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Why Public-Private Partnerships are attractive: Renegotiations

Posted Oct 22 2009 10:01pm

Public-Private partnerships (PPP) are becoming increasingly popular.  In Europe, the annual value of PPP is 22.9 billion Euros.  In the United States, where until recently PPPs played a smaller role than in many European countries, financing of transportation infrastructure via PPPs increased almost tenfold, on an annual basis, between 2006-2008 and the preceding decade (1996-2005).

Why are PPPs so popular?  One reason is that they allow the government to work with private firms without incurring the political stigma of “privatizing.”  A paper by Engel, Fischer and Galetovic (2009), however, believes that the main reason is soft budgets.  Governments can defer costs to future administration with the PPP.  “Essentially, because PPP arrangements bundle finance and construction, the firm can ‘lend’ to the government by renegotiating the contract in return for payments made by future administrations.”  The Engel-Fischer-Galetovic model generates four predictions:

(i) in a competitive market, firms lowball their offers, expecting to break even through renegotiation, (ii) renegotiations compensate lowballing and pay for additional expenditure, (iii) governments use renegotiation to increase spending and shift
the burden of payments to future administrations, and (iv) there are significant renegotiations in the early stages of the contract, e.g. during construction
.”

Using data from Chile, the authors find that 30% of all contracts between the mid-1980s and 2000 were renegotiated.  Renegotiation was especially prevalent for transportation and water projects.  Total investment in PPP contracts was initially $8.4 billion over this time.  However, after renegotiation, the ex-post cost increased to $11.3 billion, a one-third increase.

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