This report focuses on the challenges of governing infrastructure investment and public-private partnerships (PPPs) at the subnational level. Subnational governments – cities and regions – play a vital role in the infrastructure landscape. Infrastructure needs in energy, transport, water and telecommunications are substantial, estimated at USD 6.3 trillion per year between 2016 and 2030. In a tight fiscal environment, it is critical to diversify sources of financing for infrastructure investment and PPPs represent an alternative to traditional government procurement with the potential to improve value for money. However, PPPs are complex and sometimes risky arrangements that require capacity that is not always readily available in government, in particular at the subnational level. This report examines the challenges of using PPPs at the subnational level and ways to address them. It does so by focusing on three case studies: subnational PPPs in France, local Private Finance Initiative (PFI) projects in the United Kingdom, and PPPs in Virginia (United States).
Subnational Public-Private Partnerships
Abstract
Executive Summary
Most public private partnerships (PPPs) occur at the subnational level
The world needs more and better infrastructure. Demand for infrastructure investment has risen and is expected to grow due to many competing pressures. For example, economic growth globally and advances made through technology, along with needed investments to address climate change, urbanisation and demographic changes will require more and better designed climate resilient infrastructure investment. Infrastructure investment is a shared responsibility across levels of government, with subnational governments playing a crucial role. Many key areas of infrastructure – from water to sanitation to transportation to education – are often the responsibility of regional and local governments.
The OECD estimates that approximately USD 95 trillion in public and private investments will be needed in energy, transport, water and telecommunications infrastructure at global level between 2016 and 2030 in order to support growth and sustainable development, equivalent to approximately USD 6.3 trillion per year over the next 15 years.
Public sources of funding are insufficient to cover the investment needs in cities and regions and will remain insufficient if appropriate actions are not taken. The magnitude of the needs and the tight fiscal context for governments imply that mobilising private sources of financing will be crucial. Public Private Partnerships (PPP) could help narrow the infrastructure gap. However, PPPs are complex and sometimes risky arrangements, and there have been many examples in recent years of PPP failures or misuse, which call for caution in their use, in particular at the subnational level.
Despite a growing proportion of infrastructure services that have been delivered through PPPs in the last decade, current levels of infrastructure investment taking place through PPPs are still moderate. Most OECD countries (83%) report that between 0% and 5% of public sector infrastructure investment took place through PPPs in the last three years. IMF estimates indicate that infrastructure investment via public private partnerships is still less than a tenth of public investment in advanced economies and less than a quarter of public investment in emerging market and developing economies.
Although the average value of PPPs is generally higher at the national level, the number of PPPs is higher at the subnational level. In France, for example, subnational governments granted 79% of the contrat de partenariat between 2005 and 2011. In Australia, about 90% of PPPs occur at the (subnational) state level. In Germany, subnational PPPs constitute approximately 80% of PPP investment in terms of volume. In the United Kingdom, local authorities acted as the contracting authority for the majority of Private Finance Initiative (PFI) projects.
PPPs present pros and cons to the public sector. Generally, PPPs are justified when they are affordable and produce greater value for money than delivering public services or public investment through traditional means. Governments expect that private sector engagement will enhance government capacity to achieve its objectives by tapping the resources (money, technology, and knowledge) of the private sector. Gains are expected to result from benefits of risk transfer, private sector incentives, know-how and innovation. However, PPPs are not risk-free. Maximising the benefits and minimising the downsides of PPPs requires substantial public sector capacity, in particular at the subnational government level.
Subnational PPPs: overcoming the challenges
The multi-level context in which subnational PPPs occur as well as their complexity raise specific issues for successful implementation. The report highlights several considerations for using them effectively at the subnational level.
Financing subnational PPPs: watching the risks
Many of the problems reported with subnational PPPs happened because they were chosen for the wrong reasons. Subnational governments may be tempted to choose PPPs to overcome tight budgets and circumvent fiscal rules - rather than seeking value for money and affordability. These are not the right justification for a PPP, and choosing a PPP for the wrong reasons can be very risky in the long-term. PPPs create long-term ordinary liabilities for subnational governments that must be addressed. PPPs are justified when partnership represents greater value for money as compared to traditional procurement, not as a way to bypass fiscal constraints.
Once in operation, PPPs are financed by government payments (i.e. availability payments), user fees, or a combination of both – each with its pros and cons. Availability payments can place a substantial burden on subnational budgets well into the future, reducing their flexibility particularly in times of fiscal constraint. While subsidies from a higher level of government can help, as the UK case demonstrates, they should be used cautiously as they may bias the value for money assessment toward PPPs. User fees raise other issues, not the least of which is the robustness of underlying demand forecasts.
Given the complexity of PPPs and the level of capacities required to design and implement them, they should be reserved for projects of a certain size. Prior OECD work has highlighted that it is important to define a minimum project value for infrastructure being delivered through a PPP. Project development costs of PPPs are significant and are higher for smaller projects. They were estimated by the World Economic Forum to be 1-3% of total project costs for large projects (above USD 100 million) and 3-4% for smaller projects.
Intergovernmental regulatory coherence facilitates PPP use
For a PPP to be feasible, private sector actors must be able to reconcile and comply with regulations across levels of government, jurisdictions, and sectors. Private actors must navigate a myriad of regulations, which increase the administrative burden – and possibly the project cost. The experience of Virginia in the United States highlights the importance of developing a flexible and inclusive statutory framework that supports private-sector participation, accountability, and transparency without inviting political interference. Ensuring regulatory coherence across levels of government is thus critical.
Cross-jurisdictional co-ordination and economies of scale: an important factor in the use of PPPs
Infrastructure investment requires economies of scale and a match between users and geographic area. Small-scale projects that may appeal to local governments may not be appropriate for a PPP. The benefits of infrastructure are also not necessarily limited to a town, city, or even a region. Such instances can require co-ordinating investment across jurisdictional boundaries which is difficult to do. A critical issue is the ability for a number of two or more jurisdictions to enter into a binding contract with private sector actors. Horizontal co-ordination across jurisdictions can help expand the geographic coverage of the PPP, lower barriers to entry presented by small-scale projects and increase the pool of interested, qualified operators.
Administrative capacity needs are high
The technical demands associated with launching and sustaining a successful PPP are substantial. Administrative capacity needs for governments are high and not static over the life cycle of the project. Subnational governments are particularly at-risk for weak partnering capacity due to their size and available resources. Here, rural areas and smaller governments may be more vulnerable to capacity constraints than larger urban ones, although, as the French case study highlights, the latter are not immune to the challenges emerging from the complexity of PPPs. Less experienced subnational governments can face substantial asymmetries of information relative to the private sector.
Skills needed vary over the course of the project cycle. It is likely to be easier for large regions or metropolitan areas to have human resources to dedicate to a PPP project in a sustained manner over time and to benefit from arrangements that facilitate economies of scale. The availability of sufficient resources over the life of a project helps to determine whether a PPP is an appropriate strategy for a subnational government.
Governments should look to involvement of private actors, financing institutions and banks in public investment to offer more than just financing for projects. It should be a way to strengthen capacities of governments at different levels and bring expertise, through better ex-ante assessment of projects, analysis of the market and credit risks, search for economies of scale and cost-effective projects.
Political commitment and accountability
Transparency and effective procurement are central to ensuring accountability given that the complexity of PPPs can increase the risks of corruption and rent seeking. By contrast, weak capacity for value-for-money assessment and a lack of transparency may allow local or regional politicians to pursue PPPs for purposes of political expediency rather than to seek increases in efficiency or effectiveness of public service delivery. It is essential to develop a clear, transparent and stable statutory framework that supports private-sector participation, without political interference. Virginia’s flexible and inclusive statutory framework that supports private sector participation while encouraging accountability and transparency emerges as a key contributor to the state’s successful PPP programme, along with its rigorous project review process.
Key findings and recommendations
Not all infrastructure projects represent strong candidates for PPP procurement. The choice to use a PPP should be motivated by value for money compared to traditional procurement. Small scale projects that may appeal to local governments are not appropriate for the PPP approach. They do not necessarily represent value for money nor are they commercially viable. The promotion of PPP projects at the subnational level should be directed primarily at the larger jurisdictions and regions that already have the general fiscal and institutional capacities required, and also towards priority infrastructure sectors. Addressing the infrastructure challenges that arise in smaller jurisdictions or remote regions requires sustained public investment in order to ensure inclusive and balanced development in the country.
Recommendations
Legal and policy framework
Create a flexible and inclusive statutory framework that supports private sector participation.
Create PPP-specific legal arrangements with a rigorous project selection and review.
Establish clear and transparent PPP review requirements, based on value for money, affordability, but also provisions for debt review, independent audits, and official findings of public interest.
Ensure coherence of laws and regulations across levels of government and across subnational jurisdictions.
Strengthen the sustainability and credibility of contracts so that they do not fall apart with new political pressures.
Financial and budgetary arrangements
PPP proposals must demonstrate superior predicted outcomes compared to traditional public procurement alternatives.
Minimise accounting incentives to move projects “off the budget”.
Use standard ex-ante evaluation instruments.
Adopt third-party scrutiny and approval prior to tender and/or before contract signature.
Governments should look to involvement of private actors to offer more than just financing for projects, but also as a way to strengthen capacities of governments at all levels.
PPP-supporting tools
Establish subnational PPP units, in line ministries or at an arm’s length from government.
Provide standardised documents and examples of contracts adapted to different sectors, to dilute preparation costs and better support subnational governments in the preparation of PPPs.
Higher levels of government may opt for advisory rather than mandatory guidance in order to minimise the risk that standardisation constrains flexibility and innovation at the subnational level.
Develop or strengthen performance indicator systems for PPP design and implementation.
Create peer-to-peer knowledge exchange platforms for subnational governments as well as mechanisms for inter-municipal and regional co-ordination.
Establish national observatories/platforms to collect data and advise cities and regions in their choices to follow PPP performance.
Collect more systematically data on subnational PPPs to fill the data gaps.
