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Abstract
Public–private partnerships (PPPs) have become an increasingly popular way for governments to procure for their citizens certain public services. Supporters argue that the private sector can provide services more efficiently while critics complain that the long-term contracts involved reduce governments’ ability to adapt to changing needs. This paper shows that the optimal choice between a PPP and traditional public procurement depends on a number of factors, including the likelihood that changes will be necessary, the productivity of non-contractible effort exerted by private sector partners, and the bargaining power of government vis-à-vis private parties. It also shows that this choice may depend on whether the government’s objective is to maximize “value for money” or to maximize total social surplus.
Acknowledgments
The authors gratefully acknowledge helpful discussions on this topic with Jean-Etienne de Bettignies, Larry Blain, Anthony Boardman, Nicholas Hann, Elisabetta Iossa, Michael Riordan, Alan Russell and Ralph Winter; comments received at conference and seminar presentations at Zhejiang University, the University of British Columbia, the Copenhagen Business School and from anonymous reviewers; the capable research assistance of Jennifer Ng; and the financial support of the Phelps Centre for the Study of Government and Business, in the Sauder School of Business at the University of British Columbia.
Notes
1. An early version of PPPs was the Private Finance Initiative (PFI) pioneered in the UK from the early 1990s.
2. Organization for Economic Cooperation and Development (OECD) (Citation2008). For an interesting discussion of the wide range of PPP models and some of the history behind public–private cooperation in delivering public services, see Hodge and Greve (Citation2013) and the references cited therein.
3. The private sector partner is typically a consortium of firms acting through a special purpose vehicle to deliver the assets and associated services. One major way PPPs differ from one another is according to which of the tasks are assumed by the private partner. For example, in the common “DBFOM” form the private partner “designs, builds, finances, operates and maintains” the assets but in other cases the private partner will assume a smaller set of tasks.
4. Infrastructure Journal Project Database, http://www1.ijonline.com (accessed July 25, 2011).
5. See, e.g., De Bettignies and Ross (Citation2004) for a discussion of what distinguishes modern PPPs from classical contracting out.
6. There has not been enough work done to properly evaluate the success of PPP projects ex post, in part because these are generally very long-lived – and on-going – agreements, and a full accounting cannot really be done until the agreements have expired. The UK was an early adopter of the model and work by the National Audit Office there suggests some success with the private finance initiative (PFI) version of the PPP model – there are many NAO reports at http://www.nao.org.uk/. Australia has also been a leader in the use of the PPP model, and there is evidence of success there as well, see e.g. Infrastructure Partnerships Australia (Citation2007).
7. For example, see Benz et al. (2002), Hart (Citation2003), Hart et al. (Citation1997), Bennett and Iossa (Citation2006) and Iossa and Martimort (Citation2015). For a discussion of other aspects of PPPs studied by economists, see De Bettignies and Ross (Citation2011).
8. Not surprisingly, it is this aspect of PPPs that led to them being strongly opposed by public sector unions. For example, see “The case against PFI” from the website of the largest public service union in the UK (UNISON): http://www.unison.org.uk/pfi/caseagainst.asp.
9. In the UK, PPP (or PFI) is not recommended for the provision of information technology services, in part because of the high probabilities and costs of changes (see Yescombe Citation2007, p. 27). From HM Treasury (2006, p. 32): “the PFI procurement structure is unlikely to deliver value for money … where authorities require a significant degree of short-term flexibility due to fast-changing service requirements”.
10. Making the point that the surrendering of decision-making authority to the private sector in PPPs makes it more difficult for the public sector to adapt to changing demands for public services, see e.g. Organization for Economic Cooperation and Development (OECD) (2008, pp. 65–69), Yescombe (2007, section 2.12) and PricewaterhouseCoopers (2005, Chapter 2).
11. Excluding concessions in the telecommunications sector “because practically all telecommunication projects were privatized rather than concessioned, raises the incidence of renegotiation to 41.5%” (Guasch Citation2004, p. 12). Guasch studied various aspects of these renegotiations, including which party initiated the renegotiation, the form of bidding that resulted in the concession award, the incidence of renegotiation in different sectors, and the average time before contracts are renegotiated. In their study of 61 PPP road concession contracts in Chile, Colombia and Peru between 1993 and 2010, Biltran et al. (Citation2013) find that 50 of the contracts had been renegotiated at least once – and in total there were 540 renegotiations on these contracts. In 80 per cent of the cases the renegotiations were triggered by the government with higher costs then imposed on the public sector.
12. From page 8 of the NAO report: “Under PFI, almost any requested change, even as small as a new electrical socket, has to be processed through the SPV as it manages the asset during the contractual period and bears the risk of failing to meet service obligations. Often lacking the option of going to a different supplier, even for major changes, there is a risk that the public sector will have reduced leverage in negotiation and that the SPV or FM provider may not be incentivised to keep down the cost of changes or to process them quickly.” This report goes on to list the kinds of changes that come up frequently in long-term PPP contracts.
13. Two papers consider flexibility issues quite different from those studied here. Iossa and Martimort (Citation2015) consider the advantages of negotiating sequentially (i.e. with more flexibility) with a builder and operator versus bundling the two tasks. Athias and Saussier (Citation2010) look at the optimal degree of pricing flexibility within PPP contracts.
14. We will highlight the differences between this paper and the analysis of BT at various points below.
15. See also Vining et al. (Citation2005). Going back further, there are clear parallels as well with the “administered contracts” work of Goldberg (Citation1976), who recognized that large value, long-term contracts will almost certainly be incomplete, opening them up to renegotiation for any of a variety of reasons. In some cases this may need to be addressed through some form of regulatory mechanism.
16. In BT’s private sector procurement model, they consider fixed price contracts which have properties similar to our PPP contract, and cost-plus contracts which have incentive properties similar to our PUB arrangements.
17. It is possible that effort is observable. Here we only assume that effort is not contractible, i.e. that its value cannot be demonstrated for a court or any contract enforcement mechanism.
18. In fact, the most interesting cases involve changes in the nature of demand – i.e. the kinds of services to be provided. A bridge redesigned to accommodate more bicycles and fewer cars might be an example. Uncertainty about simply the level of demand for a project can often be dealt with in carefully drafted contracts.
19. In contrast, BT use a “take-it-or-leave-it” renegotiation model.
20. If this is solely a renegotiation cost, it may seem likely that s would be smaller (or even zero) when the changes can simply be ordered by the government under a traditional public procurement process. In such a case it is not difficult to show that higher renegotiation costs (that do not apply under PUB) will make PUB a relatively more attractive option.
21. It is not difficult to show that, because effort affects only costs and not benefits in our model, an alternative timing in which effort decisions are made before changes and renegotiations would produce identical results to those derived here.
22. This requires that the total benefits of making the change () exceed the costs of making the change (2
).
23. A common concern raised about PPPs, particularly when the public partner is an under-resourced government department of a developing country, is that the private partners will have more legal and technical “firepower” at the table than will the government.
24. This is not to deny that there can be a problem of firms adopting strategies in which they win the contract with an apparently attractive bid, only to threaten later that the deal must be renegotiated or they will not continue. However, sophisticated governments will be alert to this possibility, and will want to scrutinize bids carefully to assure themselves that they are feasible. Also, in a world in which most of these private sector PPP players wish to continue to win future bids with the same or other governments, such gaming could be damaging to their reputations as trustworthy partners.
25. The classic reference is Sappington (Citation1983). See also the text by Laffont and Martimort (Citation2002). It can be shown, as well, that the key trade-off between efficiency and flexibility remains even if firms are permitted to bid down to zero ex ante expected profits (and can commit to their bids) as long as there are costs associated with renegotiation.
26. If the limited liability constraint is satisfied it is very easy to see that a participation or individual rationality constraint (requiring firms to earn non-negative profits in expectation ex ante) will never be binding. For this reason we do not include participation constraints here.
27. As suggested, this does require that the winning bidder can credibly convince the government that its bid will allow it to break even in the absence of any renegotiations.
28. All proofs are contained in the online-only Appendix.
29. If we allow t to exactly equal 1 we lose uniqueness to our solutions – since the government taxes back every dollar of profit, it does not care what price it pays. Therefore, when we speak of t = 1 here, we more precisely mean t = 1– ε, where ε can be an arbitrarily small but positive quantity.
30. An alternative modeling technique could simply involve assuming that under PUB, the government does not need to renegotiate changes and can just order them. This approach, taken in an earlier version of this paper, produces essentially identical results.
31. To be clear, we do not see λ as a choice variable except to the extent that a government can choose to procure using traditional public methods, thereby effectively setting λ to one. Any form of private provision will involve, for the purposes of our model, a bargaining weight that is exogenous to the government.
32. Details on some of the steps not fully reported in this subsection are contained in the online Appendix.
33. Shadow tolls (where use is measured but the tolls are paid by the government) on road and bridge projects would be an example.
34. The optimal effort is the same here in part because effort does not affect demand in this model. It would be interesting to explore the implications of having effort influence demand as well as costs.
35. This is also shown in the online Appendix.
36. We are grateful to an anonymous referee and editor for stressing these important points to us. This referee also suggested a number of interesting supply-side issues worth exploring in future work, including the role of infrastructure pricing (e.g. tolling) on the supply response in PPP arrangements and how PPP arrangements affect the speed of that supply response.
Additional information
Notes on contributors
Thomas W. Ross
Thomas W. Ross is the UPS Foundation Professor of Regulation and Competition Policy in the Sauder School of Business at the University of British Columbia. Professor Ross received his PhD in economics from the University of Pennsylvania. His research has recently focused on competition policy, government regulation of business and public–private partnerships.
Jing Yan
Jing Yan is an assistant professor at the Central University of Finance and Economics in Beijing, China. Professor Yan earned her PhD in the Sauder School of Business at the University of British Columbia in 2013 and is now conducting research into competition policy, international trade, pricing strategies and public–private partnerships.