Henri Konan Bedie Bridge, a public-private partnership, links the north and south of Abidjan, Cote d'lvoire.

Edward F. Buffie, Michele Andreolli, Bin Grace Li,

and Luis-Felipe Zanna

Public-private

P
UBLIC-private partnerships to build • The administrative costs of writing and
and operate infrastructure assets are tendering bids for complicated long-term
partnerships increasingly common in less devel- contracts are often substantial, while limited
have been oped economies (see chart). But they
are also highly controversial. Case studies
competition and the difficulty of designing
auctions that prevent collusive behavior are
criticized as warn that public-private partnerships may be apt to result in inflated bid prices.
too costly, much more expensive than traditional pro-
curement in which public agencies build in-
• Complex contracts, the impossibility of

but when
enumerating all contingencies in partner-
frastructure assets on their own (or outsource ships that last 20 to 30 years, and cumber-
the whole construction to a private supplier). Tradi- some legal systems often lead to repeated,
tional procurement is commonly called own
economic investment by the public sector.
costly renegotiations of the original contract.
• Even i f the government bargains excep-
picture is The list of extra expenses incurred in public- tionally well and minimizes bid, tendering,

considered, private partnerships is quite long:

• The partnerships assign construction
and renegotiation costs, it cannot avoid the
extra cost of monitoring compliance by the
they look risk to the private partner to exploit the tight private partner.

much better relationships between asset construction,

quality of services, and the revenue the part- Half a picture
ner earns after operations commence—fre- But the comparison of costs presents only
quent blackouts, for example, reduce sales half of the picture. The other half contains
at poorly built power plants. But the private everything the private partner brings to the
sector cannot spread risk as widely as the table: superior technical expertise, greater
public sector; consequently, the return paid implementation capacity, and less pressure
to the private partner is usually several points to meet political objectives—such as hiring
above the interest rate on government debt. more workers than needed and purchasing

52 F i n a n c e & D e v e l o p m e n t S e p t e m b e r 2016
from favored suppliers—that hinder efficiency (de Bettig- and to reduce unemployment, underemployment, and poverty.
nies and Ross, 2004; Valila, 2005; Grimsey and Lewis, 2005). When these additional objectives are taken into account, the
These advantages translate into shorter construction time social returns to public-private partnerships and own invest-
(Monteiro, 2005; Sarmento, 2010) and better, more produc- ment diverge dramatically. (The social return is the increase
tive infrastructure—power plants that supply electricity with- in national income adjusted to reflect the value policymakers
out spikes and frequent blackouts, roads that are usable year- place on poverty reduction.) Because public-private partner-
round, and ports where cargo can be loaded and unloaded ships generally build better, higher-quality infrastructure than
quickly. The critical issue is whether the gains in speed and own investment, they raise the return on private capital more
efficiency compensate for the higher cost. I n the language and increase the demand for labor more. Consequently, if the
favored by government bureaucrats, do public-private part- difference in costs is not too great, public-private partnerships
nerships offer enough "value for the money"? More precisely, are preferable because they are more effective in reducing
do such partnerships offer better value for money than own underinvestment, unemployment, and poverty.
investment by the public sector?
Typically, policymakers answer this question by calculating Choosing the right approach
the direct return in the two investment programs. The direct But it is difficult for policymakers to assess whether the social
return is simply the return on infrastructure (the increase in returns from faster construction and better-quality infrastruc-
real GDP, holding other inputs constant, divided by the capital ture outweigh the higher costs of public-private partnerships.
cost of the project) minus either the return paid to the private We built a dynamic macroeconomic model that helps
them do that. The model tracks the interactions between
public investment in infrastructure, private capital accumu-
If the difference in costs is lation, unemployment, and real wages. Growth in the stock
of infrastructure—whether an airport, a power plant, or an
not too great, public-private irrigation project—raises social welfare directly by increas-
ing total factor productivity (the rise in output not directly
partnerships are preferable. attributable to increases in inputs such as labor and capital)
and indirectly by stimulating private investment and creating
more and better jobs. The model uses empirical estimates for
partner (including transaction and administrative costs) or the
developing economies to determine the impact of infrastruc-
interest rate paid on external debt. In a head-to-head matchup,
ture on total factor productivity and how much the real wage
the comparison of direct returns often picks own investment
rises when unemployment falls.
as the winner—the higher-quality infrastructure available in
the public-private partnership is not worth the extra cost. Welfare depends on consumption today, tomorrow, and
The direct return is easy to understand and easy to calcu- in the distant future. To measure the overall welfare gain, we
late. For two reasons, however, it is rarely an accurate predic- calculate the permanent increase in consumption that yields
tor of relative social returns. First, higher on-time completion by the same increase in welfare as the actual path of consump-
public-private partnerships is a big plus in low-income coun- tion in the investment program. A welfare gain of 10 percent,
tries plagued by acute bottlenecks in transportation, power, for example, means that the fluctuating path of consumption
telecommunications, and irrigation. When projects pay a 25 in the investment program increases welfare by the same
percent return and can be financed at 10 percent, it is best amount as a permanent increase in consumption of 10 per-
to complete them as fast as possible. Second, in most invest- cent starting today.
ment programs, the government aims not only to improve the Policymakers must determine the point at which the welfare
country's infrastructure but also to stimulate private investment gain from the public-private partnership exceeds that of own
investment. The break-even point
depends on numerous factors, includ-
Growing apace
ing policymakers' social objectives.
Investments in public-private partnerships have risen sharply in the past two decades
especially in developing economies. The table illustrates how the model
(investment in public-private partnerships, percent of GDP) can help policymakers make the right
2.0 2.0 choice. It shows the welfare gain from
— Armenia /
public-private partnership divided
1 T
— India /
1.5 1.9 by the welfare gain from own invest-
— World — Ghana 1
— LICs and LMICs — Uganda If ment under alternative assumptions
1.0 1 n
f l.U about the labor market, the speed of
0.5
construction, and the importance of
0.5
wage income relative to increases in
r^^^»^«^^ . . i . . . . i . . income per capita. In the case of own
Q J
1987 92 97 2002 07 1987 92 97 2002 07
investment, we assumed that the gov-
Source: IMF; Investment and Capital Stock Dataset. ernment borrows in the Eurobond
Note: All data are in five-year moving averages. UC • low-income country. LMIC - lower-middle-income country.
market at 6 percent and that infra-

F i n a n c e & D e v e l o p m e n t S e p t e m b e r 2016 53
 How to choose tion in public-private partnerships and traditional procure-
ment, but allow for unemployment and different welfare
When the ratio of the welfare gain from a public-private
weights for wage income and average income. In the unem-
investment to that from own investment on an infrastructure
ployment scenario, the government ignores effects on income
project exceeds 1, policymakers should choose the
distribution; in the third and fourth scenarios, it values a dol-
partnership, even though on a direct-return basis the return
from traditional procurement is higher. lar increase in wage income 50 to 100 percent more than a
dollar increase in average household income.
Difference in direct return
between own investment and What is striking is that many of the ratios exceed 1, mean-
public-private partnership, Break-even ing that public-private investment increases social welfare
percentage points ratio
more than own investment, even when the direct-return
0 0.02 0.04 0.06 0.08
gap is large. Faster construction speed alone increases the
break-even value of the direct-return gap—that is, the point
Scenario 1: Ratio when there
is full employment but speedier
at which a government would have no preference between
2.20 1.82 1.45 1.07 0.69 0.064
construction by public-private investment approaches—from zero (the value in the com-
partnership parison of direct returns when both return 10 percent) to 6.4
Scenario 2: Ratio when there is percentage points. In other words, a public-private partner-
1.27 1.13 1.00 0.87 0.73 0.040
unemployment
ship with a direct return greater than 3.6 percent generates a
Scenario 3: Ratio when the larger welfare gain than own investment with a direct return
welfare weight on wage income is
1.35 1.23 1.11 1.00 0.88 0.060 of 10 percent, once the difference in speed of construction is
50 percent higher than the weight
on average income taken into account.
Scenario 4: Ratio when the In the model with unemployment and the same speed of
welfare weight on wage income is construction, the break-even value ranges from 4 to 7.2 per-
1.38 1.28 1.17 1.06 0.96 0.072
100 percent higher than the weight
on average income
centage points depending on the weight of wage income rela-
tive to average income.
Source: Authors' calculations.
Note: Direct return is assumed to be 10 percent for own investment. It varies from a The lesson is that policymakers ought to look beyond
net of 10 percent to 2 percent for the public-private partnership. The direct return is
the net increase in GDP divided by the capital cost of an infrastructure project minus
direct returns when evaluating the merits of public-private
either the return paid to the private partner (including transaction and administrative partnerships versus own investment. Public-private part-
costs! or, in own investment, the interest paid on external debt. Welfare gain is
the permanent increase in consumption generated by an investment program.
nerships are undeniably expensive. But they are competitive
The break-even ratio is the point at which the welfare gain from public-private with traditional procurement if they enable the public sector
partnership exceeds that of own investment, even though the direct return seems to
favor own investment.
to build infrastructure faster and of higher quality. A public-
private partnership that pays a modest direct return of 2 to 5
structure earns a return of 16 percent. The direct return, then, percent may generate a higher social return than own invest-
is 10 percent for all own investment. ment that pays a direct return of 10 percent. •
In the competing public-private partnership, the borrow-
ing rate—the annual return paid to the private partner plus Edward F. Buffie is a Professor of Economics at Indiana
all transaction and administrative costs—is 15 percent, while University Bloomington. Michele Andreolli is a Research
the return on infrastructure ranges from 17 percent to 25 Officer, Bin Grace Li is an Economist, and Luis-Felipe Zanna
percent. The corresponding range for the direct return, then, is a Senior Economist, all in the IMF's Research Department.
is 2 percent to 10 percent. With own investment assumed to
return 10 percent, the comparison of direct returns alone This article is based on the authors' 2016 IMF Working Paper, No. 16/78,
strongly favors own investment: the direct return gap, the dif- "Macroeconomic Dimensions of Public-Private Partnerships''
ference between the direct return from own investment and
the direct return from the public-private partnership, ranges References:
from zero—when the direct return from both is 10 percent— de Bettignies, lean-Etienne, and Thomas W. Ross, 2004, "The
to as high as 8 percentage points—when the direct return Economics of Public-Private Partnerships," Canadian Public Policy, Vol.
from public-private partnerships is 2 percent. The case for 30, No. 2, pp. 135-54.
choosing public-private partnerships over own investment Grimsey, Darrin, and Mervyn K. Lewis, 2005, "Are Public Private
therefore rests entirely on more favorable effects on comple- Partnerships Value for Money? Evaluating Alternative Approaches and
tion time, private investment, job growth, and real wages that Comparing Academic and Practitioner Views," Accounting Forum, Vol.
offset its lower direct return. 29, No. 4, pp. 345-78.
Monteiro, Rui Sousa, 2005, "Public-Private Partnerships: Some Lessons
Several scenarios from Portugal:' E I B Papers, Vol. 10, No. 2, pp. 73-81.

The table reports results for four different scenarios. In the Sarmento, loaquim Miranda, 2010, "Do Public Private Partnerships

first, there is full employment but investment projects in the Create Value for Money for the Public Sector? The Portuguese Experience,"

public-private partnership reach the 50 percent completion O E C D Journal on Budgeting, Vol. 2010, No. 1, pp. 1-27.

point in 25 percent less time than own-investment projects. Valila, Timo, 2005, "How Expensive Are Cost Savings? On the Economics

The other three scenarios assume the same speed of construc- of Public-Private Partnerships," EIB Papers, Vol. 10, No. l.pp. 95-119.

54 F i n a n c e & D e v e l o p m e n t S e p t e m b e r 2016