Joanna Tyrowicz

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• Joanna Tyrowicz
• Limits of state

Institutional Economics
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But I thought you were going to talk about
econometrics?!

• State (especially welfare) is obliged to assure
  provision of some services, BUT...
• ...it does not have to provide them!
• Face it most of them CANNOT be provided
  inhouse ?
• Distinction between financing and provision
• Then the economic question
• What to provide and what to contract? The
  criteria!
• How to contract?
• Schedule for today
• Theory of contracting, PPPs
• Empirics of PPPs
• Empirics of PPPs in the context of development

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What is a Public Private Partnership?

• Any collaboration between public bodies, such as
  local authorities or central government, and
  private companies tends to be referred to a
  public-private partnership (PPP).
• PPP cover a wide variety of working arrangements
  and offer the opportunity for the private and
  public sectors to become involved in a
  relationship which will see the expertise of both
  sectors being utilised to deliver and maintain
  public sector assets and services.
• PFI - Private Finance Initiative
• Joint Ventures
• Outsource Partnerships

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Why do it ?

• Central Government Policy
• Governments should be keen to expand the range of
  private public partnerships because they believe
  it is the best way to secure the improvements in
  public services that politicians promised at the
  last election.
• Devolved Government Policy
• Delivering better and modern public services
  should be a top priority central and local
  administration.
• Public Private Partnerships (PPP) are an
  important part of this modernisation agenda and
  provide the basis for continuing real step change
  in how public services are delivered across
  countries.

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What is the problem about?

• Possible advantages
• lower capital constraints
• incentive-based contracts
• encouragement of innovation
• lower production costs (scale and scope
  economies).
• Possible disadvantages
• Legal
• Not defined responsibility of contractors
• Not defined relations between sectors
• Institutional
• Unwillingness to cooperate
• Not defined data exchange and data use procedures
  
• Weak administrative capacities
• Job protection!
• Cultural
• Societys distrust gt corruption claims, etc. ?

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The Temptation

• Knowledge is Power

Commercial Competitive Advantage Intellectual
Property
Political Specialist Knowledge Job Protection
Private
Public
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Economics of PPPs

• The efficiency of PPP remains an unresolved
  empirical question
• At the theoretical level
• Transaction Costs Economics
• Williamson 1976, Williamson 1999
• Incomplete Contracts Theory
• Hart-Shleifer-Vishny 1997 Hart 2003 Bennett
  Iossa 2002
• Arbitrage Theory
• Bentz Grout 2002
• A TCE approach would stress a simple idea
• The common error to be avoided is to pronounce
  that governance structures are efficient or
  inefficient without reference to the transaction
  there are transactions for which the firm is
  superior to the market, its bureaucratic
  disabilities notwithstanding
• O.E. Williamson 2002, page 20.
• Possible drawbacks of PPP contractual costs
• Transaction costs may, in certain situations,
  overcome advantages in terms of production costs

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What are potential transaction costs?
Choice of the Private Operator
Contract renewal
t
Service specification
Contract execution
Competition for the field
Competition for the field
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Franchising problems to overcome

• EX ANTE Specification of the franchised service
  and effective competitive bidding
• Imprecise specification
• adverse selection problem (the winners curse)
• Small number of bidders
• Price and quality do matter ? Artificial or
  obscure award criterion.
• EX POST
• Risks of opportunism
• Delays in construction and provision
• Efforts to renegotiate the contract
• Lower level of quality than promised
• Absence of responsiveness to consumers needs
• Price increase
• Risks of maladaptation
• Price-cost divergences
• Indeterminacies
• Those problems are particularly important when
  the transaction is uncertain and needs high level
  of asset specificity

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Potential transaction costs solutions exist!

• Contractual solutions
• Choice of the operator
• Menu auctions
• Pre-qualification criteria
• Bids formulated in terms of a constant revenue
  stream
• Allocation of risk
• Minimum level of quality required
• Execution stage
• Dissuasive but realistic penalty clauses
• Enforceable sanctions Monitoring and accounting
  procedures Capacity of expertise
• Open Book Policy Yardstick competition
  Information transparency

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Potential transaction costs solutions exist!

• Institutional solutions
• Credibility of the contracting parties
• Reputation
• Institutional dotations (corruption, property
  rights )
• Laws that constrain contractual choices and
  potential opportunistic behavior
• No institutional choice is better than another a
  priori.
• The choice between PPP and direct public
  management depends on the characteristics of the
  transactions (asset specificity / uncertainty /
  complexity)
• Recent developments show that solutions may exist
  that qualify PPP in many situations

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What should government buy?

• Paper by Bentz, Grout, Halonen (2004)
• The basic issue there are assets and there are
  services THEY DIFFER!
• If the quality of assets (e.g. the of subsequent
  operations) depend on initial asset investment,
  there is a problem
• Whether quality is high becomes private
  information of the builder (moral hazard problem)
• Whether costs of operations are high become
  private information of the service provider
• The government if it contracts has to provide
  incentives to ensure that service provider
  reveales the correct cost, i.e. there is an
  adverse selection problem at the service
  provision stage that creates informational rent
  for the service provider.

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What should government buy?

• In traditional procurement, government has to
  separately incentivise
• the builder (to overcome the moral hazard
  problem)
• and apply the revelation mechanism for the
  service provider (to overcome the adverse
  selection problem, revelation mechanism).
• In a PPP model the same company builds and then
  operates the asset to provide the service.
• Information rent gained at the service delivery
  stage is greater the more often costs of delivery
  are low
• Consequently, the consortium (of builder and
  service provider) has the incentives to build the
  best possible asset.
• PPP gives high quality for free

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What should government buy?

• BUT
• If the costs of assuring high quality at the
  investment stage are high, this for free
  mechanism no longer works
• PPP can still provide high quality, but
  revelation mechanism is overpaid (exact IC
  constraint not possible)
• Credibility of government not to have soft
  budgetary constraints afterwards
• Conclusions
• Implementing PPPs when traditional government
  costs are high are not effective (examples???)

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Contracting to FPs vis-a-vis NFPs?

• Paper by Bennett and Iossa (2005)
• Comparison of FPs and NFPs
• Incomplete contract approach
• Firm may make uncontractible investment,
  researching innovative approaches
• Control rights give power to veto implementation
  of innovation
• Consider three alternative scenarios
• No conflict innovation increases both profit and
  social benefit
• Conflict of type 1 innovation increases social
  benefit but unprofitable
• Conflict of type 2 innovation increases profit
  but reduces social benefit

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Contracting to FPs vis-a-vis NFPs?

• Model
• G and NP/FP agree on a contract that specifies
  verifiable basic standards
• NP/FP may make investment, researching innovative
  approaches
• x level and cost, in terms of disutility of
  effort, of the investment made
• x uncontractible
• Ownership of project gives veto power on
  implementation of innovation (control rights)
• Under tendering, G has control rights
• Under partnership, NP/FP has control rights
• Social benefit from innovation (if implemented)
  B0 ? B(x)
• Profit from innovation (if implemented) p0 ?
  p(x),

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Contracting to FPs vis-a-vis NFPs?

• B(x), p(x) are observable but uncontractible
• NO CONFLICT SCENARIO Bx, px gt 0
• CONFLICT OF TYPE 1 SCENARIO Bx gt 0 gt p x
• CONFLICT OF TYPE 2 SCENARIO p xgt 0 gt Bx
• Assumption Bx ? px gt 0 (it makes sense to
  invest!)

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Contracting FPs vis-a-vis NFPs?

• Conclusions
• under partnership, firm internalizes profit
  effect fully but no internalization Gs social
  benefit effect
• Under tendering, firm shares social and profit
  effect with G
• The highest investment is achieved by
• No Conflict tendering to FPs (if Bx and/or p
  high), otherwise partnership with FPs
• Conflict of type 1 tendering to FPs (if Bx
  and/or p high), otherwise partnership with NFPs
• Conflict of type 2 partnerhisp with FPs
• The highest social benefit is achieved by
• No Conflict as above
• Conflict of type 1 as above
• Conflict of type 2 tendering to NFPs
• Even if NFPs care more than an FPs about B, B may
  be greater with FP!!!

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Empirical setting, Saussier (2005)

• Water distribution, only this time in France ?
• Data sets from the French Environment Institute
  and the French Ministry of Agriculture
• A representative sample of all the French local
  authorities
• 5,000 local authorities in 1998
• Restricted to 4,443 observations in statistics
• Restricted to 3,613 observations in econometric
  tests
• Account for more than 50 of the consumers
• The question Price, cost and organizational
• Asset specificity
• Physical investments are specific (site
  specificity)
• Complexity
• Mainly due to
• difficulty of the treatments for producing
  drinkable water (e.g. the quality of the water
  before treatment)
• difficulty of transporting water to the consumer
  (the density of population)

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The case of water supply in France

• Decision local authorities decide, not State
• A great variety of organizational choices

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Institutional environment and potential
transaction costs

• Drawbacks of PPP resulting from contract
  incompleteness can be reduced by the
  institutional framework
• The intuitu personae principle
• May avoid problems linked to the choice of the
  operator
• Risk of corruption/collusion
• PPP are  administrative  contracts
• An asymmetric position between contracting
  parties
• Ex post renegotiations take place within a rigid
  framework

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The case of water supply in France USE OF PPP

• The use of PPP

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The case of water supply in France - PRICES
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Prices and organizational choices a first look
Prices for local authorities that do not contract
out the service are lower The price difference
between lease and direct public management is 32
In euros for 120 m3, without tax

• Two possible interpretations
• Collusion prices - PPP are inefficient because of
  ex ante transaction costs
• PPP are specialized on complex transactions - PPP
  are efficient

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Prices and organizational choices an econometric
test

• Naïve OLS equation, controlling for other
  parameters than organizational choices that may
  have an impact on prices

? R2 0,50 ? Lease contracts account for 27 in
the price (average bill of 140 ) ? All types of
PPP lead to an increase of price paid by the
consumer
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Prices and organizational choices an econometric
test

• Cost structure might be different from one
  organizational choice to another
• Estimate 2 equations
• Possible selection bias
• Organizational choices are not randomly chosen ?
  TCE propositions ? Heckman Method

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In what situations could drawbacks overcome
advantages of a PPP?

• Robust probit estimate of lease vs. direct public
  management
• Complex transactions (complex treatments, low
  density of population) are more probably
  organized through lease contracts
• Non-linear effect of the population size
• More than 75 of observed choices accurately
  predicted

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Prices and organizational choices an
econometrical test
Correcting for selection bias, direct public
management is still the most efficient
organizational choice
? However the price difference between lease and
direct public management decreases again (About
10 )
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Experiences of developing countries

• Paper by Estache (2004)
• PPP in infrastructure investments (790 billion)
• Steadily growing 1970s-1997, droping afterwards
• Some evidence of catastrophe
• 50 of contracts in LA renegotiated
• Reasons for divorces largely uknown
• Why such results?
• Part of PPPs where privatization related
  (railroads, roads, healthcare, etc.)
• Government Quick budget revenue, and long budget
  costs...
• Providers improving access (pressure), worse
  clients (lower profits)
• Rate of return versus total cost of ownership
  considerations
• Balduzzi (2007) paper theoretical review to
  start from

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Assignment?Thank you for your attention!

• jtyrowicz_at_wne.uw.edu.pl
• http//www.wne.uw.edu.pl/jtyrowicz
• http//www.development.wne.uw.edu.pl
• -gt Development Workshop Institutional
  Economics (2nd year)