Bob Carr, Marcus Aurelius and PPPs

I’ve been trying to get Tony Harris, friend, some time colleague, Auditor General and Fin Review columnists to post on Troppo for some time. He sent me the fantastic piece you see below the fold – which he published in the Fin on Saturday. So I’ve created a profile for him here, in the hope that he’ll post some more – at the very least some of his columns which I miss because I don’t subscribe to the Fin and they don’t allow free access to his articles on their website. I’d subscribe to their site if I could get it for the price I pay The Economist for the same kind of service. But they insist that I subscribe to a daily delivery of a hard copy of the AFR which puts it at beyond what I want to pay.

Anyway, Tony has given me permission to post the column below the fold. It appeared in the Financial Review on Saturday 15th October 2005.

Nicholas Gruen

In the middle of the year, Mr Carr, with hard-hat and reflective jacket, blessed the privately-owned Sydney cross-city tunnel in a media delight before fleeing to join Macquarie Bank. He left knowing what his favoured Marcus Aurelius, emperor and philosopher, thought about public life: “how hollow are the echoes of applause “¦ how puny the arena of human fame”. The applause was indeed short-lived. As the new NSW premier, Morris Iemma, appreciates, Mr Carr’s legacy is a troublesome tunnel.

Although only 2.1 kilometres long, the tunnel was to be an important addition to Sydney’s road network, eventually taking 100,000 vehicles a day off central business district surface roads. But since its opening a fortnight ago users have boycotted the tunnel and its expensive tolls. The government now has to force drivers through the toll gates. The tunnel has even become a flash-point for discontent over the many tolls which tax Sydney motorists.

Ten years before, in 1995, the incoming Carr Labor Government said there should be no private toll roads. It wrested power from the Fahey-Greiner Liberal governments by promising to nationalise Sydney’s existing toll roads, the M4 and M5.

But Mr Carr was quickly infected by the lure of private finance, the economic equivalent of the avian flu’. He oversaw the completion or approval of five new privately owned toll roads: the M2, the M1 (the Eastern distributor) and the Cross City Tunnel, soon to be joined by the M7, Sydney’s western orbital, and the Lane Cove Tunnel. And there are two more being considered: the link between the M2 and the freeway to Newcastle and the M4 eastern extension.

Toll Road table.gif

For each of these roads, the government claimed it had to rely on private ownership and private tolls, even though the government could have as easily borrowed the finance as the private sector. More interestingly, history proved that the government had the money.

In 1995 the Carr government inherited net debt of $12.4 billion; in 2005 NSW government net debt was minus $0.8 billion, a $13.2 billion improvement. Had the government merely kept debt constant, it could readily have twice funded all of these private toll roads.

It was an obsession with debt that drove government policy. The General Government Debt Elimination Act 1995 was introduced by Carr’s long serving Treasurer, Michael Egan, in the first nine months of the government. This pre-occupation with debt forced the state’s road agency, the Roads and Traffic Authority, to look for alternative funding.

RTA had identified many more road developments than it could finance. Even an additional tax on petrol hypothecated for road developments, three cents a litre tax on petrol introduced initially for three years introduced by the Greiner government, proved inadequate. The Carr government’s abhorrence of debt – and a political exuberance to remove road tolls plus an unwillingness to identify other revenue sources – convinced RTA that the private sector had to fund the growing gap.

It is usually the role of the private sector to identify unmet community needs and to satisfy them at a reasonable cost. But all of Sydney’s toll roads have been identified by the RTA. The first of these, the M5, was developed by a former NSW Commissioner for Roads who well understood the public need for roads. And there has been no acceptable cost: returns earned by the developers have been outstanding.

The NSW government has always allowed a toll-free alternative to tolled roads, but it has also laboured to ensure that toll roads are profitable for the private owners. It agreed to locate the toll gates for the M4 where toll paying traffic was at its thickest rather than where the private road was built. (The result is that around 20 per cent of toll-payers do not use the private road for which they are paying.) When the M5 was struggling, RTA accelerated the construction, mostly at public cost, of a toll-free western extension so that motorists would more readily pay the M5 toll. The M1, the Eastern Distributor, is only financially viable because the government constructed an extensive toll free extension.

So we can expect the RTA to ensure the profitability of the cross city tunnel, and it will do so again for the Lane Cove tunnel. The cross city tunnel will not be profitable unless current usage of 20,000 vehicles a day rapidly moves towards the 90,000 required by the developers. To achieve this RTA will do more ‘traffic calming’, as the contracts term it, in 14 surrounding suburbs, up to five kilometres from the tunnel’s entrances.

But the tunnel might be an exception to other toll roads which have typically earned extraordinary profits for their equity investors. The developers of the M4 gained several times their equity contribution when it was sold several years ago. The recent sale of the M2 secured a price nearly three times the equity investment of owners.

Profits from these roads has led Macquarie Bank – the python which has encircled Sydney with its development of the M2 and its ownership of the M1, M7 and M5 – to pay tens of millions of dollars in remuneration to executives involved in these financing deals. They have also driven up the Bank’s share price, and the value of extensive employee and board share options. (Eighteen per cent of Macquarie’s financial statements is needed to outline remuneration and other benefits paid to board members and employees.) This makes more interesting the decision of Mr Carr, who once complained about excessive profits garnered by financiers from private toll roads, to join Macquarie as a part-time consultant. He must be unperturbed or unaware of the appearances of conflict which that appointment allows.

The excessive cost borne by toll payers is also influenced by the requirement that they meet all capital costs before the expiry of the franchise agreement. This is required because road ownership passes to the government for no charge at that time.

The Cross City Tunnel has an additional impost. Unusually for such deals, developers were required to pay the state government nearly $107 million – about one seventh of the total project cost – for “the right to undertake the project.” The state might argue that this charge reduces the excessive profits typically earned from these roads, but it merely acts as a tax which adds to the tolls.

The tolls are also high because financiers cannot charge all of those who benefit from improvements to the road network. These free benefits are listed in the government’s summary of contract for the tunnel. The five categories of benefits include better traffic conditions for buses and other city road users, including pedestrians; safer and better street environments; and better air quality (at least in the central business district). It is evident that, if the tunnel works as intended, property owners on William Street, whose six lanes of general traffic are to be cut to four or two, will profit handsomely. But only road users meet all of the costs.

Because the cost of the tunnel is excessive relative to its benefits, the time saved by motorists is not worth the fee, car drivers are bypassing it. There might even be an unspoken pact that drivers boycott the tunnel, hoping that the government or the financiers will reduce charges. This apparent campaign is in its early days, but the government is already talking with the tunnel management – and the public – about free introductory offers and lower charges in off-peak periods. And the newly appointed Minister for Roads, Joe Tripodi, has complained that his predecessor and former mentor, Carl Scully, made “too many compromises” when dealing with tunnel developers.

The new premier is quickly learning that the constant electronic chime of the e-tag might be a nice sound for business but it is a warning bell for the government. He might have wished that ten years ago his predecessor should have followed Marcus Aurelius who wrote, never believe something is worthwhile if it compels you to break your promise.

Tony Harris was a senior economist in the Commonwealth and past NSW auditor-general.

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Ric Simes
Ric Simes
2022 years ago

Tony

Good article. The sorry saga highlights something that many economists have been arguing for years, namely that most if not all toll roads should be Govt owned. They can be built and maintained by the private sector (using appropriate contracts), but the risks associated with traffic flow down a particular pipe are better borne/managed by the public in the context of the overall road network.

The question now is whether we can set up a new SOC to own all new toll roads plus all roads resumed at the end of the concessions (plus even consider offering to buy some of the private toll roads at a suitable price). We could then think about getting more coherence in pricing throughout the network. It may even be an agenda that a new Premier could embrace as he tried to make his own mark and distance himself from past decisions. Maybe …

Ken Parish
Ken Parish
2022 years ago

Thanks Tony (and Nicholas). This is a timely post, especially in view of the ongoing problems of the Sydney Cross City Tunnel. Readers might also be interested in a recent post by John Quiggin at http://johnquiggin.com/index.php/archives/2005/10/01/toll-opposes-privatisation/ and a much earlier short article at the Evatt Foundation website by JQ and Christopher Sheil at http://evatt.labor.net.au/news/23.html . The latter also contains links to other Evatt articles on so-called PPPs.

JQ suggests that governments may not start looking realistically at PPPs until they are forced to disclose and properly account for the real costs of this method of financing public infrastructure in their budget papers. Until then, politicians may keep believing in the tooth fairy. This passage summarises JQ’s point:

“The need for more explicit recognition of the liabilities associated with long-term contractual commitments is heightened by recent PPP proposals modelled on the Private Finance Initiative (PFI) in the UK. …

Another serious concern is the use of assessment procedures, based on the notion of the ‘public-sector comparator’, that have already failed in the UK. Proposals for a PFI initiative to fund improvements to the London Underground have been shown to cost about twice as much as bond financing. Despite this, two of the big five accounting firms, hired by the Blair government, have signed off on the claim that the project represents ‘value for money’, relative to a public-sector comparator. (A third, Deloitte and Touche, hired by opponents of PFI, reached the opposite conclusion.)

The superficial appeal of the asset-light approach masks hidden, but grave, dangers. The idea of owning assets and putting the associated debts clearly on the balance sheet may seem old-fashioned, but in most cases, it is the right way to manage both private and public enterprises.”

Ric Simes
Ric Simes
2022 years ago

Ken

I hope that your comment that the pollies won’t respond until we revamp the reporting in Budget Papers proves to be too pessimistic. Today there is a strong consensus re economic efficiency in the provision of toll roads and there is an opportunity to tap into that consensus. This won’t come thru changed accounting in Budget Papers – indeed, John Q appears to be advoacting the use of the market value of the toll road or some variant thereof appearing in the BPs, but this relies on tolls being treated as taxes which is a real stretch. Instead, the combination of a fading of debt/deficit fetishes and the repeated fiascos over toll roads provide a basis for a changed policy approach, and many pollies are now at least privately agreeing with this.

Also, John is sceptical about the net benefits of a range of privately owned networks (including Telstra). The case is strongest for roads where the benefits of ownership (in terms of, say, innovation or improved management skills) will always be minor relative to the risks associated with traffic flow. So my proposal is to just focus on roads and not other networks for now.

observa
observa
2022 years ago
Homer Paxton
Homer Paxton
2022 years ago

Am I missing something with tollways.

If the owners numbers don’t add up and they bo belly up doesn’t the Government get the road or is it another example of the government socialising the losses?

P.S

Thanks Tony and Thank nicholas for coaxing tony to put the article on here.
Let us hope there are many more

John Quiggin
John Quiggin
2022 years ago

Just a comment on the Fin. I write for them and subscribe and I still can’t get access because editorial is separate from marketing and my subscription is a discounted offer. Their policy is the most restrictive of any publication I know – more so than WSJ or the Economist, both of which have some free content.