The Economics of PublicPrivate Partnerships P3s prepared by: J'E' de Bettignies and T' Ross Sauder S

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The Economics of Public-Private Partnerships
(P3s) prepared byJ.-E. de Bettignies and T.
RossSauder School of BusinessUBC P3 Project
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Providing Citizens with Goods and Services

• Familiar Mechanisms
• 1. private markets (most goods)
• 2. (pure) public provision (e.g. primary
• and secondary education, defense)
• 3. regulated private provision (e.g. local
• telephone service)

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When does the public sector step in?

• External effects and public goods
• Social justice (to assure adequate consumption
  for everyone)
• To control monopoly
• Other reasons (e.g. poor information)

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Perceived problems with traditional public
provision

• High and rising costs
• Weaker on-time performance
• Less innovative

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Potential key advantages of private sector
vis-à-vis public sector

• Ability to control costs
• Ability to bear risk
• Complementarities
• Flexibility
• Innovativeness
• Key knowledge
• Economies of scale/scope
• Ability to borrow (Can the gov. borrow more
  cheaply?)

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NEW Initiatives Alternative Service Delivery
(ASD)

• Contracting-out (C-O)
• (e.g. refuse collection, IT services)
• Public-Private Partnerships (P3s)
• (e.g. roads, schools, prisons)
• Privatization

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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)

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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)

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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)

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Definitions Key Elements

• Sharing of risk and reward between public and
  private partners
• Sharing of authority for decision-making
• On-going relationships, not spot-market

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How New is this?

• Private sector involvement in provision of public
  services is not new e.g. the private sector has
  frequently provided
• Basic supplies (e.g. paper, pens, desks)
• Equipment (computers, medical, automobiles)
• Construction services
• Consulting services

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What is New?

• The increased scope of the private sectors
  participation particularly in
• 1. provision of financing
• 2. provision of operation services
• 3. ownership of assets

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Some Common P3 Models

• What the private partners might do
• (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)

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Who are the private partners?

• They can be
• Private, for-profit firms
• Consortia of private, for-profit firms
• Private, not-for-profit firms

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The Public-Private Spectrum

• Private sector involvement can range from zero
  (pure public) to total (pure private)

Pure Public
Pure Private
Contracting-out
P3s
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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

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Common Areas of Application

• Roads
• Schools
• Hospitals
• Prisons
• Bridges

• Water treatment
• Property management
• Recreational facilities
• Information tech.
• Social services

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Significant Canadian P3s

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

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Canadian Municipal P3s Examples(some are
proposals)

• Incinerator
• Biosolids processing
• Recycling programs
• Water treatment
• Bridge
• Building revitalization

• Harbour revitalization
• Electric utility
• Parking management
• Public transit
• Recreation centres
• Business park

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Current BC Projects

• These are at various stages from complete (or
  nearly) to proposal stages

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Abbotsford Hospital
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Academic Ambulatory Care Centre (Vancouver)
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Britannia Mine Water Treatment Plant
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Kicking Horse Canyon Project (Phase 2)(upgrades
to Trans Canada Highway)
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Golden Ears Bridge ( Fraser River Crossing in
Vancouver area)
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Wm. Bennett Bridge (Kelowna)
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Northern Sport Centre (at UNBC)
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RAV Line
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Sea-to-Sky Highway Improvements
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Sierra Yoyo Desan Resource Road Upgrade
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Whistler Wastewater Treatment Plant
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The Proper Objective for a P3

• Assign roles 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).

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Other Reasons for P3s

• Labour union issues contracting out work of
  highly paid public sector workers
• Keeping debt off the govt balance sheet
• Hiding information from public
• Gifts to the friends of the govt
• Deflecting blame for low levels of services
• Opponents of P3s typically suspect that these are
  the real motives.

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Providing Public Services The Various Tasks

• 1. Define and design the project
• 2. Finance the project
• 3. Construction (build the project)
• 4. Operation maintenance of the project
• 5. Pay for the service

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On Assigning Tasks General Questions

• 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)
• How should risks be allocated?
• Can there be strong competition between potential
  private sector partners?

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Advantages of Private Sector Come From

• More powerful incentives
• Competition
• Expertise/Specialization
• Complementarities
• Facilitating user-pay

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Incentives

• High-powered incentives to control costs due to
  profit motive
• Ability to manage risk
• Flexibility
• Innovative

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Risk and Incentives

• Managing risk is really about 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.

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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)

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Role of Competition

• Can lower prices taxpayers or users must pay
  (allocative efficiency)
• Provides further incentives for cost minimization
  (productive efficiency)
• Provides further incentives for innovation
  (dynamic efficiency)

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Expertise of Private Sector

• May have key knowledge not available in public
  sector (esp. in developing countries)
• Economies of scale/scope with related projects
• Complementarities with other parts of the given
  project

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Complementarities -- Examples

• Benefits from coordinated decision-making with
  respect to
• Design Construction
• Construction Operation
• Financing Construction

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Implementing User-Pay

• Most often government (taxpayer) pays
• Direct pay (e.g. lease payments)
• Shadow tolls (govt pays but payments based on
  actual usage)
• In some cases there is user-pay (e.g. tolls, but
  usually with regulation of tolls)
• User-pay may be more acceptable in a P3 than in
  public provision

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Costs of Expanded Private Involvement

• Most commonly expressed
• Loss of public control of public services
• 2. Higher cost of private sector borrowing?

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Loss of Control

• What if changing circumstances demand a change in
  level or type of services?
• What if renegotiation is difficult,
  time-consuming and costly (note there is no
  competition at this point)
• What if it is difficult to measure and verify
  quality?

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Financing the Project Can the Government Borrow
More Cheaply?

• Not necessarily we must consider
• Private partner can raise capital at a low cost
  for a safe project
• Govt marginal cost of borrowing might be higher
  than average cost
• There is a value to the put option (government
  pays lower rate only because it will repay with
  near certainty)

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Challenges in P3 Design

• Typically a significant specific investment
  involved creates significant switching costs.
• Specific investments protected by contracts but
  contracts always incomplete.

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Consequence Number 1

• Both trade partners will act opportunistically
  and bargain over the surplus
• This is costly!
• Public provision avoids/mitigates this cost
• One disadvantage/cost of a P3 relative to public
  provision inefficient bargaining

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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

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Challenges to Contracting

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

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Consequence Number 2

• Control and risk allocation become very important
• Characteristic of P3s transfer of control and
  risk from public to private sector
• Cost loss of control
• Benefit increase in size of surplus, as long as
  private sector more efficient

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Providing Public Services 1Spot 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)

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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

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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

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Summary of the 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

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Summary of the 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.

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• FIN