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EXAMINED
G.W.E.B. van Herpen
Dutch Ministry of Transport, Public Works and Water Management
Directorate-General of Public Works and Water Management
AVV Transport Research Centre
1. Introduction
This essay is written as part of my study of the Economics of Transport and Logistics at the
Erasmus University Rotterdam in the Netherlands. The aim of this essay is to analyse the
advantages and disadvantages of public private partnerships (PPPs), particularly in the
infrastructure sector. At first a desk research had been carried out. After this literature study
a questionnaire had been sent out to different public and private actors, mainly in the United
Kingdom as well as in the Netherlands. The responses have been processed in this essay
and cited in italics.
Important to note is that the aim of this paper isn't the promotion of public private
partnership, nor the opposite; PPPs neither imply nor exclude the private ownership of
infrastructure or the use of (shadow) tolls. In contrast, there can be no PPP without risksharing and an approach that takes overall account of the infrastructure and services in a
transparent and stable contract drawn up within the framework of stable, appropriate and
respected legislation.
2. Public private partnerships
A public private partnership can be described as a co-operation between the public and the
private sector, in which the government and the private sector carry out a project together on
the basis of an agreed division of tasks and risks, each party retaining its own identity and
responsibilities.
The interest in PPPs is growing, notably due to the growth in the demand for infrastructure,
limited public funds to meet current and future needs and acceptance for the private sector
in the provision of infrastructure. The underlying principle behind PPPs is that, although the
public sector may need to be responsible for the delivery of a particular service, it does not
have to be responsible for actually providing the service or for undertaking the investment
themselves. In this way, all actors of a public private partnership can concentrate on doing
what they are likely to do best.
Major public infrastructural projects have always been undertaken by the private sector
under contract. The major difference between this conventional procurement model and
public private partnerships is the fact that the private sector can be regarded as a fullfledged actor.
Infrastructure can be characterised as a large, indivisible and non-rival capital good that
produces services for its users. The non-rivalness (or non-excludability) and the large cost of
infrastructure causes it to be a public good. However, infrastructure also possesses some
characteristics of a private commodity because it facilitates the use of a complementary
private commodity, like the use of a car.
A couple of decades ago the term infrastructure only referred to the material components of
transport and public utility networks, like gas, water and electricity. By now, the term has
Association for European Transport 2002
widened to embrace all aspects of public services, managed by both the public and private
sector1.
Infrastructure services exist out of two service-levels:
1)
The first-level services represent the private use that is made of the second level.
These services belong to the private domain, thus are marketable. They cannot be
used without the complementary service on the second level. Example: physical
infrastructure.
2)
The second-level services are non-marketable services and originally belong to
the public domain. Example: performance measurement, political decision-making
process.
Public private partnerships can take many forms, from simple commercialisation to full
privatisation, but in general PPP's can be considered as long term agreements between the
public and the private sector to provide and operate transport infrastructure and / or service.
These new forms of agreements are aimed at optimising the input of knowledge from both
sectors. Most of these agreements aren't based on equality, but on a principle-agent
relationship. The principal is the public infrastructure agency and the agent is the
infrastructure operator.
PPP arrangements display three essential characteristics:
1)
A significant level of responsibility and risk that is transferred from the public
sector to the private sector.
2)
Contractual arrangements are built around performance-based outcomes, rather
than work specifications.
3)
Long-term contractual arrangements.
In addition, a partnership might involve:
4)
The financing of public infrastructure development off-the-book of governments,
which might include tapping into new sources of project revenues to secure project
financing.
5)
The imposition of real tolls or other fees to finance the project.
Government
Department
Public
Service
Authority Contract
Operations
Cooperative
and Maintenance
Lease-BuildOperate
Fully public
Build-TransferOperate
Build-OperateTransfer
Wrapround
Addition
Design-BuildFinance-Operate
Fully private
Before this change of point of view, the realisation of infrastructure was a typical task of the government. In most countries, the
government was the initiator, the principal, the financier, the owner, the manager and the exploiter of roads, water systems and other
infrastructure. The only reason the private sector was involved in the realisation of infrastructure was because of their role as contractor of
the design and construction. The implicit justification for this practice was that infrastructure was so important would, benefit so many
people and require so much capital that the private sector couldn't be entrusted with this responsibility - and in any event lacks the
resources.
The approval process is the key step between project development and implementation.
Once the project has been approved, the planning phase can commence if the planning
risk is retained by the public sector.
A fair, open and accountable competition for host governments is of extreme importance
in the implementation phase.
In the post-transaction phase, the public sector is responsible for ensuring that the
private sector contractors meet statutory standards, such as safety, design and
construction standards. These should be contractually enforced by a requirement of the
contractor to submit design, construction and safety plans for approval and by the
requirement that the infrastructure will not be opened until all necessary approvals have
been satisfied.
Public
Public /
Private
Private
Private
Private
Private
Private
Public /
Private
Public
Political risk
Planning risk
Design risk
Construction
risk
Maintenance
risk
Operational
risk
Financial risk
Usage risk
Legal &
Regu- latory
risk
The allocation of risk is often seen as the defining quality of a PPP arrangement. The
general rule regarding risk transfer is that it should be allocated to the party which is best
able to manage it and at the least cost. The following categories of risk can be identified:
political, planning, design, construction, maintenance, operational, usage, legal & regulatory
and financial risk.
Identification
Option Analysis
Planning & Approval
Implementation
Post-Transaction
No hard rules can be laid down for the allocation of risk. However, in general, the scheme
above can be drawn, combining the different phases of a PPP process and the different
categories of risk. The table also shows which sector will generally assume which category
of risk.
3. Advantages of public private partnerships:
The advantages of public private partnerships can be defined as follows:
Risk Transfer
Risk will be transferred to the party which is best able to manage this risk and at
the least cost. Risk transfer ensures that the parties involved will use conservative
assumptions in developing their expectations of benefits and costs.
A detailed project risk analysis promotes a shared understanding of the project
by all parties involved in order to communicate the complexity and detail of a
scheme.
Competition
Generally, the benefits of introduction of competition to an area which is normally
dominated by public sector monopolies are: lower prices, greater innovation,
increased investment and better service.
Governments have a wide range of options for creating competitive procurement:
service contracting, management contracting, leasing and concessions. The
construction and maintenance of public assets have always been done by the
private sector; the difference PFI has brought, is that it integrates all the activities,
including project management, so there is a single competition rather than several.
It's important to realise the trade-off between competition and the length and cost
of negotiations. The best way to ensure competition is for the government to clarify
as early as possible in the process the outputs which are wanted, to avoid the
need for too many changes as the negotiations proceed.
Various
Other value for money drivers have shown to be:
Innovation.
Alignment of interest of authority and contractor.
Public sector project development skills.
Public sector comparator.
Quality of advice to public sector and bidders.
Transparency of process.
Cost of capital.
Deal flow.
Public sector implementation.
Release of hidden asset value.
Project bundling.
Involvement of third party financiers.
Cost efficiencies
Public private partnerships can lead to cost efficiencies, which are the results of
increased competition, an improved proportion of risk transfer, a closer integration of the
different aspects of a project, better whole life costing and improved innovation.
Significant cost savings can be obtained in the long run by integrating capital investment
and the delivery of services (i.e. servicing the asset), because maintenance will be
considered when the asset is designed to maximise efficiency. Another reason for the
creation of cost efficiencies is the departure from standards (thus innovation).
Time-to-delivery savings
Public private partnerships can also lead to time-to-delivery savings, caused by a greater
private incentive to generate revenue as soon as possible and the increasing experience
with public private partnerships. Another reason for these time-to-delivery savings is the
existence of a learning curve for all parties involved. The private sector is driven by profit
motives and is accountable to shareholders to ensure that the profit isn't diminished by
higher interest charges and revenue losses from delays in project completion. In the
public sector, project completion delays might not have the same perceived direct
financial impacts.
"PPP-projects can be delivered quicker than under conventional procurement
because of better project management, better management of project risks and
because the service provider is not paid until the facility becomes operational".
However, the advantage of a quicker delivery of the project has to be shaded a bit more.
The design and construction itself can be realised quicker than under the conventional
method, for the reasons mentioned above.
"PPP-processes take longer than conventional procurements because the contracts
are for long periods (25-30 years) and therefore the financial assumptions underlying
bids have to be looked at in depth. Negotiations with bidders are also lengthy. ( )
The longest period of time in the project delivery process is usually the approval
phase. If the government tenders the project before approvals have been cleared or if
the approval phase is not streamlined, very little overall time savings may accrue. ()
However, this process is beneficial in that it allows for innovation and a rigorous
appraisal of the project risks".
Therefore, it must be concluded that the approval-phase is of extreme importance. An
extensive negotiation-phase may result in a shorter design and construction-phase. The
extra costs of these phases will have to be set out against cost savings in other phases.
Although a PPP-project can be delivered quicker than a project based on the
conventional procurement, the progress of transport infrastructure projects can still be
threatened or delayed by external objections and challenges: judicial reviews, the EU
complaints procedure, the requirements of other public bodies, the presence of public
opposition or a combination of these factors. Also very important to the time scale of a
PPP-project is the capacity of the construction and ancillary sectors. In Ireland, capacity
constraints have led to above average price inflation in the construction area. This may
lead to adverse affects for the quantum of infrastructure delivered (Irish CrossDepartmental Team of Officials, 1999). Therefore, communication is very important in
order to prevent stakeholders from obstructing progress.
sector ownership. The government will probably have to pay for this transfer. Even if this
transfer is free, the government will have additional costs, compared to the concession
period before the transfer. For example maintenance costs. There are also aspects of
shadow tolls to consider.
"It is a clever mechanism that enables public sector schemes to be funded without
having to raise taxation levels.
Broad support
In common, public private partnerships are broadly supported by the European
government, the national, regional and local government and by the private sector
because of the creation of value for money and because of the new source of income.
'Attitudes to the Private Finance Initiative', a survey carried out by
PricewaterhouseCoopers, confirms that participants in the PFI believe it has been a
success in the UK. In the survey, 71% of senior decision makers in the public and private
sectors agree that 'PFI has been good for both the public and private sector'. Another
73% believe that 'PFI projects are delivering value for money for the public sector'. The
survey confirms that, after initial doubts, the private sector is now convinced of the merits
of PFI. The survey also shows that the financial markets are responding positively by
thinking creatively about financing solutions
In order to gain more support from the community it is important that the government
(and the private parties involved) informs the community as soon as possible, thereby
involving them in the project. This doesn't only help improve the quality of the investment,
it can also prevent major delays to occur.
4.
Insecurity
Whenever two or more parties enter into a contract, there is a risk that the administrative
efforts on each side will be frustrated by a lack of co-operation on the part of the other
party(s). Also, when a party enters into the tender procedure, the party may not even be
granted the concession. Because of these insecurities, the number of bidders may be
Inefficiencies
Long-term operating contracts can lead to value for money. However, they can also lead
to inefficiencies due to a lack of contestability and competition. The tender-procedure at
the beginning of the process may have introduced competition, the developer who has
signed the contracts will have the exclusive rights to an infrastructure facility, therefore
practically enjoying a monopoly. During the operation phase inefficiencies may be
created due to a lack of contestability and competition.
The terms of contract are very important. The public sector has to remain its position as
client and specify the services it requires. If the service provider defaults in the provision
of that service or delivers a sub-standard service, there should be arrangements in the
payment mechanism for dealing with such instances. Continuous default has to be able
to result in termination of the contract. The payment mechanism should also award the
licensee when performances are superior to contractual standards.
Culture gap
There exists a culture gap between the private and the public actors, which may result in
a loss of confidence in each other. The private sector's motive to take part in a public
private partnership is primarily profit-making or image-building; the public sector's motive
is merely social attractiveness. Another example of this culture gap is the different
discount rates used by the private and the public sector, which can be explained by the
difference in motives of both parties involved. In order to let the discount rates be
comparable, and thus reduce the culture gap, the public discount rate has to be adjusted
to the private discount rate. Unfair and unrealistic cost comparison procedures can
contribute to slow implementation or even failure of public private partnerships, thereby
raising transaction costs.
To overcome the gap in culture, trust is one of the most important aspects in a
partnership; without trust, real success is hard to realise. The public actors, as well as the
private actors, have to respect and comprehend each others goals, considerations and
decisions.
"There is definitely a culture gap. However, private companies are at least as good as
the public sector at realising what the customers - the end-users - really need. We
('private company') often help clients ('public sector') to understand these needs.
Many clients are also compartmentalised and people from one department don't talk
to people from another department. We add value by getting the client to cut across
these boundaries for the benefit of the customers. They would never think of doing
that by themselves without our assistance. This is one of the key areas where private
Hold-up problem
Another disadvantage of public private partnerships is the existence of the hold-up
problem, whereby a party may be able to enforce a new cost-revenue-ratio than
previously agreed upon. This problem may take place when the negotiation-position of
the parties involved change over time and when observance of the contract isn't perfectly
possible. The relative position of negotiation is influenced by the sunk cost aspect of
investments and the alternative possibilities of usage.
5. Recommendations:
In order to make the advantages more advantageous and the disadvantages less
disadvantageous, a couple of recommendations can be drawn up:
2 Temporary networks represent the opposite; instability and increased uncertainty, but also flexibility, higher independence and ability to
change.
6.
The real reasons for the broad support have to be examined before decisions about
whether to proceed with the public private partnership are made.
Accounting treatment shouldn't be prioritised over value for money.
The private sector has to be brought in the partnership as soon as possible, either as
a tender-contestant or as a participant in the market-consultation. However, primarily
design, public involvement and the environmental approvals have to be taken care of
first by the public sector before the private sector can be brought in as a tendercontestant. It is also wise to develop some sort of compensation system in order to
stimulate private actors to join the tender-procedure.
The total number of bidders should be enough to introduce effective competition, but
should be limited in order to keep control over the transaction cost, the quality of the
bids and the probability of success.
In order to diminish the transaction cost, the delays and time-scale and the
uncertainty, it is wise to use standardised contracts.
In order to prevent major delays, an honest and early communication to stakeholders
is of extreme importance.
One has got to be careful not to overrate the possibilities of value capturing as an
additional source of finance. Value capturing - also known as scope-optimalization means attracting additional sources to the project. These sources are derived from
functions which - directly or indirectly - profit from the investment in infrastructure.
However, the control on these functions is often in hands of parties which aren't
involved in the public private partnership. A rise in value of assets not directly
involved in the PPP, is hard to realise without a change in ownership.
Abstract:
In this essay, the advantages and disadvantages of public private partnerships are being
described.
PPP-projects are likely to be successful as those genuinely combining capital and service
requirements; where the risks are primarily commercial; where scope for innovation exists;
and with skilled and committed public sector management.
The main advantage of public private partnerships is the creation of value for money, which
is a collection of several factors. The most important value for money-drivers are the transfer
of risk, the output based specification, the long-term nature of contracts, the performance
measures, the increased competition and the private sector management. Other important
advantages of public private partnerships are the quicker delivery of projects, the improved
incentives to market forces, the cost efficiencies, the broad support for PPP and the
improved cost calculations by the public sectors.
However, public private partnerships also have some disadvantages. The most import one
is the increased transaction costs. This is a result of the complexity of the relations between
the diverse actors and because of the long duration of these relations. The other most
important disadvantages are the higher capital costs, the insecurity of being granted the
concession, the culture gap between the two sectors and the hold up problem.
7.
Bibliography:
ABN-AMRO Economisch Bureau Binnenland & Afdeling Public Sector (1997) Nieuwe
wegen, andere bronnen, een toekomstschets van de investeringen in infrastructuur in
Nederland.
Association for European Transport 2002
Arthur Andersen and Enterprise LSE (2000) Value for money drivers in the private finance
initiative.
Bartelsman, E.J., Canoy, M., Ewijk van, C., Vollaard, B.A. (1998) Economie van publiek
private samenwerking, ESB Dossier.
Canadian Council for PPPs (2000) British and Australian experts discuss progress in p3s
abroad.
Confrence Europenne des Ministres des Transport (1999) Conclusions
recommendations on public-private partnerships, Transport Infrastructure Financing.
and
Laan van de, G., Ruys, P., Talman, D. (2001) Optimal provision of infrastructure using
public-private partnership contracts, Tinbergen Institute, discussion paper.
Middleton, N. (1999) PPPs a natural successor to privatizations, PricewaterhouseCoopers,
International Privatisation Review 1999/2000.
Montague, A. (1999) Public-private partnerships in the UK lessons for international
projects
Moore, A.T., Segal, G.F., McCormally, J. (2000) Infrastructure outsourcing: leveraging
concrete, steel and asphalt with public-private partnerships.
Private Finance Taskforce (1999) Great Brittain, DBFO value in roads, a case study on the
first eight DBFO road contracts and their development.
Raad voor Verkeer en Waterstaat (2000) Meer markt, andere overheid, advies over de
veranderende relatie tussen markt en overheid op terreinen van Verkeer en Waterstaat.
Savas, E.S. (2000) Privatization and public-private partnerships.
Spackman, M., Dijk van, Th. (1998) Ervaringen met publiek-private samenwerking in het
Verenigd Koninkrijk, ESB Dossier.
Treasury Committee (2000) Fourth report.
Twynstra Gudde (2000) Op de goede weg ? Naar een optimale samenwerking tussen
publiek en privaat bij infrastructurele projecten.
Westlund, H. (1995/97) An interaction-cost perspective on networks and territory.
Williamson, O.E. (1998) Transaction cost economics: how it works, where it is headed.
Wilson, T. (2000) DCMF Prisons: an example of savings forecast under UK governments
Private Finance Initiative.
8.
Further Information
g.w.e.b.vherpen@avv.rws.minvenw.nl
+31 10 282 57 78
+31 10 282 50 14
www.rws-avv.nl
PUBLIC PRIVATE
PARTNERSHIPS
THE ADVANTAGES AND DISADVANTAGES
EXAMINED
INFRASTRUCTURE
First level services
Physical
infrastructure
Second level
services
Politics
AET-Conference - September 9, 2002
10
11
GENERAL ADVANTAGES
o Time-to-delivery savings
o Improved response to market forces
o Broad support
o Improved cost calculations
12
GENERAL DISADVANTAGES
o Insecurity
o Inefficiencies
o Culture gap
o Short term rigidities
o Hold-up problem
13
14
RECOMMENDATIONS
(1)
o Work transparent
o Risk transfer only to best parties
o Performance measurement necessary
o Government be clear
o Private sector involvement early in process
15
RECOMMENDATIONS
(2)
16
17
18
Public
Public /
Private
Private
Private
Private
Private
Private
Public /
Private
Public
Political
Planning
Design
Construction
Mainte nance
Operational
Financial
Usage
Legal
&
Regulatory
PHASE
Identification
Option Analysis
Implementation
Post-Transaction
RISK
19
20
Further Information
Boompjes 200
P.O. Box 1031
3000 BA ROTTERDAM
THE NETHERLANDS
Email::
Email
g.w.e.b.vherpen
g.w.e.b.
vherpen@
@avv
avv..rws
rws..minvenw
minvenw.nl
.nl
Phone::
Phone
+31 10 282 57 78
Fax:
Internet:
+31 10 282 50 14
www..rws
www
rws--avv
avv.nl
.nl
AET-Conference - September 9, 2002