Policy Research Working Paper 7340

Public-Private Partnerships

Promise and Hype

Michael Klein

Global Practices Vice-PresidencyPPP Cross-cutting Solutions AreaJune 2015

WPS7340P

ublic

Dis

clos

ure

Aut

horiz

edP

ublic

Dis

clos

ure

Aut

horiz

edP

ublic

Dis

clos

ure

Aut

horiz

edP

ublic

Dis

clos

ure

Aut

horiz

ed

Produced by the Research Support Team

Abstract

The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent.

Policy Research Working Paper 7340

This paper is a product of the PPP Cross-cutting Solutions Area, Global Practices Vice-Presidency. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The author may be contacted at muklein@gmail.com.

This paper provides perspectives on patterns of public-pri-vate partnerships in infrastructure across time and space. Public-private partnerships are a new term for old concepts. Much infrastructure started under private auspices. Then many governments nationalized the ventures. Governments often push infrastructure providers to keep prices low. In emerging markets, the price of water covers maybe 30 per-cent of costs on average, that of electricity some 80 percent of costs. This renders public infrastructure ventures dependent on subsidies. When governments run into fiscal troubles, they often look again for public-private partnerships, and price increases. As a result, public-private partnerships keep making a comeback in most countries, but are not always loved. Waves of interest in public-private partner-ships sweep different countries at different times. Overall, in emerging markets today, public-private partnerships

account for some 20 percent of infrastructure investments, with wide variations across countries and from year to year. There is no “killer” rationale for public-private partnerships. They can help raise financing when governments face bor-rowing constraints. They can be more efficient when sound incentives are applied. Existing evaluations suggest public-private partnerships tend to perform often a bit better than public provision. Yet, well-run governments can do as well. Public-private partnerships provide mechanisms to improve the governance of infrastructure ventures where govern-ments are flawed. Once the fiscal troubles are over, the politics of pricing assert themselves again. Tight pricing erodes the profitability of public-private partnerships and the wheel of privatization and nationalization keeps turning, as it has since modern infrastructure services were invented.

Public‐PrivatePartnerships‐PromiseandHype‐

MichaelKlein1

JELcodes:H44,L9,L32,L33Keywords:Public‐PrivatePartnerships,PublicSectorManagement,PrivateSectorDevelopment

1FrankfurtSchoolofFinanceandManagementandJohnsHopkinsUniversity

2

PatternsofPPPsacrossTimeandSpacePublic‐privatepartnerships–what’sinaword?Public‐privatepartnerships(PPP)aretheragethesedays‐allovertheworld.Thepopularityofthetermisrecent.Duringthe1990sitwasnotmuchused.2Unsurprisingly,therefore,thereareviewsthatthePPPphenomenonissomehownew.3Inrealitythepackagingmaybenew,butthecontentisold.Forexample,concessionsunderwhichthestatedelegatesconstructionandmanagementofpublicworkstoprivateprovidersweredeployedinFranceinthe17thcentury.InmanypartsoftheworldearlyinfrastructureprojectswerebuiltandoperatedbytheprivatesectorundercontractsthatcouldtodaybecalledPPP.ExamplesareThaiandJapaneserailwaysandFrenchwatersystems.4ThetermPPPitselfremainsfuzzy.Oftenitreferstoinfrastructureventuressuchasroads,watersystemsorpowerplants.Itmayextendtosocialinfrastructureincludingschoolsandhospitals.Itcancoverallsortsoffacilitiesfromlandfillsforwastemanagementtoprisons.Andthenthereistheuniverseofcollaborativeeffortsbetweengovernmentsandprivatepartiessuchasprogramsforvaccinedevelopmentorthesupportofsmallandmediumenterprises.JayKnott,consultantandformerUSAIDofficialhasitrightwhenhenotes,“ItseemsthattheverydefinitionofaPPPcanshiftwiththewinds.”5InthispaperthetermPPPreferstoprivateparticipationininfrastructure(telecom,transport–roads,ports,airports,andrailways–,waterandsanitation,wastemanagementandelectricity).6Activitiesthatfallunderthisumbrellamaysometimesbecharacterized,forexample,as“concession”or“franchise”or“build‐operate‐transfer”deals.Atoneextremethereare“fully”publicsectorenterprises–attheother“fully”privatefirms.Inbetweenexistsacontinuumofarrangementsthatcombinepublicandprivaterolesindifferentways.Thepublicsectormaydelegateconstructionandoperationtoaprivateparty.Itmayjustdelegateoperationorjustmanagementoronlysomeservices,likemeteringelectricity.Whatevertermweuse,itisimportanttounderstandthedetails.Forexample,proponentsofprivateparticipationinthewatersectorhavemademuchofthedifferencebetweentheFrenchapproach–concession–andtheEnglishandWelsh–

2AnearlyexampleistheInstituteforPublic‐PrivatePartnerships(IP3)thatwassetupinWashingtonin19943seeforexampletheviewontheoriginsofPPPsinWikipedia:http://en.wikipedia.org/wiki/Public%E2%80%93private_partnership4Klein,M.andN.Roger(1994)“BacktotheFuture”inFinanceandtheInternationalEconomy85https://www.devex.com/news/for‐public‐private‐partnerships‐to‐succeed‐get‐beyond‐the‐definitions‐851906Occasionally,anexamplefromsocialinfrastructureillustratesaspecialpoint.

3

privatization.Lookingcloserthereisnosignificantdifference.CananEnglishwatercompanyturnoffthetap,becauseitownsthewater?No,ithastoprovideservice.Canitclosethebusiness,digoutthepipesandleave?No.Buttheownershipisprivate,whereasinFranceitremainspublicandtheassetsreturntothepublicsectorwhentheconcessionperiodends,sayafter25years.Well,underitslicenseanEnglishwatercompanymaylosethelicense,iftheresponsibleministrysodecidesatanytimeandwithoutreason,aslongasnoticeof10yearshasbeengiven.7Theassetsarethentakenoverbythegovernment.Hence,thereisnosubstantivedifferencebetweenthetwoapproaches.Attheotherendofthespectrum,evenwhentheenterpriseisdeemedfullypublic,constructionistypicallyoutsourcedtotheprivatesectorasareanumberofservicessuchasofficecleaningorcatering.Ifwewant,wecancallthatPPP.PPPsininfrastructureandinmuchofsocialinfrastructuretypicallyoperateinsectorswherecompetitionisnotornoteasilyworkable.They–andfullypublicenterprises–arethususuallysubjecttosomeformofpriceandqualityregulation,exceptin“lawless”areassuchaspartsofSomalia.Theregulatoryrulesmaybewrittendowninacontractorsomeotherdocument,sayastatute,alicenseoralaw.Theorganizationmakingandadministeringtherulesmaybeaspecialagencyoranofficeinaministryorsomeotherpublicauthority.Allsortsofcombinationsexist.Sowhycallthings“PPP”?Justgoogleimagesunder“waterprivatization”andthen“waterpublic‐privatepartnership”.Waterprivatizationshowsrapaciousfirmsexploitingpoorpeople.UnderPPPtheimageslookbenign.Charts,slogansaboutpartnershipandsomeoccasionalhandholdingbetweenpartnersaredepicted.“Privatization”hasbecomeincendiary.“PPP”isapoliticallybenignterm,atleastfornow.8HistoryofPPPsininfrastructureThehistoryofPPPsgloballyhasyettobewritten.ThemostcomprehensivetreatisecoversthecaseofBritain.9Nevertheless,fromexistinghistoricalaccountswecanpiecetogetherabroadpicturethathelpsorganizethinkingaboutthephenomenon.Withtheriseofthemodernworld,manyinfrastructureservicesstartedinprivatehands.Thatappliestomuchoftelecommunications,railroads,electricity,towngasandnaturalgasorurbanwatersupply.Evencanalsandoverlandroadswereoriginallyprivateinplaces,forexample,EnglandortheUnitedStates.10Atthesame

7Kerfetal.(1998)“ConcessionsforInfrastructure”WorldBankTechnicalPaperNo.3998Groupsliketheglobalizationcritics,ATTAC,havestartedcampaigningagainstPPPsassuch;seeforexamplehttp://www.ppp‐irrweg.de/9Foreman‐PeckJ.andR.Millward(1994)“PublicandPrivateOwnershipofBritishIndustry1820–1990”ClarendonPress,Oxford10http://www.historylearningsite.co.uk/canals_1750_to_1900.htm;http://en.wikipedia.org/wiki/History_of_turnpikes_and_canals_in_the_United_States

4

timetherewereservicesthatstartedinpublichandsandremainedthere,forexample,theUnitedStatespostalservice,sinceBenjaminFranklinwasappointedasthefirstpostmastergeneralin1775.Duringthesecondhalfofthe19thandthebeginningofthe20thcenturysomeformofnationalizationoccurredinmanycountries.Motivesfornationalizationvaried.Atageneralleveltheyhadtodowithconcernoverprivategreedleadingtoexcessivepricesorinadequatequality.Healthconcernsdrovesomewaternationalizations.Britishelectricitycompanieswerenationalizedtofacilitatesystemintegrationwhenlong‐distancetransmissionbecameeconomic.PrussianationalizedrailservicetosubsidizethecostofUpperSilesiancoalminescompetingwithEnglishcoal.WhenearlyarrangementswereputinplacethatwemightcallPPPtoday,inflationwasvirtuallyunheardof.Withtheriseofinflationduringthe20thcenturyagreedpriceslaggedbehindcosts.Somegovernmentsthennationalizedfailingprivatefirms,asinBrazil’selectricitysector.Inanumberofcases,governmentsresortedtosomeformofpriceandqualityregulationratherthanoutrightnationalization.ExamplesarethetelephonecompanyATTintheUnitedStates;theGermanelectricitycompanyRWE;thepowercompanyofHongKongSAR,China;ChinaLightandPower;ElectricidaddeCaracasintheRepúblicaBolivarianadeVenezuela(till2007);andmanyFrenchwatercompanies.Governmentfirmsweremeanttoprovidebetterqualityatlowerprices.Disenchantmentfollowed.Lowpricesstarvedpublicfirms.Theincentivesofpublicfirmstoperformwerenotsystematicallybetterthanthoseofprivateones.Someperformedwell.Yet,manyGovernmentofficialsandmanagersofpublicenterprisesrevealedthemselvesasself‐interestedjustasthegreediestcapitalistorusedstateenterprisestopursuenon‐economicgoals,suchaskeepingpricesbelowcost.Aslongasgenerousstatesubsidiescanpaperoverthecracks,state‐ownedfirmspersevere.Butwhenfiscalresourcesaretight,thecallforprivatefinanceandmanagementbecomespoliticallysalient.Thesyndromeleadstothe“wheelofprivatizationandnationalization”(figure1).11Anumberofcountriesandinfrastructuresectorshaveundergonethecycle,notablyArgentina.Themovefromprivatetonationalinfrastructurefirmslastedwellintothe1970sinmuchoftheworld.Theproductivityslowdowninadvancedeconomiessincetheearly1970sandtheconcomitantoilcrisisputgovernmentfinancesunderstress,whetherinsomeEuropeancountrieslikeBritain,whichhadtoresorttoIMFsupportinthe1970sorinLatinAmerica,wheredebtcriseseruptedinthe1980s.

11Gomez‐IbanezJ.andMeyersJ.R.(1993)“GoingPrivate:TheInternationalExperiencewithTransportPrivatization”TheBrookingsInstitution,WashingtonD.C.andKleinM.andRogerN.(1994)

5

Asaresultanumberofgovernmentsturnedtosomeformof“privatization”ofinfrastructureservices.ChileandtheUKpavedthewayinthe1980s.Technologyadvancesintelecommunicationsmadethatsub‐sectorparticularlyattractivefortheintroductionofcompetitionandconcomitantprivatization.GeographicalpatternstodayFromthe1990sonwardswehavemoresystematicdataonPPPdevelopmentsindevelopingeconomiesfromtheWorldBank’sPPIdatabase.12ByFebruary2015itcovered6146projectsinlowandmiddle‐incomecountrieswithatotalinvestmentvolumeofabout$2.2trillion(notadjustedforinflation).Dataonpublicsectorinfrastructureprojectsare,however,stillnotsystematicallyavailable.InthefollowingestimatesbyMcKinseyonoverallinfrastructureinvestmentlevelsbyregionareusedtoputPPPdevelopmentsinperspective.13ThegeneralpictureisoneofwavesofenthusiasmforPPPsfollowedbysomedisenchantmentandconsolidation.Differentcountrieswerecaughtupinthewavesatdifferenttimes.TheWorldBank’sWorldDevelopmentReportof1994estimatedthatPPPsaccountedforsome7%ofinfrastructureinvestmentindevelopingeconomiesintheearly1990s,probablyanunderestimatebyuptohalfinretrospect.Itsurmisedthatthetotalmightdoubleinthefollowingyears.14Indeed,itexploded.In1997$150billionofPPPinvestmentsmayhaveaccountedforclosetohalfofallinfrastructureinvestment.15Acollapsefollowed.By2002PPPinvestmentsfellbacktobarely$60billion.Sincethentotalinvestmenthasrecoveredreaching$200billionin2010beforesubsidingsomewhat.16AtthesametimeGDPhadgrownrapidly.Today,PPPsaccountforsomethinglike20%oftotalinfrastructureinvestmentinlowandmiddle‐incomeeconomies,roughlydoublethelevelinthelate1980s.PPPsrarelyaccountformorethanhalfoftheinfrastructureinvestmentsofacountry.ItisfairlynormalforacountrytousePPPsfor15–25%oftotalinfrastructureinvestments.MostcountriesusePPPsatleastoccasionally;evenforexample,12In1993IcreatedthePPI(privateparticipationininfrastructure)databaseattheWorldBank,whichremainsthemainsourceondevelopmentsininfrastructurePPPs.www.ppi.worldbank.orgThedatacoverbothnewinvestmentaswellaspurchasesofexistingcompanies.13McKinseyGlobalInstitute(2013)“InfrastructureProductivity:Howtosave$1trillionayear”,WashingtonD.C.14WorldBank(1994)“InfrastructureforDevelopment”,WashingtonD.C.p.9315GDPoflowandmiddle‐incomeeconomiesamountedto$6.4trillionin1997(WorldBank(1998/99)“GlobalEconomicProspects”,WashingtonD.C.).Assumingatotalinvestmentininfrastructureof5%ofGDP,$150billioninvestedinPPPsamountedtoalmosthalfofthat.Someofthiswasinvestmentinexistingcompanies.Netnewinvestmentstillprobablyexceeded$120billionandinvestmentlevelsinemergingmarketwereprobablylowerthan5%ofGDPduetofinancialcrises.16Thisassumesanaveragetotalinvestmentlevelofabout4%ofGDP,whichishighformostcountriesexceptChina(8.5%)andtoalesserextentIndia(4.7%).

6

TurkmenistanorBelarus.SomehaveseenyearswhenPPPsaccountedforthebulkofinfrastructureinvestments,mostrecentlyBrazil.ChinahaspursuedmorePPPsthananyothercountry.Yet,onaveragePPPprojectsarerelativelysmallandaccountforlessthan1%ofChina’sexceptionallylargeinvestmentininfrastructure.Amongregionsoftheworld,LatinAmericastartedearlyandhasinvestedmostunderPPPcontracts–some38%oftheglobaltotal.Withintheregion,however,theinterestofdifferentcountriesshifted.Initially,inthe1990sArgentinawastheforerunnerinPPPstillthecountrychangeditseconomicmodelafterthecrisisof2002.Today,Brazilisthebigenthusiast.SeveralEastAsiancountriessuchasThailandandIndonesiawerecaughtupintheearlywaveofthemid‐1990s.ThenChinatooktheleadalbeitwithsmallerprojects.InEasternEurope,earlyprivatizationtouchedmostlytelecommunications.OtherPPPstookoffslowly.TheRussianFederationand,mostrecently,Turkeyaremostactivetoday.Indiastaidoutofthegameduringthe1990sbutthenbecametheglobalhavenforPPPsandprojectfinancearound2010.Sub‐SaharanAfricasawlittleinterestinthe1990s,buthasexperiencedamini‐boomrecentlydrivenbytelecommunicationsandnowalsoelectricityPPPs.OnlymodestactivityhasbeenseenintheMiddleEastandNorthAfrica.Inadvancedeconomies,17PPPshavebeenmostpopularinEuropeledbyBritain’sprivatefinanceinitiative(PFI)thatstartedunderJohnMajor.Morerecently,priortothefinancialcrisis,theybecameanapproachofchoiceinSpainandPortugal.InFrancePPPsalwayshadahomeatthemunicipallevel.SomecountriesareexperimentingwithPPPsincludingGermany.18InterestmaygrowintheUnitedStates,wherePPPsinthetransportsectorhavebecomeasubjectofdebate.Insum,therearenosimplegeographicpatterns.MostcountrieshavetriedPPPs.Somehaveseenenthusiasmwaxandwane.OthershavestucksteadilytosomeformofPPPs.Anewsetofcountrieshassofartakenupthebanner,whenactivityflaggedelsewhere.SectorpatternsMorepronouncedpatternsappearwhenlookingatPPPsbysub‐sectorofinfrastructure.Telecommunicationinvestmentstypicallyled,notablyinEasternEuropeandCentralAsia,theMiddleEastandinSub‐SaharanAfrica.Electricitywasnextinline.Withinthepowersector,theemphasishasbeenonindependentpowerproduction(IPPs)withlimitedactivityintransmissionanddistribution.Verylittleoverallhashappenedinwaterandsanitation.There,themajorgamewasChinesePPPsforwatertreatmentplants.Roadsdominatetransportsectorinvestments.

17ForadvancedeconomiesdataonPPPsarenotsystematicallyavailableoveralongerperiodasfordevelopingeconomies18WagenvoortR.etal.(2010)“InfrastructureFinanceinEurope:Composition,EvolutionandCrisisImpact”inEIBpapersVol.15No.1

7

SeveralcountrieshavetriedPPPsintheformoftollroads.ChilehasarguablythemostsuccessfulPPPtollroadprogramofanycountryintheworld.Mexicoontheotherhandwasplaguedbyimprudentapproachestoprivatetoll‐roadsinthemid‐1990s–asignificantcontributortothecurrencycrisisof1994/5.SomerailroadPPPsexist,nextinsizeaftertoll‐roads.Finally,therearesmallerinvestmentsinmanyairportsandports.Tosomedegreethesepatternssimplyreflectthesizeof“normal”investmentsinthevarioussub‐sectors.Powerplantsandroadareoftensimplybig‐ticketitems.Telecommunicationdevelopmentsstickout.Initially,mixedownershipformswerewidelyusednotleastinEasternEurope,theMiddleEastandAfrica.BynowPPPsplaylessandlessofaroleinthesectorascompetitiondrivesoutremnantsoftheoldtelecommonopolies.Telecommunicationspriceshavebeencostcoveringinmanycountriesforsomedecadesbynow.Thenewbusinessesarethussustainablewithoutregularfiscaltransfers.

RationalesforPPPs“Thegovernmenthasnomoney”Pricingandfiscaldependence.Dependenceonfiscaltransfersplaguestheothersectorsthatremainshot‐throughwithunavoidablemonopolyelementsandaresubjecttosomeformofpriceregulation.Trivially,forabusinesstowork,whetherinstateorprivatehands,thereneedtobesufficientrevenuestocovercosts.Oftenthisdefactorequiresgovernmenttransfers.Indevelopingeconomies,electricitypricescoveredonlyabout60%ofcostsintheearly1990s.By2005theycoveredaround80%ofcosts.Waterpriceshavestubbornlyremainedatabout30%ofcost.19Someinfrastructureprojects,notablymanyroads,maysimplynotbeabletochargeadequateuserfees.Raisingpricestoconsumersofwaterandelectricitycanbepoliticallyfraught.Inthecaseofwater,popularoutrageeasilyerupts.20Oppositiontoelectricitypriceincreasesisalsowidespreadalthoughittendstobemoreprominentlyaffectedbybusinesslobbiesforlowerpricesongroundsof“competitiveness”,mostrecently,forexample,inBrazilorGermany.Notethatinelectricityandwater,thetypicalexistingPPPsdonotselldirectlytoconsumers–theyselltoutilities,powerorwatercompanies.Someformoftransferfiscaltransferpaymenttendstopayforthecostof

19Costsincludeoperatingcosts,maintenanceandthecostofcapital.Onlybroadestimatesofpricerelativetocostlevelsarecurrentlypossibleforcomparisonsacrosstimeandspace.SeeKleinM.(2012)“InfrastructurePolicy:BasicDesignOptions”,WorldBankPolicyResearchWorkingPaper6274,WashingtonD.C.20NotethatmorepeopleinAfricahavecell‐phoneaccessthanaccesstomodernwatersupply.Accessisthusavailabletowhatwasnotlongagoconsideredaluxurygood.Yet,poorpeoplehavetoobtainwateratgreatexpensefromtraditionalsources,becauselowanderraticrevenuesforwatercompaniesholdbackdevelopment.

8

PPPs,whereitexceedslevelsthatcanbecoveredbycurrenttariffschargedtothefinalcustomer.Pricingpoliciesarenotonlyafunctionofpressuresfromcitizensandfirms.Intriguingly,corruptofficialsdonotusemonopoly‐pricingpowertoextractrents,eventhoughthatwouldyieldthebiggestpossibleprofit.Insteadtheykeeppriceslow,ostensiblyfordevelopmentalpurposes,whilegettingkickbacks,forexample,fromconstructionprojectsorsparepartsales.Efficientmonopolypricingwouldmeanefficientmanagementandtransparencybasedonsolidaccounting.Corruptpractices,however,requireobfuscationandshoddyaccounting.21Aslongasgovernmentscanprovideadequatefiscaltransfers,servicemaybeprovideddespitelowuserfees.Thelessuserfeescovercosts,themoreclearlyabusinessisdependentonpoliticalvagaries.Governmenttransfersobviouslysufferwhenfiscaldeficitsgetoutofcontrolindependentoftheperformanceofaparticularinfrastructurebusiness.Hencethesyndromeplaguingmanystate‐ownedinfrastructurecompaniesoflowqualityserviceprovisioncombinedwithlowprofitability.Taxpayers(theshareholderofstate‐ownedcompanies)andconsumersbeartherisks.Fiscaltroubles:Borrowingrestrictions.Whenfiscaltroublesreartheiruglyhead,governmentauthoritiescastaroundfornewsolutions.Initially,governmentsmayhavesometroubleraisingfunds.Theymayalsobesubjecttoself‐imposedprudentiallimitsonborrowing.TheMaastrichtTreatyborrowinglimitswere,forexample,onefactordrivingthepopularityofPPPsinSpain.Whenthelimitsstartbitinggovernmentsbecomeasinventiveasanycorporationtohidefinancialobligationsfromthepubliceyeandthatofcreditanalysts.Infact,governmentshaveaneasiertimetouseaccountingtricks,becauseaccountingstandardsforgovernmentstendtobelessdemandingthanforfirms,particularlythoselistedonanexchange.PPPscanbeamechanismtodisguisethefinancialpositionofgovernments.Supposeagovernmentauthoritywantstobuildaroadonwhichtollscannotbecharged.Governmentmayborrowinthecapitalmarkets,say$100million,andusethefundstopayacontractortobuildtheroad.Forsimplicity’ssakeassumetheloanisperpetualandinterestis10%,governmentwouldthenhavetorepay$10millioneveryyear.Inadditionitwillhavetopayforoperationandmaintenanceoftheroad,sayanother$10millionannually.Asgovernmentborrows,thedebtappearsonitsbalancesheet.Parliamentaryapprovalmaybenecessary.Oncetheroadisbuilt,taxpayersneedtocomeupwith$20millionperyeartofundtheroad.

21KleinM.(2011)“EnrichmentwithGrowth”,WorldBankPolicyResearchWorkingPaper5855,WashingtonD.C.

9

HowcanaPPPcometotherescue?Thegovernmentdelegatesconstruction,operationandmaintenanceoftheroadtoaprivatefirmunderacontract.Let’sfornowassumethatthefirmisjustasefficientasthegovernmentandhasthesamecostofcapital(returntoshareholdersplusinterestondebt).Thefirmborrows$100millionandrepays$10millioneveryyear.Italsospends$10millionperyeartooperateandmaintaintheroad.Yetafirmisnotprovidingadonation.Itsowners,whomayinclude,forexample,pensionfunds,wanttobecompensated.Astherearenotollrevenues,taxpayershavetopay$20millionperyear,oncetheroadisoperational.22However,governmentsoftenneednotshowthisfutureobligationontheirbalancesheet.Parliamentaryapprovalmaynotberequired.ShouldthePPPfirmhavetroubleborrowingacreditworthytierofgovernment(typicallythesovereign)cangiveaguaranteetothePPP’screditors.Againthegovernmentmaynotneedtoshowthiscontingentliabilityonitsbooksandmaybeabletoapprovewithlimitedscrutiny.23Theabilityto“cookthebooks”andavoiddemandingapprovalscanbeattractiveforpoliticianswhowishtogetaninfrastructureprojectgoing,forexample,beforethenextelections.TheBritishPrivateFinanceInitiative(PFI),establishedunderJohnMajorin1992andexpandedunderthesubsequentlaborgovernmenthasbeenoneofthelargestPPPprogramsglobally.PPPsfortransportinfrastructure,hospitals,schools,prisonsandotherpublicserviceswerefunded.Eventually,suchoff‐balancesheetborrowingledsomecreditorstowithdrawfromPFIprojectsastheycorrectlysawthattheborrowingauthorities,forexample,someNationalHealthServicetrustswereoverextended.24Also,newaccountingstandardsadoptedbythegovernmentreducedtheattractionofthePFImodelrelativetotraditionalgovernmentfinancing.Fiscaltroubles:Tightcreditconstraints.Somegovernmentsbecomecompletelynon‐creditworthy.Thetypicalargumentthenbecomes:“Thegovernmentdoesnothaveanymoney,let’sgettheprivatesectortoinvest”.Insuchasituationprojectsthatrelyongovernmenttransfersforrepayment,liketheroadexampleaboveremainhard,ifnotimpossibletofund.However,projectsrelyingonuserfeesmaybeeasiertofundasPPPsthaninpublichands.Thisisnotbecausetheprivatesectorprovidesfundingforfree.Investorswanttheirmoneyback‐withareturn.Ifprojectsarefinanciallyviable,i.e.userfeesareadequatetocoveroperatingcosts,maintenanceandthecostofcapital,thenfundingmayflow.Thecrucialissuebecomes:WhyisitpossibletofundsuchasolidprojectunderaPPPstructure,butnotunder“pure”publicownership?Afterallthegovernmentalsoborrowsfromthecapitalmarkets.

22Iftherewereuserfees,governmentcouldalsohaveusedthemtopayforobligations,justliketheprivatesector.23IrwinT.andT.Mokdad(2010)“ManagingContingentLiabilitiesinPublic‐PrivatePartnerships”TheWorldBankandPPIAF,WashingtonD.C.24http://en.wikipedia.org/wiki/Private_finance_initiative#cite_note‐gtpu‐19

10

Investors(shareholdersandcreditors)maybewillingtofundaPPP,becausethecashflowfromuserfeesisdedicatedtotheproject.Whenacash‐strappedgovernmentistheowner,itmaybetemptedtodivertcashflowtoplug“urgent”holes,forexample,inthegeneralbudget.DivertingcashflowfromaPPPwouldvisiblyviolatetheprivatepropertyrightsoftheinvestors.Governmentstendtobereluctanttodoso,becauseitwouldsendasignalthatcontractsandpropertyrightsarenotrespectedandthiscouldaffectinvestorperceptionswellbeyondtheproject.25ThePPPthusactsasacommitmentdevicethatenablesgovernmentstoattractinvestorswhowouldotherwiseshyaway.26PPP‐ThebestofbothworldsWhengovernmentsfacenotightfiscalconstraint,oneoftenhearstheargumentthatPPPsarevaluablebecausetheycancombinetheefficiencyoftheprivatesectorwiththecheapfinancingofgovernment.Bothpartsoftheargumentarequestionable.Thegovernment’scostofcapital.Indeed,inalmostallcases,theborrowingcostsofthesovereigngovernmentarelowerthanthoseofaprivateborrowerofthesamejurisdiction.Isthis,becausethepublicsectorissystematicallybetteratmanagingprojects?‐Hardly.However,whenprojectsfailgovernmentscancallontaxpayerstoensurerepaymenttoinvestors.Thetaxpayersthusprovide,forexample,unremuneratedcreditinsurance.Theissueiswhetherthecostofriskbearingimposedontaxpayersinthiswayislowerthanthecostofriskbearing27imposedonprivatefinanciersforPPPs.Touseananalogywithfinancialmarkets,wouldanappropriatefeeforcreditinsurancebythetaxpayersoffsettheostensiblefinancingcostadvantageofgovernments?Thetechnicalargumentshavebeenlargelyclarifiedbynow.28Whenprojectsaresmallrelativetonationalincome,whentheirrisks(positiveandnegativeoutcomes)arenotcorrelatedwithincomeandwhentheriskisspreadevenlyandverywidelyamongallcitizens,thenonecanarguethatthecostofrisk‐bearingfortaxpayersisimmaterial.29However,allprojectstogetherconstitutetheeconomy;henceonaverageprojectoutcomesarefullycorrelatedwithoverallincome.Inthiscase,citizen‐taxpayersbearamaterialrisk.Inaddition,forexample,insocietieswhere

25Gomez‐IbanezJ.(2003)“RegulatingInfrastructure”,HarvardUniversityPress26Themostsophisticatedcost‐benefitevaluationsofprivatizationssuggestthattheabilitytoattractadditionalinvestmentisthekeysourceofbenefits(GalalA.etal.(1994)“WelfareConsequencesofSellingPublicEnterprises”OxfordUniversityPress27Thecostofriskbearingofanindividualcanbethoughtofastheamountofmoneys/heiswillingtopaytoinsureagainstanuncertainoutcome.28GollierC.etal.(2011)“Lecalculdurisquedanslesinvestissmentspublics”RapportsetDocuments,Centred’AnalyseStrategique,RepubliqueFrancaise,PremierMinistre,Juin29ArrowK.J.andR.C.Lind(1970),"UncertaintyandtheEvaluationofPublicInvestmentDecisions,"Amer.Econ.Rev.,June

11

taxevasioniswidespreadandconcentratedamongwealthiercitizensthecostofrisk‐bearingisaccentuatedasitfallsonfewerandless‐welloffcitizens.Accountingforthiscostofrisk‐bearingmightrendertheostensiblefinancingadvantageofthepublicsectorillusory.Ultimately,itcomesdowntobeliefswhetherprivatecapitalmarketsaremoreorlessimperfectthangovernmentswhenitcomestodiversifyingrisk.30Onehastobelievethatgovernmentsarefairlyefficientandbenevolenttoassumethatgovernmentfinanceissystematicallycheaper.EfficiencyofthePrivateSector.Privatebusinessesareoftensaidtobemoreefficientthanpublicones.Whatisitabout“private”thatmakesabusinessso?Inthemid‐1990stheGovernmentofMaharashtraoptedforapublic‐privatepartnershiptobuildatollexpresswayfromMumbaitoPune,afirstinIndia.Despiteafavorablenewhighwayact,despitetaxandcustomsconcessions,theprojectfailedtoattractinterestedprivatebidders.Thestategovernmentfinallyestablishedasemi‐privateentity,theMaharashtraStateRoadDevelopmentCorporation(MSRDC)thatproceededtowinthecontractandimplementtheproject.Theroadopenedin2001.TheMSRDCwasessentiallyapublicventureincorporatedasaprivatevehicle.Managerswhowerepreviouslypublicbecameprivate.Whywouldachangeinthelegalstatusofthefirmsuddenlymakemanagersandthefirmmoreefficient?Itishardtobelievethatlegalstatuschangestheinherentabilityofpeople.Moreplausibly,peoplemaybecomemoreefficient,iftheirincentiveschangeconcurrentwiththelegalchangeoronaccountofit.Alsoadifferentincentiveregimemayattractdifferenttypesofpeople.CanthepublicsectorinstituteanefficientincentiveregimewithoutgoingthePPProute?ThisquestionleadsbacktothenuancesinthedefinitionofaPPP.Most“pure”publicroadprojects,forexample,useprivatefirmstobuildtheroad.Someevenrelyonprivatefirmstooperateandmaintainit.CoulditbethatPPPsenablenewformsofcontractsthatcannotbeinstitutedintraditionalpublicsectorprojects?TypicalclaimsabouttheadvantagesofPPPsencompassthefollowing:

• Pricecertainty–governmentknowspaymentschedule,i.e.performanceriskisallocatedtotheprivateparty

• Responsibilityformaintainingassetstransferredtoprivateparty• Scope,incentiveforinnovation• Paymentonlyaftercompletion–incentivetobeontime• Life‐cycleapproach(incentivesjointlytooptimizecostsofbuilding,

maintainingandoperatingoverthelifeofaproject)30EngelE.etal.(2014)“TheEconomicsofPublic‐PrivatePartnerships”CambridgeUniversityPress

12

Yet,publicsectorcontractsarefeasiblethatreplicatealltheseadvantages.Thegovernmentcanusefixedpricecontractstoobtainpricecertainty.Governmentcandelegateresponsibilityforassetstotheprivatesectorundermaintenancecontracts.Afixed‐pricecontractthatreliesonperformancespecificationsandleavestheprivatesectortocomeupwithinnovativeideastomeetperformancetargetsisanoption.Paymentoncompletionofworksorservicescanalsobeembeddedinpubliccontracts.Thelife‐cycleapproachisoftencitedasthekeytotheefficiencyofPPPs.31Makingasinglefirm,thePPP,responsibleforthelifeofaprojectprovidesincentivestoinvestinsuchawaythattheimpactonfutureoperationsandmaintenanceistakenintoaccountthusminimizingthelifetimecostofaproject.Traditionalpublicprocurementalsotriestoassesstheimpactofconstructionapproachesonfuturecurrentexpenditurebutmayfailtodosocomprehensively.Bynow,however,wealsofindlife‐cyclecontractsinthepublicsector.AGermanhospitalprojectappliedthisapproachinasettingthatisdefactoapublicsectorlifecycleapproach,32eventhoughitwasofficiallycalledaPPP.ThusallthecontractualimprovementsthatmightbeenabledbyaPPPcanalsobeputinplaceinapublicsectorsetting.ThekeydistinctionofaPPPwouldthennotbethecontractstructures,buttheincentivestomonitorcontractdesignandfulfillment,becauseprivateshareholdersandlendersbearperformancerisk.Theyhavetheirmoneyonthelinewhenthingsgowrong,notthetaxpayers.33Thatistypicallyakeyreasonwhycompetitivemarketsoutperformstate‐run,plannedapproaches.Underworkablecompetition,whencompaniesoverchargeorprovidesub‐standardqualityconsumerscanswitchtoanotherone.Companiesthushaveanincentivetoperform.Yet,inmuchofinfrastructurecompetitivemarketsarenotfeasibleoradvisable.Monopolyprovisionisoftenthewaytogo,forexample,formodernwaterandseweragesystems,roads,electricitytransmissionanddistributionandsimilarnetworkinfrastructure.Suchmonopoliestendtoberegulated.Priceandqualitystandardsaresetadministrativelybysomeregulatoryauthority.

31EngelE.etal.(2014)arguethatthelife‐cycleapproachiskeytothepotentialbenefitsofPPPsrelativetotraditionalpublicprocurement32Theproject,HochtaunusKliniken,nearFrankfurtiscalledaPPP.However,ownership(equity)isessentiallypublic.Lendersareinsuredagainstperformanceriskintheprojectbythelocalauthorities.Allrisksarethuswiththepublicsector–thetaxpayer.ThePPPformathelpskeeptheobligationsoffthelocalgovernmentbooks.Materiallyitjustaddstotransactioncostsandmaynotberepeatedinthisform.(communicationfromprojectstafftotheauthor)33InsomePPPsthelenders,forexample,arestate‐owned,forexample,inSpanishhospitalprojects.AsalwaysoneneedstolookatthedetailstodeterminehowpublicorprivateaparticularPPPreallyis.

13

Theprofitmotiveandpolitics.PublicsectorsupervisionofthePPPisneededtoassesswhetherpaymentstothePPPareadequate(neithertoolownortoohigh)andwhetherqualityissound.InitialbiddingforaPPPhelpsselectthebestfirmtoimplementaprojectandalsotogetthebestpossibleinitialprice.However,astimegoesbysomethingalwayschangesandcontractsneedtobeadjustedinresponse.Suchcontractmodificationisunavoidableandisnothingelsebutstandardpriceandqualityregulation.Regulationorcontractadjustmentisneededwhatevertheownershipformatis,includingpublicownership.Goodpoliciesandcontractsforeseethatandsetouttheprinciplesforadjustingterms,theprocessestogothroughfortheadjustmentandtheplayersinvolved.Priceandqualityregulationalwaysweakensincentivestobeefficientrelativetocompetition.ItisthusnolongersoclearthatPPPsarebetterrunthanpublicfirms.Theevidencesuggeststhatwell‐runpublicfirmstendmatchtheperformanceofprivatefirmsinregulatedsectors.34Yet,publicfirmsareoftenheavilyaffectedbypoliticalgoalsthatrenderefficientmanagementdifficult.Pricesmaybesuppressed.Managersmaybepoliticalappointeeswithloyaltycountingformorethancompetence.Entrenched,politicallyconnected,laborunionsmayresistefficientmanagement.Thechoiceofsuppliersmaybeaffectedbypoliticalpressure.Thelitanyofissuesiswellknown.Thecoreissuetheniswhicharrangementsforthedeliveryofinfrastructurebestcombinei)incentivesforefficiencywithii)credibilitytoinvestorsandiii)benefitsandlegitimacyforconsumersandtaxpayers.Noperfectsolutionexistsbutkeyissuesandoptionsarefairlyclear.OnepieceofthepuzzleisasensiblebalancebetweenautonomyandaccountabilityfortheregulatororPPPcontractsupervisors.Theyshouldbemandatedtopursuesociallydesirableoutcomesandatthesametimebeinsulatedasbestaspossiblefromnefariouspoliticalinterference.Thisistheissueof“independent”regulatorybodies.35AnotherpieceisthelegalformoftheprivatepartyinvolvedinaPPP.Whenqualityofservicedeliverycanbemonitoredreasonablywell,onecanusecontractsthatmotivateprivatefirmsstronglytobeefficient.36Thatmeanspaymentistiedtoachievementofmeasureablegoals:goodperformanceleadstohigherprofit.For‐profitfirmshavegoodincentivestomakethebestofsuchcontracts.Regulatorsneedtowatchoutforqualityofoutcomes.Typicallythequalityofinfrastructure

34Kwoka,J.E.(2005)“TheComparativeAdvantageofPublicOwnership:EvidencefromU.S.ElectricUtilities”inCanadianJournalofEconomics,Vol38,No.2,May35ForasurveyofthedebateandthekeymechanismstobalanceautonomyandaccountabilityseeSmithW.(1997)“UtilityRegulators–TheIndependenceDebate”inPublicPolicyforthePrivateSector12736High‐poweredincentiveschemesinthelanguageofeconomists;seeLaffontJ.J.andJ.Tirole(1993)“ATheoryofIncentivesinProcurementandRegulation”,MITPress

14

venturescanbemonitoredreasonablywellandsuchperformancecontractscanbeused.Whencriticaldimensionsofqualityarehardtomonitorstrongperformanceincentivesmayleadproviderstoskimponquality.Hospitalsareacaseinpoint.Somedimensionsofqualitycarecanbemeasured,butothersonlyimperfectly.Inthiscase,theincentiveschemesmayneedtobeweak.Thiscallsforalimitationonachievableprofit.Traditionalutilityregulation,forexample,limitsratesofreturnforinvestors.Investorsmightevenhaveanincentivetoincreasecostsinthiscase.Skimpingonqualitywouldnothelpinvestors.Alternatively,onemayemployafirmthatlimitsprofitdistributiontoshareholders.Somecountries,havehadlimiteddividendcompaniesforalongtime.Onecanalsoconsidernon‐profitorganizations.Non‐profitorganizationsneedtomakeprofitjustlikeanyotherfirmiftheywanttosustainoperations.But,theycannotdistributeprofittoshareholders.Theyareusedinmedicalestablishmentswherequalityishardtomonitorandwherepatientscannoteasilychangeproviders,forexample,innursinghomes.37Yet,governmentorganizationsarealsonon‐profits.SowhyevenbotherwithPPPsinthiscase?Thisbringsusbacktotheprivateformofincorporationasacommitmentdeviceagainstsomeformofpoliticalinterference.38Publicsectorcompaniesmayhaveahardtimeinstitutingchangewhentheyunderperform.Theymaybesubjecttopublicsectorrulesthatrenderefficientoperationsdifficultfromprocurementtolaborregulations.Politicalconnectionsofthetopmanagersandentrenchedpublicsectorunionsmayalsomakeitdifficulttoreform.StatesthusoftenusePPPsasawayofinstitutingchangeinsuchfirms.Theveryfact,thatstatesintroducePPPssometimesmotivatesremainingstatefirmstoreformaswell.PPPscanhelpprotectventuresfromdysfunctionalgovernmentbureaucracy.Theycanalsobeusedtocircumventsoundpublicpolicy.Forexample,theymaybeanexcusetoevadeorsoftensoundpoliciesfortenderingcontracts.Uptothelate20thcenturyFrenchmunicipalserviceconcessionswereawarded“gré‐à‐gré”i.e.bydiscretionarydecisionofthemayor.Thisleftroomforspecialdealsandoutrightcorruption.Inprinciple,itisfairlyclearwhatcanbedoneaboutthis.InparticulartransparenttenderawardprocessesmatterandhavebeenadoptedinFranceaswell.

37HansmannH.(2006)“TheRoleofTrustinNon‐profitEnterprise”Chapter6inHelmutAnheierandAvnerBen‐Ner,eds.“TheStudyofNonprofitEnterprise:TheoriesandApproaches”(KluwerAcademicPublishers,2003)38Becauseshareholderscannotberemunerated,non‐profitfirmsrelyonsomeformofdonationtoobtainequitycapital.Totheextenttheyobtaindonationstheycanalsobecheaperthanfor‐profitorganizations.Thiscanhelpaddressaffordabilityconcernsand,forexample,helplowerthepriceofserviceforpoorpeople.However,subsidiescanalsobecombinedwithprovisionbyfor‐profitfirms.Wherefor‐profitfirmscanbeadequatelymonitoredtheytendtobemostefficient.Combiningthiswithagoodsubsidyschemeforpoorpeoplecangiveevenbetterresultsthanprovisionbynon‐profits.

15

Givenallthedifferentconsiderations,whatdoevaluationsshow?TheysuggestthatPPPscanoutperformpublicsectorfirms,theyarenotsystematicallyworsethanpublicfirms,butgoodpublicsectorfirmsdojustaswell.39FromapublicpolicyperspectivePPPsininfrastructureareusefultoolsforreformofservicedelivery,buttheyareno“killer‐apps”.Tobalancegoodpolicywithefficientservicedeliverywecandesigndecentcontractsandinsulatethemfromunduepoliticalinterferenceviaindependentregulationandsomeformofprivateownership.Inaddition,privateformsofownershipalsomakeiteasiertotendercontractsfromtimetotimeandreplacefailingfirms.Firmsthathaveaninterestinwinningtendersinthefuturehaveanincentivetomaintainsomereputationforefficientdeliveryofqualityservice.40Tosomedegreetheabilitytoparticipateintendersinotherjurisdictionscouldalsomotivatepublicsectorfirmstoperformbetter.ElectricitédeFrance–apublicsectorcompany,forexample,haswonanumberPPPcontractsinelectricity.Yet,publicsectorcompaniesareoftennotallowedtogobidforcontractsinotherjurisdictions.Acrosstimeandspace:TheWheelofPrivatizationandNationalizationPPPsareoftenpursuedwhenthepublicsystemhasrunintotrouble.WellmanagedPPPprocessesreducethescopefordiscretion.Yet,manypoliticiansappreciatealittleflexibilityforgoodorbadreasons.Thusthepoliticalpowersthatbearetemptedtofindwaystoexercisediscretionbyinfluencingregulatoryorsupervisorydecisions.Thistendstoleadtolowerprices.ThisinturnweakensthefinancesofthePPPleadingtounder‐investment,lackofmaintenanceandqualityproblems.Eventually,governmentsmaytakethePPPbackintopublichands.ThePPPcompanymightactuallypreferthattobeingstarvedoffunds.Alternatively,PPPsmayhavebeenawaytoconductdubiousdeals.Asthearrangementsbecomesuspectmorewidelyandgovernmentschange,takingtheventureintopublichandsbecomesmoreandmorelikely.Finally,privatefirmscanalsomisbehave.SomePPPsarejustbadlymanaged.Callsfornationalizationareagainalikelyresponse.Thusthewheelofprivatizationandnationalizationkeepsturning.41ThelackofacleargeographicalpatternofPPPsovertimeisconsistentwiththeargumentsaboutacyclebetweenpublicandprivateapproachestoservicedelivery.PPPsareheretostay,buttheycomeinwavesdrivenoftenbyfiscalproblems.Yet,thewavesalsorecede.Ifwecouldpredictthebroaderpatternofeconomic

39KessidesI.(2004)“ReformingInfrastructure:Privatization,RegulationandCompetition”WorldBank,Washington;AndresL.etal.(2008)“TheImpactofPrivateSectorParticipationinInfrastructure”TheWorldBank,WashingtonD.C.40ZupanM.(1989)“TheEfficiencyofFranchiseBiddingSchemesintheCaseofCableTelevision”JournalofLawandEconomics,Vol32.41Gomez‐IbanezJ.(2003)“RegulatingInfrastructure”,HarvardUniversityPress

16

developmentandfiscalstrengthacrosstheworld,wemightbeabletopredictthefutureofPPPsabitbetter.Untilthenwearefacedwithwavesthatsweeptheworldinseeminglyrandompatterns.Figure1: