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Finance & Development
A quarterly magazine of the IMF
September 2001, Volume 38, Number 3

Public-Private Partnerships
Michael B. Gerrard

What are public-private partnerships, and how do they differ from privatizations?

Public-private partnerships (PPPs) are generally not "privatizations" in the sense that the latter term is most commonly used. (See Box 1.) A privatized business is one that was formerly owned by the public sector and is now owned by the private sector. It may operate in highly competitive markets—as, for example, an airline does—or it may hold a monopoly position and so require active regulation once it is transferred to the private sector—as a utility company does. In either case, the public sector is disengaged from the business.

Box 1. What is a public-private partnership?

Public-private partnerships (PPPs) combine the deployment of private sector capital and, sometimes, public sector capital to improve public services or the management of public sector assets. By focusing on public service outputs, they offer a more sophisticated and cost-effective approach to the management of risk by the public sector than is generally achieved by traditional input-based public sector procurement.

The discipline of drawing up a PPP contract between a public sector client and a private sector contractor, on the one hand, obliges the public sector to articulate its long-term service needs (which could be the provision of, for example, transport, education, or health sector services) and, on the other hand, ensures that the private sector will not put its capital at risk to deliver these services unless and until it is satisfied about the PPP's long-term sustainable performance. As such, PPPs can be an effective antidote to the temptations of short-termism in both the public and the private sector.

Many build-operate-transfer-style concession agreements could be classified as PPPs, insofar as the public sector remains ultimately accountable for delivery to the public of the underlying services, which is the case under the U.K. government's Private Finance Initiative (PFI). Examples of such agreements within the United Kingdom include the provision of schools or hospital accommodations and supporting services under long-term contracts, where payment by the public sector client (authority) to the private sector service provider (contractor) is spread over the term of the contract (for example, 30 years) and, furthermore, where payment is made only to the extent that the required outputs (service standards) are maintained, year after year.

By contrast, a PPP is a business relationship between the public and private sectors that is not patterned on either of these models. In the case of a Private Finance Initiative (PFI) project, the business is defined by a long-term contract in which public services to be delivered by the PPP—the outputs—are specified in great detail. In its form as an equity joint venture between the public and private sectors, a PPP is a business with certain public sector obligations set out in its constitutional documents or within contracts with the public sector.

In all cases, the scope of PPP business, and so its potential for profit, are constrained contractually rather than by market forces or the intervention of a statutory regulator. Normal private sector incentives for management still apply within a PPP, such as the need to earn an adequate return on capital, but the business is, in effect, passively regulated by virtue of the constraints placed upon it contractually and without the intervention of a regulator.

Moreover, within a PFI project, the public sector pays for services on behalf of the general public and retains ultimate responsibility for their delivery, whereas the private sector's role is limited to that of providing an improved delivery mechanism for the services. In the privatized utility model, by contrast, ultimate responsibility for service delivery is transferred to the private sector.

The essential role of the public sector in all PPPs—whether PFI project, joint venture, or other partnership structure—is to define the scope of business; specify priorities, targets, and outputs; and set the performance regime by which the management of the PPP is given incentives to deliver—and, in the case of PFI projects, also to pay for—the services. The essential role and responsibility of the private sector in all PPPs is to deliver the business objectives of the PPP on terms offering value for money to the public sector.

PPPs cannot always be well described as "partial privatizations." For example, there is an important distinction between, on the one hand, a private sector company in which the public sector holds a minority equity stake but has no influence on the objectives or operations of the company (which most would agree was well described as a partial privatization) and, on the other hand, a joint venture between public and private sectors whose business is constrained by public sector considerations or a service contract under which the public sector retains all its statutory functions. Both of these are forms of PPP.

The PPP model is very flexible and visible in a variety of forms. To date, most PPPs implemented in the United Kingdom have been concerned with the delivery of services to the public sector by a private sector partner under a long-term contract. Agreements for more than 400 such PFI projects, with a combined capital value of more than £19 billion, have now been signed in numerous sectors, including health, education, transport, defense, information technology, environmental protection, and government accommodation.

A successful PPP program will likely require a degree of reform by both the public and the private sector to create the right enabling environment. As such, there are clear drawbacks to a PPP approach to the extent that these reforms may delay implementation of investment. For the public sector, reforms would typically include a move from input- to output-based contracting, which may require significant investment in developing skills and guidance on best practices; enactment of enabling legislation—for example, to overcome issues of public sector vires (legal authority) and taxation of PPP contracts; and institutional reform to assist in prioritizing, providing resources for, and approving transactions. For the private sector, reforms may be required to build capacity in the provision of integrated whole-life-of-asset-based services to the public sector and to provide long-term (that is, 25 years or longer) project finance. Conversely, once the enabling environment has been established, the time taken to implement transactions and the fixed front-end implementation costs, for both public and private sectors, should steadily decrease, as has been the experience in the United Kingdom.

PPPs are certainly not an easy procurement option for the public sector, nor do they offer a universal solution. However, they do provide a flexible framework within which the skills and resources of the private sector can be mobilized to provide better-quality, sustainable, and more cost-effective public services in the right circumstances. (See Box 2.)

Box 2. Why are governments turning to PPPs?

PPPs generally spread the costs of procuring an asset over time and/or cause the associated capital expenditure to affect private firms' rather than the public sector's balance sheets. These objectives may be achieved by basing the procurement on the public services required—that is, upon outputs—rather than on the underlying assets, or inputs. Where public sector capital budgets are constrained, there are obvious advantages in adopting a PPP to deliver public services that might otherwise be unaffordable to a government.

At the heart of all PPPs is the deployment of private sector capital. Within a PPP framework, this can result in greatly improved value for money for the government in terms of the risks transferred to the private sector (in cases where the latter is better able to assess the risks) and powerful private sector incentives for the long-term delivery of reliable public services. These benefits are sufficient to ensure that PPPs often become the favored means of procurement, even where public sector capital constraints do not apply. In many countries, such as the United Kingdom, therefore, the motivation for making greater use of PPPs is to obtain increased value for money in the procurement of public services.

Much of the improved value for money comes from the fact that when private sector capital is deployed and is at risk—to, for example, the long-term performance of public service delivery—the right commercial decisions are made about design, operating regime, human resource planning, whole-life-of-asset costings, and so on. For a fuller analysis of the drivers of value for money, see Value for Money Drivers in the Private Finance Initiative: A Report by Arthur Andersen and Enterprise LSE Commissioned by the U.K. Treasury Taskforce (London: 2000).

PPPs operate at the boundary of the public and private sectors, being neither nationalized nor privatized assets and services. Thus, politically, they represent a third way in which governments may deliver some public services. Moreover, in a practical sense, PPPs represent a form of collaboration under contract by which public and private sectors, acting together, can achieve what each acting alone cannot. Numerous member countries of the Organization for Economic Cooperation and Development now have active PPP programs, as do a growing number of developing countries.

Evidence to date within the United Kingdom, which shows new investments in public services made through PPPs being largely completed ahead of schedule and within budget, supports the conclusion that while it may initially be more demanding for the public sector to contract on this basis, very worthwhile gains are available.

Supplementing the flow of PFI projects in the United Kingdom are a growing number of PPPs designed to make more efficient use of existing public sector assets rather than deliver public sector services by constructing new assets. These PPPs concern assets—which could be tangible assets, know-how, or intellectual property—that have either a dual use or spare capacity. Sometimes, realizing their potential will require an equity joint venture between the public and the private sectors. These PPPs fall under the U.K. government's Wider Markets Initiative.

Between these two established forms of PPP—a concessions-based business (PFI project), on the one hand, and a joint venture (Wider Markets project), on the other—lies a broad spectrum of possible PPP structures having features of both. These combination partnership structures offer some of the greatest potential for future application of PPPs because of their adaptability to the specific needs of the public sector. For example, where the scope of future service delivery cannot be fully defined at the outset, greater emphasis on joint-venture mechanics and less on detailed output specifications may be required. Alternatively, a public sector authority may decide to hold a minority equity stake in a PFI project it has commissioned, to share in the profits generated by the business.

The spectrum of possible PPPs also extends from businesses almost entirely controlled by the private sector, at one end, to those almost entirely controlled by the public sector, at the other. Outside the United Kingdom, there are PPP businesses jointly owned by the public and private sectors, but with the majority ownership held by the public sector. Examples include water utility companies within continental Europe. The explanation of why the U.K. model of PPPs generally involves effective control by the private sector, if not majority ownership, lies largely in the role that private sector finance plays in creating the necessary management disciplines for a PPP and in achieving a transfer of risk that provides value for money. Even when day-to-day management of the PPP is firmly in the hands of the private sector, which is generally the case in the United Kingdom, the PPP must still operate at the boundary between the public and private sectors in a way that privatized companies generally do not—thus further highlighting its special character.

The value that a private sector investor seeks from a PPP is a return on its capital employed—as a management incentive, this is no different from what any other private sector business seeks. The private sector investor may also have contractual interests in the PPP, but these are normally free-standing and arm's-length. The public sector, by contrast, will apply a much wider concept of value to its participation as an investor in a PPP than simply the return on its capital employed—this could include other policy considerations.

The rules by which a PPP operates must be clearly articulated within its constitutional documents or other contractual arrangements, so that the management team knows the constraints within which it must run the business. These constraints are also likely to be important influences on the human resources strategy of the business and will affect the PPP's approach to attracting and retaining the right management and staff.

To harness the potential of PPPs requires that their unique characteristics be acknowledged and exploited: first, their ability to provide a flexible framework within which the complementary roles and capabilities of public and private sectors can be combined; second, their operation at the boundary between public and private sectors, by which the public sector retains ultimate responsibility for delivering public services; and third, their status as a form of regulated business—in effect a business that is passively regulated by means of its constitution and the contracts it enters into with the public sector, without the intervention of a statutory regulator. These characteristics also explain why PPPs are generally not well described as privatizations or partial privatizations in the sense that these terms are commonly used. LE

Michael B. Gerrard is Head of Public Private Partnerships at Partnerships UK, a firm established by the U.K. government to accelerate the development, procurement, and implementation of such partnernships. He is also a Visiting Lecturer at Imperial College Management School (London).