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Finance and Public-Private Partnerships

Private finance of infrastructure grew substantially during the last twenty five years. Part of the growth has been caused by public-private partnerships (PPPs), which bundle investment and service provision of single public infrastructure projects into a long-term contract with a private single-purpose firm. Because most PPPs enjoy few economies of scope and assets are project specific, project finance is appropriate. PPP projects are highly levered. Banks tend to finance construction. During the operation of the project, bond finance substitutes for bank lending. Whether a PPP is a better way of procuring public infrastructure depends almost exclusively on the economic characteristics of the specific project, not on the way it is funded or financed. PPPs work when objective performance standards can be written into the contract between the public authority and the private firm. Moreover, proper intertemporal accounting shows that PPPs do not liberate public funds. Consequently, in the public budget and the government’s balance sheet PPP projects should be registered like public projects. The apparent higher cost of finance of PPPs---the so-called PPP premium---is not an argument in favor of public provision, since it appears to emerge due to the combination of poor contract design plus the cost-cutting incentives embedded in PPPs. Thus in the case of a correctly designed PPP contract, the higher cost of capital may well be the price to pay for the efficiency advantages of PPPs as compared with public provision.

496wp.pdf (459.87 KB)
Eduardo Engel
Ronald Fischer
Alexander Galetovic
Publication Date
March, 2014