Providing Citizens with Goods and Services

1. The Economics of Public-Private Partnerships (P3s) prepared by:J.-E. de Bettignies and T. RossSauder School of BusinessUBC P3 Project Economics of Public-Private Partnerships

2. Providing Citizens with Goods and Services Familiar Mechanisms: 1. private markets (most goods) 2. (pure) public provision (e.g. primary and secondary education, defense) 3. regulated private provision (e.g. local telephone service) Economics of Public-Private Partnerships

3. When does the public sector step in? • External effects and “public goods” • Social justice (to assure adequate consumption for everyone) • To control monopoly • Other reasons (e.g. poor information) Economics of Public-Private Partnerships

4. Perceived problems with traditional public provision: • High and rising costs • Weaker “on-time” performance • Less innovative Economics of Public-Private Partnerships

5. Potential key advantages of private sector vis-à-vis public sector: • Ability to control costs • Ability to bear risk • Complementarities • Flexibility • Innovativeness • Key knowledge • Economies of scale/scope • Ability to borrow (Can the gov. borrow more cheaply?) Economics of Public-Private Partnerships

6. “NEW” Initiatives: Alternative Service Delivery (ASD) • Contracting-out (C-O) (e.g. refuse collection, IT services) • Public-Private Partnerships (P3s) (e.g. roads, schools, prisons) • Privatization Economics of Public-Private Partnerships

7. Defining P3s (1) • “… contractual arrangements between government and a private party for the provision of assets and the delivery of services that have traditionally been provided by the public sector” (B.C. Ministry of Finance, 2002) Economics of Public-Private Partnerships

8. Defining P3s (2) • “…a cooperative venture between the public and private sectors, built on the expertise of each partner, that best meets clearly defined public needs through the appropriate allocation of resources, risks and rewards.” (Canadian Council on Public-Private Partnerships) Economics of Public-Private Partnerships

9. Defining P3s (3) • “The term ‘public-private partnerships’ has taken on a very broad meaning. The key element, however, is the existence of a ‘partnership’ style approach to the provision of infrastructure as opposed to an arms-length ‘supplier’ relationship … a P3 involves a sharing of risk, responsibility and reward, and is undertaken in those circumstances when there is value for money benefit to the taxpayers.” (Government of B.C., Building Partnerships) Economics of Public-Private Partnerships

10. Definitions: Key Elements • Sharing of risk and reward between public and private partners • Sharing of authority for decision-making • On-going relationships, not spot-market Economics of Public-Private Partnerships

11. How “New” is this? • Private sector involvement in provision of public services is not new – e.g. the private sector has frequently provided: • Basic supplies (e.g. paper, pens, desks) • Equipment (computers, medical, automobiles) • Construction services • Consulting services Economics of Public-Private Partnerships

12. What is New? • The increased scope of the private sector’s participation – particularly in: • 1. provision of financing • 2. provision of operation services • 3. ownership of assets Economics of Public-Private Partnerships

13. Some Common P3 Models: What the private partners might do: (i) Design-build-operate (DBO) (ii) Design-build-own-operate-transfer (DBOOT) (iii) Design-build-operate-maintain (DBOM) (iv) Finance-design-build-operate-maintain (FDBOM) Economics of Public-Private Partnerships

14. Who are the private partners? They can be: • Private, for-profit firms • Consortia of private, for-profit firms • Private, not-for-profit firms Economics of Public-Private Partnerships

15. The Public-Private Spectrum • Private sector involvement can range from zero (pure public) to total (pure private) Pure Public Pure Private Contracting-out P3s Economics of Public-Private Partnerships

16. Some History • Britain pioneered “new wave” with Private Finance Initiatives (PFIs) beginning in early 1990s • Now popular in many countries and many provinces in Canada • Promoted by World Bank for developing countries Economics of Public-Private Partnerships

17. Roads Schools Hospitals Prisons Bridges Water treatment Property management Recreational facilities Information tech. Social services Common Areas of Application Economics of Public-Private Partnerships

18. Significant Canadian P3s • Highway 407 – Ontario • Confederation Bridge – PEI-NB • Charleswood Bridge – Winnipeg • Pearson Airport - Ontario • St. Lawrence Seaway • South Surrey Interchange – B.C. Economics of Public-Private Partnerships

19. Incinerator Biosolids processing Recycling programs Water treatment Bridge Building revitalization Harbour revitalization Electric utility Parking management Public transit Recreation centres Business park Canadian Municipal P3s – Examples(some are proposals) Economics of Public-Private Partnerships

20. Current BC Projects These are at various stages from complete (or nearly) to proposal stages: Economics of Public-Private Partnerships

21. Abbotsford Hospital Economics of Public-Private Partnerships

22. Academic Ambulatory Care Centre (Vancouver) Economics of Public-Private Partnerships

23. Britannia Mine Water Treatment Plant Economics of Public-Private Partnerships

24. Kicking Horse Canyon Project (Phase 2)(upgrades to Trans Canada Highway) Economics of Public-Private Partnerships

25. Golden Ears Bridge ( Fraser River Crossing in Vancouver area) Economics of Public-Private Partnerships

26. Wm. Bennett Bridge (Kelowna) Economics of Public-Private Partnerships

27. Northern Sport Centre (at UNBC) Economics of Public-Private Partnerships

28. RAV Line Economics of Public-Private Partnerships

29. Sea-to-Sky Highway Improvements Economics of Public-Private Partnerships

30. Sierra Yoyo Desan Resource Road Upgrade Economics of Public-Private Partnerships

31. Whistler Wastewater Treatment Plant Economics of Public-Private Partnerships

32. The Proper Objective for a P3: Assign roles to the various public and private partners in the most efficient manner: i.e. allocate a task to the party able to execute it at least cost (quality adjusted). Economics of Public-Private Partnerships

33. Other “Reasons” for P3s • Labour union issues – contracting out work of highly paid public sector workers • Keeping debt off the gov’t balance sheet • Hiding information from public • Gifts to the friends of the gov’t • Deflecting blame for low levels of services Opponents of P3s typically suspect that these are the real motives. Economics of Public-Private Partnerships

34. Providing Public Services – The Various Tasks 1. Define and design the project 2. Finance the project 3. Construction (build the project) 4. Operation & maintenance of the project 5. Pay for the service Economics of Public-Private Partnerships

35. On Assigning Tasks: General Questions • Are there complementarities between the tasks such that some should be combined? • Who is most efficient at the task? • Special knowledge • economies of scale or scope? • Can the right incentives be put in place to get optimum performance? (contract design issues) • How should risks be allocated? • Can there be strong competition between potential private sector partners? Economics of Public-Private Partnerships

36. Advantages of Private Sector Come From: • More powerful incentives • Competition • Expertise/Specialization • Complementarities • Facilitating user-pay Economics of Public-Private Partnerships

37. Incentives • “High-powered” incentives to control costs due to profit motive • Ability to manage risk • Flexibility • Innovative Economics of Public-Private Partnerships

38. Risk and Incentives • Managing risk is really about managing incentives – the point is to assign the risks in such a way as to minimize those risks. • This is done by subjecting the party most able to control a risk to the costs associated with that risk. Economics of Public-Private Partnerships

39. Allocating Risks – A Key Feature of P3s • Technical risk (engineering or design failures) • Construction risk (higher than expected costs) • Operating risk (higher operating costs than expected) • Revenue risk (lower demand than anticipated) • Financial risk (inappropriate debt management) • Force majeure risk (war, natural disaster) • Regulatory/political risk (changes in laws) • Environmental risk (environmental damage) • Project default risk (failure through a combination of these risks) Economics of Public-Private Partnerships

40. Role of Competition • Can lower prices taxpayers or users must pay (allocative efficiency) • Provides further incentives for cost minimization (productive efficiency) • Provides further incentives for innovation (dynamic efficiency) Economics of Public-Private Partnerships

41. Expertise of Private Sector • May have key knowledge not available in public sector (esp. in developing countries) • Economies of scale/scope with related projects • Complementarities with other parts of the given project Economics of Public-Private Partnerships

42. Complementarities -- Examples Benefits from coordinated decision-making with respect to: • Design & Construction • Construction & Operation • Financing & Construction Economics of Public-Private Partnerships

43. Implementing User-Pay • Most often government (taxpayer) pays • Direct pay (e.g. lease payments) • Shadow tolls (gov’t pays but payments based on actual usage) • In some cases there is user-pay (e.g. tolls, but usually with regulation of tolls) • User-pay may be more acceptable in a P3 than in public provision Economics of Public-Private Partnerships

44. Costs of Expanded Private Involvement Most commonly expressed: • Loss of public control of public services 2. Higher cost of private sector borrowing? Economics of Public-Private Partnerships

45. Loss of Control • What if changing circumstances demand a change in level or type of services? • What if renegotiation is difficult, time-consuming and costly (note: there is no competition at this point) • What if it is difficult to measure and verify quality? Economics of Public-Private Partnerships

46. Financing the Project: Can the Government Borrow More Cheaply? Not necessarily – we must consider: • Private partner can raise capital at a low cost for a safe project • Gov’t marginal cost of borrowing might be higher than average cost • There is a value to the put option (government pays lower rate only because it will repay with near certainty) Economics of Public-Private Partnerships

47. Challenges in P3 Design • Typically a significant specific investment involved – creates significant switching costs. • Specific investments protected by contracts but contracts always incomplete. Economics of Public-Private Partnerships

48. Consequence Number 1: • Both trade partners will act opportunistically and bargain over the surplus • This is costly! • Public provision avoids/mitigates this cost • One disadvantage/cost of a P3 relative to public provision: inefficient bargaining Economics of Public-Private Partnerships

49. Controlling Opportunistic Behavior Three main possibilities: • Good contracts (can be costly to negotiate) • Good reputations – private partner wants future business and public partner does not want to scare away potential partners for other ventures • Public provision Economics of Public-Private Partnerships

50. Challenges to Contracting • Uncertainty over a long horizon • Changing government objectives • Lack of commitment for both: • Private sector (bankruptcy/exit) • Government (break contract, renegotiate) Economics of Public-Private Partnerships