The Simple Microeconomics of Public‐Private Partnerships

• Author: ELISABETTA IOSSA,DAVID MARTIMORT
• Published date: 01 February 2015
• Date: 01 February 2015
• DOI: http://doi.org/10.1111/jpet.12114

THE SIMPLE MICROECONOMICS OF PUBLIC-PRIVATE

PARTNERSHIPS

ELISABETTA IOSSA

University of Rome Tor Vergata, CEPR and IEFE-Bocconi

DAVID MARTIMORT

Paris School of Economics-EHESS

Abstract

We build on the existing literature in public-private partner-

ships (PPP) to analyze the main incentive issues in PPPs and

the shape of optimal contracts in those contexts. We present

a basic model of procurement in a multitask environment

in which a risk-averse firm chooses noncontractible efforts

in cost reduction and quality improvement. We first con-

sider the effect on incentives and risk transfer of bundling

building and management stages into a single contract, al-

lowing for different assumptions on feasible contracts and

information available to the government. Then we extend

the model in novel directions. We study the relationship

between the operator and its financiers and the impact of

private finance. We discuss the trade-off between incentive

and flexibility in PPP agreements and the dynamics of PPPs,

including cost overruns. We also consider how institutions,

and specifically the risk of regulatory opportunism, affect

Elisabetta Iossa, University of Rome Tor Vergata, CEPR and IEFE-Bocconi, Rome, Italy

(elisabetta.iossa@uniroma2.it). David Martimort, Paris School of Economics-EHESS, Paris,

France (david.martimort@parisschoolofeconomics.eu).

This is a much revised and updated version of an earlier paper.For useful comments and

discussions at different stages of this long-term project, we wish to thank the editor of this

special issue Flavio Menezes as well as Malin Arve, John Bennett, Antonio Estache, J´

erˆ

ome

Pouyet, Yossi Spiegel, Emile Quinet, Zoe Moss, Wilfried Sand-Zantman, and seminar par-

ticipants at ESNIE (Ajaccio), the Congr`

es de l’Association Franc¸aised’Economie(Paris-

Sorbonne), and the UBC P3 Project (Vancouver). Elisabetta Iossa gratefully acknowledges

financial support from the Ministry of Education, University and Research (PRIN 2008)

while David Martimort thanks Agence Nationale de la Recherche (ANR).

Received September 29, 2013; Accepted October 11, 2013.

C2014 Wiley Periodicals, Inc.

Journal of Public Economic Theory, 17 (1), 2015, pp. 4–48.

4

The Simple Microeconomics of PPP 5

contract design and incentives. The conclusion summarizes

policy implications on the desirability of PPPs.

1. Introduction

Under a public-private partnership (hereafter abbreviated as PPP), a lo-

cal authority or a central-government agency enters a long-term contract

with a private supplier for the delivery of some services. The supplier takes

responsibility for building infrastructure, financing the investment, and then

managing and maintaining this facility.

PPPs are being used across Europe, Canada, the United States, and a

number of developing countries as part of a general trend seeing an in-

creasing involvement of the private sector in the provision of public services,

under the form of privatization, deregulation, outsourcing, and downsizing

of government.1PPPs have traditionally been employed in transportation,

energy, and water but their use has recently been extended to IT services,

accommodation, leisure facilities, prisons, military training, waste manage-

ment, schools, and hospitals.

In Europe, the PPP approach was pioneered by the private finance ini-

tiative (PFI) launched in 1992 in the United Kingdom.2By 2009, approx-

imately 800 PFI projects had been signed for a capital value of 64 billion

(HL 2010).3Other European countries have also invested in PPPs, especially

France, Portugal, Spain, and Italy. Overall, more than 1300 PPP contracts

have been signed in the EU from 1990 to 2009, representing a capital value

of more than EUR 250 billion (EIB 2010). In the United States, PPPs are

most common for projects involving highway and road transportation, rail,

water supply, and waste water treatment (CBO 2007).4In developing coun-

tries, PPP agreements have grown steadily since the 1990s. According to the

World Bank’s Private Participation in Infrastructure (PPI) database, between

2000 and 2010 twenty-nine countries in Latin America and the Caribbean

implemented 688 infrastructure projects with private participation for capi-

tal value of US$191 billion. Between 2000 and 2010, 17 countries out of the

23 in East Asia and Pacific implemented 908 infrastructure projects with pri-

vate participation for capital value of U.S. $154 billion. India is the largest

market for PPI in the developing world.

1Armstrong and Sappington (2006), Levin and Tadelis (2010), Estache and Imi (2011).

2Grout (1997).

3V¨

alil¨

a, Kozluk, and Mehrotra (2005).

4In the United States, the cumulative project costs of PPPs funded or completed by

October 2006 totaled about $48 billion out of nominal capital spending on infrastruc-

ture by the federal government and states and localities of $1.6 trillion between 1985 and

2004 (averaging $80 billion annually). A number of PPPs were also developed in the 70s

for inner-city infrastructure (see Rosenau 2000).

6 Journal of Public Economic Theory

Despite this worldwide growth, evidence on PPP performance remains

mixed.5On the one hand, PFI projects in the UK seem to be delivering

cost saving compared to traditional procurement.6Improvements in com-

pletion time and cost of delivery have also been achieved,7and public bod-

ies using private finance have shown satisfaction with the services provided by

contractors.8

On the other hand, PPPs have resulted in higher water prices than tradi-

tional procurement in France.9PPPs seem also unsuitable for fast-moving

sectors; performance failures have been widespread in PPPs for special-

ized IT in the UK. Existing evidence also suggests that renegotiation has

played a pervasive role in PPPs worldwide. In Latin American and Caribbean

(LAC) countries, governments have sometimes failed to enforce contracts

and projects have been abandoned.10 Adverse institutional conditions have

also mattered. High transaction costs and unrealistic demand expectations

have made PPPs in Central and Eastern Europe less successful than in other

countries.11

These pieces of evidence not only question the values of PPPs but also

call for a better understanding of the incentive issues in PPPs. This paper

aims to build on previous works so as to identify circumstances in which the

main characteristics of PPPs are suitable to provide adequate incentives for

private contractors in infrastructure and public service provision. We also

extensively describe the empirical evidence on PPPs and use our insights to

derive clear policy implications.

For our purpose, we characterize PPPs by three main features: (i) tasks

bundling, (ii) risk transfer, (iii) long-term contract.

(i) Bundling. A PPP typically involves bundling design, building,

finance, and operation of the project, which are all contracted out

to a consortium of private firms. The consortium includes a con-

struction company and a facility-management company and it is re-

sponsible for all aspects of services. The DBFO model (“Design,”

“Build” “Finance,” and “Operate”), the BOT model (“Build,” “Op-

erate,” and “Transfer”) or the BOO (“Build,” “Own,” and “Oper-

ate”) all account for bundling of building and operations but differ

5For a general and comprehensive discussion of PPP successes and failures, see Engel,

Fisher, and Galetovic (2014) and the countries studies therein.

6Arthur Andersen and Enterprise LSE (2000).

7The HM Treasury (2003) reports that 76% of PPP projects have been completed on

time, compared to 30% of traditionally procured projects. However, we do not know what

the time line was, so we are unable to assess whether PPP delivered faster projects than

traditional procurement.

8NAO (2009).

9See Chong, Huet, and Saussier (2006).

10 Guasch (2004).

11 Brench et al. (2005).