Infrastructure in the developing world: does it need PPPs?

Bankwatch Mail invited two specialists, Matt Bull of the World Bank's Public Private Infrastructure Advisory Facility and David Price of the Centre for Primary Care and Public Health, Queen Mary, University of London, to debate the issue of PPPs in the developing world.

This article is from Issue 51 of our quarterly newsletter Bankwatch Mail

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As covered in Bankwatch Mail 50, the G20 countries, in tandem with the World Bank and other multi-lateral development banks, are pushing forward with proposals for 'exemplary regional' infrastructure projects in the developing world – with public-private partnerships (PPPs) expected to be a central method for delivering these multi-billion dollar investments.

PPPs have garnered a lot of criticism, especially in the UK that has seen the greatest use of them in Europe over the last two decades. Bankwatch has also analysed the shortcomings of PPP projects in central and eastern Europe (pdf), projects that have received substantial backing from the development banks – and this backing for PPPs in our region continues today.

However, since the onset of the economic crisis, across Europe fewer PPP deals have been done. A recent European Investment Bank paper (pdf) notes that: “The PPP market contracted considerably during the 2008-09 financial crisis. In 2010 a slow recovery started and continued in the first half of 2011. Having said this, the number and total value of PPPs remain well below their pre-crisis peak levels.”

The EIB paper points out too that: “According to Moody’s, the outlook for and fundamentals of the PPP market in Europe are stable. Deteriorating public finances have created unprecedented volatility in the cost of borrowing, but also have increased the attractiveness of PPPs as an alternative way to finance infrastructure in some countries.” It goes on to say that: “Since 2007 the total PPP market contracted and the EIB expanded its funding (of PPPs).”

Clearly PPPs remain very much on the agenda at the development banks, both in central and eastern Europe and in Africa, Asia and Latin America. Bankwatch Mail invited two specialists, Matt Bull of the World Bank's Public Private Infrastructure Advisory Facility and David Price of the Centre for Primary Care and Public Health, Queen Mary, University of London, to debate the issue of PPPs in the developing world.

Matt Bull:

Firstly, to kick things off, I think we need to address why development institutions such as the World Bank are engaging in PPP projects. The primary reason is that there is a very large infrastructure funding requirement in the developing world that cannot solely be met through constrained government and Overseas Development Aid (ODA) budgets. Let me explain further.

In developed economies, the debate on whether to engage private sector capital in the delivery of infrastructure primarily revolves around whether the assets should be privately financed or publicly funded with the direction of the debate hinging on how you value the risk transfer benefits of private finance relative to its costs. However, in developing economies, there is often no such luxury, governments often do not have the option of publicly funding their infrastructure because their fiscal positions are weak, there is little or no sovereign bond market for them to raise public finance and the ODA funding available is finite and must be shared amongst numerous 'competing' recipients.

As a result, governments find it difficult to genuinely 'invest' in their economy and instead often choose to offer the private sector the 'rights' to develop the assets on their behalf and in doing so are inviting the private sector to share in (or assume) the risks and rewards of the venture. They do this because the counter-factual is sub-optimal – i.e. without the private participation the asset may never be delivered or may come at such a high opportunity cost (e.g. reduced spending on other priorities) that to do so would be detrimental both socially and economically. Put simply, private risk capital is in some circumstances the only viable funding source.

I think this is important context because the World Bank and other multilaterals are not necessarily pursuing PPPs along ideological lines but instead are viewing them as a necessary part of the funding mix if infrastructure is to be developed and economic and social benefits realised.

This is a very different situation for example to the UK's Private Finance Initiative where there are clearly alternative procurement and funding arrangements other than PFI. So to start the debate I want to set it off on the trajectory of the developing world and not get caught up in some of the arguments that have greater relevance and validity to the developed world.

Of course, PPPs of any sort are a delicate transaction and they have to be done carefully so that the infrastructure is efficiently delivered and value for money achieved. I can go into some of the safeguards necessary to achieve this but will give David a chance to respond first.

David Price:

Let me start with Matt's key argument that whereas developed countries can choose among various financing methods, in developing economies PPPs are an economic necessity. He writes: “private risk capital is in some circumstances the only viable funding source.” The there-is-no-alternative claim has been used repeatedly to support PPPs in the UK. Ministers have insisted that investment would not take place except through PPPs and almost all new hospitals built in the last ten years have been delivered through private finance. Several of these hospitals are now in huge debt because of PPP and only three weeks ago the government had to announce a GBP 1.7 billion bail-out for seven of them.

But familiar as the argument of necessity is, I am struck by the World Bank’s reliance on it. After all, it was the World Bank which pointed out that from the public debt angle the UK government’s private finance initiative (our special variant on the PPP model) was essentially an accounting trick used to get round debt level targets. PPP debt is still public debt only it doesn’t register in the same way as straight public financing.

It’s important to be clear about this: PPP is debt underpinned by public guarantees and ultimately paid back from public funds and user charges sometimes enforced by government. If that is the case, how can it be claimed that PPP is a necessity and public financing an impossibility in developing economies?

If PPP is a policy choice and not an act of God we need to know more before we can assess the grounds for multilateral agency support for the policy. Specifically, what are these circumstances in which private risk capital is the only viable alternative? Or to put this another way, what causes of developing counties’ “weak fiscal position” has the World Bank determined can only be addressed by increased reliance on private equity and in no other way?

And the answer is important because there is nothing self-evidently “developmental” about the private risk capital option. On the contrary, there are known development costs. The PPP option places enormous financial burdens on governments and users of essential services. In the interests of the PPP industry, it cultivates larger rather than smaller schemes. It exposes poorer countries to financial market risks in ways in which they have not been exposed before. It is associated in the water sector with serious social, political and operational problems and with huge price hikes and burgeoning operating expenses.

So the policy is contentious and we need to hear more than that it is unavoidable.

Matt Bull:

Thanks for your response, but there are a few clarifications needed in what you put forth.

First and foremost, the 'there-is-no-alternative' argument (as you put it) is not the sole basis of the debate. What I was saying was that there are various differences in the models of PPPs used in the developing world compared to that of UK PFI. We should not, therefore, frame the discussion solely around a critique of UK PFI as this is only partially relevant given that it is one very narrow form of PPP.

In accounting and monetary terms, there is, frankly, a big difference between PFI and many of the deal structures in the developing world to date. This difference is important.

I do not necessarily disagree with all of your comments on UK PFI – clearly mistakes were made in the structuring of some of the projects and in some cases the risk transfer under the project has proved illusory and government has been left with large contingent liabilities and relatively little contractual flexibility. However, a lot of this is unique to the PFI model. There are other models in use across a spectrum.

For example, a greenfield concession PPP funded by the private sector with the majority of revenue risk transferred to the private sector has a very different set of liabilities to a 'government-pays' PFI. This is exactly why Eurostat (via ESA95) offers a different accounting treatment for PPP projects depending on the deal structure in question to reflect the relative financial risk exposure of the public sector.

The financial burden on government is simply not the same as under PFI because the private sector is taking much more of the risk on the asset's finance, construction and use. Moreover, the asset will typically pass back to the public sector with a residual value at the end of the contract. There is a trade-off, of course, because the burden passes to users and this needs to be carefully considered in line with willingness and ability to pay, and effective regulation – all things we help governments with in deciding whether PPPs are appropriate.

From the opposite end of the spectrum, various PPPs have been launched which use just performance-based management contracts. In this case, there is no private funding requirement, there is greater flexibility and probably smaller contractual liabilities for the procuring authority than under PFI, but significantly less potential for transfer of key risks such as construction risk and these may have to publicly financed with often a very high effective cost of capital.

So, the point I am making is that PPPs are a range of procurement options for governments to be considered alongside traditional methods, and all approaches have different trade-offs. There is no 'one-size fits all' approach but instead a menu of options that responds to the growing realisation across the world that traditional procurement methods are not always the best way of maximising 'whole-life' asset value. There are other options and governments should be free to explore and make the relevant value judgement on their use.

The World Bank has no dogmatic approach to PPP and is not 'nailed to its mast'. We merely recognise that private sector participation and/or investment can be both necessary and, in some cases, desirable. We will help governments find whatever solution works best for the country and project in question. Perhaps a conventional non-PPP approach will be taken, or it may be the opposite – e.g. a large concession.

The decision to pursue a PPP is, and always will be, a value judgement from politicians and decision-makers because you do not have the luxury of knowing what the exact counter-factual situation would be. Because of this, there will always need to be self-determination on the part of governments to adopt PPP with no dogmatic imposition of any particular approach by institutions such as the World Bank. Remember: institutions like the World Bank are dedicated to poverty alleviation and recognise that infrastructure can play a key role in that. These are the first-order priorities; how to procure the assets and pay for them are ensuing issues.

I do need some clarity on your position. I am intrigued to know whether you dismiss all PPPs out of hand and whether you acknowledge the different risk profiles for government of different models of PPP beyond that of PFI.

I also am intrigued to know whether you acknowledge the infrastructure funding gap in the developing world and that developing countries do not have the budget headroom to deal with the gap and must use other tools.

I take your point about likening PFI to debt, and IFRS (for example) agrees with you, but let's imagine PFI was the only model (it is not as discussed). Do you believe it is not normal business for governments to use leverage (within reason) as a tool for investment if you estimate its value for money and the government has a high discounted time value of money as a government?

David Price:

It’s significant that you acknowledge “mistakes were made” in the UK’s PPP policy. PFI deals in the UK were and are still masterminded by financial and management consultancies such as KPMG, PwC, Anderson Consulting and Mott MacDonald. These companies often act for the private and public sectors and their staff have populated PPP units in the UK Treasury and the health service.

In fact, there has been a revolving door between the companies and the civil service. For example, the former head of the Treasury’s PFI Taskforce, the body responsible for designing PPP policy, is now chairman of a large private equity company.

Reliance on consultancy firms is a consequence of the financial and legal complexities of PPP, which are beyond the competence of traditional public administrators. But this dependency means that the policy “weaknesses” to which you refer are largely the responsibility of commercial companies that have advised government, devised and signed off the deals, and produced deeply misleading reports about the policy’s achievements (details of which I would be happy to supply). These companies aggressively market their PPP expertise internationally and I think it’s fair to regard the policy as, in itself, the commercial product of firms that stand to benefit from its adoption by governments around the world. In my view this puts PPPs in a different light and it raises important questions about democratic accountability.

The esoteric nature of PPP fundamentals is highlighted in your paragraph three in which you refer to international guidelines for determining when a PPP is regarded as a government liability and when it is regarded as private.

Whilst I do not think this is the place to discuss accounting standards in general, I would make two points. The first concerns the purpose served by distinctions of this type, namely, whether or not PPPs bring in extra resources: if a PPP is classed as a public debt it is said not to involve extra resources; if it is classed as a private debt it is said to involve extra resources. But as my colleague Mark Hellowell has pointed out, the distinction is largely illusory because all PPP projects “require a commitment of future resources in much the same way as conventional borrowing and cannot provide governments with any ‘additional’ resources.”

As you rightly point out, and this is my second point, this interpretation only applies where PPPs are reliant on tax financing alone, which is PFI’s chief characteristic. In the UK’s national health service, PFI is paid for entirely from the public health care budget and so the crucial question is whether the budget is big enough (that is, whether the PPP is affordable).

This is not the main issue where PPPs are financed from payments made by users, for example, water PPPs. Here PPPs could generate extra resources, but only by increasing user charges. Economists generally refer to users’ “willingness to pay” in this context (as you do too). But this term does not convey the potentially acute social stresses that can arise from higher bills.

Many essential services only reach the poor because of hidden threads of cross-subsidy that make up a sort of social contract. These are exactly the type of arrangements that PPP companies operating concessions are likely to seek to eradicate. You may argue that removal of hidden taxes of this type is right and proper. But then I think the onus would be on you to devise an alternative system of support for access to essential services.

Moreover, the international nature of PPPs and their duration exposes users to new cost pressures. When payments cross borders, payers may be exposed to exchange rate risks. When concession contracts last for years, they may be exposed to inflation or indexation risks. How these matters are arranged in concessions is often not completely clear or the arrangements are insufficiently scrutinised because contracts are confidential. So the financing model may bring risks and costs that would not otherwise bear on users, including some of the poorest in society.

You finish by asking, first, whether I dismiss all PPPs out of hand even though different PPP models involve “different risk profiles for government” and, secondly, whether I accept that it is “normal business for governments to use leverage (within reason)”. It would be unscientific to dismiss all PPPs out of hand because little is known about operational PPPs or indeed about the actual transfer of risk which you say distinguishes PPPs.

This, however, is one of the policy’s most tantalising aspects, for despite in excess of GBP 50 billion PPP investment in the UK, the policy remains unevaluated by government. We simply do not know whether risks have been transferred and at what cost.

If private finance is part of “normal business” of government I do not accept that it should be. In the UK, a presumption against private finance (enshrined in a civil service code known as the Ryrie Rules) was only lifted in the late 1980s as a prelude to PPPs. What exactly is the case for project finance and leverage? I am still not sure.

Matt Bull joined the World Bank in October 2011 and he oversees a portfolio of trust fund activities in Africa. Before joining the World Bank, Matt worked for PricewaterhouseCoopers and Steer Davies Gleave in their respective project finance businesses where he advised and structured a range of project financings in infrastructure in a number of countries and sectors.

David Price is senior research fellow at the Centre for Primary Care and Public Health, Barts and The London School of Medicine and Dentistry, Queen Mary, University of London. He has been involved in research into public private partnerships for 16 years and has also published widely in the likes of The Lancet and The Guardian on the impact of international economic law on public health policy and on health care reform.

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