Ehtisham Ahmad1 Amar Bhattacharya2 Annalisa Vinella3 and Kezhou Xiao4
Given that public investment requirements far exceed available resources in most developing countries, channeling public resources wisely as well as leveraging the opportunities to utilize both national and international sources of private or institutional finance is necessary. A range of instruments is possible, involving combinations of public and private management and financing arrangements (see the companion paper, Ahmad 2014).
Some investments are likely to be predominantly public, especially, when externalities exist in the provision of a balanced and inclusive basis for sustainable growth (e.g., education, regional infrastructure, and operations and maintenance). These are also needed to facilitate involvement by domestic private investors and foreign direct investment (FDI). There is a global growing trend toward the private sector's involvement in infrastructure financing and the provision of public services.
Private sector involvement takes diverse organizational forms and arrangements. These range from privatization to deregulation, outsourcing, and government downsizing (see Armstrong and Sappington 2006). An increasingly popular mechanism through which the private and public interests combine is associated with public-private partnerships (PPPs) to finance and manage infrastructure projects across Europe, the US, Canada, and in several developing countries. In this paper, we focus on both the form of investment, e.g., PPPs, as well as the sources of financing.
A fundamental issue is risk sharing in the presence of information asymmetries. Private investors face high risks during the development and construction phases. This relates not only to the costs involved and the subsequent pricing that may be constrained by the state, but also to future revenue streams in relation to uncertain usage and demand. Once the project is completed and operational, it becomes somewhat easier to securitize the potential revenue streams and involve the private sector in managing the undertaking. However, in spite of evidence that a project's success or failure is more sensitive to construction risks than operational risks,5 a fully general classification cannot be made, as the exact types of risks are likely to be highly sector- and project-specific.
In this paper, we stress that the issue of accurate information on the generation of subnational liabilities is important not only to generate adequate signals for investment but also for macroeconomic management. This is especially the case in a multilevel country, and is typically ignored at some peril, as occurred, for example, when the Mexican crisis was exacerbated by the debts for highway projects that had been contracted without federal government guarantees. We also discuss the specific case of subnational liabilities that have appeared in China, and indicate measures required to ensure that these do not degenerate into macroeconomic difficulties while simultaneously ensuring that they remain a sustainable mechanism for financing sustainable investments.
In some cases, macro problems arise due to the failure of PPP contracts and the ample room available for gameplay, which, on the one hand, leads to inefficient investments and, on the other hand, to a buildup of liabilities that go unheeded until a crisis emerges. Following the recent economic crisis, the International Public Sector Accounting Standards (IPSAS) tightened its accounting rules for PPPs to ensure a better recognition of liabilities. Key issues relate to the ownership of the asset and beneficiary interests at the end of the contract. The sectoral dimensions are important, as are the public finance implications-including the recognition of liabilities, provisioning, and generating public finances to cover the public component. Special issues arise in multilevel countries, regarding both the aggregate buildup of liabilities and their sustainability, as well as the credibility of contracts and incentives to renege.
Section 1 describes some general trends in involving the private sector in public projects. Section 2 focuses on PPPs and asymmetric information. Section 3 draws some policy conclusions.