Ross Presentation

Public-Private Partnerships: Economic and International Dimensions Jean-Etienne de Bettignies and Thomas W. RossSauder School of BusinessUniversity of British Columbia: 

Public-Private Partnerships: Economic and International Dimensions Jean-Etienne de Bettignies and Thomas W. Ross Sauder School of Business University of British Columbia

Motivation: 

Motivation P3s are becoming increasingly popular as a mechanism to deliver public services in Canada, the U.S. and elsewhere A huge quantity of written work on P3s, but most by those with a vested interest one way or the other Where is the academic work?

Defining P3s (1): 

Defining P3s (1) “… 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” (B.C. Ministry of Finance, 2002)

Defining P3s (2): 

Defining P3s (2) “…a 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)

Defining P3s (3): 

Defining P3s (3) “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 P3 involves a sharing of risk, responsibility and reward, and is undertaken in those circumstances when there is value for money benefit to the taxpayers.” (Government of B.C., Building Partnerships)

Definitions: Key Elements: 

Definitions: Key Elements Sharing of risk and reward Sharing of authority for decision-making On-going relationships, not spot-market

Providing Public Services – The Tasks: 

Providing Public Services – The Tasks 1. Define and design 2. Finance 3. Construction (Build) 4. Operation and maintenance 5. Pay for the service

Choosing P3s: The Basic Trade-Off: 

Choosing P3s: The Basic Trade-Off Increased productive efficiency Risk of allocative inefficiency through loss of control

Perceived problems with traditional public provision: 

Perceived problems with traditional public provision High and rising costs Weaker “on-time” performance Less innovative

Advantages of Private Sector: 

Advantages of Private Sector More powerful incentives (the carrot) Ability to manage risk Flexibility Competition (the stick) Ability to control costs Innovativeness Expertise/Specialization Key knowledge Economies of scale/scope Complementarities

“NEW” Initiatives: 

“NEW” Initiatives Contracting-out (C-O) (e.g. refuse collection, IT services) Public-Private Partnerships (P3s) (e.g. roads, schools, prisons) Alternative Service Delivery (ASD) (e.g. C-O, P3, privatization)

What is New in Modern P3s?: 

What is New in Modern P3s? Modern P3s go beyond simple, traditional outsourcing – particularly with respect to: 1. number of tasks outsourced 2. bundling of tasks 3. outsourcing of financing and operations

The Proper Objective for a P3:: 

The Proper Objective for a P3: Assign the tasks to the various public and private partners in the most efficient manner: i.e. allocate a task to the party able to execute it at least cost (quality adjusted)

Factors to consider in allocating tasks:: 

Factors to consider in allocating tasks: Who has best information / skills? What about economies of scale & scope? Who has best incentives? Connectedness of tasks. What can be controlled by contract?

Allocating Risks – A Key Feature of P3s: 

Allocating Risks – A Key Feature of P3s 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)

Risk and Incentives: 

Risk and Incentives To us, managing risk is managing incentives – the point is to assign the risks in such a way as to minimize those risks. This is done by subjecting the party most able to control a risk to the costs associated with that risk.

Who are the private partners? They can be:: 

Who are the private partners? They can be: Private, for-profit firms Consortia of private, for-profit firms Private, not-for-profit firms

The Public-Private Spectrum: 

The Public-Private Spectrum Private sector involvement can range from zero (pure public) to total (pure private) Pure Public Pure Private Contracting-out P3s

Some History: 

Some History Britain pioneered “new wave” with Private Finance Initiatives (PFIs) beginning in early 1990s Now popular in many countries and many provinces in Canada Promoted by World Bank for developing countries

Common Areas of Application: 

Common Areas of Application Roads Schools Hospitals Prisons Bridges Water treatment Property management Recreational facilities Information tech. Social services

Significant Canadian P3s: 

Significant Canadian P3s Highway 407 – Ontario Confederation Bridge – PEI-NB Charleswood Bridge – Winnipeg Pearson Airport - Ontario St. Lawrence Seaway South Surrey Interchange – B.C.

Relevant Economic Theory: 

Relevant Economic Theory ex post incentives: Principal-agent theory Transaction cost theory ex ante incentives: Incomplete contracts theory

Economics of P3s: Key Considerations: 

Economics of P3s: Key Considerations Typically a significant specific investment involved – creates significant switching costs. Specific investments protected by contracts but contracts always incomplete.

Costs of Expanded Private Involvement: 

Costs of Expanded Private Involvement Essentially the costs of loss of control or the costs of more elaborate contracting to avoid control issues What if changing circumstances demand changes in the level or type of services? What if it is difficult to measure and verify quality?

Controlling Opportunistic Behavior: 

Controlling Opportunistic Behavior Three main possibilities: Good contracts (can be costly to negotiate) Good reputations – private partner wants future business and public partner does not want to scare away potential partners for other ventures Public provision

Challenges to Contracting: 

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

Advantages of Private Sector: 

Advantages of Private Sector More powerful incentives (the carrot) Ability to manage risk Flexibility Competition (the stick) Ability to control costs Innovativeness Expertise/Specialization Key knowledge Economies of scale/scope Complementarities

Providing Public Services 1:Spot Markets : 

Providing Public Services 1: Spot Markets 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)

Providing Public Services 2: P3s: 

Providing Public Services 2: P3s P3s 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

Providing Public Services 3: Pure Public Provision: 

Providing Public Services 3: Pure Public Provision Pure public provision looks good when Significant specific investment Complex or uncertain environment Significant need for public sector flexibility/control

Choosing how to provide the service:: 

Choosing how to provide the service:

On Assigning Tasks: General Questions: 

On Assigning Tasks: General Questions Is there strong competition between private firms? 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? Can the right incentives be put in place to get optimum performance? (contract design issues)

Complementarities -- Examples: 

Complementarities -- Examples Design -- Construction Construction -- Operation Financing -- Construction

Some Common P3 Models: : 

Some Common P3 Models: (i) Design-build-operate (DBO) (ii) Design-build-own-operate-transfer (DBOOT) (iii) Design-build-operate-maintain (DBOM) (iv) Finance-design-build-operate-maintain (FDBOM)

On Assigning Task 2 - Financing: 

On Assigning Task 2 - Financing Q: Can the government borrow more cheaply? A: Not necessarily – we must consider: Private partner can raise capital at a low cost for a safe project Gov’t marginal cost of borrowing might be higher than average cost There is a value to the put option

Other “Reasons” for P3s: 

Other “Reasons” for P3s Labour union issues Keeping debt off the gov’t balance sheet Hiding information Gifts to the friends of the gov’t Deflecting blame Opponents of P3s typically suspect that these are the real motives.

Organizing the P3 Effort inside Gov’t:: 

Organizing the P3 Effort inside Gov’t: Two Main Approaches: 1. Organized by client department 2. Professional P3 shop (e.g. Partnerships BC) Economies of scale in a professional shop, but also issues of regulatory capture

P3s Go International: 

P3s Go International Once services are outsourced, they can be traded internationally Standard gains from trade apply to these services

Countries in the P3 Game – A Sample: 

Countries in the P3 Game – A Sample

Large International Players: 

Large International Players

What Can Foreign Partners Bring?: 

What Can Foreign Partners Bring? As with traditional advantages of trade & FDI Skills etc. Economies of Scale Money Competition (current account issues not so relevant – will not replace imports)

Barriers to Greater Foreign Participation: 

Barriers to Greater Foreign Participation Ideology National security and privacy issues Contract enforcement across borders Sovereignty issues

Trade Agreements and P3s: 2 Concerns: 

Trade Agreements and P3s: 2 Concerns Under GATT/WTO can we ever go back to public provision if we want? Investor protection under NAFTA – can governments be sued for regulations and other actions that harm foreign partners?

P3s in Developing Countries: 

P3s in Developing Countries Has become an important mechanism for the provision of infrastructure World Bank support. Reasons: Shortages of skills Shortages of capital (borrowing constraints)

Developing/Transition Economies in P3s: 

Developing/Transition Economies in P3s

Developing Countries’ P3 Investment in Infrastructure 1990-2001: By Region: 

Developing Countries’ P3 Investment in Infrastructure 1990-2001: By Region

Developing Countries’ P3 Investment in Infrastructure 1990-2001: By Sector: 

Developing Countries’ P3 Investment in Infrastructure 1990-2001: By Sector

Special Concerns in Developing Countries: 

Special Concerns in Developing Countries Uncertain stability does not mix with long contracts Do skills travel well? Corruption

Lessons Learned (1): 

Lessons Learned (1) 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

Lessons Learned (2): 

Lessons Learned (2) Constraints on public borrowing favours P3s Professional P3 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.

Future Research Directions: 

Future Research Directions More detailed and objective review of past P3 projects More on relative costs of borrowing for public vs. private sector More detailed modeling of basic P3 tradeoff

Assessing Success or Failure: 

Assessing Success or Failure Failure to public is when services are provided at higher cost/lower quality/later date than with traditional methods Failure to private partner is when that partner loses money – but there is always some risk of that, especially given that one of the purposes of P3 is to shift risk

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