In a recent NBER working paper, Engel, Fischer and Galetovic outline when and how to use public private partnerships (PPPs) in infrastructure. Broadly, they argue that PPPs can be used to increase spending and efficiency gains— better maintenance, reduced bureaucratic costs, and filtering white elephants among others. However, governance of PPPs is important, especially appropriate risk allocation and avoiding opportunistic renegotiations.
PPPs allow governments to increase spending in infrastructure because: (i) investment via PPPs does not contribute to fiscal deficit and add to public debt in the short run, and (ii) such investment is not subject to regulatory oversight and budgetary controls.
There are tradeoffs too as government has to forgo future stream of tax/toll revenue from projects that are financed via PPPs, which do not require large upfront investment by the government. PPPs are also used to promote private investment in infrastructure to replace an incompetent public sector. Large infrastructure projects require stronger capabilities to mange contracts and execute projects.
There are tradeoffs too as government has to forgo future stream of tax/toll revenue from projects that are financed via PPPs, which do not require large upfront investment by the government. PPPs are also used to promote private investment in infrastructure to replace an incompetent public sector. Large infrastructure projects require stronger capabilities to mange contracts and execute projects.
According to the authors of the working paper, the main reasons for opting for PPPs over public provision are:
- Narrow focus and dedicated management (contract with employees governed by private law, incentives to manage infrastructure per contract with public authority, SPV to build and manage projects)
- Bundling (quality of service is contractible and life-cycle approach toward maintenance reduces maintenance and operations costs
- Fewer construction delays (because of the opportunity to charge user feeds or receive government transfers once project is operations)
- Filtering white elephants (private players will not opt for projects where user fees cannot pay for capital and operational expenditures)
- Avoiding bureaucratic costs (related to rigidities in public spending and corruption)
- Advantages of private financing (mitigate moral hazard by tightly controlling changes in the project’s design and disbursing funds by banks according to project construction timeline/stages)
- Better and less expensive maintenance (continuous maintenance is efficient as intermittent maintenance incurs 1.5 to 3 times the cost of continuous maintenance)
For PPPs to succeed, government should have higher capabilities as financing is more complex and there is scope for opportunistic behavior (long-term contract and dealing with government entities).
Sometimes government has to bail out PPP projects, thus absorbing all the downside risks. There are also cases of contract renegotiation, which opens up avenue for corrupt practices. This can be avoided by using contracts with better risk allocation (concessionaire bears all the exogenous demand risks but renegotiation is allowed in the case of low realization of demand). For instance, Present-Value-of-Revenue (PVR) contracts have built-in renegotiation condition if demand realization is low, in which case contract term is extended but contract itself is not modified. They authors suggest that careful planning, project design, and project management are vital for successful PPPs.
Sometimes government has to bail out PPP projects, thus absorbing all the downside risks. There are also cases of contract renegotiation, which opens up avenue for corrupt practices. This can be avoided by using contracts with better risk allocation (concessionaire bears all the exogenous demand risks but renegotiation is allowed in the case of low realization of demand). For instance, Present-Value-of-Revenue (PVR) contracts have built-in renegotiation condition if demand realization is low, in which case contract term is extended but contract itself is not modified. They authors suggest that careful planning, project design, and project management are vital for successful PPPs.
On the fiscal implications of PPP projects, they argue that PPPs have been used as a means of evading fiscal spending constraints. The use of off-balance sheet expenditure is often termed as “fiscal illusion”. The debt is recorded as financial liability but does not become a part of budget itself over short to medium term. The authors argue that the advantage of PPPs should lie in efficiency gains, not only fiscal accounting gimmickry to increase spending.
