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November 6, 2013

International Report Reviews Potential Regulation of PPPs

In April 2013, the International Transport Forum (ITF) released "Better Regulation of Public-Private Partnerships for Transport Infrastructure," which discusses the risks and potential regulatory responses for public-private partnerships (PPPs) and is a follow-up to their September 2012 international roundtable held on the topic.  ITF is a 54-member research organization within the Organization for Economic Cooperation and Development (OECD).

As discussed in a previous Policy Updates series, PPPs seek to provide a greater role for the private sector in the design, construction, and management of transportation facilities.  This expanded private role can range from both designing and constructing the same facility to including broader responsibilities such as operations and maintenance or finance.  Proponents argue that PPPs can both deliver transportation projects more efficiently than the public sector and supplement increasingly constrained public budgets.

However, the international experience of using PPPs for transportation infrastructure has been mixed.  The ITF report reiterates the risks of PPPs, which have been extensively discussed in the literature.  It notes that the costs for many PPPs become inflated, requiring contracts to be renegotiated.  The report describes four key causes for cost inflation (or lower-than-expected revenues):

  • Weak economic growth. Slow economic growth reduces demand for transportation facilities, and lower traffic levels lead to lower toll revenues.
  • Optimism bias. Incentives to get a project approved may cause analysts to make overly favorable revenue forecasts.
  • Strategic misrepresentation. Creditors may use favorable revenue forecasts to secure better terms from government bodies that may already be under pressure related to political and financial costs of cancelling or delaying a project.
  • Budgeting practice. Public agencies may seek to work around statutory funding limits or requirements for legislative approvals by extending PPP contracts for work that could have been predicted in the initial contract.

The report makes several recommendations to reduce public exposure to risk.  For one, improved analysis during the evaluation of PPP proposals would acknowledge the likelihood of cost inflation and compare proposals to actual experience through a "reference class" of completed PPPs.  The report also recommends improved budgeting and accounting for PPPs.  Governments too often consider PPPs to be off their balance sheet, when in reality such arrangements often require public commitments.  Public agencies should recognize and plan for these long-term liabilities, as well as apply standard budgeting controls to PPPs.

Further, the report makes more detailed recommendations for better regulation of PPPs by relying on public utility models.  In this approach, the government would establish a dedicated regulatory agency to oversee PPP contracts, set quality standards, and then monitor the private sector's performance against those standards.  This agency would help to improve the public transparency of PPP contracts.

The regulator would also set rates of return for the private investor, index these rates to an inflationary measure, and revisit these rates periodically in response to external conditions.  Because of the extensive risk, technical expertise, and long asset lifecycles, PPPs are unattractive to many types of investors, thereby reducing the potential level of private investment.  Guaranteed rates of return, within a regulated performance context, could help to make PPPs more attractive to private investors while protecting the public interest.

GO TO 2040 calls on the region to pursue appropriate PPPs on a project-by-project basis, noting that these arrangements can be complex and should be "handled with a high degree of transparency and care."  PPPs are no silver bullet for the region's transportation funding needs, although they can leverage investments and promote more efficient project delivery and lifecycle management.  ITF's report suggests ways to appropriately regulate PPPs, capitalizing on their advantages while protecting the public interest.