Economics of Public Private Partnerships

Introduction

Public Private Partnerships or the PPP Projects are the answer to the development of countries like India that are starved of resources where the government finds itself unable to commit massive funds for infrastructure development and yet, needs such projects for economic growth. This article examines the economic aspects of the PPP projects by applying theory to the practice as is the case in India. Before launching into the discussion, it would be pertinent to note that PPP projects are here to stay and despite opposition from various quarters, it would be better if the decisions on such projects are made on economic concepts based inputs rather than on the whims and fancies of the players.

Incentives and Distortions

To start with, private players must be incentivized to participate in the PPP projects. Starting from the initial tendering to the contract singing and extending to the execution, implementation, and maintenance, at each stage, the private players must be assured of returns on their investment. For instance, it is common for many highways and other construction projects in India to be executed on a Build-Operate- Own/Transfer mode wherein the concessionaire is allowed to levy tolls and collect money from the motorists using such infrastructure. It is the case with the airports wherein the private players can operate them through revenues accrued by way of levies and user development fees.

However, in recent years, there has been a tendency by civil society egged on by vested political and other interests to agitate against the levying of tolls on highways. This creates a disincentive for the private sector as they can neither recoup their investment nor transfer the project considering the sunk costs. Therefore, the incentive system must be in place and equally important is the honoring of the contractual obligations by the government in a transparent manner.

Correct Estimation of Risk and Return

Apart from the incentives that must lure the private players, the risk and return equation must not be skewed against the latter and the reward system being offered to the private players must be appropriate to the risks that they are carrying. For instance, it is common in India to draft concessionaire agreements that are skewed in favor of the government in some cases and in favor of the private players in other cases. The determination of as to who is rewarded depends on a host of factors including the closeness of the private players to the powers that be and other forms of crony capitalism. This must be avoided at all costs and the risk and reward equation must be scientific in nature without allowing for biases etc.

The Problems of Moral Hazard

Having said that, it must also be noted that in some cases, the Indian government has been bending over backwards to some private players especially in the case of ports and airports. This has taken the form of arranging for soft loans and deferring the payment period as well as bailing them out when necessary. This creates a problem of moral hazard wherein such concessions to some can be demanded by the others as well. The world witnessed the mega bailouts of the big banks in the aftermath of the 2008 financial crisis. Some economists decried such bailouts as being morally hazardous as they reward bad behavior and penalize those who have played by the rules, it is indeed the case that the Indian government would well be advised to draw lessons from this and ensure that it does not fall into this trap.

Mapping Demand and Supply

Next, and perhaps the most important aspect as far as economic theory is concerned is that there must be a balanced demand and supply equation as far as the PPP projects are concerned. Recent research indicates that the construction industry has been overly invested in leading to excess supply in the absence of adequate demand. For instance, the inventory buildup in some of the infrastructure projects such as public housing and the creation of SEZs or Special Economic Zones reveals that massive investments have been made in these sectors that have resulted in oversupply.

Allocation of Resources

Fourth, the guns vs. butter dilemma is something that the Indian government grapples with as far as PPP projects are concerned. Considering the fact that India is still a developing country and hence, needs to invest massively in creation of social infrastructure, it is faced with a dilemma of channeling investments and partnering with the private sector according to the priorities that are determined by the above aspects. However, it is also the case that India needs modern infrastructure such as world-class airports and hence, cannot shy away from inviting private participation in such ventures. At the same time, there have been vociferous protests against excessive investments in infrastructure that ignore the needs of the average person. Therefore, it is indeed a balancing act for the government as it tries to grapple with this dilemma.

Conclusion

As can be seen from the above discussion, PPP projects have to be evaluated financed, and revenue generation done based solely on the economic aspects by applying theory and not because of political or other considerations. For long, the PPP projects in many developing countries have been hostage to political compulsions and hidden agendas of vested interests. It is high time all the stakeholders agreed on evaluating and executing the PPP projects on the basis of the points mentioned in this article rather than on the basis of vote bank politics and crony capitalistic considerations.