Public–private partnership

Overview

A public–private partnership (PPP, 3P, or P3) is a long-term arrangement between a government and private sector institutions. Typically, it involves private capital financing government projects and services up-front, and then drawing revenues from taxpayers and/or users for profit over the course of the PPP contract. Public–private partnerships have been implemented in multiple countries and are primarily used for infrastructure projects. Although they are not compulsory, PPPs have been employed for building, equipping, operating and maintaining schools, hospitals, transport systems, and water and sewerage systems. Cooperation between private actors, corporations and governments has existed since the inception of sovereign states, notably for the purpose of tax collection and colonization. Contemporary "public–private partnerships" came into being around the end of the 20th century. They were aimed at increasing the private sector's involvement in public administration. They were seen by governments around the world as a method of financing new or refurbished public sector assets outside their balance sheet. While PPP financing comes from the private sector, these projects are always paid for either through taxes or by users of the service, or a mix of both. PPPs are structurally more expensive than publicly financed projects because of the private sector's higher cost of borrowing, resulting in users or taxpayers footing the bill for disproportionately high interest costs. PPPs also have high transaction costs. PPPs are controversial as funding tools, largely over concerns that public return on investment is lower than returns for the private funder. PPPs are closely related to concepts such as privatization and the contracting out of government services. The secrecy surrounding their financial details complexifies the process of evaluating whether PPPs have been successful. PPP advocates highlight the sharing of risk and the development of innovation, while critics decry their higher costs and issues of accountability. Evidence of PPP performance in terms of value for money and efficiency, for example, is mixed and often unavailable.

Definition

There is no consensus about how to define a PPP. The term can cover hundreds of different types of long-term contracts with a wide range of risk allocations, funding arrangements, and transparency requirements. The advancement of PPPs, as a concept and a practice, is a product of the new public management of the late 20th century, the rise of neoliberalism, and globalization pressures. Despite there being no formal consensus regarding a definition, the term has been defined by major entities. For example, The OECD formally defines public–private partnerships as "long term contractual arrangements between the government and a private partner whereby the latter delivers and funds public services using a capital asset, sharing the associated risks". According to David L. Weimer and Aidan R. Vining, "A P3 typically involves a private entity financing, constructing, or managing a project in return for a promised stream of payments directly from government or indirectly from users over the projected life of the project or some other specified period of time". A 2013 study published in State and Local Government Review found that definitions of public-private partnerships vary widely between municipalities: "Many public and private officials tout public–private partnerships for any number of activities, when in truth the relationship is contractual, a franchise, or the load shedding of some previously public service to a private or nonprofit entity." A more general term for such agreements is "shared service delivery", in which public-sector entities join with private firms or non-profit organizations to provide services to citizens.

Debate on privatization

There is a semantic debate pertaining to whether public–private partnerships constitute privatization or not. Some argue that it isn't "privatization" because the government retains ownership of the facility and/or remains responsible for public service delivery. Others argue that they exist on a continuum of privatization, P3s being a more limited form of privatization than the outright sale of public assets, but more extensive than simply contracting out government services. Because "privatization" has a negative connotation in some circles, supporters of P3s generally take the position that P3s do not constitute privatization, while P3 opponents argue that they do. The Canadian Union of Public Employees describes P3s as "privatization by stealth".

Origins

Governments have used such a mix of public and private endeavors throughout history. Muhammad Ali of Egypt utilized "concessions" in the early 1800s to obtain public works for minimal cost while the concessionaires' companies made most of the profits from projects such as railroads and dams. Much of the early infrastructure of the United States was built by what can be considered public–private partnerships. This includes the Philadelphia and Lancaster Turnpike road in Pennsylvania, which was initiated in 1792, an early steamboat line between New York and New Jersey in 1808; many of the railroads, including the nation's first railroad, chartered in New Jersey in 1815; and most of the modern electric grid. In Newfoundland, Robert Gillespie Reid contracted to operate the railways for fifty years from 1898, though originally they were to become his property at the end of the period. The late 20th and early 21st century saw a clear trend toward governments across the globe making greater use of various PPP arrangements. Pressure to change the model of public procurement was associated with the neoliberal turn. Instigators of the policy portrayed PPPs as a solution to concerns about the growing level of public debt during the 1970s and 1980s. They sought to encourage private investment in infrastructure, initially on the basis of ideology and accounting fallacies arising from the fact that public accounts did not distinguish between recurrent and capital expenditures. In 1992, the Conservative government of John Major in the United Kingdom introduced the private finance initiative (PFI), the first systematic program aimed at encouraging public–private partnerships. The 1992 program focused on reducing the public-sector borrowing requirement, although, as already noted, the effect on public accounts was largely illusory. Initially, the private sector was unenthusiastic about PFI, and the public sector was opposed to its implementation. In 1993, the Chancellor of the Exchequer described its progress as "disappointingly slow". To help promote and implement the policy, Major created institutions staffed with people linked with the City of London, accountancy and consultancy firms who had a vested interest in the success of PFI.

Around the same time, PPPs were being initiated haphazardly in various OECD countries. The first governments to implement them were ideologically neoliberal and short on revenues: they were thus politically and fiscally inclined to try out alternative forms of public procurement. These early PPP projects were usually pitched by wealthy and politically connected business magnates. This explains why each countries experimenting with PPPs started in different sectors. At that time, PPPs were seen as a radical reform of government service provision. In 1997, the new British government of Tony Blair's Labour Party expanded the PFI but sought to shift the emphasis to the achievement of "value for money", mainly through an appropriate allocation of risk. Blair created Partnerships UK (PUK), a new semi-independent organization to replace the previous pro-PPP government institutions. Its mandate was to promote and implement PFI. PUK was central in making PPPs the "new normal" for public infrastructure procurements in the country. Multiple countries subsequently created similar PPP units based on PUK's model. While initiated in first world countries, PPPs immediately received significant attention in developing countries. This is because the PPP model promised to bring new sources of funding for infrastructure projects in transition economies, which could translate into jobs and economic growth. However, the lack of investor rights guarantees, commercial confidentiality laws, and dedicated state spending on public infrastructure in these countries made the implementation of public–private partnership in transition economies difficult. PPPs in the countries usually can't rely on stable revenues from user fees either. The World Bank's Public-Private Infrastructure Advisory Forum attempts to mitigate these challenges.

Funding

A defining aspect of many infrastructure P3s is that most of the up-front financing is made through the private sector. The way this financing is done differs significantly by country. For P3s in the UK, bonds are used rather than bank loans. In Canada, P3 projects usually use loans that must be repaid within five years, and the projects are refinanced at a later date. In some types of public–private partnership, the cost of using the service is borne exclusively by the users of the service, for example, by toll road users such as in the case of Toronto's Yonge Street at the dawn of the 19th century, and the more recent Highway 407 in Ontario. In other types (notably the PFI), capital investment is made by the private sector on the basis of a contract with the government to provide agreed-on services, and the cost of providing the services is borne wholly or in part by the government.

Special purpose vehicle

Typically, a private-sector consortium forms a special company called a special-purpose vehicle (SPV) to develop, build, maintain, and operate the asset for the contracted period. In cases where the government has invested in the project, it is typically (but not always) allotted an equity share in the SPV. The consortium is usually made up of a building contractor, a maintenance company, and one or more equity investors. The two former are typically equity holders in the project, who make decisions but are only repaid when the debts are paid, while the latter is the project's creditor (debt holder). It is the SPV that signs the contract with the government and with subcontractors to build the facility and then maintain it. A typical PPP example would be a hospital building financed and constructed by a private developer and then leased to the hospital authority. The private developer then acts as landlord, providing housekeeping and other non-medical services, while the hospital itself provides medical services. The SPV links the firms responsible of the building phase and the operating phase together. Hence there is a strong incentives in the building stage to make investments with regard to the operating stage. These investments can be desirable but may also be undesirable (e.g., when the investments not only reduce operating costs but also reduce service quality).

Financial partners

Public infrastructure is a relatively low-risk, high-reward investment, and combining it with complex arrangements and contracts that guarantee and secure the cash flows make PPP projects prime candidates for project financing. The equity investors in SPVs are usually institutional investors such as pension funds, life insurance companies, sovereign wealth and superannuation funds, and banks. Major P3 investors include AustralianSuper, OMERS and Dutch state-owned bank ABN AMRO, which funded the majority of P3 projects in Australia. Wall Street firms have increased their interest in PPP since the 2008 financial crisis.

Government

Government sometimes make in kind contributions to a PPP, notably with the transfer of existing assets. In projects that are aimed at creating public goods, like in the infrastructure sector, the government may provide a capital subsidy in the form of a one-time grant so as to make the project economically viable. In other cases, the government may support the project by providing revenue subsidies, including tax breaks or by guaranteed annual revenues for a fixed period.

Risks

Within public-private partnerships (PPPs), there are various risks associated. One risk common within PPPs is the lack of proper or accurate cost evaluation. Oftentimes the estimated costs of a project will not properly account for delays or unexpected events, leading to the costs to be larger than what was projected. Another risk within this area is with change of governance from differing political representatives could lead to projects being diminished or reduction of the allocated budget. This is common within PPPs as different political actors are likely to scrutinise their opponents based on their ideological positions.

Profits

Private monopolies created by PPPs can generate a rent-seeking behavior, which leads to spiraling costs for users and/or taxpayers in the operation phase of the project. Some public–private partnerships, when the development of new technologies is involved, include profit-sharing agreements. This generally involves splitting revenues between the inventor and the public once a technology is commercialized. Profit-sharing agreements may stand over a fixed period of time or in perpetuity.

P3 justifications

Using PPPs have been justified in various ways over time. Advocates generally argue that PPPs enable the public sector to harness the expertise and efficiencies that the private sector can bring to the delivery of certain facilities and services traditionally procured and delivered by the public sector. On the other hand, critics suggest that PPPs are part of an ideological program that seeks to privatize public services for the profits of private entities.

Off-balance-sheet accounting

PPPs are often structured so that borrowing for the project does not appear on the balance sheet of the public-sector body seeking to make a capital investment. Rather, the borrowing is incurred by the private-sector vehicle implementing the project, with or without an explicit backup guarantee of the loan by the public body. On PPP projects where the cost of using the service is intended to be borne exclusively by the end-user, or through a lease billed to the government every year during the operation phase of the project, the PPP is, from the public sector's perspective, an "off-balance sheet" method of financing the delivery of new or refurbished public-sector assets. This justification was particularly important during the 1990s, but has been exposed as an accounting trick designed to make the government of the day appear more fiscally responsible, while offloading the costs of their projects to service users or future governments. In Canada, many auditors general have condemned this practice, and forced governments to include PPP projects "on-balance sheet". On PPP projects where the public sector intends to compensate the private sector through availability payments once the facility is established or renewed, the financing is, from the public sector's perspective, "on-balance sheet". According to PPP advocates, the public sector will regularly benefit from significantly deferred cash flows. This viewpoint has been contested through research that shows that a majority of PPP projects ultimately cost significantly more than traditional public ones. In the European Union, the fact that PPP debt is not recorded as debt and remains largely "off-balance-sheet" has become a major concern. Indeed, keeping the PPP project and its contingent liabilities "off balance sheet" means that the true cost of the project is hidden. According to the International Monetary Fund, economic ownership of the asset should determine whether to record PPP-related assets and liabilities in the government's or the private corporation's balance sheet is not straightforward.