As the discussion above emphasizes, while there is a clear need of maintaining flexibility in time to deliver what is really needed at that time, there is also a clear need to structure this flexibility so as to limit as far as possible the potentially very high costs it may imply, particularly if abused. As a general principle, therefore, post-award contractual changes should be avoided as far as possible; they should be rare and exceptional events, particularly when changes are requested by the private-sector party.
One general and somewhat obvious principle of contract design that may help to soften this trade off is trying to build in the original contract clauses for all anticipated potential changes. This sums up to try 'making the contract as complete as possible', taking into account the cost of writing a complex contract that details many possible contingencies from which only few will effectively realize. A contract that regulates ex ante anticipated potential changes produces a sort of built-in flexibility that reduces the need for contractual changes and is not subject to most of the downsides of renegotiation discussed earlier.
If the anticipated potential changes can be properly specified in terms of output, then the price of these changes may already be established at the initial competitive selection stage. If they cannot, then clauses dealing with contractual changes should determine cost-based compensation for the changes (as in cost-plus contracts).
Although investments in contract design that regulate potential changes are welcome, a complete contract is not something one can aim at in a 30-year long procurement relationship. The complexity and long-term horizon typical of PPPs are bound to make any such contract incomplete and subject to requests for changes linked to unanticipated events. Even the contractual provisions for anticipated changes may easily become obsolete over time, and their adaptation may become necessary in the light of unexpected major technological changes. In this context, post-award contract changes, renegotiation, and contract completion can be efficient means to address issues arising from contract incompleteness, and so they should not be ruled out. The challenge for contract design is then to identify and support efficiency-improving contract revisions.
To the extent that a revision may lead to ex ante undesirable outcomes, such as rent shifting and politically-motivated investments, there is a case for the design of contracts that explicitly foresee future renegotiations and pre-emptively establish principles and procedures to rule the revisions if the parties call for them. Let us call them 'bad renegotiation'-proof contracts. The literature provides useful insights on how contract design can ensure that future renegotiations will contribute to achieving the PPP objectives. Contract design can do something about renegotiation (influencing its occurrence and outcomes) not only because it can directly affect the contract characteristics determining the degree of incompleteness and the likelihood of revisions (as documented by Guasch et al., 2006), but also because it can require compulsory and structured renegotiation processes that limit the scope for abuse.
In this regard, the initial PPP contract should already address as clearly as possible:
(i) the circumstances that justify tariff and output adjustments,
(ii) when and how to implement benchmarking and market testing to test the value for money of the proposed changes,
(iii) the circumstances under which the contracting parties are entitled to call for a more general contract renegotiation,
(iv) specific principles and procedures to rule the revision.
A basic and somewhat obvious criterion often advanced to deal with contract changes required by the private-sector party is linked to the size of the shock leading to the proposed changes. Small unexpected shocks are unlikely to constitute a real threat to the financial stability of the firm. Thus, small shocks do not justify the costs and risks linked to a contract revision. Very large unanticipated (hence exceptional) shocks, instead, may threaten the financial stability of the firm in such a way that - unless a contractual change is introduced - the private-sector party may not be in a position to continue fulfilling its service obligations.
As mentioned earlier, under these conditions renegotiation often occurs in reality, particularly if the cost of service disruptions is considered large. However, one also has to be sure that the shock is really unanticipated, exceptional, and independent of the private partner's efforts before going for a costly bail out of a failing private-sector party through renegotiation, rather than going for its replacement. The risk, again, is disrupting the whole procurement process by favoring private partners that are unable to anticipate shocks or to act so as to minimize their impact, i.e. less able private partners, and by selecting their overly aggressive offers - which are probably cheap because they do not anticipate well the possible shocks - rather than more appropriate and expensive ones.
Another basic principle is that, given their negative effects on governance and efficiency, renegotiations should be extremely open and transparent procedures. To improve on transparency, the contract may envisage calling a third party, e.g. an arbitrator, an independent commission, or a group of experts, to evaluate the case and seek to conciliate the needs of both parties without too much harm for the taxpayer. To limit discretion and disagreement the contract may also provide a limit as to the amount that can be renegotiated without calling for a new tendering process.
Problems such as rent shifting and politically-motivated anticipated spending, i.e. problems that arise from weak enforcement, political interests, and failures in the regulatory environment, are probably beyond the range of influence of the contract design. However, the contract design should manage efficiently the risks resulting from these problems, e.g. regulatory risk resulting from weak institutions, cost overruns and financial risks resulting from macroeconomic shocks as we discussed in section 3.
It is noteworthy that some of the regulatory and institutional factors are not outside the range of influence of the institutions ruling- and agencies implementing PPP agreements. Thus, certain actions can be taken to address some of the problems distorting renegotiations outcomes, i.e. leading to 'bad renegotiations'. For instance, improving skills of regulators, ensuring the agency negotiating PPP contracts do not depend on the ministry of public works, etc.