SUBOPTIMAL CONTRACTING OF PUBLIC-PRIVATE PARTNERSHIPS

Some PPP contracts have been incorrectly designed, misallocating risks, and some have been excessively inflexible, or at times excessively flexible. An example of incorrect risk allocation is the Dulles Greenway project in Virginia, which went into default in its first few years due to overestimating demand for the road. Alternatively, a contract may be too inflexible in the face of changing conditions, leading to large costs while the parties reach a new agreement. This is the case of Orange County SR91, where the private party used a noncompete clause to oppose an expansion of the competitive public road until it was bought out by the county.

One result of these contracting failures is that government PPPs with private concessions around the world are routinely renegotiated. From Table 2 below, we observe that this is also common in the United States: six out of twenty projects have undergone a major change in the initial contractual agreement, favoring the concessionaire, and two additional projects have pending renegotiations. If we consider that, on average, seven years have passed since financial closure for these U.S. projects, this is a high renegotiation rate.

TABLE 2 Transport Public-Private Partnerships in the United States: 1991-2010

Source: Public Work Financing, October 2010, and other sources.

* CB=competitive bidding. UO=unsolicited offer.

** Significant changes in initial contract terms to the advantage of the firm. PR=pending renegotiation.

Industry participants often claim that circumstances change over the life of a concession. Because most infrastructure facilities last for several decades, renegotiations of inherently incomplete contracts are to be expected. If so, the argument runs, there is little to be worried about, because renegotiations provide the necessary flexibility to adapt to changing circumstances.

While there is some truth to this point, it ignores three rather disturbing features of renegotiations. First, sometime they occur shortly after contracts are awarded. Second renegotiations typically seem to favor the private party. Third renegotiations are often used to circumvent budgetary control and anticipate government spending because they typically involve additional financial commitments by the PWA that are paid mostly by future administrations. The high frequency of renegotiations of PPP contracts represents a serious problem which alters the conceptual basis of the industry.

The problem with renegotiations is that they undo the potential advantages of competitive auctions when these are used to assign the project.6 Since renegotiations occur in the absence of competition, the results can be very profitable t the private party. Furthermore, pervasive renegotiation tend to give an edge in projects to firms with more-developed lobbying abilities (because they can offer better condition initially in the expectation of improving the conditions after renegotiation), and this ability is not necessarily related t technical proficiency in providing the infrastructure.

Some states, including Florida and Indiana, require legislative approval of PPP projects after the concessionaire has bee selected. Legislative approval may be viewed as renegotiation b design, because the conditions under which the concessionaire is selected are modified after the competitive selection process.

The problem with renegotiations is that they undo the potential advantages of competitive auctions when these are used to assign the project.

This is likely to favor firms that are well-connected with the legislators who determine the final contract, and may result in selection of a firm that is good at lobbying but less good at building and operating projects.