What are Public-Private Partnerships and the general principles behind such institutional arrangements?

[Response by Rui Cunha Marques, February 2010]

Public-private partnerships (PPPs) are, essentially, a public procurement arrangement (business relationship) between the public sector and the world of business where risks, rewards and responsibilities are shared. The concept has a large scope of application, but its utilization is particularly relevant at different stages of the infrastructure project where responsibilities are assigned for design, funding, construction, management, maintenance or operation of the infrastructure assets.

Formally, PPPs are established through a contract or a set of contracts, where private entities, called private partners, agree to the development and delivery of a clearly defined activity. The activity fulfills a collective need and for this reason there is continued government interest in it. The private partner(s) is responsible for all pre-determined stages of the activity, and its involvement can be over a period of variable duration depending on the tasks executed. The public partner focuses on the definition of the goals that the project aims to attain, price and quality of service definition and supervision, as well as other contractual terms.

In considering PPPs, it helps to distinguish Private Sector Participation (PSP) from “partnerships”. For example, full divestiture (privatization) need not be included as PPP as the public partner disengages itself entirely from the activity, except to the extent that there remains regulatory oversight. So a broad definition of PPPs might take as its starting point a state-owned enterprise whose ownership and external governance arrangements (formal regulation) change. Alternatively, privatization could be categorized as PSP. At the other end of the spectrum, while outsourcing or service contracts can involve contracts with private enterprise, labeling that arrangement as a “partnership” might imply too close a relationship and the label is not the best possible. Similarly, private sector purchase of the bonds of state-owned enterprises can be characterized as participation, but not necessarily partnership.

So, we will use the term private sector participation (PSPs) broadly defined when referring to involvement of the private sector and Private Public Partnerships (PPPs) when considering contractual and institutional PPPs. Among the different possible classifications, PPPs can be categorized into two types: a PPP of a purely contractual nature and a PPP of an institutional nature (see “What are the different types of PPP arrangements?”).

The following are the main general principles of the PPPs:

a) PPPs are aimed at the satisfaction of collective needs
A PPP generally occurs in the context of the provision of a public service (in other terms a service of general interest), or the construction and management of a public infrastructure, which is intended for the use of the population. Examples include public utilities and transportation services for the former and roads, airports, generation plant, hospitals, prisons and water and wastewater treatment plants for the latter. Due to its public purpose, there are obligations and principles of public service that must be respected and enforced in order to achieve a successful PPP. Principles such as universality, continuity, equality of treatment (fairness in both the process and in outcomes), high quality of service, existence of reasonable profits (returns are commensurate with the risks borne by the private party), and transparence of the activities carried out are important requirements for services directly provided to the citizens and their assurance is fundamental when they are delegated to the private sector.

b) PPPs often involve long term arrangements
Often, PPP implies a long term relationship, comprising various phases of the infrastructure project or its provision (design, construction and operation). When the activities of construction and financing correspond to a significant part of the contract value, the projects should be designed in a whole-life costing perspective, assuring their economic and financial balance, and enabling an effective transfer of risks to the private sector and promoting the project’s financial self-sustainability. For example, a PPP for a dam which has long-life should have a contract duration corresponding to a long-term.

c) PPPs involve the total or partial financing of the project
PPPs involve, almost always, the partial or total funding of the project by the private partner. Financing and the arrangements associated with financing are very complex and difficult to standardize. Although there might be PPPs without private financing, the fact that the private partner participates with its own capital provides incentives for good performance. Therefore, a financing structure of the PPP which includes equity from the private sector is considered a good practice.

d) PPPs are output oriented
Unlike traditional public procurement, where an input-based payment system is often adopted, PPPs are remunerated according to the results and performance obtained. This approach towards results consequently leads to a clear incentive for the private partner to be efficient and innovative in the contract management, enabling higher profits if it outperforms the initial performance targets. These productivity earnings sooner or later will be transferred to the public partner (generally in the form of lower prices to customers, better quality or minor charges for the tax-payer). PPPs also target the achievement of pre-specified goals.

e) The private partner bears a significant number of risks
The various risks associated with the contract must be allocated to the party best able to manage them, that is, the party able to mitigate the risk. As a rule, the risks relative to the infrastructure operation and service provision should be allocated to the private partner, as well as the project and construction risks. It is more difficult to determine who is best able to mitigate consumption/demand risks (for example in the case of a toll road where the private sector only has limited influence over traffic volume) and these, as well as foreign exchange risks and political risks are often retained by the public sector. The adequate risk transfer and allocation is a condition sine qua non for the success and effectiveness of the PPP.