The Simple Micro-Economics of Public-Private Partnerships

Abstract

We build a unified theoretical framework to analyze the main incentive issues in Public Private Partnerships (PPPs) and the shape of optimal contracts in those contexts. We present a basic model of procurement in a multitask environment in which a risk-averse agent chooses unobservable efforts in cost reduction and quality improvement. We begin by studying the effect on incentives and risk transfer of bundling building and operation into a single contract, allowing for different assumptions on the contractual framework and the quality of the information held by the government. We then extend the basic model in several directions. We consider the factors that affect the optimal allocation of demand risk and their implications for the use of user charges and the choice of contract length. We study the relationship between the operator and its financiers and the impact of private finance. We discuss the trade-off between incentive and flexibility in long-term PPP agreements and the dynamics of PPP contracts, including cost overruns. We also consider how the institutional environment, and specifically the risk of regulatory opportunism, affects contract design and incentives. We conclude with some policy implications on the desirability of PPPs.JEL Classification: D8, L5, H54, H57.

Assigning Tasks in Public Infrastructure Projects: Specialized Private Agents or Public Private Partnerships?

“…Following Iossa and Martimort (2008) we compare unbundling and different forms of bundling in an incomplete contract framework. In a moral hazard context with a risk averse contractor we discuss how different institutional forms affect investment incentives and risk shifting.…”

“…We consider two kinds of PPPs: In the base case the PPP is restricted to building and operating. As shown by Iossa and Martimort (2008) a PPP will then be preferable to unbundling if a qualityenhancing investment in the building stage also reduces the operating cost (positive externality). Having in mind our application -the PPP that is in charge to build, operate and (partially) finance the motorway A8 between Augsburg and Munich -we extend the analysis by considering explicitly that the quality-improving investment may also boost demand for the service.…”

“…The remainder of the paper is organized as follows: In section 2 we present an extended version of the base model from Iossa and Martimort (2008) that allows us to consider the (partial) shifting of demand risk. In order to obtain a reference point for the further analysis, we replicate the results from Iossa and Martimort (2008) concerning bundling vs. unbundling of building and operating in our setting.…”

“…In order to obtain a reference point for the further analysis, we replicate the results from Iossa and Martimort (2008) concerning bundling vs. unbundling of building and operating in our setting. In section 3 we explicitly analyze how the possibility to shift part of the demand risk to the PPP af-fects the preferability of this kind of institutional setting.…”

“…2 Bundling of construction and operation Iossa and Martimort (2008) attempt to provide a general theoretical framework to analyze the incentive issues regarding PPPs. Building on a unified model they identify circumstances under which a PPP is likely to be preferable to traditional forms of public service provision.…”