1. Public Private Partnerships An Academic Understanding, or Not 2003 NEFPP Annual Conference

2. From An Economist’s Viewpoint Presumption that Markets are Better –Requires competition –Not necessary to be private – competing govt. teams –Markets can also fail Excluded social costs – then markets over provide Excluded social benefits – then markets under provide Anti-competitive Measuring Benefits –Sum of net benefits to private & public entities –Include social effects not priced by the market Incentives Matter Presumption that Markets are Better –Requires competition –Not necessary to be private – competing govt. teams –Markets can also fail Excluded social costs – then markets over provide Excluded social benefits – then markets under provide Anti-competitive Measuring Benefits –Sum of net benefits to private & public entities –Include social effects not priced by the market Incentives Matter

3. Structuring the Academic Question: Incomplete Contracts What is a Contract? –Identifies investment/contribution –Measures output –Defines payoff –Allocates ownership (control of residuals) Human capital generated – knowledge Decisions making power Theory of the Firm –If a complete contract is possible – contract out –Firm is the set of activities not contracted out Incomplete Contracts –What? –Typically keep internal to the firm What is a Contract? –Identifies investment/contribution –Measures output –Defines payoff –Allocates ownership (control of residuals) Human capital generated – knowledge Decisions making power Theory of the Firm –If a complete contract is possible – contract out –Firm is the set of activities not contracted out Incomplete Contracts –What? –Typically keep internal to the firm

4. Implications for Public-Private Allocation If Complete Contracts: Private Incomplete Contracts and Public Services –Identifying service quality objective Education Health care –Maintaining asset quality –Identifying investment –Responding to new conditions Then What? –Complete public –Partnership – set up contracts where possible = PPP If Complete Contracts: Private Incomplete Contracts and Public Services –Identifying service quality objective Education Health care –Maintaining asset quality –Identifying investment –Responding to new conditions Then What? –Complete public –Partnership – set up contracts where possible = PPP

5. What Is A PPP? I’m Not Really Sure Areas for Private Role –Financing –Construction –Operation –Ownership Not Complete Privatization –Public must continue to have role –The 3 rd P – partnership is key Is it Contracting Out? I’m Not Really Sure Areas for Private Role –Financing –Construction –Operation –Ownership Not Complete Privatization –Public must continue to have role –The 3 rd P – partnership is key Is it Contracting Out?

6. Where is the Academic Literature? Theory of the Firm – Endless Arcane Work Privatization – Big in UK/Europe –Valuing public assets –Allocation of assets –Post-privatization regulation Explicitly PPPs –Very little in the economics literature –Focuses on contracting out Role of budget incentives Strength of public sector union –Costs we can measure – quality is harder Theory of the Firm – Endless Arcane Work Privatization – Big in UK/Europe –Valuing public assets –Allocation of assets –Post-privatization regulation Explicitly PPPs –Very little in the economics literature –Focuses on contracting out Role of budget incentives Strength of public sector union –Costs we can measure – quality is harder

7. Undeveloped Beliefs: The Economist’s Priors Are the Arguments for PPPs Valid? –Economic Benefit from Private Sector Role –Economic Benefit of Government Role –Political Motivations What are the Concerns? What Guidelines Do We Have? Are the Arguments for PPPs Valid? –Economic Benefit from Private Sector Role –Economic Benefit of Government Role –Political Motivations What are the Concerns? What Guidelines Do We Have?

8. “Economic” Motivation for Private Role Cost Savings in Private Sector –Public sector unions Wages Work rules –Speed of action (process is less of a value) –An underlying assumption about public values Better Incentives for Innovation in Private Sector –Does the manager reap the reward? –How is the risk allocated? Greater Flexibility in Responding to the Unexpected Cost Savings in Private Sector –Public sector unions Wages Work rules –Speed of action (process is less of a value) –An underlying assumption about public values Better Incentives for Innovation in Private Sector –Does the manager reap the reward? –How is the risk allocated? Greater Flexibility in Responding to the Unexpected

9. Political Motivations for Private Role Get Debt Off Government Books –Private firms finance / own –Public agency pays user fee Avoid Political Process: No Scrutiny No Policy Reversal: Commit to Long-Term Contracts Economists Do Not Treat These as Benefits –Commitment to long term stream of payments = debt –Assume the political & bureaucratic processes are valid Get Debt Off Government Books –Private firms finance / own –Public agency pays user fee Avoid Political Process: No Scrutiny No Policy Reversal: Commit to Long-Term Contracts Economists Do Not Treat These as Benefits –Commitment to long term stream of payments = debt –Assume the political & bureaucratic processes are valid

10. A Comment of Government Financing Lower Cost of Capital as Argument for Govt. Role –Project cash flows –Corporate guarantee –Tax base Getting the Price Right –Interest on the debt –Effect on interest on other borrowing –Cost of repayment Private – diverted cash flows Public – economic cost of taxation (20-30%) Is the Risk Being Priced? Lower Cost of Capital as Argument for Govt. Role –Project cash flows –Corporate guarantee –Tax base Getting the Price Right –Interest on the debt –Effect on interest on other borrowing –Cost of repayment Private – diverted cash flows Public – economic cost of taxation (20-30%) Is the Risk Being Priced?

11. Concerns About PPP Who is the Partner? –Presupposes experience –Public subsidy of corporate learning by doing Is the Risk Really Being Shared? –Transferring risk ≠ lower cost, unless… –Who picks up the pieces when it blows up? What is the Exit Plan? –This in part defines ownership –Does it create the right incentives? Writing the Contract –Incentives –Cost minimization vs. quality provision Who is the Partner? –Presupposes experience –Public subsidy of corporate learning by doing Is the Risk Really Being Shared? –Transferring risk ≠ lower cost, unless… –Who picks up the pieces when it blows up? What is the Exit Plan? –This in part defines ownership –Does it create the right incentives? Writing the Contract –Incentives –Cost minimization vs. quality provision

12. What are the Guidelines of Theory? Model –Cost minimization vs. service quality –Private Sector Good at cost minimization Weaker incentives for provision of quality –Can’t write contract for quality –Benefits are shared When Does a PPP Work Best? –When negative effect of cost reduction on quality are smaller –Quality is easier to observe/measure/contract –Service quality is less important. Model –Cost minimization vs. service quality –Private Sector Good at cost minimization Weaker incentives for provision of quality –Can’t write contract for quality –Benefits are shared When Does a PPP Work Best? –When negative effect of cost reduction on quality are smaller –Quality is easier to observe/measure/contract –Service quality is less important.