Fundamentals of Public-Private Partnerships and Privatization

IFC Workshop on “Leveraging PPPs for Development”

Colombo, Sri Lanka, December 13th, 2010

Rui Sousa Monteiro(World Bank Institute)

Contents

• What is a public-private partnership

• Rationale for PPPs

• Main differences between privatization and PPPs

• Some myths regarding PPPs

• Efficiency requirements

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What is a PPP (1)

• Public-private partnerships (PPPs) are a new way for procuring infrastructure and long-life assets

• Instead of procuring separately…– the design,– the construction, and– the maintenance of those assets,

• …public authorities…– contract simultaneously with a private partner for all that,– and pay for the provision of services (the availability of

the infrastructure) or allow the private partner to collect user-fees from the users of infrastructure services

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What is a PPP (2)

• PPPs are not design-build contracts:– they include the design and construction of the

infrastructure (or other long-life assets), but also the long-term maintenance of the assets

– the private partner is the responsible for the global financing of the project and is paid (by the public authority or the users) according to the actual quality and performance of the assets

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What is a PPP (3)

• PPPs are long-term contractual relationships between a public sector entity and a privatesector entity

• The private partner commits itself to providing a set of services according to some specified performance levels

• The public partner monitors the performance and pays the services or grants the private partner the right to collect fees from users

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What is a PPP (4)

• PPPs are referred to by many different acronyms, typically including the letters…– D (design)

– B (build)

– O (operate)

– F (finance)

• For example, DBFO; some are also known as PFI (from the UK procurement program), or concessions, or franchises, and sometimes even as privatizations (albeit they are not really privatizations)

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What is a PPP (5)

• PPPs are a new procurement tool, but similar contracts were used in the past– in the XVIII and XIX in Europe, and also in the

Ancient Egypt and in Imperial Rome– many of those contracts were successful, but many

also failed and were rescued by governments (sponsors were financiers able to influence govt)

• The current PPP contracts benefit from the developments brought by project finance, and from the credibility added by due diligence by third parties (financing entities)

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Public infrastructure

basic for economic growth and for the quality of life

poormaintenance

butoften

affectedby

▪

Why a PPP

• If (let’s emphasize, if) well designed, efficiently procured, and effectively enforced, PPP contracts may eliminate or reduce those issues

• One critical point is having:– A private partner (with private capital at stake)– A long-term contract based on performance

• And the other is having, in the public sector:– The adequate capacity for designing, evaluating,

procuring and enforcing the contracts

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Alternatives

fast delivery poor design

cost overruns

better design

fast delivery

slow delivery

higher financing cost

poor maintenance

long-term contractgood design

design−buildcontracts

improvedtraditional

procurement

PPPprocurement

▪

From infrastructure to service

• A typical PPP contract prescribes at least the provision of infrastructural services according to some performance levels– implying that the private partner will build or

upgrade an infrastructure and be responsible for its maintenance

• But in many contracts the private partner will be also responsible for the provision of:– intermediate services or services to end-users

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Rationale for PPPs

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design of infrastructure

construction of infrastructure

maintenance of infrastructure

provision of equipment

maintenance of equipment

provision intermediate services

provision services to end-users

D-B PPP PPP PPP PPPTradit.

In each case, services provided according to public sector rules

core

Incentives: performance

• Efficient PPP contracts are performance based: private sector revenue depends on outputvolume and performance levels (key performance indicators are monitored by the public partner)

• Contractual efficiency in PPPs is jeopardized by input or process requirements (usual in traditional procurement) because they affect commitments based on performance/output

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Incentives: hostage capital

• Having private capital at stake adds credibility to the contractual commitment (public entities cannot present the same credible commitment on costs and schedules)

• But it also helps in the selection of the proper private partners (facing the prospect of effective contract enforcement, rent-seekers and less efficient bidders will not be financed by the financial sector)

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PPPs and privatizations (1)

• The provision of public services is typically assumed by governments as their responsibility

• But the actual production and delivery of some of those public services may be allocated to public entities or to private entities

• These allocation may be done through:– outsourcing, or– public-private partnerships (PPPs)

• PPPs must be distinguish from privatization

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PPPs and privatizations (2)

Outsourcing: some components of public service are bought in the market; short-term contracts

PPPs: some components of public service (e.g. the infrastructure needed for service provision), or the whole public service, are contracted to a private provider through medium- or long-term contracts; public authorities monitor provision

Privatization: the responsibility for service provision is transferred to private partners, subjected to market discipline or a regulator

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PPPs and privatizations (3)

• In the case of privatization, public authorities rely on the market (e.g. for food supply) or on regulators (e.g. telecom) for service delivery

• In the case of PPPs, public authorities perceive service provision as their responsibility, for constitutional reasons (justice, national defense, basic health, public education, etc) or for natural monopoly reasons (roads, water distribution, sanitation, etc); PPP contracts must define performance levels, and they must be monitored

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Why private production?

• Private firms are profit-seeking entities: if they are subject to the discipline of the market, or constrained by effective regulation, or incentivized by performance contracts, they will be cost-efficient producers and consumers will benefit from cost-efficiency

• Governments may privatize whole plants, utilities, or activities; or simply outsource some activities; or contract PPPs, aligning the incentives of private partners with public interest

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PPPs

• With PPPs, the private partner:– provides infrastructural services or public services– obtains the needed infrastructure and other assets

• The public authorities:– pay services and/or allow private partner to collect user-fees– do not release responsibility for provision of public service

• Some examples:– Provision of infrastructure for public services

(e.g. highways, bridges, tunnels, railways, ports, airports, hospitals, schools, prisons, etc.)

– Provision of other long-life assets (e.g. trains, trams)

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Diversity of PPPs

• Governments may use different PPP schemes:– the government pays the availability of infrastructure

– the government pays service provision

– service users pay user-fees to the private partner

• In some cases, the private partner collects user-fees on behalf of the public partner, but are paid by the public partner according to service availability

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Example:a road or tunnel

– Toll-road: paid by users (with or without government subsidy to cover funding gap)

– Non-tolled road: availability paid by government

– Mixed case: PPP operator paid according to availability, but collecting tolls on behalf of government

• A performance-based contract, allocating construction risk to the private partner, is costly, but pays in cases of significant complexity and of need for high-quality maintenance

• May include user-fees or not

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Example:solid waste disposal

• Range of possible activities:– Building and maintaining a landfill– Collecting garbage– Sorting and recycling– Composting and generating energy

• Paid for by municipalities or government, according to service availability and volume

• Small fees may be collected from users

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Example:a diagnostic center

• Range of activities:– Building facilities & buying/leasing equipment– Maintaining facilities and equipment– Delivering diagnostic services according to

contractually specified performance levels

• Paid by government & through user fees

• Similar contracts may be established for dialysis, radiotherapy, and physical rehabilitation centers

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Example:a public hospital

• Range of services:– Building or upgrading a public hospital– Maintaining facilities and equipments– Providing services according to public rules

• Users receive service according to public rules and perceive a PPP hospital as a public hospital

• Government pays according to contract, monitors & enforces the agreed performance levels

• Similar contracts may be established for primary care facilities

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Myth: PPPs and privatization

“PPPs are identical to privatization, transferring to the private sector the control of public services and public policies”

• The success of a PPP project depends on the careful management of the contract by the contracting authority, ensuring its enforcement

• The contracting authority must perceive itself as the ultimate responsible for service delivery and keep in charge of public policies

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Myth: PPPs and private profits

“PPPs generate profits for private partners, deviating public resources from service provision to private benefit”

• With well designed, well procured, and well enforced contracts, private providers will have profits if they deliver value-for-money (in terms of price-quality balance) and will have losses in the opposite case

• Aligning these incentives is critical for the efficiency of PPPs, as well as for their acceptance by users and tax-payers

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Myth: PPPs and user-fees

“PPPs are simply a way for governments to implement or increase user-fees”

• PPPs are sometimes used for governments as an easy way for introducing user-fees or for having them closer to the effective cost of service

• But PPPs should only be used where they introduce more efficiency in service delivery

• So it is critical that users actually identify those increases in fees with increases in quality of service, or that they perceive the financial unsustainability of previous policies

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Myth: PPPs & public resources

“PPPs transfer to private entities the control of future public resources”

• PPPs should be designed and procured in a way that avoids this, allowing the private partner to manage infrastructures and services, but having the contracting authorities in control of policies and managing fiscal risks

• Public authorities need to have enough capacity, not only to manage the contract, but also to be perceived by the public as effective and not captured by the operators

• In the absence of accountability, fiscal responsibility, and transparency, PPPs may indeed be a tool for rent-seeking

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Myth: PPP and fiscal space

“PPPs allow governments to use private capital for building infrastructure, eliminating the usual public finance constraints”

• PPPs use private capital to finance capital investment, but many of them require long-term payments by public authorities and create budgetary risks that should be carefully evaluated and budgeted

• PPPs should not be perceived by public authorities as zero-cost projects

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Myth: PPPs and risk allocation

“PPPs transfer to the private sector all the risks associated to an infrastructure project”

• The private sector needs to face some risks in order to be incentivized to manage efficiently the infrastructure and services; other risks should be kept in the public sector

• Even some risks allocated to the private partner may, under some circumstances, be transferred back to government; fiscal risks should be carefully identified

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Myth: PPPs and govt capacity

“Using PPP contracts, public authorities can rely on private sector expertise, and so avoid the need to build technical and managerial capacity in the public administration”

• Public authorities need not care for production, but they need to keep (or create) capacity for contract management, as they will be the ultimate responsible for service provision

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PPP main sectors

• May we deliver PPPs for every kind of projects?

No

• We should refrain from doing PPPs for projects:– where technological change is pervasive

– where public policy may change significantly

• PPPs are most useful in stable projects where complexity is high and there is a significant need for quality and reliability

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effectiveness

▪

Some concerns

Efficiency, sustainability

• Experience has demonstrated PPP effectiveness for– the rapid development of infrastructure– the improvement of service to end-users

• Efficiency (from the viewpoint of public finance) and affordability need to be addressed carefully

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Do not rely only on good contracts.

The efficiency and affordability of PPPs depend on the existence of an appropriate institutional environment.

institutions for steering and managing procurement

institutions for contract management and regulation

▪

institutions for the continuous evaluation of budgetary costs and risks

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institutions for project identification, appraisal and selection

Thank you

Rui Sousa Monteiro

senior public-private partnerships specialistWorld Bank Institute1818 H Street, N.W.Washington, D.C. 20433, USAtel: +1-202-473-9450e-mail: RMonteiro@WorldBank.org

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