IFCs Help Governments Do More With Less

Over the past half-century, governments around the world have increasingly relied on the private sector to provide goods and services. Under the general banner of “public private partnerships” (PPPs), the private sector has designed, built, funded, and operated roads, rail, ports, water, telecommunications, schools, hospitals, prisons, and other infrastructure.[i]

While the cost effectiveness of PPPs varies, when designed well they are able to deliver improvements at lower cost than through direct government provision. There are broadly four reasons for the superiority of PPPs.

First, PPPs enable governments to implement projects that simply would not be possible due to budgetary constraints. A report from Audit Scotland published in 2020 noted that, “Since 2005, Non-Profit Distributing (NPD) and hub private financing have supported £3.3 billion of additional investment in public assets. … Councils have used NPD and hub private financing to improve local infrastructure. This has enabled projects to proceed that would not otherwise have been affordable.”[ii]

Second, private companies have stronger incentives to develop and implement innovative solutions, ranging from new technologies to more effective management, that keep costs down, thereby making them more competitive and increasing their chances of winning bids. Relatedly, private companies can operate in multiple jurisdictions, enabling them to benefit from economies of scale and learning-by-doing.

Third, private companies can specialise in particular aspects of PPP provision. For example, some specialise in initial infrastructure development, while others specialise in ongoing maintenance and servicing. Yet others specialise in the development and oversight of contractual arrangements and related legal services. Last but by no means least, some companies specialise in providing finance to projects, often pooling capital from multiple jurisdictions.

Fourth, governments can—and do—subject private companies to contractual terms and regulations that they cannot so easily apply to their own operations. The government can thus hold the company or consortium accountable if it does not abide by the terms of the agreement, subjecting it to fines or in extreme cases terminating and retendering the agreement. By contrast, the government has less incentive to subject its own operators to such accountability. In addition, long-term contracts mean that PPPs can take a longer-term view of investments than would be the case for government-run projects that would be subject to the vagaries of annual capital budgetary constraints.

Take water, for example. Prior to the privatisation of government-run water authorities in England and Wales in 1989, the sector had underinvested in improvements necessary to meet water quality and environmental standards.[iii] In part, this was caused by difficulties the water authorities faced in raising capital, due to the high level of debt they had already incurred, as well as problems in the wider economy.[iv] But this was exacerbated by a conflict of interest: the same authority that regulated water quality also managed the sewage that was causing the pollution and contributing to poor water quality.

To overcome this conflict of interest, as part of the privatisation process the UK government set up three separate regulatory bodies: one to oversee compliance with potable water quality standards, one to regulate environmental quality, and one to regulate prices. To satisfy their customers and meet their regulatory obligations, since privatisation the water companies have invested over £160 billion in improvements to infrastructure and services.[v]

The result: water quality has improved significantly and in 2021 was found to be 99.97 per cent compliant with standards;[vi] pollution has fallen dramatically, resulting in a rise in populations of fish and other aquatic species such as otters;[vii] and in real terms prices are estimated to be 30 per cent lower than they would have been had water remained in the public sector.[viii]  No doubt more can and should be done to reduce pollution, flooding, and coastal erosion, while improving water management and conservation. But this is almost certainly more likely to happen, and cost less, under a regime of privatised ownership with government regulation than if the water companies were renationalised.[ix]

Unsurprisingly, unions representing government workers have not been happy about the shift towards private provision of goods and services that their members were previously supplying. In response, they have funded studies and campaigns seeking to renationalise privatised industries and take back direct control over infrastructure and services provided under PPPs. They have been aided in this endeavour by academics and other NGOs with aligned interests and ideologies.

One part of this campaign has taken the form of attempts to demonise the use of offshore entities as part of the ownership and/or funding structure of private companies supplying goods and services. For example, Scotland Against Public Private Partnerships (SAPP) recently published a Briefing Paper that claimed the use of PPPs involving companies based in “tax havens” harms the local economy, reduces tax revenue, and impedes compliance with regulations. But the evidence contradicts these claims.[x]

Take Hub North Scotland, a partnership between 16 public sector bodies and ACP: Hub North Ltd, the private sector partner. Hub North designs, builds, funds, and maintains a range of infrastructure projects in the North of Scotland—mainly schools and health care facilities.[xi] It has been praised for its innovative and inclusive “placebased” approach to development, which involves bringing together community representatives to identify local needs and then develop plans based upon those needs.[xii] This is very much in line with best practice advocated by the Local Government Association in the UK, which notes:

“Longer-term partnerships, where the private partner takes a long-term stake in the success of an area, can enable broader measures for successful places to be established and offer greater influence over long-term local employment planning and community benefit.”[xiii]

Estimates suggest that by the end of 2021, the £700 million invested by Hub North had led to 314 new jobs, 200 apprentices, 126 graduate trainees, over 1,000 work experience days, and new business to the tune of over £450 million.[xiv] It is noteworthy that Hub North completed three secondary schools, two primary school and a community centre during the COVID-19 pandemic. So much for harming the local economy!

As for “loss of tax revenue,” this seems an odd concern to raise regarding the use of PPPs in general, given SAPPP’s preferred alternative, direct operation by government, would entail no tax revenue whatsoever. Notwithstanding this, SAPPP’s claim is not substantiated by the evidence, which shows that companies involved in these PPPs pay significant amounts of tax.

SAPPP notes that the private sector partner, ACP: Hub North Ltd, is a 50:50 joint venture between Currie & Brown Equitix Ltd and Galliford Try Ltd and documents several of the companies associated with the joint venture, including holding companies domiciled in Cayman, Guernsey, and the United Arab Emirates. In apparent support of its assertion that this structure results in the loss of tax revenue, it notes that for Currie & Brown Equitix Ltd, “Operating profit was £820,000 (2021) and £1,259,000 (2020) (No tax payable either year) (Source: Currie & Brown Equitix Limited Annual Report & Accounts 2021).”

However, an analysis of the filings with Companies House of the various UK-domiciled parent companies associated with the joint venture suggests that during 2020 and 2021 they paid around £200,000 in tax directly attributable to ACP: Hub North Ltd.[xv] Moreover, the two companies in the joint venture with holding companies in offshore jurisdictions, Currie & Brown Ltd and Equitix Ltd, appear to have paid considerably more corporation tax on the profits from ACP: Hub North Ltd than the company whose holding company is domiciled in the UK, Galliford Try PLC.[xvi] This would directly contradict SAPPP’s claim.

One reason companies with offshore holding companies may be more profitable—and pay more domestic corporation tax—is that by sourcing funds offshore their capital costs are lower. Indeed, this a major reason why companies establish structures in tax neutral jurisdictions such as Cayman and Guernsey. It enables them to pool capital from multiple jurisdictions without imposing an additional layer of tax, enabling them to obtain investments at a lower cost than would otherwise be possible.

Meanwhile, the owners of companies domiciled in tax neutral jurisdictions will pay tax on income where that is due. For example, if a UK domiciled person holds shares in a Cayman company, they will be required to pay UK tax on profits distributed by that company. Also, and contrary to the claims that Cayman is a “secrecy” jurisdiction, Cayman maintains a verified registry of the beneficial owners of companies and automatically shares information on persons in that registry with the tax authorities in which those persons are domiciled (i.e. HMRC in the case of the UK).

The second allegation made in the SAPPP Brief is that “The secrecy of tax havens imposes constraints particularly with regard to financial issues but also in regard to company compliance with international, national and local regulations such as operational practices, health and safety and employment regulations.” This assertion is incorrect in all respects.

First, when a government writes a request for proposals (RFP) for a PPP contract, it typically includes a requirement to disclose the nature and costs of the financing. Indeed, as a report on the PPPs by Audit Scotland notes, one of the key advantages of using PPPs is that they typically require express commitments to complete projects within specified timeframes at a specified cost.[xvii] As such, and as Audit Scotland also notes, PPPs typically transfer some or all of the financial risk of a project to the private sector company undertaking the project. These risks can include cost over-runs and increases in project financing costs (due, for example, to changes in the base rate of interest, changes in the availability of capital due to credit rationing by banks and other financing entities, and project cost inflation). When projects are undertaken directly by the public sector, albeit often through contracts with private sector companies, a greater proportion of those risks are retained by the public sector body. The fact that investors in a PPP include entities based in offshore jurisdictions does not alter in any fundamental way the ability of a government to include such conditions.

Second, operational practices, health and safety, and employment regulations are primarily national and local matters. In the case of the PPPs operating in Scotland, this means UK and Scottish laws and regulations, and local bylaws, as well as the voluntary practices and contractual commitments of the companies. Moreover, as noted above in relation to water companies, PPPs can help reduce conflicts of interest that otherwise arise when the same a government authority is responsible for both the operation of and regulation of an entity. The suggestion that companies implementing these projects are somehow immune from such laws and regulations by dint of the fact that their ultimate owners, investors, and/or the providers of capital are based outside Scotland is simply false.

Third, PPPs in principle enable governments to introduce explicit performance criteria, with rewards for meeting or exceeding those criteria and penalties for under-performance. For example, a PPP consortium building a new school or hospital might receive a financial bonus for each day the building is completed ahead of schedule, with similar fines for each day it is delayed. It is practically unheard of for such performance-based rewards and penalties to be included in direct service contracts with government-run entities.

In sum, PPPs offer an effective means of enabling governments to undertake projects that would otherwise not be possible due to capital constraints, while also overcoming some of the conflicts of interests that arise when projects are implemented directly by government.

The ability to avail of funds from overseas, sourced through tax neutral jurisdictions such as Cayman and Guernsey, can reduce the cost of capital, lowering the total cost of the project and increasing its profitability, generating additional benefits to the local economy, as well as to government through increased tax receipts. Prohibiting the participation in PPPs of entities based in tax neutral jurisdictions would raise the cost of capital, making it more difficult to undertake PPPs, which of course is the objective of the critics.

Footnotes:

[i] https://ppiaf.org/sites/ppiaf.org/files/documents/toolkits/highwaystoolkit/6/pdf-version/1-21.pdf

[ii] https://www.audit-scotland.gov.uk/uploads/docs/report/2020/nr_200128_npd_hubs.pdf

[iii] https://www.ofwat.gov.uk/wp-content/uploads/2015/11/rpt_com_devwatindust270106.pdf

[iv] Id. at 2.

[v] https://www.water.org.uk/blog-post/thirty-years-on-what-has-water-privatisation-achieved/

[vi] https://dwi-content.s3.eu-west-2.amazonaws.com/wp-content/uploads/2022/08/19153555/E02750078_DWI-Public-water_England_V07.pdf

[vii] Supra note 4. See also: https://www.gov.uk/government/publications/water-and-sewerage-companies-in-england-environmental-performance-report-2021/water-and-sewerage-companies-in-england-environmental-performance-report-2021, which shows that the overall trends in terms of pollution incidents and other significant environmental concerns are largely positive – contrary to assertions made in the summary (which seems to focus on 2021 alone, which would seem to be a blip) and in various media reports.

[viii] Supra note 4.

[ix] The Report of the recent House of Lords Inquiry into Ofwat, for example, suggests some possible improvements in the regulatory framework (https://committees.parliament.uk/publications/34458/documents/189872/default/). 

[x] https://www.jubileescotland.org.uk/wp-content/uploads/2023/03/SAPPP_Policy-Paper.pdf

[xi] https://www.hubnorthscotland.co.uk/projects#operational; In some cases, Hub North’s role has been limited to the design and build stages.

[xii] https://www.pressreader.com/uk/the-press-and-journal-aberdeen-and-aberdeenshire/20211126/282492891966509

[xiii] https://www.local.gov.uk/publications/public-private-partnerships-driving-growth-building-resilience

[xiv] Supra note 9.

[xv] Analysis on file with author and available upon request.

[xvi] These calculations of the implied tax contributions of ACP: Hub North Ltd assume that the income to parent companies from ACP: Hub North Ltd is directly attributable to the bottom line. This may overstate the actual contributions, for example because of costs incurred by the parent companies that have not been allocated against income from the subsidiary. But this would apply to all three companies.

[xvii] Supra note 2.

Julian Morris FRSA
Julian Morris has 30 years’ experience as an economist, policy expert, and entrepreneur. In addition to his role at ICLE, he is a Senior Fellow at Reason Foundation and a member of the editorial board of Energy and Environment. Julian is the author of over 100 scholarly publications and many more articles for newspapers, magazines, and blogs. A graduate of Edinburgh University, he has masters’ degrees from UCL and Cambridge, and a Graduate diploma in law from Westminster. In addition to his more academic work, Julian is an advisor to various business and a member of several non-profit boards.