Efficiency and Equitability Implications of the Propositions

PPP, from a total social 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 costs of contracting. The figure (Figure 26) below illustrates the basic line of this thought by combining the two earlier figures in one representation. The idea is that the most important distinction between PPP and the traditional procurement path is a significant increase in the scale and scope of responsibilities conferred to the supplier, as well as the duration of these responsibilities, denoted by the arrow (1) on the horizontal axis.¹³⁸ The vertical axis, in turn, represents the unit production costs (UPC = c + F / q) and transaction costs TC.

138 The axis thus represents the two axis of the earlier figure (Figure 13) folded on their diagonal.

Physical scale and scope; temporal duration of the project Costs

(2)

(3)

(1)

TC of DBB

TC of PPP

€0.1-1bn 20-50 yrs.

€1-2m 1-2 years

Figure 26 Illustration of the unit production and transaction cost implications of increasing the physical scale and scope, as well as the temporal duration of the project

The solid lines that fall in the increasing direction of the horizontal axis signify the decreases in unit production costs associated with either the traditional approach or PPP. The dashed lines that rise in the increasing direction of the horizontal axis represent the increases in transaction costs associated with either the traditional contracting practices or the PPP concession. The proposition thus states that under certain circumstances the reduction in production costs is, indeed, greater than the associated increase in transaction costs, which means that PPP is comparatively efficient. In other words, a significant shift in the size and duration of the project (1) decreases production costs (2) by a magnitude greater than it increases the transaction costs (3). This allows us to formulate the next proposition:

Proposition 4: There exists a point in the increasing direction of the size and duration of a project at which PPP becomes comparatively efficient

The figure (Figure 27) below illustrates the proposition, by showing the total T of unit production costs and transaction costs (T = UPC + TC = c

+ F / q + TC) associated with the traditional approach and PPP, as a function of the project size and duration.

Physical scale and scope; temporal duration of the project Total

costs

Costs of traditional procurement

Costs of PPP

p

Figure 27 Illustration of the total comparative costs of traditional procurement and PPP

The dashed vertical line signifies a hypothetical point p, at which the PPP scheme becomes comparatively efficient. Because the PPP curve falls below traditional one, the figure also attests that due to the opportunities to exploit technological synergies and invest in specialized capital, it would, indeed be beneficial to increase the physical scale and scope as well as the duration of project contracts, as long as appropriate transaction cost minimizing contractual mechanisms are put in place. Nonetheless, the logic does not carry on forever: at some point the transaction related and organizational complexities of managing an utterly large and long project become disadvantageous.

This argument is supported by a substantial increase in PPP activity, as well as a growing body of world-wide empirical evidence, which suggests that with sizeable projects where there are significant on-going maintenance requirements, the private sector can offer project management skills resulting in a greater proportion of assets being delivered on time and to budget, and more innovative design and risk management expertise

to provide better value for money, and to meet the needs and wants of the client better than the traditional models of procurement.

6.3.2 Equitability

Let us next assume that the previous proposition is correct and that we are beyond point p, in the increasing direction of the horizontal axis, meaning that due to cost advantages PPP results in a higher net surplus than the traditional path of procurement. In other words, there is a larger cake to be shared. From an efficiency perspective it is irrelevant how the resulting surplus is distributed. In practice, on the other hand, the parties to a trade are likely to be more concerned with their own welfare instead of total welfare – which brings us to equitability considerations.

The figure (Figure 28) below illustrates the higher surplus associated with PPP with an alternative representation. The logic of the figure is to show in the middle the total societal benefits that an infrastructure project of a given size and duration (beyond point p) generates during its whole lifecycle, and illustrate the total production costs, total transaction costs and resulting net surplus that organizing the production of the infrastructure asset and services throughout the lifecycle either by PPP (left side) or a traditional scheme (right side) involves. Assuming that the previous proposition is correct, we can next focus on the implications to equitability.

Societal benefits

Production costs

Transaction costs

Net surplus

Production costs Transaction

costs Net

surplus

PPP Traditional

Figure 28 Illustration of the trade-offs between PPP and traditional procurement predicted by the theory of industrial organization

In brief, economic theory also predicts that the competitive-negotiated procedure, the profit sharing mechanism and contract adaptation mechanisms associated with PPP do not allow the government to capture as large a share of the net surplus. In other words, the government captures a smaller share of a larger cake, and the supplier captures a larger share of a larger cake.

Proposition 5: Government captures a comparatively smaller share of the higher surplus associated with PPP

The figure (Figure 29) below illustrates this proposition in turn. The justification for the proposition is two-fold. First, at the time of contracting, the competitive tension of a partly negotiated procedure is lower than in the pure auction mechanism used in traditional procurement, and therefore the government is unable to “push” the outcome to the proximity of the horizontal axis. Second, in the long run, the government induces the contractor to exert higher effort by sharing some of the societal externalities created with the contractor through a variable wage structure,

which essentially means that the supplier captures even more of the surplus associated with the project.

w

π

Government’s Payoffs Supplier’s

Payoffs

Efficient PPP contracts Efficient

traditional contracts

Winning competitive-negotiated bid w*

π*

Figure 29 Illustration of the equitability considerations of PPP predicted by economic theory