In negotiating a public-private partnership for building and operating improvements to the Interstate 66 corridor outside the Beltway, Transportation Secretary Aubrey Layne has created a new template for looking at privatization and outsourcing.
Traditionally, when government perceives a public need — building roads, educating children, running prisons — it undertakes to do the job itself. But government bureaucracies are prone to rigidity, bloat and overruns. As a corrective, Republicans and conservatives often propose outsourcing important functions to the private sector. But privatization is vulnerable to cronyism, favor-seeking and private enrichment at public expense.
A third way, Layne’s way, requires government to run more like a business — but not in the sense normally understood as a penny-pinching attention to costs. When businesses negotiate deals and contracts, they expend tremendous effort thinking about risks and contingencies. Government rarely does. That’s why privatization efforts often go awry. Private-sector negotiators take their public-sector counterparts to the cleaners by extracting concessions on obscure points in the contract that can lead to big payoffs down the road. Layne says government needs to develop a similar capacity to manage risk.
As I explained in the previous post, “How the McAuliffe Team Saved $2.5 Billion,” Layne adopted a new approach to project management for “Transform 66.” First, he developed a term sheet, a list of elements deemed essential from a public-policy perspective that could not be bartered away. In the case of I-66, these included park-n-ride lots, a mass-transit service, and future upgrades to the transportation corridor.
Then he established a baseline — what would it cost for the Virginia Department of Transportation to undertake the project itself? If VDOT could do the job for less, on a risk-adjusted basis, then there was no point in dishing off the work to the private sector. But if a private bidder could do the job for less, the public would benefit.
But those were just first steps. Layne analyzed transportation projects as a continuum of risks. For any large project, for instance, there is the risk that construction could run behind schedule or over cost. VDOT was once notoriously unreliable in delivering projects on schedule and on budget, although it has gotten much better. Also, there is O&M risk — the risk that operations & maintenance will cost more than assumed. This is particularly an issue if the condition of roads and bridges is to be maintained to specified performance standards. Then there is financial risk, critical in toll-financed projects. Financial models are predicated on assumptions of how many motorists will pay tolls and how much they will pay. If ridership and revenues fall short, the tolling entity, whether public or private, could wind up defaulting on its bonds — a highly visible event.
It is worthwhile noting that these risks exist whether VDOT explicitly recognizes them or not. For many years, construction delays and overruns were routinely buried in budgets that were impenetrable to the public. Maintenance costs were divorced from project costs and rolled into transportation district expenditures. No one bothered to check if actual ridership matched the projections that justified the project. If ridership fell short, there were no visible repercussions. Poor management might result in less money available for future construction projects, but it was invisible, so no one was held accountable.
Layne’s key insight is that different parties vary in their tolerance for taking different types of risk — for reasons often unknowable to the state. One player, for instance, might accept a lower return on investment in order to get a toehold in a strategic market. A corporation, facing zero-interest policies in the European Union, might wish to transfer assets to the U.S. Another player might have tax reasons for structuring an investment in a particular way.
Therefore, it is critical to bring as many players bidding on a project as possible, and not to settle upon a given approach right away. When discussing the I-66 project, five different consortia submitted five different design-build proposals (in which they would design and build the project, then turn it over to VDOT), five design-build-operate projects (leaving bond-financing and ridership risk with the state) and three outright concessions (in which the private parties would assume operational and financial risks).
Negotiations with multiple parties also creates what Layne calls “price discovery” — the state gains new insight into the economics of the project that allows it to push for better terms. Private consortia suggested opening HOT lanes to trucks to generate additional revenue. The idea added value to the deal, and Layne accepted it.
At the end of the I-66 process, Layne concluded that offering a 50-year concession to Express Mobility Partners offered the best deal to Virginia — $2.5 billion better than the deal offered when Governor Terry McAuliffe took office.
While the details of maintaining a transportation system differ from those of, say, a prison system, a school system, a prisoner recidivism-reduction program or a mental health program, I see no reason why Layne’s method couldn’t be applied to other government functions.
Layne had an advantage because Virginia has experimented with public-private partnerships for many years now. Even though the McDonnell administration made some blunders, it did introduce new thinking, it pushed the envelope, and it made mistakes from which Layne could learn. Outsourcing transportation projects has had a steep learning curve, as would privatization of prisons or any other government function. Any ambitious effort to re-think how government delivers services will experience bumps along the way but, as Layne has proven, the rewards could be tremendous.
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