Comparative Economic Efficiency of Public-Private Partnership

eventually realize the actual risk inherent in the governments deteriorating loan portfolio, which would obviously include some very risky ventures (stimulated, partly, by cheap capital), lower the general credit rating of the nation as a consequence, and thereby correct the pricing of capital inevitably. Thus, by the logic of induction, because the practice is undesirable if extended indefinitely, it follows that the practice must be undesirable for a singular case too.

By confusing its role as a social planner and a producer unit, the government distorts the functioning of markets. A public option may not be economically the most low-cost alternative, but it is nevertheless chosen when low-cost capital offsets higher production costs. A government cannot, by borrowing and investing itself in the project benefit the domestic economy, because it could achieve the same effect by adopting the role of a pure investor and letting the project company raise funds at a fair cost of capital. Therefore, to evaluate a public and private led production on a level fair basis, the government should, itself, finance on a project basis, or allow the private party access to the low-cost funds available on the government’s credit rating. However, even this approach would fail to account for differences in transaction costs between a PPP and a traditional government led approach.

7.3 Comparative Economic Efficiency of Public-Private Partnership

societal benefits at a lower cost relative to the traditional approach?

Ultimately, this question can be answered only through empirical research;

but the study addressed the question based on a theoretically well-founded framework and logical reasoning, and produced explanatory propositions in result.

The study focused on the implications of increasing the physical scale and scope as well as the temporal duration of transport infrastructure projects.

It seems there are better opportunities to exploit economies of scale and scope as well as to invest in specialized capital that yield long-run cost savings in PPP. However, the main point predicted by the theory of industrial organization is that these cost savings are inevitably offset to some extent by an increase in the transaction costs associated with writing contracts under progressively more difficult circumstances, i.e. with more sizeable projects and longer-run contracts. Another problem with sizeable projects and long-run contracts is also that due to cognitive constraints and unforeseeable events, it may be impossible or highly costly to design contracts that account for all contingencies. However, for the purpose of maintaining clarity and simplifying the analysis, complexity and uncertainty were held constant. The table (Table 4) below summarizes the propositions and the key justifications for each proposition:

Table 4 Summary of the propositions on the comparative economic efficiency of PPP predicted by theory

Proposition Justification

The comparative unit production costs of PPP are negatively related to the physical scale and scope of the project

PPP reduces comparative unit production costs due to higher economies of scale and scope associated with a more sizeable deliverable

The comparative unit production costs of PPP are negatively related to the temporal duration of the project

PPP reduces comparative unit production costs due to higher (front-end) potential to invest in specialized physical and human capital

The comparative transaction costs of PPP are negatively related to the physical scale and scope, and the temporal duration of the project

PPP makes proper use of incomplete contracts, positive incentive and dedicated neutral arbitration mechanisms under persistent information asymmetry; whereas the traditional paths of contracting fail to account for the persistent information asymmetry related to infrastructure goods

There exists a point in the increasing direction of the size and duration of a project at which PPP becomes comparatively efficient

The benefits of a reduction in unit production costs of PPP outweigh the associated increase in transaction costs, which is an assertion also supported by empirical evidence

Government captures a comparatively smaller share of the higher surplus associated with a PPP scheme

PPP is associated with the dynamics of a competitive-negotiated procedure and the use of variable, profit-sharing compensation

Nonetheless, the point is that, in principle, an increase in the transaction costs associated with a more sizeable and longer project is unavoidable.

However, the common motive of minimizing costs still applies, and there

are alternative contracting paths that can be followed to minimize transaction costs under progressively more difficult circumstances.

PPP, from a total welfare perspective is efficient, when the benefits gained from technological synergies related to a more sizeable project deliverable as well as the opportunities to invest in dedicated, specialized capital and the consequent long-run yields offset the higher explicit costs of contracting. Assuming so, the resulting surplus is also divided more equitably between the government and the supplier. In other words, the private supplier captures a proportionally greater share of the surplus implied by infrastructure production than in the traditional approach. In reverse, the government surplus is proportionally lower, even if it is higher in absolute terms due to more efficient production and transaction cost economics.

As already noted, the analysis did not incorporate comparative changes resulting from increasing uncertainty and complexity. It, however, seems warranted to argue that when a project is of a highly complex and uncertain nature, it is ill-suited for a PPP arrangement. For example, it is difficult to enact a proper payment structure if the value of the output is difficult to assess, that is, when quality plays a significant role in contrast to quantity, making monitoring very costly, if not impossible.

In services such as hospital care, where the experience of the patients is strongly affected by the empathy, discreteness and other intangible qualities of the personnel and where many unique, unforeseeable events may arise, PPP is hardly viable. It would be extremely difficult to specify all contingencies, let alone monitor the intangible qualities of the service.

In road networks, in contrast, where complexity and uncertainty are relatively low, PPP seems more viable. This view is consistent with world-wide empirical evidence and, in fact, gives an explanation of why PPP projects are first launched in markets with mature, tangible goods, where complexity and uncertainty are relatively low.