1.1 Introduction
Although the use of public private partnerships (PPPs) is endorsed by Governments and agencies at both national and supranational levels (Montagu and Harding 2012), there is little guidance for decision-makers in terms of the circumstances in which they are likely to deliver better outcomes than the alternatives, and why. Better understanding of these issues is needed to ensure that appropriate PPP strategies are selected, and that the related processes are well-designed and implemented. This chapter aims to address this need, and draws on a narrative review1 of theoretical and empirical research in order to identify the benefits that PPPs can generate compared to alternative mechanisms of delivery and, alongside the sources of additional costs and risks that they give rise to, in order to ensure that the right investments are selected and that these represent value for money.
1.2 Benefits from Public Private Partnerships in the Health Sector
The economic case for the PPP model resides in its ability to allocate the risks associated with delivering infrastructure and related services more effectively than other approaches. If this is achieved, the model can result in better investment decisions, and may reduce the whole-life costs of providing goods of a given quality (VÀlilÀ 2005). The transfer of risk is normally achieved in two ways. First, the payment to the private operator (by contracting authorities or service users) is made as, when, and to the extent that the outputs specified in the contract are delivered, creating an incentive for the operator to ensure that the goods being purchased are routinely available for use at the agreed standard (Farquharson et al. 2011).
Accordingly, while the payment to the private operator is, in most cases a prospective global budget,2 it is paid retrospectively and includes an element that is conditional on performanceâspecifically, performance in terms of the availability and quality of contracted assets and services (Hellowell et al. 2015). Therefore, if the payment is linked to key performance indicators that are well-specified and measurable (De Bettignies and Ross 2004, 2011), adequate arrangements are in place for the monitoring and verification of performance (Domberger and Jensen 1997), and contractual relations are broadly equitable between the parties (Lonsdale and Watson 2007), then any failure of the private operator to achieve specified outcomes results in financial losses (Reiss 2005). The operator has a strong incentive to avoid losses and, therefore, to deliver on its contractually specified obligations.
Second, as the payment mechanism effectively caps the operatorâs total income, there is an incentive for the operator to minimise its costs of production. A distinctive feature of PPPs is that they âbundleâ together a range of activities (design, construction, operations and maintenance, and various categories of service provision) in a single contract, such that the operator of a PPP has both the capability and the incentive to exploit economies of scope (Schleifer 1998; Grossman and Hart 1986; Hart 2003; Iossa and Martimort 2012), for example by investing in innovations which lower production costs or enhance quality (Barlow and Köberle-Gaiser 2009).3 If it is further assumed that bidding processes are competitive, and that private operators can foresee the opportunities to minimise costs, the incentive framework places downward pressure on the price of the contract for the purchaser.
However, empirical evidence on the question of whether PPPs can be relied on to deliver lower costs and better quality in comparison with alternative mechanisms is mixed (Acerete et al. 2012). In general, the evidence suggests that PPPs hold promise for decision-makers that wish to achieve greater certainty over outcomes such as cost, quality and service volumes than may be achievable via alternative delivery mechanisms (National Audit Office 2003, 2005). Certainty over outcomes is evidently a different matter compared to how desirable the outcomes are. After all, a project that delivers the specified goods on budget may still represent poor value for money if the price paid for these outcomes (by society or by specific purchasers) is too high (Hellowell 2010). There is, as yet, no conclusive evidence that PPPs have on average led to lower costs or contract prices.
One potential reason is that the bundling and risk-transfer features of the PPP model do not appear to have led to the kind of cost-reducing innovations that are predicted by theory. Barlow and Köberle-Gaiser (2009) undertook interviews to investigate the degree of innovation in the design and construction of PPP hospitals in the UK. They examined evidence from six case studies drawn from early PPP schemes, the identities of which were not revealed. The study showed that, in the view of many contractual stakeholders, the dominance of financial players in project delivery decision served to stifle innovation. The study concluded that PPPs had led to a fragmentation in responsibilities and an inefficient allocation of risks which, far from encouraging innovation, had in fact impeded it.
1.3 Sources of Additional Costs
There are several features of the PPP model which may generate additional costs. The most important are transaction costs and finance costs (i.e. the costs of deploying private capital).4
The Transaction Cost Economics (TCE) framework, pioneered by Oliver Williamson (1985, 1990), has been used to provide an account of why PPPs are likely to be associated with higher transaction costs than other forms of delivery (Lonsdale 2005). In the TCE framework, economic actorsâbuyers and sellersâare constrained by bounded rationality, while the self-interest orientation of actors is characterised by opportunism, or âself-interest seeking with guileâ (Williamson 1985, pp. 47â8). When opportunism on the part of buyers and sellers is combined with bounded rationality, either of the parties may be able to take advantage of lacunae in the otherâs knowledge to further its pecuniary interests.
The impact of these behavioural factors on outcomes is dependent on two dimensions of the transaction: asset specificity (i.e. the extent to which investments by the parties are specific to the transaction) and uncertainty (e.g. the extent to which current objectives are subject to change). In a PPP, both asset specificity and uncertainty are high. In the former case, both parties face considerable switching costs if they wish to withdraw from the deal (see Sect. 1.3 for an example). In the latter case, the duration and scope of contracts ensure that, in a rapidly changing industry such as healthcare, there is a strong likelihood of contractual incompleteness and a need for renegotiation during the contract (Lonsdale 2005). In this context, the TCE framework predicts that the processes of contract negotiation and monitoring will be extensive, and involve substantial costs for both buyers and sellers.
Dudkin and VĂ€lilĂ€ (2005) showed that a sample of PPPs undertaken in the UK generated higher transaction costs in the pre-contractual phaseâabout 10% of the capital expenditure value of the project, on average, for both contracting authorities and preferred bidders, and up to 5% of that value for losing biddersâthan other forms of procurement. They attributed this to their longer-term character, greater financial complexity and distinct emphasis on risk-sharing, all of which will tend to increase tendering and negotiating costs.5
Turning to the private finance component of the PPP model, sources of additional cost may include finance fees and other finance-related expenses, including lendersâ fees, that are higher than is the case in the liquid and efficient markets for Government debt (Hellowell 2015). For example, equity investors often hedge against certain risks (such as variation in inflation and interest rates) by purchasing financial derivatives. The associated fees, which add to the costs of production for the private operatorâand hence, ultimately, to the price charged to the public sector (Yescombe 2008)6âhave no equivalent in the other mechanisms of delivery.
In addition, the rates of return on commercial debt and equity may add to costs (Hellowell and Vecchi 2012). The interest cost on private finance has...