GROWING ECONOMIES THROUGH PUBLIC PRIVATE PARTNERSHIPS: EXPLORING THE BENEFITS AND RISKS OF PPPS FOR INFRASTRUCTURE INVESTMENT IN EMERGING ECONOMIES

Sophie attended the 2017 OECD Forum and is a UNSW Co-op Scholar. She is currently completing her final year of a Bachelor of Commerce. She has a passion for change making and has held several internship roles at Coca-Cola Amatil, TAL, and Westpac.

ABSTRACT

The increasing population growth and urbanisation of emerging economies is driving an increase in demand for infrastructure investment across the globe. Historically, Public-Private Partnerships (PPPs) have been used to connect public infrastructure projects with private investors, promising innovative solutions and improved resource allocation for emerging economies (OECD, 2012). However, recent PPPs have demonstrated that without clear goals, outcomes and strategic plans, these infrastructure projects can be exposed to a tremendous amount of risk for both parties, both in monetary and social terms.

POLICY RECOMMENDATIONS

Since PPPs are subject to natural monopoly characteristics, regulators must do their best to minimise risks and ensure value for money for all parties. This paper makes three policy recommendations in order to encourage PPP investment by mitigating the risks and capitalising on the benefits of the partnership. These policies aim to assist in addressing the infrastructure constraints which hinder economic growth in emerging economies. Since infrastructure investment often presents specific risks to private investors and governments, certain actions may be taken to encourage PPP investment.

Initial policy recommendations include:

(a)  Developing appropriate legal and regulatory frameworks to support both private and public parties,

(b)  Creating a detailed and well-structured strategic plan for the PPP, and

(c)  Consulting community members in all phases of the PPP in order to avoid poor social and environmental outcomes.

INTRODUCTION

According to the OECD, total global infrastructure investment requirements by 2030 will reach USD 71 trillion (OECD, 2015). Currently, 1.2 billion people live without electricity, 1 billion live more than 2km from an all-weather road and 750 million people lack access to safe drinking water. PPPs have been a popular mechanism used by governments to ‘procure, implement and manage’ public infrastructure and services projects, utilising the resources and expertise of the private sector (Hayes, 2017, p.1). These partnerships connect public infrastructure projects with private investors, promising innovative solutions and improved resource allocation for emerging economies (OECD, 2012). This issue has come to the forefront of international policy as ‘bridging the infrastructure gap’ has become an important step in achieving UN Sustainable Development Goal 9 which aims to ‘build resilient infrastructure, promote inclusive and sustainable industrialization and foster innovation’ (United Nations, 2015, p.1).

Successful PPPs have been implemented across the globe in order to address issues of water supply, power supply, food storage, education facilities, transport facilities and health facilities, just to name a few.

Unfortunately, PPP investments have remained flat over the past decade. This research aims to encourage private sector investment in PPPs by critically examining the benefits and risks of PPPs, to both emerging economies and private investors, as well as recommending policies which aim to create successful PPPs. Encouraging PPP investment will ultimately assist in addressing the infrastructure constraints which hinder economic growth in emerging economies.

BENEFITS OF PPPS

Emerging Economies

PPPs allow governments to harness private sector capital, combined with skills, assets and innovative expertise which will improve public services and much needed infrastructure in emerging economies through investment and operational efficiency (The World Bank, 2016). The inclusion of the private sector in the infrastructure projects means involving skilled private sector management expertise in the planning, execution and delivery of the task. This is important in ensuring that the project can be delivered on time or ahead of schedule and enables the sharing of private sector research and developments which can be applied to the project.

Importantly, since both the private sector and government are parties to the contract, the risk of the project will be shared according to which party is better equipped to manage the particular risk. This risk sharing requires effective communication and a detailed risk analysis in managing the complexities of the project. Furthermore, it helps to ensure that all risks are noted and mitigated if possible

Emerging economies often struggle with financial backing and funding requirements of projects due to the often limited financial resources available in the country. PPPs can assist in resolving this issue as the private sector is able to provide much needed support in terms of financial and strategic backing (Koveos & Yourougou, 2013). 

Overall, many issues which are encountered by the public-sector in project implementation are resolved through a partnership between governments and the private sector. This due to the careful project planning and skilled expertise which help to increase efficiencies and ultimately improve the affordability for governments. Additionally, PPPs further support governments through risk sharing and increased access to long term financing through credit enhancement (PWC, 2005). 

Private Investors

Corporate social responsibility has become increasingly important in today’s business world. Companies and consumers are becoming far more aware of the importance of sustainability practices and the importance of aligned values between companies and consumers. Investment through PPPs will improve a company’s public image and reputation which will ultimately increase public trust in the company, build public relations and strengthen market position.

McKinsey & Company’s Public-Private Partnerships Report (2009) demonstrates, however, that private sector benefits from PPPs include far more than solely a ‘better public image’. These agreements allow companies to access knowledge, experience and market understanding, giving them competitive advantages in other areas of investment. Furthermore, this experience will widen networks and encourage relationships with competitors, ultimately improving their market position in terms of relationship management and network creation.

It has been shown that productivity improvements have resulted from PPP investments as companies improve their own ability to supply goods and services. Additionally, PPPs have helped to create new markets, especially in areas where public and private sector partners have a joint interest in the product. For example, this benefit has been experienced in Africa where public-sector partners create favourable market conditions by removing trade barriers and foreign customer duties in order to ensure access to the product of the PPP (EY, 2015). Ultimately, this partnership with the public-sector provides improved market conditions in which the private company can provide their goods and services.

Finally, an important benefit of PPPs is the sharing of risk and investment (OECD, 2008). This is a benefit for both the private sector and the government as project risks are allocated to the party best equipped to manage the risk. This process aims to reduce uncertainty and improve the expected return on investment. Additionally, the policy-making and political powers of the public-sector can be used to the advantage of the private sector in developing strategies and identifying and minimising investment risks.

RISKS OF PPPS

Emerging Economies

Oxfam Australia raised concerns about PPPs, suggesting that certain projects had shown a lack of accountability for social, health, livelihood and food security in the absence of evaluation of projects for affected communities (Mariott, 2014). It is evident that some PPPs have demonstrated a lack of transparency, participation by governments and disregard from local stakeholder interests. This has resulted in detrimental, rather than positive, effects on the local stakeholders. Thus, since PPPs ultimately aim to improve living conditions and economic growth, it is important for all impacts of the project to be considered in the initial planning phases.

Furthermore, the complexity of the structure of PPPs often presents issues for governments as public authorities are forced to implement ‘processes outside their normal field of confidence’ (PPIAF, 2009). This means that project goals may be misaligned due to misunderstandings, eventually leading to agency costs. These agency costs have been experienced where national government policy, international guidelines and public-sector expectations are misaligned, resulting in inadequate outcomes for at least one party to the agreement.

When constructing a PPP, it is important for the local government to maintain a certain level of dominance in the infrastructure project. This is vital in ensuring that large foreign contractors do not affect the local contracting industry as this would have social implications of an increase in employment as well as political implications in the attitudes of governments towards PPP contracts. 

Finally, it is vital that the risk of cost overrun is mitigated since the detrimental effects of cost overruns have historically caused disastrous effects on communities. This was seen in the example of Lesotho, which replaced a tertiary care hospital and has since led to cost overruns which the Lesotho government is locked into, incorrectly diverting important and scarce funds (Marriott, 2014).

It is important that strong strategic plans are developed in the construction of an infrastructure project in order to protect both parties from the inherent political, societal and financial risks of PPPs. With the historical lessons of failed PPPs, new partnerships need to consider these risks in planning and developing their investment strategy and timeline, in order to achieve the best possible outcome.

Private Investors

The long-term, complex nature of the projects are often politically or socially challenging to implement and introduce (World Bank, 2016). In addition, despite the possibility of sharing risk with the public-sector, financial risks include interest-rate and exchange-rate fluctuations which may discourage private investors to take part in the PPP, specifically in an unstable economic environment (Macquarie Capital, 2015).

Hayes (2017) discusses the structural challenges that are faced by the private sector in emerging economies. These challenges include corruption, weak business environments and political instability. For private investors, corruption poses a significant risk in signing up to a PPP due to the inherent political instability of the partnership (Hall, 2015). In mitigating these risks, it is important that governments become more transparent and focus on improving governance and fair competition in order to support the private sector in the investment.

Due to the long-term nature of PPPs, it is difficult to identify all possible risks that may be encountered throughout the partnership. The change in government has the potential to alter attitudes towards PPPs, thus causing issues in terms of foreign contractors or changes in tariffs and duties. Therefore, in the preparation and implementation phases of PPPs, it is important to minimise political risk through robust partnerships and regulatory frameworks. This will provide private investors comfort in the stability of the agreement and the success of the infrastructure project (Maier, 2015).

Finally, the private sector is aware of the ‘failed PPPs’ that have resulted from poor management, lack of government transparency, lack of government interest in the project and unidentified project risks (Scott, 2013). Failed PPPs may lead to detrimental reputational effects on the company which project a negative public image. This risk of reputational damage is a serious concern for private investors, and therefore PPPs need to ensure that all possible projects risks are accounted for and considered in the design, implementation and execution of the project.

POLICY RECOMMENDATIONS

Firstly, there is a need for a detailed PPP strategy in order to increase private sector interest in PPPs. This recommendation involves a formal strategic plan and project guide which outlines the project aims and details the potential risks that need to be considered.

A successful PPP needs to have a clear long term strategic vision. In order to achieve this vision, a detailed strategic plan should address the infrastructure needs which the project aims to satisfy and clearly set out project phases and estimated times of completion and budget allocation. The plan should also include a cost-benefit analysis which considers the fiscal risks, constraints and implications. Furthermore, through consultation with experts, the strategic plan should look into the potential environmental and community impacts of the project.

In order to achieve a smooth and successful partnership and project, extensive research into similar PPPs and World Bank commentary on these PPPs should take place. By learning from other projects and unexpected issues that were encountered, the team will have the opportunity to mitigate the risks to the best of their ability.

Secondly, appropriate legal and regulatory frameworks need to be established in order to attract private sector investments. In order to decide whether to go ahead with the PPP investment, private investors will evaluate the frameworks in order to understand their rights and responsibilities as well as the actions they can take in certain situations.

These frameworks should include investor protection, contract design and renegotiation, infrastructure procurement, dispute resolution and separation of risk between parties. Ultimately, these frameworks should encourage PPPs by boosting transparency, protecting investors from political instability and ensuring fair competition in relevant industries. Furthermore, as mentioned in the OECD 2015 report, governments should introduce implementation oriented guidance in order to encourage private investment in the form of PPPs.

A report by The World Bank and PPIAF (2011) demonstrates that strong legal and regulatory frameworks will encourage private sector participation as they provide clarity on government policies in relation to the infrastructure sector in which the PPP will be used. Both government and private investors are provided comfort through frameworks which increase project predictability and transparency.

Frameworks in emerging economies which often have weak legal and regulatory institutions provide stability and predictability. When crafting policy, it is important to ensure that a balance is found between fixed legal and regulatory frameworks and a flexible framework which can be adapted overtime and for different PPP projects (PPIAF, 2011).

Finally, it is vital that community consultation is performed prior to the implementation. This involves a thorough examination of the social and environmental impacts that the PPP may have, and the ongoing effects of these impacts. Since PPPs aim to improve standards of living, it is important to consider all impacts on all stakeholders, not solely the perceived benefits of the direct parties to the PPP contract.

The Australian Council for International Development observed that large scale infrastructure projects can have negative social impacts such as displacement of people and loss of indigenous culture, as well as environmental impacts such as land degradation and air and water pollution. Without community consultation in all stages of the PPP, poor decisions may be made which deteriorate the standard of living for locals. For example, in Ghana, the entire national water service was restructured for a PPP project, resulting in issues with providing water to poor communities (Hall, 2015). In the planning phases of PPP projects, an analysis of the surrounding communities and the potential impacts on standards of living must be considered. If necessary, a community liaison should be assigned in order to ensure that the community members are not negatively impacted by the project.

CONCLUSION

PPPs have clear benefits to emerging economies in supporting their economic development and economic growth. The above analysis has demonstrated the obvious risks involved, however with a clear and detailed strategic plan, the right frameworks in place, and a focus on community consultation, the PPP will likely succeed. These policy recommendations aim to facilitate PPPs in which the strengths of both parties are capitalised and risks are shared appropriately, resulting in positive outcomes for both parties in the agreement.

Ultimately, in order to achieve the UN 2030 Sustainable Development Goals, policies need to ensure that PPPs are designed and implemented in a way that identifies and mitigates all possible risks to all parties in order to maximise potential benefits from the partnership.

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