Failure in public partnerships

The Jakarta Post

— Agustus 14, 2009–

Being perhaps the most geographically unique country in the world, Indonesia faces a higher burden compared to other, continental nations in ensuring infrastructures equitably to its citizens.

Instead of producing this infrastructure alone, the government has, since 2005, mobilized the necessary funds from the private sector, both domestically and internationally, by enacting Presidential Decree No. 67/2005, an umbrella regulation for public private partnerships (PPPs). Until to day, the PPPs have embarked on 87 projects, worth a combined total of more than US$34 billion (PPP Book, 2009).

Regardless of any potential benefit, a PPP is neither a perfect concept nor a panacea. As an example, the United Kingdom is the leading country in terms of PPPs; however, there was a spectacular case of failure surrounding Metronet (UK House of Commons, Transport Committee, 2008).

This £15.7 billion (US$25 billion) project was signed off on in 2003. Tasked with maintaining and renewing the London underground, Metronet declared bankruptcy in 2007. Although Metronet is not a typical PPP in terms of money and complexity, it offers substantial lessons to learn from.

Learning from the Metronet case, Vining and Boardman (2008) defined essential rules for governments to avoid the failure of PPPs.

The first rile is to ensure regulations that ensure transparency for all PPPs are adopted. There are some fundamental indicators for real transparency such as consistent and timely budget reporting; public availability of all contracts; public consultation; a fair bidding process; and the disclosure of potential contingent liability.

Simply, without transparency, a PPP is more likely to end up in disaster; either the government will end up having to bail it out with additional funds or the PPP will be stopped altogether.  Hence, this is the meta-rule.

The second rule is to create separately the regulation; analysis; contracting; and oversight agencies. By definition, the regulation agency constructs fundamental regulations to all agencies, ensures compliancy and solves conflicts that may occur among agencies. The analysis agency analyzes the social cost-benefit of PPP proposals, assesses possible contingent liabilities, fiscal and other risks and chooses the best partnership scheme that is in line with national macroeconomic frameworks.

Meanwhile, the contracting agency organizes all PPPs: tendering bids, selecting partners and making and monitoring contracts. The oversight agency evaluates performance of all PPPs to minimize government expenditure and to keep track of all future liabilities, as well as ensuring the contracting agency fulfills requirements for transparency and bidding process.

Inevitably, these separations are needed to secure checks and balances. A single powerful PPP agency is more likely to abuse its authority and end up with failures. Indeed, there is no uniform design of these agencies, especially for the contracting agency. In UK, the contracting agency is formed as a public and private joint venture; in India it is under the Ministry of Finance; while in Korea it is under a think tank.

In respect to decentralized institutions, the contracting agency in Indonesia may be established at both central and local government levels. However, a PPP center is necessary to coordinate all PPP units; to share resources in terms of knowledge, experience and expertise; to improve capacity and to achieve efficiency and reduce costs. In conclusion, the key point of this rule is that a balanced power system ensures the success of a PPP is more likely.

The third rule is to ensure that the bidding process is reasonably competitive. It is impossible to achieve the highest efficiency and the lowest cost in a monopolistic market. Obviously, competition among three to five bidders is better than between two bidders or less.

So, the government, as the PPP promoter, should be proactive in searching for the optimal number of bidders by neither favor nor restrict particular bidders. Moreover, the PPP promoter can encourage bidders by lowering the bidding costs, and if possible, remunerating some or all. Thus, the highest potential of a PPP will not be met unless fair competition is secured.

The fourth rule is to avoid a stand-alone company with limited equity or a large consortium of partners. Forming a separate, special purpose vehicle (SPV), may create moral problems for the parent company, which lowers its own equity at risk. If problems arise, easily, the SPV can declare bankruptcy rather than finding operational solutions.

Similarly, a private sector partner that is too large creates no incentive to provide the needed organizational leadership fundamental to the success of a PPP. The key point is to ensure that the private sector partners have strong incentives to maximize their capacity to administer the project by sharing adequate interests and risks.

The fifth rule is to prohibit the private sector contractor from selling the contract too early. Needless to say, the primary advantage of a PPP is synergy among partners and the agreement to share resources, risks and rewards. Meanwhile, a PPP is usually a long term contract divided into design, construction, operation, and transfer to government phases.

So, if a partner thinks that it can sell a contract in the early phase, before all of the bugs are known, it will have an incentive to under invest in the project. Eventually, when problems arise, it is not clear which company should be blamed and held responsible. Thus, the government should enforce an optimal time lag before permitting a partner to sell the contract to others parties.

The main advantage of a PPP is public private synergy. But the PPP is not a perfect concept; there is the potential for failure. Hopefully, the government can avoid these potential failures by ensuring the right rules are put in place.

The writer works at the fiscal policy office and is a master’s student at the Asian Public Policy Program, Hitotsubashi University, Tokyo. This is his personal opinion.

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