In this report, we focus our discussion on legislative conditions. In most cases, appropriate legislations should be set in place prior to the private sector involvement in designing, building, operating, maintaining, and financing transportation infrastructure on public land. Such legislations govern which part of functions to be privatized and what types of schemes highway agencies can undertake. While highway agencies are in charge of specifying details in contractual terms, policymakers pass legislations to either: (1) promote PPP schemes to aggressively pursue resulting financial benefits with recognized associated risks, or (2) limit applications of PPP to be prudent about protecting the public interest against any associated risks. In addition, governments must carefully proceed when promulgating PPP supporting legislation since the voters are often wary of governments enacting measures that may be construed to broadly endorse privatization and risk the public interest.
Legislative conditions also influence the attractiveness of PPP deals for private firms, the types and levels of risks for both public and private sectors, and actual financial benefits for the public. In France, for example, the passage of a 2004 law made possible PPP contracts beyond long-term lease agreements (Lestrange et al. 2005). With long-term lease agreements of France's pre-2004 concession model, the private entities have some degree of protection from uncontrollable events that substantially raise the risk of the project, including changes in law insufficient traffic demand to recoup the cost. However, the newly-allowed design-build-finance-operate schemes may not provide incentives attractive enough to offset the risks that private investors have to take, or to generate sufficient interest in the program (Lestrange et al. 2005).
In another example, when it decided to contract out the management of the Virginia Dulles Toll Road, the State Corporation Commission of Virginia was required by a legislation to retain a right to set toll schedules (1992). This demands a degree of trust between the public and private entities because the profit for the private firm in this deal can be limited by the decisions of the public commission. This type of legislation may reduce the attractiveness of a project to the private sector. It should be emphasized that legislations provide a general framework or a set of ground rules within which highway agencies can use PPP strategies (or not) for the provision of highway infrastructure.
Table 2-1: Risks and Background Conditions Affecting PPP Agreements
| Legislative: | PPP-enabling legislation allowing a speedy approval process or hefty incentives can lower the transaction and time costs associated with initiating the agreement and make the PPP more attractive to private investors. A good balance between offering private incentives and protecting the public interest is needed. Public agencies usually shield private investors from the risk of legislation turning against a project once it is underway. |
| Contractual: | The type of PPP contract used affects the opportunities for the private firm to streamline costs. Ideally, the chosen scheme would incentivize the private entity to consider the long-term effects of choices made during the project, seek to minimize its lifetime costs, provide flexibility, include opportunities for profit and efficiency gains sufficient to offset the set-up costs of the PPP, and align the motivations of the private entity with the public interest. A key part of the agreement hinges upon the initial value assessment of the project. |
| Political / Public Perception: | Public hostility toward PPPs and privatization can jeopardize projects. The political support for PPPs can be worsened if the public has already experienced a failed PPP for a similar type of project. |
| Competition: | If a new toll PPP facility is built too close to an existing parallel toll route, the split traffic demand may be insufficient to financially support both projects. Additionally, there will be high transaction costs involved with orchestrating cooperation between private entities where competing PPP routes intersect affect one another. |
| Market Conditions: | PPP proposals must remain competitive with other investment opportunities available to private firms. When the private market presents many attractive investment opportunities, the public sector may have to add incentives and lessen the degree of investor risk transfer in order to keep PPP projects competitive, but this may diminish the overall cost savings and increase payments from both the highway agency and the road users. |
| Environmental Approval Issues: | Many countries require environmental approvals before projects can begin construction. Because the length of time needed to obtain these approvals can be uncertain, the public sector usually retains this responsibility either for obtaining approval before soliciting private sector bids, or by offering to compensate investors for time lost due to environmental delays. |
| Public-Private Relations: | Conditions, such as rate-of-return caps, ensure that the private sector does not exploit the project in the interest of maximizing profits. However, experience to date suggests that a cooperative relationship between the public and private entities is more beneficial to a PPPs success than a meticulously worded contract. |
| Usage: | Traffic demand is generally projected to increase over time, but there is a chance that demand for travel along a new roadway may not meet projections, posing financial risks to private entities involved in both actual and shadow toll PPP schemes. The public sector sometimes offers to subsidize this risk because the private sector has little control over traffic demand. |
| Construction: | Changes in construction material and labor costs can hinder the cost effectiveness of a highway construction project. |
| Currency: | Developing countries sometimes use foreign finance institutions to fund highway PPPs. Devaluation of the home currency against the finance one can be fatal to a project under this funding scheme. |
| Public vs. Private Sector Goals | The PPP agreement must successfully balance the public sector's goal of protecting the public interest with the private sector's profit-driven motives. |
Source: (Iseki, Uchida, and Taylor, 2007).
When the laws are set to reduce the risks for the private sector, it may reduce the benefits for the public sector in the PPP deal. For example, Spain gradually passed a series of laws since the 1950's to promote PPPs by increasing concession periods, protecting the concessionaires against interest rate fluctuations, and using shadow tolls to fend off motorist unrest (Bult-Spiering and Dewulf 2006). While this increased shouldering of risks by the public sector makes PPPs more viable to private entities, it reduces the potential for savings over the traditional public procurement methods.
Our first report on public-private partnerships identified the following financial risks associated with PPP strategies for highway projects:
(1) the environmental clearance risks arising from delays in obtaining the needed approvals,
(2) the risk of political and public opinion delaying or requiring costly modifications to the project,
(3) construction cost overrun risks,
(4) risks associated with operations, and
(5) the risk of natural disasters.
These factors should be carefully distributed between the public sector and the private sector-whichever best able to control each of these risks-taking into account a potential tradeoff between the amount of transferred risks and the attractiveness of a project. To some degree, risk sharing works best when legislation and contracts are flexible enough to allow for modifications in the event of unforeseen circumstances. At the same time, when policymakers are seriously concerned and do not desire to leave the allocation decision to highway agencies in regard to any of these risks, they can enact laws to specify a responsible party for such risks. For example, since the first and second risks are political in nature, laws can require the public agency to be responsible for these risks.
There is a fundamental trade-off between public and private sector interests that legislation need to take into account and balance out. While legislation should enable public agencies to transfer as much risk as possible to realize financial savings, it should not require a transfer of so much risk that it will lead to a significant reduction of the private sector's interest in the deal, or cause the private entity to charge exorbitant user fees to protect itself in an overly-risky transaction.