Private
finance
Debt
Tax
justice
Aid
Financial
architecture

The fiscal costs of PPPs in the spotlight

Added 16 Mar 2018

This article was originally published in the UNCTAD Investment Policy Hub


Public-private partnerships (PPPs) are increasingly being promoted as a way to finance development projects. To pave the way for PPPs, donor governments and financial institutions, led by the World Bank Group, have set up multiple donor initiatives to promote changes in national regulatory frameworks, to provide advice and to finance PPP projects.

The value of PPPs in the developing world has grown rapidly since 2004 - over an eight-year period, investments through PPPs increased by a factor of six, from US$25 billion to US$164 billion.[1] Since then, the trend has been more volatile - although investment in PPPs fell in 2013, they picked up again and continued to increase in 2014 and in 2015 (US$104 and US$118 billion, respectively).[2] 2016 saw another fall - to US$70 billion - due to declining investment in developing markets.[3] But increased efforts by multilateral development banks to leverage private financing in both emerging and low-income economies indicate a more determined push towards reducing the risks for private sector investors.

Why PPPs have often proven costly

There is growing evidence that a more cautious stance towards PPPs may be warranted. The cost of PPPs may be one of their crucial weaknesses. Indeed, PPPs have certain characteristics which make them potentially more expensive than traditional public procurement. These characteristics include the cost of capital, profit expectations by the private partners and transaction costs associated with the negotiation of complex PPP contracts.

The cost of financing for PPP projects is typically higher than for public sector works. The reason for this is simple: national governments can usually borrow money at lower interest rates than the private sector, because lending to private companies is normally riskier than lending to governments, which are less likely to default. In the case of the United Kingdom (UK), a 2015 review by the UK’s National Audit Office (NAO) found ‘that the effective interest rate of all private finance deals (7%-8%) is double that of all government borrowing (3%-4%)’.[4] In other words, the costs of financing of PPP-operated services or infrastructure facilities were twice as high for the UK public purse than if the government had borrowed from private banks or issued bonds directly.

The costs of PPPs result not just from explicit liabilities, as stated in the contractual arrangements, but also from non-transparent contingent liabilities. These are financial obligations, the timing and magnitude of which depend on the occurrence of some uncertain future event outside the control of the government (for example, if the exchange rate of the domestic currency falls, or if the demand for the requested service or facility falls below a specified level). In many cases, governments have to guarantee above-average income streams in order to attract private investors. The list of guarantees offered to firms to make PPPs look ‘bankable’ may be substantial. They can include loan repayments, guaranteed rates of return, minimum income streams, guaranteed currency exchange rates and guaranteed compensation, should new legislation affect an investment’s profitability.

Guarantees are more likely to be triggered in times of economic malaise or crisis (for instance, when the demand for a certain service goes down due to lower economic activity) rather than when the economy is doing well, but they can also be triggered as a result of poor planning. Experience shows that accurate demand projections are crucial for cost certainty. Unfortunately, in PPP projects, the incentives for rigorous analysis can be weak in both sectors, private and the public. Some researchers have stressed that PPPs can involve an ‘optimism bias’ because the strategic overestimation of demand is common practice.[5] To take just one example which came to light in August 2017: a consortium operating the ‘A1 Mobil’, a PPP-run motorway between Hamburg and Bremen, was on the verge of insolvency and wanted to sue the State for damages amounting to €778m.[6] The company was counting on revenue generated by tolls for trucks, but due to the financial crisis, traffic was below expectations.

In addition, PPPs often suffer from a lack of transparency and limited public scrutiny, which can lead to poor decision-making resulting from less oversight, and can increase opportunities for corrupt behaviour. On the one hand, there are usually higher costs associated with poor transparency – including in accounting for PPPs – throughout the project cycle. The lack of transparency frequently leads to less informed fiscal policy decisions and encourages governments to go ahead with projects even when they can create fiscal problems in the future. Conversely, an increased level of transparency brings its own benefits as it increases democratic accountability of the PPP process and enables citizens and parliaments to understand who will pay what to whom, when, and from which budget.

Taken together, these factors tend to result in a heavy fiscal burden that undermines, in the medium and long term, the State’s capacity to support other services. It is therefore more important than ever to understand the conditions required to ensure that efficiency gains materialise, as these gains cannot be taken for granted. Interestingly, in most cases, evidence shows that efficiency gains depend on the sector, the type and size of projects, the private sector increasing capital investment as agreed in the contract, and the country context in terms of regulatory environment and governance.[7]

Finally, many governments record the costs of PPPs in financial statements and budgets in a way that creates a false incentive for using PPPs. Current accounting practices allow governments to keep the costs and liabilities of PPPs off-balance sheet, and thus to circumvent budgetary constraints. However, shifting public debt to government-guaranteed debt does not reduce governmental debt liabilities. Rather, it obscures accountability and hinders scrutiny by parliamentarians and the public.

Civil society concerns and demands

On the basis of an increasing body of evidence collected over the years by civil society organisations (CSO)[8] and other stakeholders,[9] in 2017, Eurodad joined more than 150 organisations in launching a PPP Manifesto that highlights the risks to public finances of promoting PPPs, as well as undermining democratic accountability, and human and environmental rights.[10]

Eurodad strongly believes that PPPs would be less favoured than public procurement if a) they were transparently accounted for and budgeted, and b) if the cost-benefit analysis and information relating to public contracting had to be publicly disclosed.

In order to avoid the fiscal burdens that PPPs can entail, policy makers as well as international organisations must take a more nuanced approach to PPPs. The World Bank has been playing a leading role in incentivising PPPs by providing advice and financing to change national laws and to structure PPP projects. Civil society groups have repeatedly raised concerns about the active role of such a powerful institution. The launch of the ‘cascade’ approach in April 2017[11] – which characterised the ‘private finance first’ approach to development finance – raised red flags in relation to the screening tools needed to compare thoroughly the full costs and implications of the public and the private financing options to implement development projects. CSOs are calling on the World Bank to stop favouring PPPs over other alternatives, ensure that governments undertake a careful cost-benefit analysis, and on this basis select the financing mechanism best suited for each project. International organisations advising governments must also be more straightforward about the full fiscal implications over the long term and the risk comparison of each option.

If, having carefully considered all the options, governments choose to go down the PPP route, they have a responsibility to be more transparent and accountable towards their constituencies. The contract value and long-term fiscal implications of each project must be included in national accounts, rather than being off-balance sheet. Full details of guarantees and contingent liabilities associated with PPPs, the conditions that will trigger them, and all PPP-related documents should be publicly disclosed. This will allow citizens to have a clear understanding of the fiscal risks involved and will increase democratic accountability.

_________________________________________________


[1] Eurodad’s calculations on the basis of the World Bank’s Private Participation in Infrastructure (PPI) database. Also available in Mathieu Vervynckt and María José Romero, ‘Public-Private Partnerships: Defusing the ticking time bomb’. Eurodad (2017), http://www.eurodad.org/files/pdf/1546817-public-private-partnerships-defusing-the-ticking-time-bomb-.pdf.

[2] Ibid.

[3] World Bank Group, 2016 Private Participation in Infrastructure (PPI) Annual Update (2017), https://ppi.worldbank.org/~/media/GIAWB/PPI/Documents/Global-Notes/2016-PPI-Update.

[4] HM Treasury, ‘The choice of finance for capital investment’ Briefing by the National Audit Office (2015), http://www.nao.org.uk/wp-content/uploads/2015/03/The-choice-of-finance-for-capital-investment.pdf.

[5] Antonio Estache and Stéphane Saussier, ‘Public private partnerships and efficiency: a short assessment’ European Centre for Advanced Research in Economics and Statistics (ECARES) (2014), https://www.cesifo-group.de/DocDL/dicereport314-forum2.pdf.

[6]The Guardian, ‘Autobahn row hits German election: “we’re selling it off like a second-hand car”’ (20 September 2017), https://www.theguardian.com/world/2017/sep/20/row-over-autobahn-renewal-selling-it-off-like-a-second-hand-car-german-election.

[7] María José Romero, ‘What lies beneath? A critical assessment of PPPs and their impact on sustainable development’ Eurodad (2015), http://eurodad.org/files/pdf/559e6c832c087.pdf

[8] See e.g. Maria José Romero, ‘What lies beneath A critical assessment of PPPs and their impact on sustainable development’ Eurodad (2015), http://www.eurodad.org/whatliesbeneath; Mathieu Vervynckt and Maria José Romero, ‘Public-Private Partnerships: Defusing the ticking time bomb’; Eurodad (2017), http://www.eurodad.org/files/pdf/1546817-public-private-partnerships-defusing-the-ticking-time-bomb-pdf; CEE Bankwatch (2008) Never mind the balance sheet, https://bankwatch.org/wp-content/uploads/2011/06/never_mind_the_balance_sheet.pdf; Oxfam (2014) A dangerous diversion, https://www.oxfam.org/sites/www.oxfam.org/files/bn-dangerous-diversion-lesotho-health-ppp-070414-en.pdf; Jubilee Debt Campaign (2017) Double standards: How the UK promotes rip-off health PPPs abroad, http://jubileedebt.org.uk/wp-content/uploads/2017/08/Double-standards-final.pdf.

[9] Many academics are conducting research on PPPs, see e.g. the network EQUIPPPS: https://www.equippps.net/.

[10] http://eurodad.org/PPPs-Manifesto.

[11] World Bank Group, ‘Forward look – A vision for the World Bank Group in 2030. Progress and challenges’ (2017), http://siteresources.worldbank.org/DEVCOMMINT/Documentation/23745169/DC2017-0002.pdf. See Eurodad’s comments on the ‘cascade’ approach here: http://www.eurodad.org/imf-worldbank-spring-meetings.