What are the pros and cons of Public-Private Sector Partnerships (PPPs)?
This is the second part of my trilogy on PPPS, following on from Public-Private Sector Partnerships (PPPs) “Who pays for and who finances our infrastructures?” and in which we are going to talk about the strengths and weaknesses of a PPP.
What are the pros of PPPs?
In 2009 I read my doctoral thesis entitled “New Light Rail Concessions: Public and Private Sector Associations. Comparison of management and financing models”, therein I had compiled some of the advantages that scientific literature had bestowed upon them:
- Especially in terms of operation, costs can be notably reduced, often due to the fact that possible interference on the part of politicians and trade unions can be lessened.
- It is possible to create an enriching level of competition from a technological as well as technical standpoint. This is achieved through the tender process for the selection of a private sector company.
- This allows for the Public Sector Administration to be guided with this is often short on experience in the field. The projects deal with an infrastructure using new technology that public sector managers are not aware of, the private sector can then provide this knowledge through its practical experience.
However, it has been used greatly in Spain, in my opinion, for two reasons:
- Firstly, because this was not added to the public deficit, at least to the same extent as with direct public investment, as I explained in my last post on PPP.
- Secondly, it allowed for the creation of a powerful industry that nowadays competes the world over after having acquired invaluable experience due to having taken part in innovative and ground-breaking projects in Spain. This has brought about the desired results and has probably led to part of the increase in Spanish exports. Below is an extract from a North American trade magazine:
MAIN COMPANIES BIDDING ON TENDERS. 2011
|COMPANY||Number of concessions for roadways, bridges, tunnels, railways, ports and airports. Public Private Partnerships in excess of $50m, currently in service or under construction as ofOctober 2011.|
|ACS Dragados (Spain)||72||46|
|Ferrovial / Cintra (Spain)||35||20|
And what is the downside with PPPs?
Well, clearly they are more expensive. This is the most controversial point in this article, every time I explain this in congresses, it either surprises or leads to a heated debate, especially when very few people had actually considered this before the current economic downturn took hold. They are more expensive because you are transferring the financing to the private sector along with the risk associated with the same. Private financing is more expensive than its public counterpart, at least in developed countries. Furthermore, the private sector wants to make a return on its investment, what economists refer to as the internal rate of return (IRR). Though beyond this, the private sector tends to cover its back with a risk coefficient. In short, it is like a mortgage on a house, it is granted, we can take on the project, but then we have to pay it back with high interest rates. This can be shown by the following formula:
ΔFC PPP= Increase of financial costs of a PPP
PrFC= Private Financial Cost
PuFC= Public Financial Cost
IIR= Expected internal rate of return
RC=Risk coefficient, varies with each project
Indeed, we are talking about rates that could oscillate between 10% and 20% annually more than the cost of public financing in terms of equivalent bank interests. That is some mortgage! How can this overrun be justified? Well, when these three circumstances take place.
- There are no public sector budgets, either due to the financial situation or due to the convergence of deficit criteria and budgetary stability that also existed in boom periods due to EU impositions.
- There is a fundamental public transport project for the sustainability of the region, or of the country. One that would create socio-economic benefits that compensate for the over-expenditure of the PPP.
- The Public Sector Administration (and therefore all of the citizens) can pay for this in the future, in other words, just like the mortgage. It is true that the increase in economic activity that the project could generate will help recover part of the investment through company taxes and other possible taxation.
If these scenarios do not occur, perhaps it would be better to wait until there is a public budget capable of handling the project. In short, ideally, whenever it is possible, investment for transport projects should be performed:
- Through public investment, the cheapest option.
- Private operation, which reduces the costs caused by political and trade union meddling, something I will write about in greater detail at a later date. These savings in costs, based on my experience, do not compensate the excessive financing costs commonplace with PPPS.
There, I have put forward some issues and so now it is over to you. Do you think that the economy could be given a boost with the development of PPPs? What type of projects do you consider paramount?