Hidden Value

• Author: Edward F. Buffie, Michele Andreolli, Bin Grace Li, and Luis-Felipe Zanna

Hidden Value Finance & Development, September 2016, Vol. 53, No. 3

Edward F. Buffie, Michele Andreolli, Bin Grace Li, and Luis-Felipe Zanna

Public-private partnerships have been criticized as too costly, but when the whole economic picture is considered, they look much better

Public-private partnerships to build and operate infrastructure assets are increasingly common in less developed economies (see chart). But they are also highly controversial. Case studies warn that public-private partnerships may be much more expensive than traditional procurement in which public agencies build infrastructure assets on their own (or outsource construction to a private supplier). Traditional procurement is commonly called own investment by the public sector.

The list of extra expenses incurred in public-private partnerships is quite long:

The partnerships assign construction risk to the private partner to exploit the tight relationships between asset construction, quality of services, and the revenue the partner earns after operations commence—frequent blackouts, for example, reduce sales at poorly built power plants. But the private sector cannot spread risk as widely as the public sector; consequently, the return paid to the private partner is usually several points above the interest rate on government debt.The administrative costs of writing and tendering bids for complicated long-term contracts are often substantial, while limited competition and the difficulty of designing auctions that prevent collusive behavior are apt to result in inflated bid prices.Complex contracts, the impossibility of enumerating all contingencies in partnerships that last 20 to 30 years, and cumbersome legal systems often lead to repeated, costly renegotiations of the original contract.Even if the government bargains exceptionally well and minimizes bid, tendering, and renegotiation costs, it cannot avoid the extra cost of monitoring compliance by the private partner.Half a pictureBut the comparison of costs presents only half of the picture. The other half contains everything the private partner brings to the table: superior technical expertise, greater implementation capacity, and less pressure to meet political objectives—such as hiring more workers than needed and purchasing from favored suppliers—that hinder efficiency (de Bettignies and Ross, 2004; Valila, 2005; Grimsey and Lewis, 2005). These advantages translate into shorter construction time (Monteiro, 2005; Sarmento, 2010) and better, more...