Explained: The Qualified Case For Public-Private Partnerships In Public Infrastructure

The theoretical case for PPPs rests on three main pillars.

One, private participation ushers efficiencies which lower life-cycle costs of the project. Two, private participation allows for more appropriate risk-sharing, including alleviating political economy constraints.

Three, private participation crowds-in much-needed private capital to supplement budgetary resources in financing long gestation projects. The natural consequence has been to promote PPPs which bundle construction, operation, and maintenance into long-term contracts which generate Value for Money (VfM) over the project’s life-cycle when compared to public construction and management.

As global experience over the past four decades has shown, the reality of increasing efficiency and lowering costs has been far more nuanced. In fact, the reality with private participation in infrastructure has turned out to be far less promising than expected.

The biggest challenge has been in writing contracts which clearly define service standards and capture all possible future contingencies. Incomplete contracts, with attendant transaction costs in implementing and enforcing them, have been the overwhelming norm.

Accordingly, failures to adhere to contractual obligations and struggles with enforcing them are a feature of PPP contracts across sectors and around the world. The dissonance between contracted and realised costs and efficiencies from across the world have been stark.

Much of the mainstream discussion on these problems have hitherto revolved around the issue of ‘obsolescence bargain’.

This concerns the possibility of government opportunism, arising out of the belief in governments that the private contractor is locked into a long-term contract and could, therefore, be dictated to.

This manifests in the form of one-sided changes to contractual obligations, most often motivated by political economy considerations. Failure to adhere to contractual obligations on periodic tariff increases are an example.

Another argument in favour of PPPs enhancing efficiency and lowering life-cycle costs is that of constraints imposed on public systems by eco-system factors. Eco-system constraints can vary across sectors and contexts.

For example, in transportation, it may be difficult for governments to raise tariffs on a toll road operated by itself compared to a contractually obligated tariff increase. Or government employees may be captured by political and other vested interests that public managers may not be able to control. Or inter-jurisdictional coordination may be easier because the private management can exercise more control over their employees than government management (say, co-ordination among different sanitation wards, different property tax collectors etc). Or the private provider is better positioned in being able to ring-fence activities, cost them, and levy user fees.

The presumption is that the private provider is better positioned to reduce the significant costs these two problems impose. But, as evidence from life-cycle costs of infrastructure projects from across the world suggests, this presumption falls apart. In fact, even if we assume that the private sector can wring out efficiencies in some cases, the second problem is not easily surmounted. In fact, addressing the second the problem may be significantly costlier for the private sector.

This can be traced to an irony about how the population views the government and the private sector. We may collectively agree that the private sector is more efficient and less corrupt than the government.

But when problems surface – tariff increase, user fees, big accident, grave omissions, loss of jobs etc – debates are triggered that invariably frames the problem (correctly, most often) as one of private profiteering, and the same social mood swings violently against the private sector.

In fact, the public has deeply internalised the belief that private sector delivery will be much superior that even small shortfalls in quality arouse a disproportionately (when compared to a similar failure by the government) higher level of anger and public discontent.

Further, once a service provider is large enough and service delivery interfaces closely with the civil society, it starts to face the same problems with employees and their unions, subcontractors, local political leaders, consumer groups etc that governments struggle with.

In such large entities, their managers and workers are no less prone to be captured by vested interests. And unlike the government with its institutional authority, the private provider is very badly positioned to negotiate acceptable enough bargains in such situations.

Finally, even the apparent strength of co-ordination that private providers are presumed to enjoy is questionable. More than internal co-ordination, all such outsourced activities involve significant coordination with external agencies, the majority of whom are again government-controlled, and with civil society, which trusts the government more than a private provider. The private provider is at a big handicap compared to public providers in this regard. In developed countries, with their strong state capacity, this alone weakens the case for private provision of infrastructure services.

The second rationale for PPPs, the risk-sharing argument, too has not lived up to expectations. As Bent Flyvbjerg, a professor at the University of Oxford, has shown, the approvals and financial closure processes of large projects invariably suffer from optimism bias (delusion) and strategic misrepresentation (deception).

Accordingly, construction delays and attendant cost overruns have been a feature of infrastructure projects. It is now
widely agreed that private developers are not well placed to bear construction risks. This is reflected in the very high risk-premiums associated with the construction phase of infrastructure projects.

Aggressive bidding by developers, with excessively optimistic assumptions, to bag the contract too has become commonplace. Government officials also underplay or misrepresent the true costs in order to ensure internal administrative approvals. The belief is that once the project is approved and construction starts, additional features and costs can be more easily added.

The third pillar, perhaps the least desirable reason for PPP contracting, has emerged as the primary reason today for private participation in infrastructure. Governments do not have the fiscal space to meet massive financing needs; so private capital and PPPs are needed.

But, as we shall see later, there is evidence to argue that the life-cycle costs of PPPs may often be higher than public provisioning. It starts with the cost of private capital, which is significantly higher than the cost of public finance. This is amplified by risk-allocation in such projects. In particular, certain risks, especially related to construction, are beyond the control of the private sector and are best borne by governments. All this cascade into a much higher life-cycle project cost.

The aforementioned challenges associated with PPPs do not mean that they have no role to play in infrastructure development and services delivery. We now examine the areas and conditions where PPPs might be useful.

The identification of activities appropriate for privatisation should consider Hart and Co’s analysis of private contractors’ incentive to ignore non-contractible quality.

In case of activities like prisons and air traffic controllers, there are either too many dimensions of quality or externalities generated that their capture in a contract poses prohibitive transaction costs and detracts from the provider’s operational control. But without their inclusion, the private operators will doubtless be incentivised to skimp on investments or ignore those dimensions so as to reduce costs.

Another factor for consideration on PPPs should be the state’s capacity. In developed countries, state capacity is strong and local governments are reasonably capable of managing large utility systems – after all, the UK is the only country with a fully private water and sewerage utility.

The efficiency gains from private provision of utility services are likely smaller than the significant costs. Short to medium-term service contracts may be the more prudent option for these countries.

In contrast, in developing countries state capacity is extremely weak. Public service delivery is, in most cases, of very poor quality – leakages, contamination, interruptions, unreliable, poor safety and so on. Most egregiously, public systems are over-staffed and with limited accountability to deliver on outcomes.

The scope for efficiency improvements from private operation and management can be very high, though it often comes at a steep and unaffordable price for consumers. But this has to be traded-off with the state’s weak capacity to manage even simple contracts, with the attendant risk of having lopsided contracts, which ends up causing private benefit at public cost.

There is another even bigger challenge, one whose impact is particularly significant in India at this moment. This is the problem of bureaucratic ‘decision-paralysis’ arising from the precedents established by the activist actions of the oversight agencies over the last decade.

They manifest in the form of the actions of the Comptroller and Auditor General (CAG) of India, Central Vigilance Commission (CVC), Central Bureau of Investigation (CBI), and the Courts, collectively the 4Cs.

Courts, in particular, have been liberal with entertaining petitions related to administrative issues. And these litigations, especially on human resource issues, go on for a long time. Further, in-sourced provision of infrastructure services creates the need for frequent procurements and short-term service contracts. And these are the other major source of litigation. Furthermore, given their financial implications, they are among the most politicised parts of the government. This also creates the conditions for controversies followed by 4C activism.

Officials naturally become wary of the uncertain future of their decisions and the likelihood of being accused of corruption by the mere fact of a decision has contributed to benefits to private providers. They become loath to examine issues objectively and take decisions on merits which can potentially benefit private parties. They prefer to take cover behind mechanistic solutions like auctions or they let courts decide. Worse still, they prefer to pass
the buck and refrain from decision-making.

The attendant risk of being accused of having caused private benefit to contractors hauled up through a humiliating media trial even years after the event can be understandably paralysing for most officials. The result is an administrative environment that is inhospitable to private participation.

So does this mean we should step away from PPPs? Far from it! My assessment of PPPs hinge on “the efficiency of the private firm has to be high enough to offset the higher capital costs of its investment, as well as the cost of enforcing its contract and risk of its failure”.

While there is scope for PPPs, they have to be chosen for the right reasons –efficiency improvements and not fiscal considerations, and for O&M and not construction cum-management. And in the context of India, there is the political economy issues arising from trade unions and the 3Cs that need to be kept in mind.

Gulzar Natarajan is an IAS Officer. Views expressed are personal.

This is the fifth article in a multi-part article series on infrastructure financing and the challenges associated with the sector. Read the first part here, second part here, third part here, and the fourth part here