enough complaint by private contractors all over the world, but one that Britains pioneering, risk-transferring structure was supposed to obviate.
Metronet appealed to an independent arbitrator, asking for more than half a billion extra pounds to cover just two years of one contract. When it lost the appeal in mid-Julythe arbitrator ruled that it was inefficientits shareholders and lenders decided that they couldnt put more money into a losing deal. So Metronet walked away. Now taxpayers are responsible for the £2 billion debt that the Tube guaranteed, regardless of whether the government tries for a contract with a new provider (likely at higher costs, given Metronets complaints), or has London retake control.
The failure of the Tube deal highlights the immutable fact that the public sector can never rid itself of the risks that taxpayers assume on infrastructure projects. A private-sector firm is only as resourceful as its shareholders and lenders allow it to be, and it can walk away from an investment at any timesometimes at a loss, to be sure. Indeed, part of the magic of our capitalist system is that if companies run into trouble, they can declare bankruptcy, discharge or restructure their obligations, and then start over. British taxpayers, on the other hand, cannot walk away from the Tube, and are responsible not only for the public sectors mistakes but also, ultimately, for the most catastrophic private-sector errors.
Further, even on a successful private-public deal, likeso farthe one with Metronets smaller counterpart on a few other Tube lines, the public sector must continually oversee any private companys performance. Customers who use the Tube have no practical alternative, so private-sector competitive pressures dont work. And once a long-term contract expires, the public sector must take its infrastructure assets back, even if only to contract them again to the same private firm or another one.
Through well-designed, carefully overseen deals, the public sector can transfer certain responsibilities to private companies, though it should always retain enough independent expertise to know whether its getting a good deal. This is especially important for larger, more complex deals, where there are fewer competing players to hold prices down, and where vital details are often hammered out after the government chooses its bidder. London itself contracts out its public bus services to private companies, under deals much better defined than the Tube one. Here in the United States, Miami has signed a long-term contract with a European-led firm to build and operate a new harbor tunnel on a fixed schedule, for a fixed price. Well have to see what happens, of course, if costs wildly exceed estimates once work is well underway.
But on deals large and small, the public sector must understand that while it can use the private sector more intelligently than it often has, it cant abdicate what has always been a core public-sector role, second only to assuring public safety. Lets hope that the governors and mayors ultimately responsible for fixing Americas aging roads, bridges, subways, and dams take a lesson from Londons experience. Even as they look for new ways to carry out their responsibilities, they can never sign away their responsibility to lead.