The Seven Sins of Flawed Public-Private Partnerships

There are three stakeholders in a public-private partnership (PPP): (a) the government in office, (b) private firms (financial and non-financial) and investors (individual and institutional), and (c) final beneficiaries (taxpayers or users, present and future). The raison d'être of PPPs is threefold: (i) to crowd in private firms and investors into projects that they would otherwise not undertake; (ii) to transfer to the private sector a significant part of the risks and costs that the government would otherwise fully absorb; and, (iii) to ensure that the project's efficiency/quality is at least equal to that obtained if the government alone carried all costs and risks.

Several important (yet often ignored) implications follow. First, outsourcing (e.g., construction and maintenance) to the private sector does not by itself constitute a PPP if all risks and costs are, in one way or another, still borne by the government. Second, a PPP does not reduce total risk; it simply distributes it differently, involving private sector firms and investors.2 Third, the total costs borne by the final beneficiaries would be lower under a PPP (compared to a project whose costs and risks rest completely in the government's balance sheet) only if the PPP achieves efficiency gains; otherwise, what beneficiaries save in taxes they would pay in user fees, although, under a PPP, more of the costs would be assigned to direct beneficiaries/users, than to taxpayers at large. Fourth, that a PPP can provide (cash) budget relief may be a welcome corollary for the government in office but it is not a core objective of a PPP.3

The problem is that achieving in practice the raison d'être of PPPs is much more complicated than often believed. In particular, things are biased against final beneficiaries. Why? Because, under a weak PPP policy, regulatory and institutional framework, the interests of private firms and investors, on the one hand, and those of the government in office, on the other, do not naturally coincide with the interests of present and future taxpayers and users. The government in office has incentives to get the projects on the ground as soon as possible (the "monument effect") without affecting today's budget but leaving liabilities to future governments (the "myopic cash saving" effect).4 It also has incentives to underestimate or hide contingent liabilities associated with PPPs (the "concealment" effect). For their part, private firms and investors involved in PPPs have incentives to earn as much profit as possible while transferring as much of the costs and risks as possible to the government (the "one-sided bet" effect-heads I win, tails the government loses). In the absence of a sound PPP policy framework, therefore, the dice are indeed loaded against final beneficiaries, whose interests are not well represented in the PPP design and selection process.

Hence, to ensure that PPPs actually add value to society, a well-designed policy framework (including well-designed laws, regulations and procedures) is of the essence. Such a framework would adequately represent the interests of the final beneficiaries, by promoting efficiency gains, by greatly reducing the incentives of the government in office to over-guarantee, and by significantly curbing the incentives of private firms' and investors' to unduly shift costs and risks to the government. The rest of this note highlights seven deadly sins of poorly designed PPPs, the key things to avoid when designing and implementing PPP policy.

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1.  This policy discussion note was prepared by Augusto de la Torre and Heinz Rudolph, both from the World Bank.

2.  As regards risks, this note focuses only on the idiosyncratic risks associated with a particular PPP. Aggregate and systemic risks, which affect economic activities within a given national jurisdiction across the board, by definition cannot be diversified away within that jurisdiction. Aggregate and systemic risks are incorporated in sovereign risk ratings and can only be reduced slowly overtime via sustained economic development and institutional improvement.

3.  Any contingent liability that the government bears under a PPP remains in reality in the budget (inter-temporally), regardless of whether it is disclosed or not in the budget numbers. Moreover, as noted, taxpayers and/or users still get the entire bill of a PPP (and not just the part borne by the government), if not via taxes, via user fees; although they may also (and hopefully) get some efficiency benefits.

4.  Democratically elected governments are typically pressured during the four to six year term to inaugurate some visible infrastructure projects. Considering that a construction period of a typical highway, port, or airport may take three to five years, the lag time for negotiations is limited, hence the tendency to negotiate poorly and over-guarantee.