City Journal Home. SEARCH SITE Advanced Search
 
City Journal Summer 2014.
City Journal Current Issue
 
EMAIL | PRINT | RESPOND | SHARE

Nicole Gelinas
Notes from the Underground
A company maintaining the Tube gets off the train early—and provides useful lessons for the U.S.
23 August 2007

Last month, London saw the failure of one of the two private-sector partnerships that have run its Underground’s 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. London’s subway debacle provides a useful lesson for the United States, where a recent bridge collapse in Minnesota has served as a reminder of public infrastructure’s fragility. While the private sector has a role to play in building, upgrading, and maintaining public infrastructure, it can never assume the public sector’s ultimate responsibility—financial 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 Blair’s audit office decided that the Underground’s public-sector managers weren’t “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. Metronet—made up of five private-sector infrastructure giants, including Bombardier—won the biggest contracts, and thus responsibility for most of the Tube’s assets. Another team that included San Francisco–based 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” wasn’t 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 project—money that they could afford to lose—and borrowing the rest. But banks refused to lend the money without a government guarantee. That was no surprise. Lenders didn’t 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 London—whose own government, led by mayor Ken Livingstone, was less bullish on the private contracts than was Blair, who held the purse strings—would cancel the contracts, leaving them in the lurch. So the British government directed London’s 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 wasn’t 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 couldn’t do the work the government wanted for what the government was paying—a common enough complaint by private contractors all over the world, but one that Britain’s 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-July—the arbitrator ruled that it was inefficient—its shareholders and lenders decided that they couldn’t 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 Metronet’s 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 time—sometimes 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 sector’s mistakes but also, ultimately, for the most catastrophic private-sector errors.

Further, even on a successful private-public deal, like—so far—the one with Metronet’s smaller counterpart on a few other Tube lines, the public sector must continually oversee any private company’s performance. Customers who use the Tube have no practical alternative, so private-sector competitive pressures don’t 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 it’s 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. We’ll 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 can’t abdicate what has always been a core public-sector role, second only to assuring public safety. Let’s hope that the governors and mayors ultimately responsible for fixing America’s aging roads, bridges, subways, and dams take a lesson from London’s experience. Even as they look for new ways to carry out their responsibilities, they can never sign away their responsibility to lead.

EMAIL | PRINT | RESPOND | SHARE

 

More by Nicole Gelinas:
All the World’s Not a Stage
Progressive Impatience
New York’s Next Public Safety Revolution
More . . .
This story was cited in:
RealClearPolitics
LondonUnlocked
Click to visit City Journal California
Get the Free App on iTunes


Home |  About City Journal |  City Journal Books |  Archives |  Links
Contact Us |  Subscribe Print |  Subscribe Online |  RSS |  Advertise |  CJ Mobile

CONTACT INFO:

subscriptions: (800) 562-1973 • editorial: (212) 599-7000 • fax: (212) 599-0371

Copyright The Manhattan Institute