Comments to Eduardo Engel’s “Public-Private Partnerships: Optimal Auction and Contract Design”

1. Comments to Eduardo Engel’s “Public-Private Partnerships: Optimal Auction and Contract Design” Juan Benavides Inter-American Development Bank Brasilia April 26, 2005

2. The diagnostic • I agree on the impact of two design flaws of programs designed to attract private capitals to infrastructure (i.e., weak regulation and poor risk allocation) • “Privatize now, regulate later” reflects both an ideological bias and lack of public funds (generalized crises of public provision of infrastructure). Abuse of privatization´s scope

3. Improvements in risk allocation • Engel, Fischer and Galetovic have led the proposals to improve concession contract design • The successful application of the LPVR approach heavily relies on: • Effective contract enforcement by courts • Moderate level of technical uncertainty (advanced designs) • High quality forecasts of initial traffic flows

4. Improvements in risk allocation • “Plain vanilla” LPVR may not avoid renegotiation or endogenously filter white elephants • In greenfield large, complex projects (tunnels) • If the starting traffic level is so low that expected income will never catch up to break even • When strategic operators take advantage of weak enforcement to make renegotiation profits ex post • When the project is –paradoxically- too profitable and public funds are very scarce (expropriation risk)

5. Improvements in risk allocation • The perfect example of a good application: Santiago-Valparaíso toll road • Maintenance of an existing highway with no competing alternatives • High, stable traffic flow recorded for more than 23 years • Culture of payments • Credible courts and public guarantees

6. Application scope • LPVR brings substantial efficiency gains whenever applicable • In countries with high redistribution pressures and imperfect property rights protection, contract design should reflect the relevant constraints • Second-best choices are necessary to minimize expropriation risk or the deadweight losses of opportunistic renegotiation (highest priority)

7. Application scope • Lesson from China “In a system where courts cannot be relied upon to protect property rights, letting the government hold residual rights in the enterprise may have been a second-best mechanism for avoiding expropriation. In such circumstances, the expectation of future profits can exert a stronger discipline on the public authority than fear of legal sanction. Private entrepreneurs felt secure not because the government was prevented from expropriating them, but because, sharing in the profits, it had no interest to expropriate them.” (Rodrik 2004)

8. Financial structures for economically sound transportation projects Case 1: LOW fiscal space credibility - PPPA: profit-sharing - PPPA: profit-sharing - Single-payment outsourcing contracts (+) (-) Private profitability - PPPB: public/community procurement (matching); evaluate tax earmarking - PPPC: concession revenue supplemented by land use rights Low High Contract enforcement by courts

9. Financial structures for economically sound transportation projects Case 2: HIGH fiscal space credibility - PPPA: profit-sharing • PPPD: concession with public guarantees • Pure concessions (+) (-) Private profitability • Civil works • Single-payment outsourcing contracts - PPPE: classic PPP with recurrent public payments Low High Contract enforcement by courts