Economics of Public-Private Partnerships

Familiar Mechanisms: 1. private markets (most goods) 2. (pure) public provision (e.g. primary and secondary education, defense) 3. regulated private provision (e.g. local telephone service)

Economics of Public-Private Partnerships

effects and public goods Social justice (to assure adequate consumption for everyone) To control monopoly Other reasons (e.g. poor information)
External

Economics of Public-Private Partnerships

 High

and rising costs Weaker on-time performance Less innovative

Economics of Public-Private Partnerships

Ability to control costs Ability to bear risk Complementarities Flexibility Innovativeness Key knowledge Economies of scale/scope Ability to borrow (Can the gov. borrow more cheaply?)

Economics of Public-Private Partnerships

 Contracting-out

(C-O) (e.g. refuse collection, IT services) Public-Private Partnerships (PPP) (e.g. roads, water, schools, prisons) Privatization

Economics of Public-Private Partnerships

contractual arrangements between government and a private party for the provision of assets and the delivery of services that have traditionally been provided by the public sector

Economics of Public-Private Partnerships

cooperative venture between the public and private sectors, built on the expertise of each partner, that best meets clearly defined public needs through the appropriate allocation of resources, risks and rewards.

(Canadian Council on Public-Private Partnerships)

Economics of Public-Private Partnerships

 The

term public-private partnerships has taken on a very broad meaning. The key element, however, is the existence of a partnership style approach to the provision of infrastructure as opposed to an arms-length supplier relationship a PPP involves a sharing of risk, responsibility and reward, and is undertaken in those circumstances when there is value for money benefit to the taxpayers.
Economics of Public-Private Partnerships

 Sharing

of risk and reward between public and private partners Sharing of authority for decision-making On-going relationships, not spot-market

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 Private

sector involvement in provision of public services is not new e.g. the private sector has frequently provided:
Basic supplies (e.g. paper, pens, desks) Equipment (computers, medical, automobiles) Construction services Consulting services

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 The

increased scope of the private sectors participation particularly in:

1. provision of financing 2. provision of operation services 3. ownership of assets

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Economics of Public-Private Partnerships

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They can be:

Private,

for-profit firms Consortia of private, for-profit firms Private, not-for-profit firms

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 Private

sector involvement can range from zero (pure public) to total (pure private)

Pure Public

Pure Private

Contracting-out

PPP

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 Britain

pioneered new wave with Private Finance Initiatives (PFIs) beginning in early 1990s Now popular in many countries Promoted by World Bank in developing countries

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 Roads Schools Hospitals Prisons Bridges Railways Airports Sewerage

Water

treatment Property management Recreational facilities Information tech. Social services Electricity gen/trans/dist

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 DESCRIBE

THEM TO YOUR NEIGHBOUR. YOUR REIGHBOUR REPORTS IN PLENARY

10

MINUTES

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 Incinerator Biosolids

Harbour

processing Recycling programs Water treatment Bridge Building revitalization

Economics of Public-Private Partnerships

revitalization Electric utility Parking management Public transit Recreation centres Business park

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1. 2. 3. 4. 5.

Define and design the project Finance the project Construction (build the project) Operation & maintenance of the project Pay for the service

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1.

2.

Are there complementarities between the tasks such that some should be combined? Who is most efficient at the task?
Special knowledge economies of scale or scope?

3.

4. 5.

Can the right incentives be put in place to get optimum performance? (contract design issues) How should risks be allocated? Can there be strong competition between potential private sector partners?
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1. 2. 3. 4. 5.

More powerful incentives Competition Expertise/Specialization Complementarities Facilitating user-pay

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 High-powered

incentives to control costs due to profit motive Ability to manage risk Flexibility Innovativeness

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 Managing

risk is really about managing incentives the point is to assign the risks in such a way as to minimize those risks. is done by subjecting the party most able to control a risk to the costs associated with that risk.

This

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1. 2. 3. 4. 5. 6. 7. 8. 9.

Technical risk (engineering or design failures) Construction risk (higher than expected costs) Operating risk (higher operating costs than expected) Revenue risk (lower demand than anticipated) Financial risk (inappropriate debt management) Force majeure risk (war, natural disaster) Regulatory/political risk (changes in laws) Environmental risk (environmental damage) Project default risk (failure through a combination of these risks)
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 Can

lower prices taxpayers or users pay (allocative efficiency) Provides further incentives for cost minimization (productive efficiency) Provides further incentives for innovation (dynamic efficiency)

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have key knowledge not available in public sector (esp. in developing countries) Economies of scale/scope with related projects Complementarities with other parts of the given project
May

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Benefits from coordinated decision-making with respect to: Design & Construction Construction & Operation Financing & Construction

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 Most

often government (taxpayer) pays

Direct pay (e.g. lease payments) Shadow tolls (govt pays but payments based on actual usage)
In

some cases there is user-pay (e.g. tolls, but usually with regulation of tolls) User-pay may be more acceptable in a PPP than in public provision

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Most commonly expressed:

1.

Loss of public control of public services

2. Higher cost of private sector borrowing?

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 What

if changing circumstances demand a change in level or type of services? What if renegotiation is difficult, timeconsuming and costly (note: there is no competition at this point) What if it is difficult to measure and verify quality?

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Not necessarily we must consider: (i) Private partner can raise capital at a low cost for a safe project (ii) Govt marginal cost of borrowing might be higher than average cost (iii) There is a value to the put option (government pays lower rate only because it will repay with near certainty)
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1.

2.

Typically a significant specific investment involved creates significant switching costs. Specific investments protected by contracts but contracts always incomplete.

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PROS
     

CONS
     

Competitive process Increased transparency Well designed risk allocation Balance sheet consideration Private sector efficiencies and innovation Commercial risk sharing

Complexity High transaction costs Higher borrowing costs than public financing Skill deficit for Administration Structuring risks Public perception and political reactions

Reference EBRD 2004

 Both

trade partners will act opportunistically and bargain over the surplus
This is costly! Public provision avoids/mitigates this cost

One

disadvantage/cost of a PPP relative to public provision: inefficient bargaining

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Three main possibilities:

Good contracts (can be costly to negotiate) 2. Good reputations private partner wants future business and public partner does not want to scare away potential partners for other ventures 3. Public provision
1.

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 Uncertainty

over a long horizon Changing government objectives Lack of commitment for both:
Private sector (bankruptcy/exit) Government (break contract, renegotiate)

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 Control

and risk allocation become very important Characteristic of PPPs: transfer of control and risk from public to private sector
Cost: loss of control Benefit: increase in size of surplus, as long as private sector more efficient

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 We

see that spot markets work well to supply goods and services governments and their citizens need when:
There is lots of competition and supply No significant specialized investments are involved

(e.g. pencils for schools)

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PPPs become an attractive option when

Significant specific investment Low cost of contracting

Most important uncertainty can be anticipated and considered in the contract Outputs measurable and verifiable

The private sector brings efficiency improvements especially with competition

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 Pure

public provision looks good when

Significant specific investment Complex or uncertain environment Significant need for public sector flexibility/control

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1. 2. 3.

4. 5.

Ex ante competition important Private sector might have scarce skills Private sector may benefit from economies of scale Labour relations important Observability and measurability of quality a key issue

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1.

2.

3.

4.

5.

Constraints on public borrowing favours PPPs Professional PPP shop may be a good idea (but beware regulatory capture!) Risk goes to party most able to manage it If the project requires innovative thinking this favours private sector Complementarities will be important in allocating tasks.
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THE END

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