After four years of negotiations in both chambers of the German legislature, the Federal Parliament and the Federal Council, a sweeping policy package was approved in early June 2017 that includes nothing less than 13 changes in the German Constitution. These changes, which will reform the financial relations and jurisdictions between the federal government and the states, will have wide-ranging consequences. The German public has discussed the implications of these reforms and continues to do so.[i] Criticism includes not only the nature of this reform but also the very questionable political process that led to it.
While the changes in the German Constitution comprise several different, unrelated policy areas, this article takes a close look at the consequences for infrastructure– in particular, the potential privatization of German motorways (Autobahnen). While official statements claim that the reform prohibits privatizations in any form, critical legal loopholes remain – for instance, for public-private partnerships (PPPs).[ii] Accordingly, there is a significant discrepancy between rhetoric and reality.
This article has two main sections. The first deals with the controversial political process and the content of this reform, while the second part will further explain the problematic implications of PPPs for which this reform will open the floodgates.
The Infrastructure Company and its Loopholes for Privatizations
The current policy package is not the first approach to privatization in the German context. After WWII, state-regulated capitalism and the expansion of the welfare state led to the creation of many state-owned companies. However, there have been several waves of privatizations and PPPs in Germany since the 1960s, including in vital sectors such as energy supply, public transport, education, health services and recently the roads and schools. PPPs are often referred to as partial privatizations; however, a clear definition is non-existent. In Germany, they include long-term contractual relations between private entities and the state in which the private firms contribute financial resources and serve in a number of different modalities. These PPPs often caused resistance and criticism, especially when it concerned public services and infrastructure.[iii]
Germany is currently governed by a Grand Coalition between two parties. One, the CDU (Christian Democrats) tends to favor private sector participation; the other, the SPD (Social Democrats) is more skeptical in this respect. The SPD and its German Minister of Economic Affairs, Sigmar Gabriel, were eager to explain that the changes to the Constitution would not lead to privatizations of highways, knowing how unpopular such measures are among the SPD voters. However, these pledges were misleading, which will be discussed in the following.[iv]
The reform will create a so-called Bundesfernstrassengesellschaft – an infrastructure company to handle new investments in and maintenance of the German highways. The purpose of this infrastructure company is to attract private capital for desperately needed infrastructure investment. While this entity remains 100% under state ownership, its legal form (GmbH) is a private, limited liability company. As such, the company can open the “backdoor” for “partial” privatizations or PPPs. In the case of a GmbH, the parliament cannot influence the decisions made by the company and its board, e.g., on the introduction of tolls or user fees. Democratic control through the parliament or the governmental audit office ends, since data and documents are subject to business confidentiality rules.[iv] This fact seems to be actively ignored when faction leader Opperman of the SPD announced at the daily TV news Tagesschau:
We neither want the highways nor the infrastructure company to be privatized in any way. We want to exclude that. – Opperman, May 2017
Why were this company and the route to “backdoor” PPPs designed in the first place? The rationale is to create a shadow budget that doesn’t appear on the official state balance sheet as it would be otherwise subject to the “debt brake” or the European Maastricht-criteria – hence, a cover-up of public debts. The German “debt brake,” fully effective since 2016, is a constitutional deficit rule, requiring that state and federal budgets are balanced without any outstanding debt. The European Maastricht Treaty of 1992 determined that total state indebtedness must be limited to 60% of GDP.[v]
Prof. Hermes, one of the official consultants in this matter, stated that a judicial dilemma arises in the sense that the state tries to exercise control over this infrastructure company, e.g., in terms of tolls and user fees, while designing the institution in a way that debts are hidden from the state budget. Unfortunately, one cannot have both.[vi]
Public vs. Private Interests
To address the multi-billion infrastructure investment gap that accumulated over the last years while staying within the “debt brake” and the Maastricht-criteria, Minister of Economic Affairs Gabriel created the so-called Fratzscher Commission. Established in 2014, its composition was unbalanced. Although economists and labor unions were part of it, the dominance of banks, insurance companies and representatives of the construction industry was striking. CSOs were excluded. Not surprisingly, the recommendations of the commission’s final report reflected the interest of the financial and construction industries almost completely – proposing the above-mentioned infrastructure company and the extensive participation of private capital in infrastructure investment on a project basis – in both the subnational and national inter-state highways.[iv]
The substantial backlog of investments in maintenance and development of public infrastructure is showing that the state alone is not able to meet those challenges alone. Public-private partnerships can significantly contribute to close this investment gap. – Preface of the Fratzscher-Commission Report, 2015
However, there was no consensus reached on the respective roles of the private and public sectors. This caused the labor unions to issue an alternative statement in which they pleaded for a contrary approach – favoring higher public investments using financial leeway within the “debt brake.”[vii]
The missing consensus reflects itself in the present policy package that conforms significantly to the interests of the financial and construction industries. Private investment in public infrastructure is an attractive business model, according to the Fratzscher Commission. Its findings come at a time when the monetary policy of the European Central Bank (ECB) has led to historically low interest rates in Europe, threatening the profitability of the banks and insurance companies.[iv] The German model of life insurance requires a certain level of interest rates in order to enable the insurers to provide contractually fixed returns to their customers plus a profit. Life insurers invest primarily in secure assets like state bonds; however, European state bonds currently generate lower return than the guaranteed return of life insurance which puts them in a difficult economic situation.[viii] Hence, PPPs offer alternative and secure investment opportunities.
The infrastructure company will become a reality, since it was approved by the Federal Parliament and the Federal Council in the first week of June. The mechanism for the approval of the reform is unusual and anti-democratic. It is also remarkable that reports about the reform are so inaccurate and misleading; they make the false claim that the reform will not lead to PPPs.[iv]
In a joint press statement, the German general associations of the insurance (GDV) and construction industry (HDB) explicitly praised the outcomes of the commission. Michael Knipper, director of the HDB stated:
PPPs have proved themselves. All previous projects were within the cost and time frame, additional costs were nonexistent. – Michael Knipper, 2015[ix]
This claim lacks evidence. In a 2014 study conducted by the German federal audit office (BRH), six previous German PPP highway projects were investigated on their economic efficiency – the result: A cost disadvantage of €1.9 billion or, set in relation, nearly 40% more than the public works alternative.[x] Another 2011 study, jointly issued by the BRH and the 16 German state audit offices, unveiled massive mismatches between the reality of PPP performance, on the one hand, and previous benevolent economic efficiency assessments by private consulting firms, on the other.[xi] Although no German PPP projects were handed back to the state over their contractual duration (30 years), several projects were cancelled due to failures and cost overruns. This is consistent with international cases. In the UK, where there are 30 years of experience with PPPs, 28% of PPPs were "subject to buyout, termination or major problems.”[iii][xii] This corresponds to evaluations of PPP projects issued by the World Bank.[xiii]
One would think that this empirical evidence would lead to rational and science-based decision making. This is obviously not the case.
According to Schlieter (2017)[xiv] at the end of May 2017, the SPD wanted to ensure that skeptical party members would tow the official party line and join in its announcement that privatizations are excluded from the compromise made with the CDU. Surprisingly, in a new report that was leaked to the press at the end of May 2017, the BRH revised its former position towards PPPs (see above) and retracted its criticism. Given its formal neutrality and its critical and explicit position towards PPPs before, this is quite suspicious. Moreover, an invitation from the SPD to Prof. Hermes, a critical legal scholar and consulting expert on this matter, was retracted in order not to disrupt this show of unity. As noted above, the changes to the German Constitution were approved by the Federal Parliament as well as the Federal Council in the beginning of June. An amendment of article 90 states (in translation):
The participation of private entities in the form of PPPs is excluded for route networks that embrace the whole federal highway grid or the whole grid of other freeways in a state, or major parts of it.
Referring to Prof. Hermes, the formulation of “major parts” is still open for interpretation.[xiv] While public-private partnerships in connected grids are prohibited and limited to distances of 100km, these still have a significant impact when being aggregated. However, this number is stated in “normal” law and can, therefore, easily be changed with a single majority, contrary to the Constitution.[xv]
The opponents of the bill hoped that leftist parties (such as the socialist party Die Linke or the Green Party, since they are part of several state governments) could have dissented within the Federal Council. Both parties were quite critical of this reform. However, since it offers significant reallocations of financial resources from the federal to the state level, critics say that these voices were silenced by horse-trading and log-rolling.[iv] Given the scope and nature of this reform as well as the questionable political process that led to its approval, this duplicitous process is unworthy of a western democracy. While the CDU never made a secret of favoring private sector participation, the SPD, in particular, failed to disclose the truth about the reform to German citizens.
Infrastructure Investment and the Role of Private Capital
This section provides further background on private sector participation in public infrastructure and key economic arguments driving promotion of PPPs, particularly their alleged superior efficiency and improved service quality.
From an economic point of view, infrastructure is critical for development and growth. First, it provides certain services that contribute to the gross domestic product and, second, it can increase overall factor productivity when transaction costs are reduced and overall efficiency is enhanced.[xvi] Besides this conceptual perspective, the practical importance of infrastructure is illustrative, since it provides the foundation, the “hardware,” for the provision of public services – electricity, public transport, health services, education, housing, etc. Infrastructure is therefore not only of economic relevance but is also a crucial factor in ensuring social equality and well-being, for instance, by providing also marginalized groups access to markets and basic needs. Roads and highways are particularly relevant in this regard. Germany still has one of the most capable infrastructure grids in the world, however, together with extensive infrastructure come high costs of maintenance, renovation and required investment to meet demands of new technology such as digitalization.[iii]
Meanwhile, the German investment backlog accounts for €120 billion and an additional €200-250 billion for the energy transition and digital infrastructure. This adds up to a total up to €320-370 billion in addition to the current investment.[iii] But, since 2003, there is even (net) negative public investment and inadequate community investment, in particular. This means that current investment doesn’t offset deterioration of infrastructure; maintenance and development are insufficient. Concerning roads and highways, the IMK Report of 2014 calculates an additional demand of €4.7 billion per year in investment.[xvii]
So how to address this problem? In times of the austerity paradigm enforced by the German Finance Ministry, there are limited state budgets institutionalized by the German “debt brake” as well as the Maastricht-criteria of the European Union. This diminishes the fiscal space for public expenditure and investment.
If one follows this (questionable) argument, the only source of additional funding that remains is the private sector. It is not a new phenomenon that the private sector is taking over parts of the economy that were formerly considered being public. The neoliberal approach and its inherent principles of privatization, deregulation, and austerity still prevails.[xiii] It has been promoted since the Thatcher and Reagan years and institutionalized on a global scale, also in Germany. Financial markets and their actors such as private equity firms, insurance companies, and commercial banks have trillions of dollars/euros at their disposal that seek to be invested in profitable assets – especially in times of current low interest rates.[iv] So why not use these savings for infrastructure investment?
Deconstructing the Efficiency Argument
There is nothing inherently wrong with the private sector’s basic principle of profit maximization – within the “rules of the game” as Milton Friedman puts it. In fact, it is the foundation of a free market economy. However, there are legitimate questions about whether or how this principle should be applied to the provision of public infrastructure services. This is especially the case since PPPs are seldom transparent, which breeds corruption and dysfunction. A preferably broad, affordable and inclusive provision of such services often collides with the private sector’s pursuit of efficiency and revenue. A private firm’s obligation is to generate profit on behalf of its shareholders.[xiii]
Again, the concept of “profit-seeking” by private actors is legitimate and encouraged for good reasons since a mutual transaction between two entities, in which both engage for their own benefit, creates wealth. However, a problem occurs when it comes to public infrastructure, such as roads and highways. Referring to Adam Smith’s division of income sources – profits, wages, and rents- rent requires the least effort and is, therefore, quite attractive.[xviii] In our case, introducing tolls for roads and highways owned or managed by private firms produces rent. In this sense, full privatizations or PPPs may lead to “rent-seeking” – an extraction of value without a commensurate contribution to wealth generation. Simply put by Nobel price winner Robert Shiller:
Making money out of something that used to be free. - Shiller 2013
In other words, the revenues created by introducing user fees or increased prices are often not sufficiently compensated for by providing appropriate services. Nevertheless, as Prof. Hermes (2016)[vi] puts it, citizens have to pay for infrastructure in one way or another, in the form of taxes and/or user fees. However, in terms of privatized infrastructure, citizens are additionally contributing to the profit of the company through their taxes and tolls. Empirical evidence suggests that the private sector is not more efficient or effective than the public sector when it comes to infrastructure, but they are likely more expensive.[iii][vi][vii][xix][xx]
The studies on evaluated PPPs projects, mentioned above, confirm this more theoretical approach. Unfavorable outcomes may include benefit reductions, increased prices and rents with simultaneous decreases in the quality of services, corruption, the erosion of built infrastructure due to lack of upkeep, and market monopolies and oligopolies leading to social exclusion and rising inequalities.[iii]
In Europe, the case of Portugal illustrates another concern. According to the IMF, Portugal has the highest cumulative investments in PPPs, especially in roads, of all EU countries. Its financial commitments to PPPs correspond to 6% of its GDP, not counting subnational PPPs. In its PPP contracts, the Portuguese government guaranteed a minimum revenue stream to the investors. Then, as often happens, the demand projections for use of Portuguese roads were too optimistic. Since use of roads was lower than expected, the toll revenues were insufficient. Therefore, the state had to compensate private firms for the shortfall by putting off-budget (or contingent) liabilities on budget. Since the liabilities were originally "off-budget," there was an illusion that the government had more fiscal space than it did.[xi]
Suggesting Alternative Approaches
There is no question that the infrastructure investment gap needs to be addressed. The question that needs to be asked and answered is “how.” The interest rate for long-term federal debt has declined for years, enabling favorable conditions for public investments without colliding with the “debt brake.” For instance, fiscal leeway within the debt brake provides over €10 billion in 2017.[xxi] Public infrastructure must fulfill one crucial criterion – inclusiveness. Among others, the alternative statement of the unions in the Fratzscher Commission formulates constructive recommendations in this regard. Public infrastructure should be financed by taxes in order to share the burden since user fees would marginalize the already most vulnerable parts of society. This basically follows a redistributive argument. A more progressive tax system that abolishes privileges of high incomes, property and inheritances would create the required fiscal space for public expenditure. Also, the planned European finance transaction tax represents a potential opportunity is this respect. Moreover, one could take budgetary obligations for public infrastructure investment into consideration that would at least compensate for depreciation of infrastructure.[vii] Martin Schulz, the SPD’s current candidate for chancellor proposed such an investment obligation. The CDU criticizes this approach stating that money is not the problem, but rather long planning and preparations periods and a lack of shovel-ready projects.[xxii] However, this argument does not apply to an investment obligation that equals infrastructure depreciation to keep provisions at least constant. Repair and renovation do not require “shovel-readiness” or long-term legal approval processes. Besides this, taking bureaucratic (and reformable) obstacles as a justification for inactivity in this pressing issue is not constructive.
If, in the end, private sector participation becomes necessary in order to provide “additionality” in the financing of public infrastructure, it remains crucial that contractual details are transparent and accessible. Also, significantly higher costs compared to state credits need to be avoided and risk allocations balanced.[xiii][viii]
An elevation of special interest over public interest is not compatible with the principles of democratic decision-making. The accelerated and non-transparent legislative process leading to reform of infrastructure laws as well as the false representations of the reform are not worthy of a consensus based democracy such as Germany.
The neoliberal aversion to public spending is based on ideology not knowledge. The public good should be provided by the public sector, not private firms. However, where private firms engage in PPPs, transactions and contracts must be completely transparent, including off-budget liabilities, or there is little hope for accountability.