PPPs are being used for building, operating and financing infrastructure in transport, water, energy, health, education, waste management and so on. Notwithstanding the policy relevance, still little theoretical and empirical work has been carried on the topic. In this paper we have reviewed and unified in a common and flexible framework the existing literature on PPPs in an attempt to fill this gap.
Our analysis has pointed at the efficiency gain that PPP arrangements can bring over traditional forms of procurement, but it has also emphasized how PPPs may be unsuitable in a variety of circumstances. The bundling of project phases that characterizes PPPs provides incentives to the private contractor to take into account the long-term project costs, from building to maintenance and operation. When the externality across project stages is positive, this improves incentives and, through appropriate risk transfer, yields better quality and less expensive projects. We have seen how this holds under a large class of schemes where complete contracts contingent on operating costs can be signed with both the builder and the operator. But, with a negative externality across project stages, bundling may increase agency costs, making traditional forms of procurement preferable. PPP contracts also lack the flexibility to adjust to new circumstances, user needs, or technologies, which points to the unsuitability of PPPs in very uncertain environments.
Thus our analysis suggests that PPPs are more beneficial when a better quality of the infrastructure can significantly reduce cost at the operational stage (including maintenance cost), when infrastructure quality has a great impact on the quality of the service, and when demand for the service is stable and easy to forecast. This points to the suitability of PPPs in the transport and water sectors, where infrastructure quality is key and demand is relatively stable, whilst it suggests that PPPs are less likely to deliver efficiency gains for nursing homes and schools, where service quality is mainly determined by human capital investment, or for IT services, where demand evolves quickly over time.
We have seen that in a PPP contract, although this is not specific to PPPs, satisfaction of consumer's needs and better service quality can be incentivized through the allocation of demand risk and the choice of contract length. In particular, the contractor should bear more demand risk in sectors such as transport, where users pay for the sfervice and demand levels are affected by the contractor's effort. Contractors should bear less risk in sectors such as prisons, where users do not pay and usage is mainly determined by government's policy. Contract length should be higher in sectors where demand risk is lower, as in the water sector as opposed to the transport sector. Financially free-standing projects can bring the additional cost that contract length must be increased to allow the firm to recoup its initial investment, which results in excessive risk transfer. Thus, welfare under PPPs is higher when service quality is verifiable, demand risk is low or the firm can diversify risk, and when there are government contributions or the initial capital investment is low. Recourse to private finance can however result in improved incentives for the operator if lenders bring their expertise in monitoring the operator's effort. In this respect, PPPs might be suitable also for high capital value projects.44
Bundling of project phases and long-term contracting allow PPPs arrangements to provide efficient long-term incentives and to optimize the trade-off between investment and maintenance along the life of the project. This helps to prevent cost overruns but it requires institutions with strong commitment power. As the risk of regulatory opportunism increases, the case for PPPs is weaker.
Two important issues have been left out of the analysis. The first relates to the award procedure. As PPP contracts must cover the design, building, operation and finance of the infrastructure, scoring rules need to account for a variety of quality and cost dimensions. Further, communication between procurement authority and potential contractors is needed to match project proposals with authority's needs. In Europe, the auction procedure for awarding PPP contracts, the so-called "Competitive Dialogue", was indeed designed to combine communication with competition.45 Research on the topic however remains limited.46
Second, beyond the case of regulatory risk, we have been silent about much of the institutional contexts in which PPP contracts are designed. There are at least two aspects that deserve more attention in this respect. The first one is related to the internal organization of the public sphere and its consequences on the likely important delay in having the various public entities involved (local governments, the central State, various Ministries) agreeing on a public demand.47 The second important omission of this paper on the political economy side is that we disregarded the issue of collusion between the contracting agency and the firm, though some research exists on the topic. In Martimort and Pouyet (2008) for instance, PPPs are shown to increase the risk of capture for political decision-makers. Indeed, the very reason of the benefits of PPPs is that those contracts allow some efficiency gains that raise the power of incentives, and thus stakes for collusive behavior.48 This like other important issues on the design and usefulness of PPP contracts await further research.
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44Although we have not fully explored this aspect.
45In private procurement, Bajari, McMillan and Tadelis (2008) show that contracts where communication is important are more likely to be awarded by negotiation than by auction.
46See Doni (2007) for a brief discussion of the alternative procedures for PPP contracts.
47See Dobrescu, Friebel, Grosjean and Robeck (2008) on this issue.
48More generally, there exists a literature dealing on the political side of privatization (Shleifer and Vishny (1994), Bennedsen (2000), Laffont (2005, Chapter 3) and Martimort and Straub (2007) among others). Although its focus is not on PPPs per se, some of its lessons would certainly apply.