Price regulatory offices exist to stop monopolies from overcharging for their services or facilities. This involves close and skeptical scrutiny of the monopolist’s costs, including proposed and final investment costs. In 2006, when the plan for T2 was developed, the regulator’s office was concerned about possible cost overruns. The airport’s record was not particularly good in that respect, and it was central to the office’s responsibilities that passengers not be left paying the bills for poor managerial cost control.
Consider first the history of a new pier built at the airport, Pier D. Money for a new pier was sought by the airport in 2001 and included in the investment plan that formed part of the regulatory price calculation. Although in the subsequent five years, the airport collected the full charge, the pier was not built. Standard regulatory treatment for this problem is straightforward: the cost of the undelivered project was deducted from the next price cap even though the next period’s investments all still needed to be delivered. This included the airport’s new plan for the pier, for which €the regulator allowed 93 million. This time the pier was built, but at a final cost of €125 million. The airport sought the recovery of its full expenditures. Part of these arose from matters outside its control. In the end, the regulator’s office allowed €16 million of the €32 million overrun to be recovered; the remainder was judged to be the responsibility of the airport, which accordingly suffered a partial loss on this investment.
This was not an ideal approach. It required the airport to first build Pier D but to discover only afterwards how much of its cost the regulator would allow to be recovered through higher airport charges. So, prompted by experience of international regulatory practice (there are no wheels needing to be invented in the cost control business), and conscious that the new terminal would cost much more than Pier D, we developed in 2007 a new approach. First, we required the airport to publish its investment plans, project by project, setting out the need for the projects, their facilities and functionalities, the timetables, and the costs. We sent all projects costing more than €5 million to a quantity surveying consulting firm for assessment. The QS firm reported to us on whether budgets seemed too low, too high, or about right. We published that report on our website and asked for comment including from airlines using the Dublin. Projects that airlines supported (i.e. were prepared to pay for) at the costs proposed by the airport, were added to the investment base. Projects supported by one side but not the other required a regulatory judgment. A final investment budget was set by the regulatory office, and airport charges for the next period derived accordingly. All this information is still available today online
Secondly we set out rules on how various situations would be treated – cancellation of a project, non-delivery of a project, delivery of projects unplanned at the time of the regulatory decision, projects delivered under budget, cost overruns due to new user requirements, costs overruns credibly due to factors outside the company’s control, and costs overruns due to poor project management. For each case, a specific regulatory treatment was set out. The intention was to give the airport flexibility to vary its investments as circumstances changed, or user requirements were explicitly amended, but to let unjustified cost overruns fall on the airport shareholders. These rules were distilled into a single summary table. Parties knew where they would stand in advance: the airport, if there were unjustified controllable cost overruns, and the airlines if they sought extra functionality from a project.
After T2 had been built, the final cost was €932 million against a budget of €778 million. Again, the airport sought full compensation. The regulator’s office allowed half of these costs to be recouped from airport charges. The other half was deemed the responsibility of the airport, meaning again that the airport will never recover the full costs of T2.
This is just an outline of the process – but there is enough to allow some principles to be derived. Cost controls must start with incentives, the realization that developers have an incentive to overcharge and a mechanism sufficient to the task is needed to stop them. In health, it should be a public body that acts in the position of the regulator and reaches contracts with developers who contract to deliver hospitals against budget, with explicit, public rules about how cost outturns will be treated.
This will involve some confrontations – cost control is not for the faint-hearted. Streams of letters are received insisting that the cost control policies mean that laws will be broken, competition rules breached, stock market directives ignored and that the regulator’s office must change direction immediately. Information will be offered in private, for private discussions, but on condition that nothing is put in the public domain unless the firm agrees. There will be other correspondence, sometimes pretty offensive. The annual reports of the regulated firm will be none too complimentary.
In the political world, anonymous remarks will be attributed to unnamed ministers, along the lines that staff of the regulator’s office should stop being a nuisance and risking delays in essential infrastructure. Civil servants will (metaphorically) drum their fingers on desks, and not hide their regret at outsourcing regulation to economists and other head-in-the-clouds types.
But the consolation is that the public will be protected
I do not claim that there’s a perfect fit between regulatory cost control and control of the budget for the children’s hospital. I do claim that the airport regulator’s office was firm about setting accountability rules in advance for capital cost overruns. These gave the airport management a very strong financial incentive to deliver a project on time and on budget, and clarified that cost overruns would fall substantially on the shareholders of the airport. In the case of the children’s hospital, there is no clarity – to the point where the government now needs to pay private-sector accountants even to find out what the various public sector bodies were doing!
To control costs, there can only be a single ‘regulator’ (or body with cost-control responsibilities) and a single builder counterpart. In fact, once the government commissions a project – putting its requirements in writing into the public domain – its direct role should be over. The role of the ‘regulator’ is then to run a tender to identify a builder that can deliver the project (as prescribed) at lowest final cost. It has been reported that the children’s hospital project applied for and was granted an exemption from the standard public procurement rules. A regime that chases minnows and spares monsters is the worst outcome of all – high costs and few benefits.
Site choice and other decisive influences on cost have to be part of the responsibility of the ‘regulator’. In that regard, governments can achieve more by intervening less, in particular by denying themselves the ‘meddling’ powers that will cause them to be pestered by such nefarious forces as multimillionaire medical consultants fighting turf wars. Governments have limited their own role in other areas with few regrets.
If it is not possible to sign a completely fixed-cost contract, then having the builder’s costs evaluated by a consultant QS is even more crucial than at the airport. Clauses that allow for cost escalation need to be policed by consultant engineers on site, from whom written agreement is needed when the developer proposes material cost adjustments above and beyond those contracted for. Cost-plus clauses should be related to official published building-cost inflation statistics.
Relevant principles therefore include role clarity, ‘regulatory’ independence, and full transparency. Currently, we have a nirvana for builders and a nightmare for taxpayers and politicians.
It is not false modesty to finish by saying that the intellectual credit for these ideas goes mainly to economist and other colleagues of mine working at the regulator’s office. The regulatory reports mentioned in this posting may be found on the CAR website.