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PPP Introduction and Overview

15.4. Disadvantages and Pitfalls of the PPP Option

In addition to offering benefits and advantages, PPPs are also a procurement option, however, one that has weak spots and potential disadvantages.

  • PPPs are significantly more complex than traditional procurement methods. Consequently, there is a significant risk in sinking resources into unworthy or unsuitable PPP projects that consume more resources than conventional and less complex procurement routes. PPP projects demand more highly specialized resources and attention by the government. The time needed for PPP project preparation is longer than for public works projects, and governments wanting quick results may be discouraged from following the PPP route. The complex nature of PPPs may be mitigated by sound and detailed guidelines for managing the PPP process, as well as realistic time frames and appropriate organization of resources and knowledge (for example, PPP units);
  • The PPP route has more visibility and political exposure. After political change, new government administrations can perceive that they are only paying for an infrastructure project that generated political benefits to others (their predecessors) in the past. Worse, it is also currently reducing their budgets to develop new projects. This negative factor can be mitigated in several ways: proper communication policies, the search for political consensus on the use of the PPP model, and the establishment of a PPP program;
  • Public controversy may emerge due to the public belief that PPP implies either a rise in charges or the application of new user charges. Both the public and unions may react and be opposed to PPPs, especially when they imply substitution for the direct provision of a public service. Again, communication is the essence of managing perception and contestation risks. Additionally, retrenchment is a specific matter that deserves careful attention and specific management[43];
  • PPP procurement has significantly higher transaction costs, both for the public sector and the private sector/contractor community. These higher costs are inherent in the higher complexity of the procurement, particularly during the tender process, but also in preparation/appraisal and monitoring resources. This disadvantage can be minimized if projects with only a certain significant capital size are procured. Provided a project is of a sufficient size, the PPP efficiencies are likely to outweigh the higher transaction costs;
  • PPPs produce a higher cost in terms of surveillance for governments, introducing higher performance monitoring to make sure that the efficiency and quality gains are actually delivered. However, this higher cost is part of the price of a more reliable quality of service. In traditionally delivered projects, the costs of ongoing quality monitoring are often less visible as they are seen as “business as usual” for the procuring authority, and therefore not costs of the project. Alternatively, monitoring does not occur at all, leading to a degradation in the quality of service; and
  • The PPP route appears to be more expensive in terms of financing, as the cost of private financing includes a risk premium in the form of a margin in interest rates and the equity Internal Rate of Return (IRR) requested by the private equity capital, which by definition is a more expensive financial instrument than the alternative of direct government financing. However, the government’s cost of borrowing understates the true cost of financing as it does not remunerate the government for bearing risk in the project.

This does not mean that the PPP option is by definition more expensive. However, if the project is unsuitable for a PPP solution, is poorly structured, or the procurement process or the contract is poorly managed, the use of expensive private finance is unlikely to be offset by other efficiencies. This creates an unexpected extra burden in terms of affordability that is not compensated for by the efficiency savings.

  • Countries with less sophisticated accountability and fiscal monitoring regimes face a risk that PPPs will result in excessive budget commitments that threaten long-term fiscal sustainability. When a PPP is not recognized as contributing to public debt, there is a risk of ignoring/dismissing the long-term fiscal implications. Long-term budget sustainability may be endangered as a result. This may be offset with a robust appraisal (which is more demanding than in a normal procurement) and an appropriate policy framework in terms of controlling aggregated PPP commitments (see chapter 2 for further information on this matter). Examples of excessive fiscal risks are discussed in PPP Reference Guide, Version 2.0 (World Bank, 2014);
  • Rigidity: As a long-term contractual commitment for the public party, a PPP implies rigidity in budget management (potential renegotiations of a contract to decrease costs in an unforeseen economic downturn are costly). The only way to handle rigidity pitfalls is by controlling the aggregated exposure of PPPs and analyzing affordability carefully (chapter 2.8.5 provides a description of the relevance of reporting and accounting); and
  • Lack of competition (post award): After the signing of the contract, contract renegotiations are frequent. When this happens, being a monopolistic supplier, the private operator has an advantage in negotiating with the government compared to a supplier in a competitive market (OECD 2008). The only way to mitigate these risks is to build flexibility for change into the contract, together with clear boundaries. Chapters 7 and 8 deal extensively with contract change matters.

 

These features represent weak points, disadvantages and risks inherent in the PPP route. Therefore, the PPP option may not be the most appropriate for a specific project if these risks are not manageable by the government so as to substantially eliminate or mitigate them. Similarly, PPP may not be appropriate if the government does not have mechanisms of control in place (for example, control of aggregated exposure and proper affordability analysis).

A project needs to fit with the PPP tool, and it should be recognized that PPP procurement is not appropriate for every infrastructure project.

Furthermore, a particular country may face additional challenges to develop the PPP route successfully, which relates to macro-economic conditions and the general framework for doing business in the specific country. (This is explained below in section 5.6).

 

[43] For specific guidelines on retrenchment, see the International Finance Corporation’s (IFC's) Good Practice Note - Managing Retrenchment (August 2005) and IFC's Performance Standard 2.

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