London Underground's Privatization Experiment Dead as Remaining PPP is Bought Out

» Mayor Boris Johnson instructs Transport for London to purchase controlling shares of Tube Lines, the PPP process’ remaining private infrastructure manager.

Former London Mayor Ken Livingstone sued the government twice in the early 2000s to prevent the full-scale contracting out of maintenance and work on the London Underground, which then-Chancellor of the Exchequer and soon-to-be-former Prime Minister Gordon Brown imposed on to the city beginning in 2003. The U.K. government, which provides financial sponsorship for most of the reconstruction of this city’s huge transit network, forced a series of public-private partnership (PPP) agreements through, giving big contracts to private enterprises Tube Lines and Metronet in exchange for the city getting big bucks from the national government to rebuild its decaying subway.

To Livingstone, a Labour politician, the multi-billion-pound PPP deals were undermined by a “fatal flaw” that kept public sector ownership of the system but gave private entities control over it. As a report to the Mayor put it in 2001, “Implementation of the PPP would be unsafe, inefficient, and prohibitively expensive.” The PPP process allegedly cost £500 million in consultancies and fees just to set up.

Livingstone must feel relieved in his vindication. In 2007, Metronet fell into administration (bankruptcy) and was subsequently absorbed by Transport for London (TfL), the public authority that runs the region’s rail and bus system. This put two-thirds of the Underground maintenance and renovation contracts back in government hands. Now, in the shadow of the British national elections last week, Livingstone’s replacement, conservative Mayor Boris Johnson, decided to buy out Tube Lines, which held the remaining third of contracts, after a public conflict over whether the company was being reasonable in its cost estimates for work to be done.

One of the largest forays into re-privatization of a public transportation entity in the West has come to an end, less than a third of the way into what was supposed to be a thirty-year commitment.

I’ll be the first to admit that I’ve been a repeated critic of significant private involvement in the creation of what is supposed to be public infrastructure, so I may come at this discussion with a bias.

But the facts here speak for themselves: The history of the London Underground’s journey in and out of private stewardship should put a damper on what is increasingly frequent talk from the United States to Uganda of expanding PPP models into the provision of a whole series of public services. That is — I say this with a degree of self-imposed moderation — at least until the reasons for London’s failures are understood and appropriate precautions are taken to prevent similar problems from occurring in the future.

Otherwise, we may see a whole lot of wasted spending.

It’s worth reviewing the way the London PPP process was set up: three contracts were written, each covering the renewal and maintenance of about a third of the system’s 250 miles of track for a period of thirty years. The government let the contracts out to bid, and two companies won: Metronet took the Bakerloo, Central, Victoria, Waterloo & City, Circle, District, East London, Hammersmith & City, and Metropolitan Lines while Tube Lines took the Jubliee, Northern, and Piccadilly Lines. TfL would continue running the trains, but these companies were to be paid to do the work keeping stations, trains, and track up to par — under the direction of TfL management. This went far further than the usual government agency/contractor relationship by giving almost complete control over the system to the private companies rather then just bits and pieces of work to be done, as is more typical.

After the 30-year contracts were signed in 2003, there wasn’t much room for maneuver, though a “Tube Arbiter,” Chris Bolt, was supposed to guarantee that the cost estimates of work to be done by the private consortia and to be paid out by TfL were accurate reflections of reality. Theoretically, the involvement of private contractors would reduce overall costs by inducing the supposed “creativity” of the private sector.

Unfortunately, that “creativity” was motivated by profit and insider deals, particularly in the case of Metronet, which gave exclusive contracts to the companies that owned it, including Bombardier, the train maker, Atkins, an engineering specialist, and Balfour Beatty, a construction firm, increasing costs substantially. Because the PPP contract spread out over a 30-year period, the “competitive” nature of private involvement in the reconstruction of the Tube was abandoned as soon as the deal was signed.

And then Metronet fell apart beginning in 2007, forcing TfL to pay back £1.7 billion in borrowing, of which the taxpayer lost £410 million — not exactly chump change. The government had bet on private sector productivity, and lost.

The problem for the public sector, of course, is that it can’t allow investments like those in the London Underground to be simply thrown away: The system must be upgraded, no matter the cost. Thus the government gave the PPPs a 95% guarantee on their borrowing, virtually eliminating any risk. It was the public’s responsibility to clean up the mess when Metronet broke down: It had no other choice.

Tube Lines was in better shape financially; the decision by Mayor Johnson to buy it out had a lot more to do with a conviction that the public sector could do the work better than private companies than a fear that Tube Lines would go bankrupt. TfL will spend £310 million to buy out the shares of Tube Lines’ owners, contractors Bechtel and Grupo Ferrovial, funds that the mayor’s office claims it can make up by eliminating shareholder profits, cutting “middle management fees,” reducing the amount of duplicated work, and taking out debt at cheaper rates than was possible by a private company.

But Johnson’s main concern — the situation that got him into this buyout deal in the first place — had been the fact that while TfL had scheduled £4 billion to pay for seven years of upgrades for the routes covered by Tube Lines, the company claimed to the PPP arbiter that they would cost £4.46 billion — £460 million of which TfL did not have on hand. So the only choice was to reduce the amount of work planned to be done — or simply purchase the company’s commitments, eliminating direct private involvement in the London Underground, exactly the choice Mr. Johnson’s TfL made.

The problem, suggested former London Underground Managing Director Tim O’Toole last year, is four-fold:

“The lack of competitive bidding in allocating work over 30 years results in inflated costs and preferential fees to the involved private companies; negotiations over future or new work are conducted without the ability to introduce market discipline, resulting in higher costs; in place of competitive bidding, the structure relies on record-keeping, derivative measurements and man-marking, all at additional administrative expense; the asymmetry of information in favour of the private companies leads to a claims culture, resulting in future unpleasant budget overruns.

It is unclear whether TfL will be able to maintain its infrastructure for a cheaper price than have the PPP companies: The claimed reason for involving private actors in the first place was that the government-performed upgrade of the Jubilee Line, done in the 1990s, had been a fiscal disaster, going over budget by one billion pounds. And PPP Arbiter Chris Bolt suggested this year that TfL’s work was more expensive than that of Tube Lines.

Yet the experience with Metronet, which probably had far too much on its plate — was an unforgivably colossal failure: That company had £17 billion worth of improvements planned over a thirty-year period, but was £2 billion over budget just five year in. Before it was put into administration, it had refurbished only four stations, versus the seventeen it had been expected to complete by that point. Moreover, TfL claims it is improving the Victoria Line more efficiently than is Tube Lines on equivalent work elsewhere in the system; that company had been very late in completing its own work on the Jubilee Line.

Administrative costs will go down, as the “partnership” between public and private entities was marked more by disputes over costs than agreements. TfL and the PPP companies sued one another repeatedly over the course of the past ten years. Former Mayor Livingstone has suggested that the difference in cost estimates between Tube Lines and TfL could be accounted for by the outrageous salaries the former pays its staff — 150 from Bechtel and Grupo Ferrovial, for example, are paid an average £500,000 each annually, compared to the £90,000 they might receive in the public sector. Mayor Johnson agreed, suggesting that the price difference was the result of management fees: “In other countries this would be called looting,” he said. “Here it is called the PPP.”

And it is definitely true that the public sector is able to take out loans at lower interest rates than were the PPP companies.

No matter what, London continues to set records in terms of how much money it spends on improvements. Arbiter Bolt has demonstrated that peer systems from New York to Hong Kong cost 20 to 40% less than London — in terms of purchasing-power parity — to complete similar work. This, however, may have more to do with work conditions specific to the United Kingdom than anything else.

If Mayors Livingstone and Johnson are correct — that the PPP process resulted in increasing costs for construction that would be better managed by a publicly-controlled entity — the decision to pull leadership of the Tube renewal program back into the heart of TfL makes a lot of sense. Indeed, the example of Metronet suggests that the limited risk assumed by the private companies at least under the terms of this process has yielded few if any tangible benefits for the London public, actually costing the government millions of pounds that would have been better spent on construction. Peter Hendy, current Commissioner of TfL, expects to save hundreds of millions of pounds over the course of just a few years, and he argues that TfL will be able to complete renovations to the Northern Line (so far very late) faster and with fewer disruptions than had the PPP company.

The more recent controversy with Tube Lines demonstrates the failure of a massive 30-year contract with a single organization. There is little motivation for improved performance and there are too many ways in which the private sector can orient its decision-making inappropriately around profit creation, often with the goal of generating huge salaries for its upper-level employees — spending that wouldn’t occur similarly in government.

The London Underground has improved significantly over the past decade: its renovated stations look modern and its operations reliability has significantly increased. But the public likely would have benefited from similar upgrades at a lower cost had TfL remained in charge. Indeed, the positive differences in the system are the result of a vast expansion in public contributions for its maintenance thanks to a national government effort to expand support for transit, not some sort of private-sector ingenuity. The latter seems mostly to have resulted in delays and cost overruns — all at a cost to the taxpayer, not private industry, which has mostly gotten away unscathed.

Tim O’Toole, the former Tube Managing Director, suggests a more conventional financing structure, which would include shorter-term contracts for smaller work commitments. This would allow TfL to adapt to changing circumstances more rapidly and adjust spending based on needs, not profits or the broader economic environment, notoriously difficult for the private sector to adapt to, unlike the far more steady hand of government.

The involvement of private firms in fulfilling specific, project-based contracts rather than an attempt to literally pass off the running of the network to corporate entities seems to be the appropriate future for London. The ideologically charged vision of a “business-oriented” approach to transportation investments pushed by Gordon Brown a decade ago has been debunked as misleading and expensive. There are things an efficient public sector can be good at, and mass transport may be one of them; the next stage of the London Underground’s history, back in public hands, will provide definitive evidence for that assertion’s validity. Other cities considering such a significant PPP process should get to know this example well before moving forward.

In related news, Boris Johnson released the Mayor’s Transportation Strategy yesterday. Image above: London Underground sign, from Flickr user jessicamelling (cc)

14 Comments | Leave a Reply »
  • Tom West

    Private companies exist to make profits. Unless you can be sure that the private company will do things sufficiently cheaper (for a given output) that their cost+profit is less than the public sector’s cost, then all you are doing is wasting taxpayers money.

    Many major transit infrastructure investmnets are contracted out ratehr than done in-house (when was the last time a new subway tunnel was built using in-hosue staff?), so the public sector already beenfits from any possible private sector efficiencies.

    Contracts awarded by governmental entities to the private sector come in two sorts: (1) where everythign is specifidedin minute detail, so there is no scope for innovation or mistakes; and (2) where there is potential for the private company to try and do things better, at the risk of screwing up and doing things worse.

    All in all, I have never seen any convinceing exampels of where a private company has does a government job signficantly better than the public sector could do it. (Any examples anyone?)

    • The privatization of JNR is generally considered a success. So is the privatization of Conrail.

      The reason today’s JRs are more successful is that JNR’s failings came from political meddling – namely, government-backed construction of unprofitable lines, such as a Shinkansen line to the Prime Minister’s home region.

      Conversely, the privatization was not done at fire sale pace, as was done in post-Soviet Russia and Thatcherist Britain. Instead, the government broke up JNR into multiple companies, organized them as private businesses that just happened to be owned by the state, and eventually sold the rehabilitated companies to investors. The same history is more or less true for Conrail, except that the political difficulty that privatization solved was not just about overbuilding but also about overregulation.

      Privatization for the sake of privatization does work sometimes – for example, the Hong Kong MTR – but, again, it needs to be done slowly, to ensure the result is a first world-style profitable business rather than a Russian oligarchy-style rent extraction operation.

      • Drewski

        Conrail’s privatization was a disaster for Ohio. We’re stuck with parallel rights of way, and the cost of creating a true network is blown out because it would require NS and CSX to co-operate. (That in itself could generate a lawsuit on restraint of competition.) The Cleveland – Erie corridor is a prime example of this. This is a heavy freight line, with major potential for intercity (HSR) and regional rail. It would be relatively simple to combine the two corridors, but there are places where rights of way would need to be swapped. Neither NS nore CSX is likely to agree to this, because it means that both would have to not only agree to joint operation of a line, but would also be inviting passenger traffic. North American railroads have a marked hostility towards passenger rail. This is a corridor where public investment in grade separation could benefit both the existing private haulers, and any new traffic, and allowing for increased speed with improved safety and environmental standards.

        Sixty years ago, there were four mainline routes between Cleveland and Akron. Today there’s not one. Interurbans ran every 15 minutes at rush hour in the late 20′s; today a good chunk of that interurban is the Ohio 8 freeway. With Conrail, there was a body working to get rid of surplus rights of way while retaining maximum access. Why have two parallel single-track lines when you can have one double-track line? This was Conrail’s approach. Today, the combination of terrain and development patterns make it difficult to get even a 60 mph service running between Cleveland and Akron (via Hudson); without Conrail, there’s nobody big enough to place priority on that line as an initial connection. Neither MPO can make the case for this line, not least because there would be opposition from CSX or NS for using any part of their existing routes. We have far more r/w capacity than is being used, yet it can’t be used because it isn’t treated as a truly public right of way. Conrail did that for us, and now that it doesn’t, there is no force to shape a network. France, Germany and the UK went through this decades ago, Conrail was doing it, but once again, we in Ohio are left with consequences while others take what they want.

        • Nathanael

          Worse, the problems happening in Ohio with the Conrail privatization are happening in nearby states too, and also the problems within Ohio are hurting natural interstate routes. Why can’t I travel quickly from Chicago to upstate NY? CSX, Ohio, and Indiana.

  • eldondre

    “so the public sector already beenfits from any possible private sector efficiencies”
    in theory, though these private consulting companies aren’t necessarily the same as private companies such as, say, the railroads. they often run in the same circles as the people putting out the RFP’s, and public agency RFP’s are often littered with political garbage from the minority contracting game to the lowest bidder rules. It’s worth noting that the creativity of the private sector seems to run hottest in competitive industries. private companies that have large profit margins often operate much like a government agency.
    “All in all, I have never seen any convinceing exampels of where a private company has does a government job signficantly better than the public sector could do it. (Any examples anyone?)”
    hmm, UPS? the railroads? I think, rather, the opposite is true. there are only certain situations where the government provides a better product at a lower cost. I know people who work for the DOT, they sleep in their trucks half the day. anyway, I suppose you mean infrastructure. aside from the freight railroads, which have a long history of PPP’s (and effective ones at that), I was impressed with the new privately built highway in santiago (paid for with tolls). It certainly can be done, but perhaps, no one can get things done in the west anymore. wasn’t too long ago that I read an article that pointed out that china built an entirely new airport in the amount of time it took the UK to approve the design of a new terminal. time is money. lastly, regarding the tube, I do think that subways are a relatively poor fit for a PPP…especially in a highly developed area. Perhaps if a private company was to build and maintain a new tunnel in a new area where they benefitted from the increase in property values through RE development (much like the railroads used to operate) that’s one thing…but deriving enough money from the operation of transit itself? that’s another. transit’s fundamental problem is that much of the benefit it provides is captured by someone else. the same is true of highways as well. you build a new highway, taxpayers foot the bill, but developers capture the profits by developing farms that are now accessible. good, bad, indifferent. no system is perfect.

  • Patrick M

    It’s hard to construct a profit-motive enterprise around maintenance and safety. Your goal is to maintain the tracks to prevent horrific accidents, loss of life, and massive service interruptions. Since the system usually works day in and day out, every day, for decades, people expect it to run properly all the time.

    There is an excellent book called “Off the Rails” which chronicles the privatization of British rail infrastructure into the company RailTrack, the lapses in safety that came about to pay dividends to shareholders, and the subsequent Hatfield derailment at 115 mph that killed four and wounded 70.

    http://en.wikipedia.org/wiki/Hatfield_rail_crash

    When you have an enterprise that has safety as a top goal, putting a profit motive on the table always leads to temptation to “sweat the assets” and defer maintenance, which as we saw in Britain, or in the Minnesota bridge collapse- can be deadly.

    The best role for private sector participation in track maintenance is through bidding on small jobs where work is thoroughly inspected by track safety experts from the government. Firms can compete to provide the lowest cost repairs and maintenance that meet the appropriate standard, but a third party not driven by profit but by life safety outcomes ensures that the standard is met.

  • Tom West has a good point. In nearly all situations in western economies, government spending is directed to private enterprise i.e. the UK Government funds Crossrail and bids out a contract to construct it. A private engineering firm designs it and private construction contractors build it. The government’s only role in this process is choosing the firms it thinks will do the best job, or the firm that bids the lowest per the guidelines. When private firms get into operation of infrastructure instead of the construction of it is when problems arise as Yonah has pointed out here. That’s where your argument fails, Tom.

    Transportation, whether by automobile, train or aircraft, is essentially regarded as a public good and right. To a certain extent, transportation actually is a public good, it can be consumed in reasonable quantities without affecting others’ ability to consume it. Fallacies exist in this model, especially with the inclusion of driving as a “right” as it is often seen in the United States. When private operators become involved in the operation of the infrastructure, transportation ceases to be a public good unless heavily regulated (think US passenger rail just before Amtrak was founded). Profit becomes the goal, not allowing people to get from place to place. When expectations arise for private companies to provide a public good without explicit support from a government (like rural flights operated by US airlines), profit is impossible. Hence the default of MetroNet.

  • eldondre

    “When you have an enterprise that has safety as a top goal, putting a profit motive on the table always leads to temptation to “sweat the assets” and defer maintenance, which as we saw in Britain, or in the Minnesota bridge collapse- can be deadly.”
    were that but it true. deferred maintenance is hardly caused simply by the profit motive, at least here in the states. there is a problem in today’s market economy as it’s unhealthily skewed towards financial profits (which are taxed at much lower rates than production). It simply is not profitable to run capital intensive productive capacity anymore, which is why railroads, despite working quite well towards safety goals, still need government help. that said, contrary to progressive opinion, American freight railroads are, for the most part, fairly well run and workplace safety is taken very seriously. I think those that take the lesson that “private investment in transportation cannot work” aren’t really learning anything, but expressing a belief. It would seem that a highly unprofitable business is not a good place for investment. OTOH, profitable businesses can and are run by private companies and that goes for any business. I think we can all agree American freight and air transportation have both benefited mightily from deregulation. Regulation of passenger rail was a failure, as Amtrak has also been. The reality is that if it’s too good to be true, it probably is, and that’s certainly the case when the government wants to get something for nothing. OTOH, when a government is unable to address a need, especially with a highway, there’s certainly room for a PPP.

    • Nathanael

      “I think we can all agree American freight and air transportation have both benefited mightily from deregulation. ”
      Nope. Air transportation is going completely bankrupt, and both safety and comfort have been thrown overboard.

      “Regulation of passenger rail was a failure, as Amtrak has also been.”

      On the contrary, Amtrak is an amazing success. Who else could have done that well with that little money, while paying huge rents to private companies for track access, without actually getting the companies to deliver on their side of the deal?

      The reality is that if it sounds too good to be true, it probably is, and that’s certainly the case when private corporations promise something for nothing.

  • Anon256

    Cost savings from private-sector involvement seem to more often arise from escaping political control/influence than from any inherent “creativity” of the private sector.

    An example was the use of a cut-and-cover tunnel for part of the Canada Line route in Vancouver. Had this decision been under government control, the government would likely have bowed to political pressure to use a much more expensive bored tunnel. (Whether the externalities resulting from the construction were properly accounted for is another matter, but businesses and NIMBYs will happily ask government to spend $100 to avert a $1 loss).

    The potential for the private-sector to save on operating costs is much greater. Just as Metronet gave preferential treatment to its owners at Bombardier and Balfour Beatty, so governments and politicians will often give preferential treatment to labour unions that support them. In New York, huge concessions to the transit workers’ union mean that for example the MTA’s commuter express bus routes are hemorrhaging money, even as private express buses and commuter vans make significant profits.

    Perhaps we will see more use of private contractors on infrastructure projects in the future to make the decisions politicians are too cowardly to make themselves. Unfortunately it seems that MetroNet and Tube Lines failed to provide even this service.

    • Nathanael

      This is a rather good summary of the cost tradeoffs. In-house government operation is subject to government unions having much more power than private unions, and subject to politicians demanding costly pointless things; but privatized operations are subject to corner-cutting, massive administrative overhead, and self-dealing/profit extraction by the private companies.

      Pick your poison depending on which problem is harder to prevent. Short terms for privatization contracts seem to help reduce the profit extraction, but make the corner-cutting worse.

  • Well done writeup. In any consideration of employing a PPP an agency has to look at the risks vs. potential rewards. The very nature of private enterprise is normally antithetical to providing public services such as transit. You want a “floor” in place in case the PPP does what private enterprises often tend to do, i.e. go out of business. The more complex the public service (and as a highly systems-oriented technology, urban transit is arguably in the upper realm of complexity), the less it lends itself to private oversight. In Southern California Metrolink has relinquished its O&M contracts back to Amtrak after several lapses of safety under the watch of the private companies hired last decade.

    Obviously the private sector should play a role (as a consultant I admit bias her). Too often state employee unions fight tooth and nail against “contracting out” consulting services such as engineering, I’m thinking specifically of certain state highway departments.

    I realize there is a world of difference between PPPs and “contracting out” – but in any such enterprise the appropriate relationship is usually to have top agency brass manage, oversee and direct the work of reporting private consultants. Within this schema, the appropriate division of labor is almost always variable, depending on the scope of the project or program, the agency’s resources, and the level of trust built up with the consultant.

  • DBX

    The sight of Boris Johnson taking a major company into public ownership, after said company was privatized by a Labour government — truly, politics has been stood on its head. The fact that it’s the right decision is truly the punchline of the failure of NuLab®.

  • [...] the collapse of the massive London Underground PPP scheme early this month, the future of major private involvement in the maintenance and operation of [...]

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