Joanna Tyrowicz Limits of state

1. Joanna Tyrowicz Limits of state Institutional Economics

2. “But I thought you were going to talk about econometrics?!” • State (especially welfare) is obliged to assure provision of some services, BUT... • ...it does not have to provide them! • Face it: most of them CANNOT be provided „inhouse”  • Distinction between financing and provision • Then the economic question: • What to provide and what to contract? The criteria! • How to contract? • Schedule for today: • Theory of contracting, PPPs • Empirics of PPPs • Empirics of PPPs in the context of development

3. What is a Public Private Partnership? • Any collaboration between public bodies, such as local authorities or central government, and private companies tends to be referred to a public-private partnership (PPP). • PPP cover a wide variety of working arrangements and offer the opportunity for the private and public sectors to become involved in a relationship which will see the expertise of both sectors being utilised to deliver and maintain public sector assets and services. • PFI - Private Finance Initiative • Joint Ventures • Outsource Partnerships

4. Why do it ? • Central Government Policy • Governments should be keen to expand the range of private public partnerships because they believe it is the best way to secure the improvements in public services that politicians promised at the last election. • Devolved Government Policy • Delivering better and modern public services should be a top priority central and local administration. • Public Private Partnerships (PPP) are an important part of this modernisation agenda and provide the basis for continuing real step change in how public services are delivered across countries.

5. What is the problem about? • Possible advantages: • lower capital constraints; • incentive-based contracts; • encouragement of innovation; • lower production costs (scale and scope economies). • Possible disadvantages • Legal • Not defined responsibility of contractors • Not defined relations between sectors • Institutional • Unwillingness to cooperate • Not defined data exchange and data use procedures • Weak administrative capacities • Job protection! • Cultural • Society’s distrust => corruption claims, etc. 

6. The Temptation “Knowledge is Power” Commercial Competitive Advantage Intellectual Property Political Specialist Knowledge Job Protection Private Public

7. Economics of PPPs • The efficiency of PPP: remains an unresolved empirical question • At the theoretical level: • Transaction Costs Economics • Williamson 1976, Williamson 1999 • Incomplete Contracts Theory • Hart-Shleifer-Vishny 1997 ; Hart 2003 ; Bennett & Iossa 2002 • Arbitrage Theory: • Bentz & Grout 2002 • A TCE approach would stress a simple idea: • The common error to be avoided is to pronounce that governance structures are efficient or inefficient without reference to the transaction… there are transactions for which the firm is superior to the market, its bureaucratic disabilities notwithstanding O.E. Williamson 2002, page 20. • Possible drawbacks of PPP : contractual costs • Transaction costs may, in certain situations, overcome advantages in terms of production costs

8. What are potential transaction costs? Choice of the Private Operator Contract renewal t Service specification Contract execution Competition for the field Competition for the field

9. Franchising: problems to overcome • EX ANTE: Specification of the franchised service and effective competitive bidding • Imprecise specification • adverse selection problem (the winner’s curse) • Small number of bidders • Price and quality do matter  Artificial or obscure award criterion. • EX POST: • Risks of opportunism • Delays in construction and provision • Efforts to renegotiate the contract • Lower level of quality than promised • Absence of responsiveness to consumers’ needs • Price increase • Risks of maladaptation • Price-cost divergences • Indeterminacies • Those problems are particularly important when the transaction is uncertain and needs high level of asset specificity

10. Potential transaction costs: solutions exist! • Contractual solutions: • Choice of the operator • Menu auctions • Pre-qualification criteria • Bids formulated in terms of a constant revenue stream • Allocation of risk • Minimum level of quality required • Execution stage • Dissuasive but realistic penalty clauses • Enforceable sanctions;Monitoring and accounting procedures; Capacity of expertise • ‘Open Book’ Policy – Yardstick competition ; Information transparency

11. Potential transaction costs: solutions exist! • Institutional solutions: • Credibility of the contracting parties • Reputation • Institutional dotations (corruption, property rights …) • Laws that constrain contractual choices and potential opportunistic behavior • No institutional choice is better than another a priori. • The choice between PPP and direct public management depends on the characteristics of the transactions (asset specificity / uncertainty / complexity) • Recent developments show that solutions may exist that qualify PPP in many situations

12. „What should government buy?” • Paper by Bentz, Grout, Halonen (2004) • The basic issue: there are assets and there are services – THEY DIFFER! • If the quality of assets (e.g. the of subsequent operations) depend on initial asset investment, there is a problem • Whether quality is high becomes private information of the builder (moral hazard problem) • Whether costs of operations are high become private information of the service provider • The government – if it contracts – has to provide incentives to ensure that service provider reveales the correct cost, i.e. there is an adverse selection problem at the service provision stage that creates informational rent for the service provider.

13. „What should government buy?” • In traditional procurement, government has to separately incentivise • the builder (to overcome the moral hazard problem) • and apply the revelation mechanism for the service provider (to overcome the adverse selection problem, „revelation mechanism”). • In a PPP model the same company builds and then operates the asset to provide the service. • Information rent gained at the service delivery stage is greater the more often costs of delivery are low • Consequently, the consortium (of builder and service provider) has the incentives to build the best possible asset. • PPP gives high quality „for free”

14. „What should government buy?” • BUT: • If the costs of assuring high quality at the investment stage are high, this „for free” mechanism no longer works • PPP can still provide high quality, but „revelation mechanism” is overpaid (exact IC constraint not possible) • Credibility of government not to have soft budgetary constraints „afterwards” • Conclusions • Implementing PPPs when traditional government costs are high are not effective (examples???)

15. Contracting to FPs vis-a-vis NFPs? • Paper by Bennett and Iossa (2005) • Comparison of FPs and NFPs • Incomplete contract approach • Firm may make uncontractible investment, researching innovative approaches • Control rights give power to veto implementation of innovation • Consider three alternative scenarios • No conflict: innovation increases both profit and social benefit • Conflict of type 1: innovation increases social benefit but unprofitable • Conflict of type 2: innovation increases profit but reduces social benefit

16. Contracting to FPs vis-a-vis NFPs? • Model • G and NP/FP agree on a contract that specifies verifiable basic standards • NP/FP may make investment, researching innovative approaches • x : level and cost, in terms of disutility of effort, of the investment made • x uncontractible • Ownership of project gives veto power on implementation of innovation (control rights) • Under tendering, G has control rights • Under partnership, NP/FP has control rights • Social benefit from innovation (if implemented): B0  B(x) • Profit from innovation (if implemented): π0  π(x),

17. Contracting to FPs vis-a-vis NFPs? • B(x), π(x) are observable but uncontractible • NO CONFLICT SCENARIO: Bx, πx> 0 • CONFLICT OF TYPE 1 SCENARIO: Bx> 0 > π x • CONFLICT OF TYPE 2 SCENARIO: π x> 0 > Bx • Assumption: Bx+ πx> 0 (it makes sense to invest!)

18. Contracting FPs vis-a-vis NFPs? • Conclusions • under partnership, firm internalizes profit effect fully but no internalization G’s social benefit effect • Under tendering, firm shares social and profit effect with G • The highest investment is achieved by • No Conflict: tendering to FPs (if Bx and/or π high), otherwise partnership with FPs • Conflict of type 1: tendering to FPs (if Bx and/or π high), otherwise partnership with NFPs • Conflict of type 2: partnerhisp with FPs • The highest social benefit is achieved by • No Conflict: as above • Conflict of type 1: as above • Conflict of type 2: tendering to NFPs • Even if NFPs care more than an FPs about B, B may be greater with FP!!!

19. Empirical setting, Saussier (2005) • Water distribution, only this time in France  • Data sets from the French Environment Institute and the French Ministry of Agriculture • A representative sample of all the French local authorities • 5,000 local authorities in 1998 • Restricted to 4,443 observations in statistics • Restricted to 3,613 observations in econometric tests • Account for more than 50% of the consumers • The question: Price, cost and organizational • Asset specificity • Physical investments are specific (site specificity) • Complexity • Mainly due to • difficulty of the treatments for producing drinkable water (e.g. the quality of the water before treatment) • difficulty of transporting water to the consumer (the density of population)

20. The case of water supply in France • Decision: local authorities decide, not State • A great variety of organizational choices

21. Institutional environment and potential transaction costs • Drawbacks of PPP resulting from contract incompleteness can be reduced by the institutional framework • The intuitu personae principle • May avoid problems linked to the choice of the operator • Risk of corruption/collusion • PPP are « administrative » contracts • An asymmetric position between contracting parties • Ex post renegotiations take place within a rigid framework

22. The case of water supply in France – USE OF PPP • The use of PPP

23. The case of water supply in France - PRICES

24. Prices and organizational choices: a first look Two possible interpretations • Collusion prices - PPP are inefficient because of ex ante transaction costs • PPP are specialized on complex transactions - PPP are efficient Prices for local authorities that do not contract out the service are lower The price difference between lease and direct public management is 32 € In euros for 120 m3, without tax

25. Prices and organizational choices: an econometric test • «Naïve» OLS equation, controlling for other parameters than organizational choices that may have an impact on prices: R2 = 0,50  Lease contracts account for 27 € in the price (average bill of 140 €) All types of PPP lead to an increase of price paid by the consumer

26. Prices and organizational choices: an econometric test • Cost structure might be different from one organizational choice to another • Estimate 2 equations: • Possible selection bias • Organizational choices are not randomly chosen  TCE propositions Heckman Method

27. In what situations could drawbacks overcome advantages of a PPP? • Robust probit estimate of lease vs. direct public management • Complex transactions (complex treatments, low density of population) are more probably organized through lease contracts • Non-linear effect of the population size • More than 75% of observed choices accurately predicted

28. Prices and organizational choices: an econometrical test Correcting for selection bias, direct public management is still the most efficient organizational choice  However the price difference between lease and direct public management decreases again (About 10 €)

29. Experiences of developing countries • Paper by Estache (2004) • PPP in infrastructure investments ($790 billion) • Steadily growing 1970s-1997, droping afterwards • Some evidence of catastrophe: • 50% of contracts in LA renegotiated • Reasons for „divorces” largely uknown • Why such results? • Part of PPPs where privatization related (railroads, roads, healthcare, etc.) • Government: Quick budget revenue, and long budget costs... • Providers: improving access (pressure), worse clients (lower profits) • Rate of return versus total cost of ownership considerations • Balduzzi (2007) paper – theoretical review to start from…

30. Assignment?Thank you for your attention! jtyrowicz@wne.uw.edu.pl http://www.wne.uw.edu.pl/jtyrowicz http://www.development.wne.uw.edu.pl -> Development Workshop & Institutional Economics (2nd year)