Muskrat Falls project illustrates problem with public ownership of large-scale projects
A couple of weeks before the election began, the federal government offered a multi-billion-dollar aid package to Newfoundland and Labrador to help the province complete the stagnant over-budget Muskrat Falls hydroelectric project. Ottawa will buy an equity stake in the project and provide loan guarantees as part of a $5.2 billion aid package. This represents almost $10,000 per resident of the province and one of the largest bailouts in Canadian history, which underscores the challenges of public ownership of large-scale infrastructure projects.
How did we get here? The Muskrat Falls project is a hydroelectric power generation and transmission development that Nalcor Energy, a provincial Crown corporation, sanctioned and started to build in 2013 with the authorization of the Newfoundland and Labrador government. The 824-megawatt hydroelectric plant on the south side of the Churchill River in Labrador was expected to come online in 2017 along with its two transmission lines.
So, what happened?
Well, what usually happens when governments undertake large-scale infrastructure projects—poor planning, lack of oversight, cost overruns and mismanagement.
Consider, for example, the significant differences between the estimated costs of the project at the time it was approved in 2013 ($7.4 billion) versus the costs reported in March of 2020 ($12.7 billion). This underestimation is just one of many findings from an inquiry commission, which reported in 2020.
In its report, the commission stated that the government of Newfoundland and Labrador “failed in its duty to ensure that the best interests of the province’s residents were safeguarded,” pointing to a lack of appropriate oversight of Nalcor at all stages of the project. The commission also found that Nalcor’s contractual arrangements directly led to delays and cost overruns.
Overall, the commission found that Nalcor exhibited a “combination of unrealistic optimism, a willingness to misrepresent costs, schedule and risk, and an inability to change course when things were going wrong.”
But this is no surprise. It’s well known that cost overruns and schedule delays are a near inevitable feature of large-scale public infrastructure projects. Oxford University scholar Bent Flyvbjerg co-authored a study examining major government projects in 20 countries and found that nine out of 10 public infrastructure projects incurred cost overruns. Simply put, large projects done in the public sector are not well-suited to minimize costs.
That’s not to say the public sector is not staffed by well-intentioned and skilled civil servants. Indeed, Canada has one of the best, most professional civil services in the industrialized world.
But government officials face markedly different incentives than people in the private sector. If a private company goes over budget, the owners and employees pay the price through lower rates of return and/or reduced compensation. In other words, the cost of missteps is borne directly by those responsible, which imposes a real discipline on economic decisions.
However, that level of discipline and accountability cannot be found in the public sector. If the construction of a large-scale infrastructure runs over budget (like the Muskrat Falls project) no politician or government official will lose their own money or face any meaningful consequence. It’s a basic principle in economics that people are far more careful with their own money than other people’s money.
Overall, instead of trying to act like a large-scale construction company, governments should stick to improving incentives for investment through competitive taxes and a reasonable and consistent regulatory regime. By doing so, private companies will be more willing to invest and build much-needed infrastructure.