Working to find actionable solutions to the nation's key challenges.

Untangling Five Myths About Public-Private Partnerships

By Andy Winkler, Niki Deininger

Tuesday, September 18, 2018

America’s infrastructure—including its transportation, water, energy, and broadband systems—require considerable investment to both meet existing maintenance needs and to upgrade, modernize, and expand in coming years. In its most recent Failure to Act report, the American Society of Civil Engineers (ASCE) estimated that, despite recent congressional efforts to devote more funds towards the nation’s infrastructure, the United States is still about $2 trillion shy of the $4.59 trillion that will be needed to maintain and upgrade the nation’s infrastructure systems through 2025. The brunt of these costs will fall on local governments since they own much of the country’s infrastructure assets and federal contributions have trended downward. With a vast array of demands for limited public resources—including healthcare programs, pensions, and debt service—it is increasingly difficult for local governments to cobble together the funding to pay for their infrastructure needs.  

In recent years, the public sector has turned to innovative ways to address its growing infrastructure backlog. Public-private partnerships, or P3s, are one option to leverage private sector capital to finance public infrastructure projects. The private sector is often well-positioned to take on project risks, provide needed funds, and offer valuable expertise to aid the public sector in infrastructure construction, installation, and sometimes service delivery.

Despite numerous cases demonstrating the benefits of P3s, some stakeholders are reluctant to engage the private sector in public infrastructure projects. In part, this is because there are notorious examples of P3s that (according to some) have “failed” and were not in the public’s best interests. The varied success of past P3 projects has created misconceptions or myths about their value and continues to deter some governments from exploring P3s. Yet the state of the country’s infrastructure, and the public sector’s inability to bear the full cost of needed projects by itself, demands that policymakers work to separate fact from fiction and better promote P3 best practices. Doing so would help local governments avoid some of the pitfalls of early P3 experiments and deliver the best value to the public, while ultimately leading to better-maintained infrastructure over the long term. Here are five common myths about public-private partnerships.

Myth 1: P3s Are the Same As Privatization

One reason confusion surrounds P3s is because the term has no standardized definition. Some sources use words like privatization, outsourcing, and leasing interchangeably with public-private partnerships. BPC defines P3s as an agreement between a public authority and private entity to share the risks and responsibilities of delivering a project. P3s can take a variety of forms along a spectrum of responsibility and risk-sharing, with greater or lesser private involvement in the project based on the negotiated agreement. On one end of the spectrum, for conventional or design-build projects, a private company may have a minimal role. On the other end of the spectrum, however, A private company could have a minimal role on one end of the spectrum and a significant one on the other, in some cases including purchasing or leasing the asset from the public. The main difference between P3s and privatization is that the former encompasses a wide array of possible partnerships whereas the latter involves the sale of a public asset to a private company. Figure 1 outlines some of the most common types of P3s.

Common Public-Private Partnership Agreements and the Roles of the Public and Private Secto

 Public PartnerPrivate Partner
ConventionalPublic offers individual contracts for design and construction; public operation and maintenance; public financingDifferent private companies win contracts for individual project stages
Design-Build (DB)Public offers a single contract for design and construction; public operation and maintenance; public financingPrivate company responsible for project from design through construction
Design-Build-Operate-Maintain (DBOM)Public offers a single contract for the design, construction, operation, and maintenance; public financingPrivate company responsible for the project from design through operation and maintenance
Design-Build-Finance-Operate-Maintain (DBFOM)Public offers a single contract for the design, construction, operation, and maintenancePrivate company responsible for the project from design through operation and maintenance; private financing for a fixed number of years
Private OwnershipPublic sells asset to private entityPrivate company responsible for all stages of project indefinitely; may be subject to regulations

While the sale of an asset may be considered a type of P3, most do not include privatization. In fact, the most common type of P3 agreement is design-build, which some stakeholders do not even consider a P3 because of how limited the private sector role is. Specifically, the Public Works Financing database, a comprehensive record of 221 P3s across the country completed between 1996 and 2016, found that 53.9 percent of public-private partnerships were design-build. About 31.7 percent of projects involved private financing and around 14 percent included operations or maintenance components without private financing. Notably, the prevalence of these contract types also varies dramatically by the type of infrastructure asset.

Myth 2: P3s Mean the Loss of Public Control of an Asset

A major concern of governments and their constituents is that P3s mean the loss of community control of a public asset. In this context, “control” can mean a few things: ownership, decision-making authority, or the ability to set or maintain prices and quality standards. While there have certainly been cases domestically and abroad of this occurring, the public sector has various tools at its disposal to retain control based on its needs. Chief among them is the P3 agreement itself: the public sector can negotiate a contract that ties financial incentives to specific performance metrics. By clearly defining all expected responsibilities in the P3 agreement, the public sector can shift a significant amount of risk to a private entity. For example, Virginia’s Dulles Greenway and the Indiana Toll Road demonstrate how the public sector successfully transferred financial uncertainty to a private company. In each case, the public sector was not responsible for covering maintenance costs resulting from overestimating drivers’ projected demand for tolled roads. By assuming this risk, the private entity has a clear financial incentive to succeed, and ultimately perform in accordance with the desires of the public sector and its constituents.

BPC also recommends specific steps for public entities to enhance oversight, transparency, and accountability of P3 projects—all of which help communities maintain control over public assets.

Myth 3: P3s Always Result in Higher Costs

When it comes to project delivery, one of the major benefits of P3 agreements is that they tend to lower costs. By bundling multiple stages of a project together, such as design and construction, the public sector can save on project delivery time and costs due to better coordination of resources. Bundling additional components like financing, operation, and maintenance can achieve even greater cost savings. For example, when a private contractor is responsible for the condition of the asset over a long-term contract and required to deliver the asset back to the public in a specific condition, it is less likely to cut corners or use cheaper materials if doing so results in higher long-run operating and maintenance costs. Whereas more conventional procurements tend to emphasize upfront costs (favoring projects with cheapest price tag), well-executed P3s incorporate future operating and maintenance costs to deliver the best value of the expected life of the project or contract.

Private financing is a primary reason that stakeholders believe P3s inherently raise costs. While private financing is more expensive than tax-exempt debt, when combined with the other advantages of P3 agreements—such as a faster project delivery time, risk sharing, and private expertise—a public-private partnership is generally more cost efficient in the long run. While the public sector can reap considerable savings from greater cost certainty alone, risk transfer and some repayment options can also result in cost savings. Specifically, part of the risk-sharing of P3 agreements typically includes granting the private entity a share of profits from project revenue in exchange for assuming revenue risk. Having the private sector assume this risk can protect the public from unanticipated maintenance costs in the future, which could ultimately save governments money. For example, in Pennsylvania’s Rapid Bridge Replacement project, the state’s Department of Transportation is obligated to pay fixed annual maintenance costs to the contractor. This not only ensures the sufficient maintenance of the bridges over 25 years, but also protects the state against any additional, unintended future costs.

Private financing is also beneficial because it removes the need for upfront public funding and can finance projects for a greater duration compared to conventional project delivery. Considering the tremendous demand on current public budgets, the option to use private financing allows the public sector to address crucial infrastructure projects that it may otherwise not be able to complete.  

Myth 4: P3s Are the Best Choice for an Infrastructure Project

While P3s offer several advantages for the public sector, they are not automatically the best choice. When it comes to financing options, the United States has a robust, tax-exempt municipal bond market which offers favorable rates for many localities. Municipal securities may be more suitable than private financing for a project depending on state law, statutory debt limits, and public credit ratings. Yet since the 2008 financial crisis, many cities are less willing to assume such debt and instead are turning to private capital.

To determine whether a P3 is the most efficient approach for a given project, the public sector should perform various cost-benefit analyses. A widely-used option is value-for-money analysis, which compares the expected cost of a project using a conventional method against the anticipated cost of the same project under a P3 agreement. This analysis indicates which method offers the best value for its cost. While the public sector should use whatever methodology it deems appropriate, it is imperative that governments conduct analysis to demonstrate which delivery method is the most efficient use of its resources.  

Myth 5: P3s Are Only Useful for Large-Scale projects, urban areas, or projects that involve tolls

Another common misconception about P3s is that they are only useful for large-scale projects or ones that collect tolls. Although it is true that the project cost and risk are important considerations in choosing P3 delivery, smaller projects can also be suitable for public-private partnerships. Examples such as Detroit’s Metro Freeway lighting project and Pennsylvania’s Rapid Bridge Replacement project demonstrate that bundling multiple smaller projects together under a single P3 agreement can be cost-effective and efficient. Both projects leveraged the economies of scale from a P3 to renovate and replace multiple smaller infrastructure projects which the public sector may not have been able to fix otherwise.

This is particularly true for much of rural America. In rural communities, there is often a considerable need for improved infrastructure, even while the prevalence of small-scale projects and lack of funds restricts the public sector’s ability to address those needs. By bundling multiple small, rural projects, authorities can provide the necessary scale to attract private investment. Kentucky, for instance, bundled multiple broadband projects together in a P3 agreement to improve and expand access to high-speed internet. Pennsylvania also used bundling in a P3 agreement for a private company to design, build, finance, operate, and maintain 29 compressed natural gas fueling stations in rural areas across the state. In addition to faster project delivery and lower fuel costs, Pennsylvania estimates that bundling saved the state about $46 million.  

Project bundling is just one example illustrating the range of possible P3 agreements. Another example involves various options for repaying private debt. While many P3s continue to rely on tolls or user fees to pay financing costs, recent P3 agreements demonstrate innovative alternatives. The Port Miami Tunnel, for example, was funded by milestone and availability payments rather than tolls. These payments came from state and local revenues and were paid to the contractor annually, contingent upon quality standards outlined in the concession agreement. Variations in P3 agreements illustrate that there isn’t just one type of public-private partnership, but an array of possibilities depending on the scope and type of project at hand. 

P3s Can Be a Valuable Tool for the Public Sector

Since no two P3 agreements are exactly alike, it is important to understand the advantages and disadvantages of pursuing a public-private partnership for a given project prior to entering into an agreement. Specifically, the public sector should clearly define the expected purpose and public benefits of a project beforehand, and then be able to negotiate on behalf of those interests in its concession agreement. By aligning financial incentives with a private entity’s performance, the public sector can safeguard against unanticipated future costs, decline in service quality, and demand or revenue risk.

Untangling the myths surrounding P3s is the first step to better understanding how the public sector can   harness private capital and expertise to fulfil the country’s vast infrastructure needs in a timely and cost-efficient manner.

 

KEYWORDS: P3S