Public–Private Partnerships, Corruption and Inefficiency

Abstract

The chapter examines the formation of public–private partnerships (PPPs), one of the most important organizational forms to evolve over the last few decades. In particular, we analyse a possibility that has been relatively under-analysed in the literature, namely the possibility of collusion between the private firm and the governmental department in case of PPP formation. The chapter first develops a simple formal model based on risk sharing that is capable of analysing this issue. It then shows that PPPs are more likely to form in case the externality gains out of the project are significant, and the agents are quite risk averse. Otherwise, PPP formation may lead to bribery and sub-optimal project choice, and the government may opt for government control instead.

This chapter draws on the authous’earlier work, Roy Chowdhury and Roy Chowdhury (2016).

Appendix: The London Metro PPP

Tubelines were awarded the Jubillee, the Northern and the Picadelly lines, while Metronet got (a) the Bakerloo, Central and Victoria, and (b) the District, Circle, Hammersmith and City lines. The negotiations were extremely complex, with the work being phased over 30 years. Tubelines and Metronet were to do the upgradation, while the London Underground Limited (LUL) was to provide the final services. In fact, the complexity of the contract meant that advisory services themselves cost 109 million pounds. Further, the delay in project allocation meant that the LUL had to provide substantial compensations to the various bidders, including the losers.

Broadly, the contract specified two aspects, risk allocation among the parties, and the payment mechanism. As to risk allocation, the demand risk was borne by LUL as they did the final service provision. The cost overrun risks were, however, shared, as the amount of cost overruns to be borne by the private companies were capped. This reduced the incentives for checking overruns, as is clear from the Metronet experience. Metronet’s incentive for checking costs overruns was not very strong, as Metronet’s shareholders were also suppliers of the consortium, so that any higher costs would translate into revenue for them! In fact Metronet had cost overruns four times that of expected costs. However, Tubelines which did not have such an interlinked structure incurred no cost overruns. Finally, financing risk was also shared. While financing was provided privately by the Infracos, the public sector-borne substantial risks via a debt guarantee entitling lenders to recoup 95% of their invested funds in case of early contract termination.

Turning to the payment mechanism, it involved basic Infrastructure Service Charge (ISC), combined with bonuses and deductions. Performance was measured in terms of journey time capability (JTC), i.e. the time needed for a train to complete a journey. Ambience and general conditions of trains were measured by consumer surveys.