Why contracts fail: a game theoretic approach to managing urban water

ABSTRACT

In developing countries, urban water is often provided by public private partnership (PPP). However, PPPs remain highly contentious, with many contracts renegotiated or stalled. Prima facie, this stems from issues in the French model of contract design between two parties – the government and the private operator. Critics point out that in reality, the PPP is a tri-party exchange of promises, services and fees linking the interests of the private operator, the government and the people. We propose a game theoretic analysis comparing a two-party contracting model with a tri-party one, which is tested against a real-world experiment in the water utilities in Manila and Jakarta. Paradoxically, we find that a tri-party contracting model, though analytically more faithful in separating the interest of the government from the consumers’ leads to sub-optimal outcomes. In practical terms, we find that an independent regulator may not generate better outcomes.

KEYWORDS:

• Urban water
• privatization
• game theory
• regulation
• water governance

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. For the private sector to make a profit, it also depends a lot on how it is covered by tariffs, for example how it is specified in the contract the associated rate of return and such. There are cases where the investments made were not appropriately recovered.

2. In 2005 the urban population served by piped water was at 30.557 million.

3. Compared to Singapore (US$0.55), Manila (US$0.35), Kuala Lumpur (US$0.22) and Bangkok (US$0.29).

4. From a global comparison perspective, this price may still be below average (Pinto and Marques 2017).

5. In other words, it is assumed that under the optimal contract the value of is such that the government is better off choosing ‘Adjust the tariff’ against ‘Not adjust’.

6. In the model, we take it as zero investment (‘Not invest’) for simplicity, which does not alter the main result. This means the status quo is maintained.

7. This is a sufficient condition. Without such an assumption, it is possible that only corner solution could exit and the consumer’s constraint also binds at zero, since the (I,t) profile affects the payoffs of both the government and the consumers in the same direction. However, even in this case, the main implication of the model is not affected – consumers’ utility is always sub-optimal in the tri-party game. For simplicity of analysis, we adopt this technical assumption.

8. The case was filed in 2012 by the Coalition of People rejecting the Privatization of Water in Jakarta (KMMSAJ), a coalition of various community organizations.