PPP benefits and limitations

In the first section of this guide, we have addressed some important issues concerning public-private partnership (PPP) as an approach to infrastructure development, namely we have introduced the concept of PPP, discussed both economic and social infrastructures, cleared up the confusion regarding the notions of PPP and privatization, and finally we have highlighted the difference between PPP and traditional infrastructure procurement (TIP).

In this section we go further by showing the benefits and limitations of PPPs.

Benefits and limitations of PPPs

PPPs have several benefits for both the public and private sectors. At the same time, PPPs suffer from a number of limitations, which we, at Visionary Consulting Co, believe they can be, to a great extent, mitigated. PPPs have benefits for both public and private sectors, however, they are not free of challenges Benefits Attracting Private Capital: Due to budget constraints, many projects fail to qualify as a government priority using TIP approach. Capitalizing on private capital, local or international, might make it possible to implement such projects using the PPP model.

In fact, one of the primary reasons governments are increasingly considering the PPP approach is to attract private capital. PPP is viewed as a viable means to finance projects that would not otherwise be feasible due to fiscal limitations. PPP projects are however not free, as the private sector needs a return out of its investment through either availability payments (government-pays PPPs), fees charged to the user of the services (user-pays PPPs) or the development of additional revenues that can be generated from the public asset such as renting shops, hotels, car parks and so on in an airport project. Consequently, using a PPP structure would provide a sort of financial relief for the government.

Realization of efficiency gains

PPPs in most infrastructure projects can offer significant efficiency gains compared to TIPs. The gains accrue from allocating to the private sector those risks that are better handled by them than the public sector, such as those associated with construction costs. In fact, a key motivation for employing a PPP model is the realization of efficiency gains through improved project delivery, operation, and management as well as access to technology. The goal is to improve the quality of a public service delivery by taking advantage of private sector efficiency, resources, and expertise.

Long-term solutions

The creation of long-term solutions for the provision of public infrastructure through tackling issues such as inferior construction quality and inadequate maintenance. Certainly, being responsible for operating an asset for twenty years, the private sector will make sure that the asset is built properly. On the other hand, as the private partner’s payment (by the public partner) is under risk of nonpayment or deduction should the asset fail to meet performance standards, then this private partner needs to ensure that sufficient resources to asset maintenance are allocated. Further, PPP models create incentives to reduce the life-cycle costs of assets. For instance, in a highway project, let’s assume that there are two options to build the road.

With the first option, construction will be cheaper initially, but maintenance costs would be higher over the long-term. The second option might be more expensive in terms of construction but will have lower maintenance costs over the long run. In a PPP project, the private partner will select the second option, because it integrates maintenance cost implications into the overall project design and will be the cheapest alternative over the lifetime of the asset.

Risk transfer

This is a fundamental benefit, to the public partner, of the PPP model which relates to the transfer of risk to the private sector. By transferring risk to the private sector, government finances are protected against the potential cost overruns that are often significant in public infrastructure projects. Indeed, risk sharing is a crucial element in Public-Private Partnership (PPP) projects. Ideally, each risk is borne by the party best equipped to manage it. The private sector often takes on construction and operation risk due to their expertise in these areas. Conversely, the public sector might retain risks like changes in law or unexpected social impacts. Sharing revenue risk is also common, where both public and private partners see financial benefits if the project exceeds expectations, and share the burden if it underperforms. This collaborative approach to risk allocation helps ensure a successful PPP project.

Limitations PPP suitability

PPPs are not suitable for all types of projects, even in countries where PPPs have been promoted actively. Only a limited share of public projects has been pursued through these models. Due to their long-term nature, normally PPPs are not suitable in sectors with rapid changes, e.g. information technology, while they work better when there is a long-term and predictable need for infrastructure services. Therefore, the main question is whether we need the infrastructure to be operational for the next say 20 or 30 years, if the answer to this question is yes, then PPP might be the solution. Furthermore, certain projects in sensitive sites that are linked to national security, for instance, are not usually considered as a suitable PPP projects.

PPP complexity

The structural complexity of PPP projects can create high transaction costs. The project must be large enough to justify such high procurement costs. Consequently, some countries only consider a PPP model for projects with budgets above a certain threshold. Lack of Local Capacity: Lack of capacity of local companies to deliver these types of projects as they might not be sufficiently equipped to manage the risks related to a PPP project.

Political concerns

PPPs can be sensitive from a political point of view. The public might feel that the government is being too generous with specific private sponsors. Further, the establishment of PPPs might entail the introduction of the “User-pay Principle” which can create public discontent. Certainly, strong political support is critical for the success of a PPP project.

Inflexibility

PPP structures might be relatively inflexible and poor at accommodating changes. For instance, it might be costly for the public entity to modify project specifications once the project has been awarded.

Note: Hassan Abdulrahim is senior instructor, Economics & Finance, at Canadian College Kuwait and Deputy CEO, Visionary Consulting Company