The (Empirical) Economics of Public-Private-Partnerships (PPP) CONTRACTS
Jose Luis Guasch
Former Head of the World Bank Global Expert Group on PPP
Professor Emeritus of Economics, University of California, San Diego
Senior Adviser, The Growth Dialogue, George Washington University, Washington DC
Ajaccio, Corsica, France
What are PPPs?
PPP or “Public Private Partnerships” is a generic term for a contractual and long term relation between the public sector and a private operator granting to the private operator the right to provide the service and receive compensation via tariffs or government payments.
The term PPP describe a range of contractual agreements –such as design, construction, financing, operations, maintenance and rehabilitation, management etc.
Types of PPPs
Increasing level of delegation, risk & irreversibility
Build-Lease Transfer / PFI
BOT / Concession
100% private ownership
100% public ownership
PUBLIC PRIVATE PARTNERSHIPS
Tipology of PPP:
Management Contracts or Leasing (financing done by the public sector), the private operator manages and operates the service
Existing project:Construction (light), Rehabilitation, Maintenance, Operation, Small Investments
New Project: Design, Construction, Operation, Maintenance, (en general). Large Investment
Main Characteristics of PPP
Long term contract: 10 to 30 years (so long term financing required)
Usually financed by private sector-fiscal space
Bundling of activities: construction, financing, operacions, rehabilitation and maintenance etc
Ownership of assets remains with the State (few exceptions)
Risk sharing with the private operator
Cost/Investment recovery by private party, trough tariffs or government payments or a mixture of both
Private operator has the right/obligation to provide the service for the duration of the contract. His only asset oversees and regulate the implementation of the project and insures compliance with contract
Contract establishes all conditions, rights and obligations of both parties
At the end of the concession period, the service and assets reverts back to the Government without compensation (in general)
Drivers of PPP
Fiscal constraints in countries
Severe infrastructure Gaps and unmet needs
Weak capacity of government to design and implement projects
Virtues of PPPs
Private firms tend to be more efficient:
Build faster and underestimate costs by less
Economies of scope in designing, building and maintenance
Capital markets impose discipline
Agency problems are less severe - same firm in charge of construction and maintenance
Risk gives stronger incentives
More accurate demand projections
Benefits of PPPs
PPP can generate significant benefits: efficiency, cost reductions, social inclusion, aditionality of financing improve welfare quality of service
Accelerate investment program and levels of service, coverage
Improve the quality of service, reliability and extent
Increase access to public services
Relief fiscal pressure and provide fiscal space with the additionality of financing
Bundling effect: solves the maintenance and rehabilitation problem by internalizing it: improves quality of stock and service
Transfer of risks to private operatorduccion de costos y demoras en construcion
Cost reductions and reduction of construction delays
Improved transparency of investment
Focus on level of service rather than getting physical assets
But is not automatic-requires knowledge and commitment- capacities, processes, filters, institutions, fiscalization and use of best practices to design contracts and efective regulation
Weaknesses of PPP
Lenghtier project preparation time
Significant higher costs (than public works option) of project preparation and even more costs of project supervision/regulation-both construction and operations phase
Require more and better and project studies and analysis than public works
Vulnerable to aggressive bids
Vulnerable to renegotiations and conflicts
Issue of financing-long term
Contingent liabilities-fiscal issue
Key Vulnerability of PPPs: Post Contract Award Management: Managing Change: Renegotiation of Contracts
Critical and often ignored or treated lightly or as a residual
Why? Long term contract 15-30 years
Issues do and will come up, not able to be detailed in contract
Creates opportunities for abuse
Need to be prepared: diffuse, pre-empt and address
Contract needs to address a fair amount specifically or trough guidelines
Critical risk matrix and risk allocation: set in stone-revisiting with care and period bound
But how about public works-the alternative to PPPs, if there is public financing…?
With levels of costs overruns from 40 to 150% of original costs (average 85%) and incidence of delays 70% of projects on average
KEY: And that risks and costs are taken by the State (while in the PPP a large part of that risk and costs is trasfered to the private operator)
And how about maintenance and rehabilitation? And the quality of the stock of infrastructure?
PPP Versus Traditional Public Works
Have PPP performed better?
Strenghts and Weaknesses
Difference between PPP and public works: A PPP buys a service vs Public Works that buys and asset-Example Public Lighting: LEVEL OF SERVICE
Buying the asset, it gets posts and lamps.
Buying the service via PPP it gets the level of lighting in the streets and through out the day.
Need to define the level or standards of service, remunerations and sanctions linked to compliance.
International Experience with PPPs
Well structured PPPs provide Value for Money
When PPP projects fail, this is typically due to:
Inadequate project preparation / risk allocation
Lack of credibility of the tendering agency
PPPs are not “free” nor the answer to all infrastructure needs
In UK and Australia, PPPs represent only 10-15% of total infrastructure investment
SOME EXAMPLES OF COSTS OVERRUNS AROUND THE WORLD
The Sydney Opera House (a Public Work Project) ended costing 15 times over the original budget
The Internacional Airport in Denver, Colorado (a Public Works Project) ended costing US$ 5,200 versus original budget of US$ 3,200 millones ( …and 16 months later than scheduled)
CITEs-Centers of Knowledge and Technology Transfer
Project Selection: “Quasi” White Elephants
An example of a country with numerous white elephants is Belgium, where the political pressures to replicate spending on both sides of the linguistic divide led to a category of projects denominated grands travaux inútils. These include several kilometers of abandoned subway tunnels, almost-empty light rail lines, and many unused viaducts and bridges (see Le Petit Guide des Grands Travaux Inutiles, Jean-Claude Defossé (1990) and EFG (2014) ).
The Economics of PPP
A contract between the public sector and the private operator, where the public sector is expected to reap the benefits of the project and the private sector to earn its fair share of return to capital
A number of factors drive the success of that undertaking: legal, institutional, procedural, regulatory, political, financial, competitiveness/markets, risks etc
Start with project identification, to project preparation, and contract design, procuring the project and ending with the oversight of project implementation
Where Do We Stand? Good News and maybe “Quasi” Good News
Plenty of Theory Research on PPP mostly adapted from the Contract Theory Literature
Relatively little empirical research on PPP
And plenty of open questions on PPP to be addressed empirically: ripe for research work
Data, often the problem, is improving and so is accessibility to that data, and ample heterogeneity very useful to tests hypothesis
Needs proactivity and creativity
Bibliography: Generic I
The Economics of Public-Private Partnerships: A User Guide de Eduardo Engel, Ronald Fischer y Alexander Galetovic, Cambridge University Press, 2014
Eduardo Engel, Ronald Fischer and Alexander Galetovic. 2010. “The economics of infrastructure finance: Public Private Partnerships versus public provision,” EIB Papers, 15, 41–69, 2010.
José Luis Guasch. 2004, 2016. Granting and Renegotiating Infrastructure Concessions: Doing it Right. Washington: The World Bank Press.
The best-known general introduction to PPPs is Grimsey and Lewis (2004a). See also OECD (2008). Shorter introductions are de Bettignies and Ross (2004), Hemming (2006), IMF (2004), and Sadka (2006). Grimsey and Lewis (2005b) collect many articles on PPPs. Vaillancourt-Rosenau (2000) and Akintoye, Beck, and Hardcastle (2003) are useful collections of essays. Estache (2006)takes a stock of experiences on PPP
Michael Klein. 1997. “The Risk Premium For Evaluating Public Projects,” Oxford Review of Economic Policy 13, 29–42.
Bibliography: PPP Terms, Contracts and versus Public Works
Daniel Albalate and Germá Bel. 2008. “Regulating concessions of toll motorways: An empirical study on fixed vs. variable term contracts.” Transportation Research Part A: Policy and Practice 43(2) 219-229.
John Bennett and Elisabetta Iossa. 2006. “Building and Managing Facilities for Public Services.” J. of Public Economics, 90, 2143–60.
Tim Besley and M. Ghatak. 2001. “Government Versus Private Ownership of Public Goods,” Quarterly Journal of Economics, 116, 4, 1343–72.
Mathias Dewatripont and Paul Legros. 2005. “Public-Private Partnerships: Contract Design and Risk Transfer.” EIB Papers, 10, 120–145.
Eduardo Engel, Ronald Fischer and Alexander Galetovic. 2001. “Least-present-value-of-revenue Auctions and Highway Franchising.” J. of Political Economy, 109, 993–1020.
——————————————————. 2014. “Is there a PPP interest rate premium?” Mimeo. ——————————————————. 2013. “The Basic Public Finance of Public-Private Partnerships,” J. of the European Economic Association.
Paul Grout. 1997. “The Economics of the Private Finance Initiative.” Oxford Review of Economic Policy, 13, 53–66.
Paul Grout and M. Stevens. 2003. “The Assessment: Financing and Managing Public Services.” Oxford Review of Economic Policy 19, 215-234.
Oliver Hart. 2003. “Incomplete Contracts and Public Ownership: Remarks and an Application to Public-Private Partnerships,” Economic Journal, 113, C69–C76.
Elisabetta Iossa and David Martimort. 2011. “The Simple Microeconomics of Public-Private Partnerships.” Mimeo.
David Martimort and J. Pouyet. 2008. “To Build or Not to Build: Normative and Positive Theories of Private-Public Partnerships.” International Journal of Industrial Organization, 26, 393–411.
Timo Välilä. 2005. “How Expensive are Cost Savings? On the Economics of Public-Private Partnerships.” EIB Papers, 10, 95–119.
Tim Irwin. 2007. Government Guarantees: Allocating and Valuing Risk in Privately Financed Infrastructure Projects. Washington: The World Bank.
Bibliography: Procurement and Corruption
Lewis-Faupei, S., Neggers, Y. Olken, B. y R. Pande, “Can Electronic Procurement Improve Infrastructure Provision? Evidence from Public Works in India and Indonesia,” American Economic Journal: Economic Policy, forthcoming.
Bandiera, O., A. Prat, y T. Valletti, 2009. “Active and Passive Waste in Government Spending: Evidence from a Policy Experiment.” American Economic Review 99(4), 1278–1308.
Burguet, R. y Y.K. Che, 2004. “Competitive Procurement with Corruption”.. RAND Journal of Economics 35(1), 50–68.
Celentani, M. y J.J. Ganuza, 2002. “Corruption and Competition in Procurement.” European Economic Review 46(7), 1273–1303.
Olken, B., 2007. “Monitoring Corruption: Evidence from a Field Experiment in Indonesia.” Journal of Political Economy 115(2), 200–249.
Tran, A., 2008. “Can Procurement Auctions Reduce Corruption? Evidence from the Internal Records of a BribePaying Firm.” Harvard Kennedy School job-market paper
Eduardo Engel, Ronald Fischer y Alexander Galetovic, 2015 “Renegotiation and Corruption.” Mimeo.
Eduardo Engel, Ronald Fischer and Alexander Galetovic. 2005. “Highway Franchising and Real Estate Values.” J. of Urban Economics, 57, 432–448.
Eduardo Bitrán, Eduardo Engel, Ronald Fischer and Alexander Galetovic. 2015. “Soft budgets and renegotiations in public-private partnerships.” Mimeo.
José Luis Guasch. 2004, 2016. Granting and Renegotiating Infrastructure Concessions: Doing it Right. Washington: The World Bank.
JL Guasch, JJ Laffont and S. Straub. “Renegotiation of Concession Contracts: A Theoretical Approach”, Review of Industrial Organization, , Volume 29, #1-2, August-September 2006
José Luis Guasch, Jean-Jacques Laffont and Stephane Straub. 2007. “Concessions of Infrastructure in Latin America: Government-led Renegotiation.” J. of Applied Econometrics 22, 1267-1294.
José Luis Guasch, Jean-Jacques Laffont and Stephane Straub.2008. “Renegotiation of Concession Contracts in Latin America: Evidence From the Water and Transport Sectors.” International Journal of Industrial Organization 26, 421-442.
Eric Maskin and Jean Tirole. 2008. “Public-private partnerships and government spending limits.” International Journal of Industrial Organization 26, 412-420
Matthew Ryan and Flavio Menezes. 2013. “Default and Renegotiations in PPP Auctions.” Mimeo
Bitran et al 2010. “ Case Study: Renegotiations in Chile, Colombia and Peru”
Profitability of Firms:
“How Profitable Are Private Infrastructure Concessions in Latin America?: Empirical Evidence and Regulatory Implications”, The Quaterly Review of Economics and Finance 45, 380-402, 2005, (with Sophie Sirtaine, Maria Elena Pinglo and Vivien Foster).
Impact of Regulation (varios aspects) on Performance
The Impact of Private Sector Participation in Infrastructure in Latin America: Lights and Shadows and the Road Ahead, The World Bank Press, 2008, (J. L. Guasch, L. Andres, T. Haven and V. Foster)
Uncovering the Drivers of Utility Performance, World Bank Press, Washington DC, USA 2013 ( J. L Guasch, L. Andres and Jordan Schwartz)
Empirical Economics on PPP
Plenty of (research and policy) open questions:
PPP vs Traditional Public Works
Realized Return to Investors
Value for Money-Public-Private Sector Comparator: Methodology
Definition and Measurement of success
LPVR, Fees, Tariffs (single vs polynomial)
Reverse envelope opening
Valuations of risk premiums on risk transferred to private
Service levels/quality vs other
Selection of Projects Process: Outcomes (Impact and Complementarities)
Jurisdiccions, Approvals and Outcomes (impact)
Role and Timing of Ministry of Finance
Risk Asignment and risk sharing mechanisms
National vs Sub-National performance
Regulation: Independent regulator vs agency vs unit at Ministry
Obvious issue/constraint: DATA, but improving
Most common and available: PPP Projects: Investment (volume), Number of Projects, Sectoral Distribution, Institutionality (ie PPIAFF Data set, PIAFF II, Doing Business/components, CEPAL, IDB, IDB/Oxford)
Common and “available: Procurement Data on PPP: award criteria, number of bidders, “bids”
Plenty of summary statistics
From summary statistics to correlations to causality to policy…
United Kingdom New Approahes to PPP Programs From PFI to PF2
Criticism of Private Finance Initiative (PFI) developed by UK in the 1990s
From PFI to PF2
Parliamentary Treasury Select Committee found that "PFI should be brought on balance sheet. The Treasury should remove any perverse incentives unrelated to value for money by ensuring that PFI is not used to circumvent departmental budget limits. It should also ask the OBR to include PFI liabilities in future assessments of the fiscal rules”
The National Audit Office in 2011 was much more critical, finding that the use of PFI "has the effect of increasing the cost of finance for public investments relative to what would be available to the government if it borrowed on its own account" and "the price of finance is significantly higher with a PFI
Reforms to UK PFI now PFI2
i) Allowing the public sector to take equity positions to improve transparency of costs and returns (having a Director in the Board);
ii) Simplyfing the procedures to reduce preparation time and costs without sacrifying quality and competition;
iii) Improve transparency;
iv) Allow more flexibility;
iv) Revisting risk matrix allocation with public sector retainig or sharing aditional risks;
v) Facilitate access to capital markets and to longtermd debt;
vi) Greater standarization of documents and contracts;
vii) revisiting and simplifing, along mostly qualitative elements, the concept of value for money.
Based mainly in Latin America PPP/Concessions
Original Sample 1000 concessions
New added 589 concessions (Peru, Mexico, Colombia, Brazil, Uruguay, Chile, Central America, Dominican Republic, CA)
Complemented as needed (mainly explicative, cualitative, corroborative) with samples from countries in other regions
Swiss Challenge Allowed
Average Number of Competing Bidders
Bonus Points Government Financial Support
Time Given for Third Parties to Express Interest
100% USP Proponent
75% USP Proponent
90% USP Proponent
97.5% USP Proponent
85% USP Proponent
36% USP Proponent
90% USP Proponent
Characteristics and Competition in Unsolicited Proposals (USP)
Projects, 2005-20015: Swiss Challenge
Average concession returns by countries
(Guasch et al 2006)
Source: own calculations, based on concessions’ historical financial statements and the authors’ growth assumptions
¿What is a Renegotiation?
A renegotiation is a modifications of the contract not foreseen in it
i) Mainly by a change in the risk assignment matrix or of its extent
ii) By a change in the scope of the project-so called complementary contracts, additionality of investment/works etc (but even then it depends whether it was foreseen and guided in the contract,…)
iii) By other changes (derived) on the contract conditions (such as duratión/term, schedule and timing of investment, investment levels, tariff structure, service levels, performance indicators, etc)*
iv) By clarifying or corrective changes in the contract-often of reduced impact
Clarification: Compensations to operator for the occurrence of specific events are not renegotiations, when it is specified in the contract. They do add to the costs of the contract, and do have adverse fiscal consequences. And they do generate conflicts on two accounts: On assessing the causality of the event-who is responsible and on determining the proper level of compensation
Renegociatión, most often linked or triggered by:
i) Additions or changes in the scope of the Project usually originated (but not always) by the Government,
ii) Shortfalls in demand/revenues
iii) Rent seeking opportunities
iv) Political oportunities
iii) Aggressive bids or mistakes in the bids
Aggressive bids, intended to win the project, but with the objective to subsequently renegotiate better terms (positive returns)
Aggressive bid defined when, net profits do not cover return to capital from day one
R = PQ-OC-T-D
Costs associated with disputes, conflicts and renegotiations are:
Time and financial resources: to address and resolve the conflict.
Social and Political: Since conflicts tend to be highly visible and have great coverage of the media, leading to disenchantment of citizens, the PPP model tends to lose credibility and public support, and it may weaken or kill the program.
Financial/Fiscal: Often the results of the negotiation have a fiscal cost to the government.
Economic and Social: Users tend to be adversely affected by the results of conflicts, particularly renegotiations (in terms of reduced access, higher or lower prices and delays in service quality)
On average, those costs range from 2 to 30% of investment
Overall pricing of uncertainty on that account is around 2-4 percentage points of cost of capital
Why Renegotiation is an important issue? Implications
Eliminate the competitive effect of the auction including transparency: questioning the credibility of the model/program
Voids value for money analysis. Outcomes usually adverse to users, government and welfare overall
Asymmetric information and lack of transparency of bilateral negotiations and skills of public sector to renegotiate the contract:
Distortion in public tender, in that the most likely winner is not the most efficient operator but the most expert/qualified in renegotiations
Decreases the benefits/advantages of PPP and the welfare of users, and usually it has a fiscal impact by increasing liabilities to the government
Confirms rational expectations of operators
While some can be efficient, many of them are opportunistic
Contrast with PPP adjudicated trough non-competitive biddind, trough bilateral negotiations
Water and Sanitation
Other sectors: social et al
Incidence of Renegotiation of PPP Contract PPP in (Broad) Infrastructure and its Evolution-1990 a 2014
Source: Guasch (2004) updated 2014
Not an Exclusivity of Emerging Countries: Renegotiations also take place in Developed Countries
Expropiation of land and rights of way
Bankability of Projects
Renegotiations by Type/Cause: Evolution-1990 to 2014
Source: Guasch (2004) updated 2014
Summary Statistics of the Sample by Country, 1993-2010
MAIN TRENDS AND ELEMENTS ADDRESSED IN RECENT PPP PROGRAMS REFORM I
Identification and seleccion of PPP projects
Increased use to require the “Business Case” for the project (informe de evaluacion)
Jurisdictions (Finance Ministry) and Filters and Timing of Green Lights
Ceiling of (sectoral) indebtedness
Increased Use of Level of Service Indicators
Accounting and Management of Governmnet liabilities (firm and contingent)
Process of Unsolicited Proposals (Swiss Challenge and others)
Linkages with Subnational Projects
MAIN TRENDS AND ELEMENTS ADDRESSED IN RECENT PPP PROGRAMS REFORM II
Aggressive Bids (performance bonds etc)
Renegotiations of Contracts: Platform
Financing (Project Finance)
Revised Treatment and Processes for Land Expropiation and Liberation of Interferences
Model Contract Clauses
Implementation of Green Book
Increased Use of Transparency Initiatives-Web use
Elimination of Clauses about Financial/Economic Equilibrium
MAIN TRENDS AND ELEMENTS ADDRESSED IN RECENT PPP PROGRAMS REFORM III
Coordination Protocols for all relevant institutions
Increased Use of Panel of Experts
Modification of Value for Money (VfM) from cuantitative to cualitative
More stringent conditions for use of Guarantees (MRG)
Sharing of Extraordinary Benefits (risk issue)
Addressing Financial Closure Problems
Structure of upcoming project portfolio (and implications) fully financed vs co-financed (or in Brazil PPP vs Concessions)
Increased use of Institutional Investors/Capital Markets
Sharing (among bidders when short list) of costs of technical evaluations
Reimbursement by winner of cost preparations by other bidders