Soft budgets and endogenous renegotiations in transport PPPs: An equilibrium analysis

Abstract

It has been known for some time that renegotiations of public-private partnerships (PPPs) are related to the political cycle. For example, in his seminal work on renegotiations Guasch (2004) found that incoming administrations tend to renegotiate the contracts signed by previous administrations to adjust policy priorities and avoid political costs (e.g. increasing tolls). More recently, Aguirre (Aguirre et al., 2015) found that Peruvian transport PPPs are renegotiated with higher frequency during election years. This paper contributes to the literature by exploring the incentives that prompt governments to renegotiate PPPs in equilibrium. We show that a basic feature of the political cycle—the current government may be replaced by a different administration—, the long horizon of PPP contracts, which span several administrations, and the off-balance sheet treatment of PPPs combine to endogenously produce PPP renegotiations as an equilibrium outcome. Somewhat surprisingly, the current government (referred to as ‘incumbent’ in what follows) wants to bring forward infrastructure spending even when it does not affect the probability of reelection.

It is important to understand what drives renegotiations because in the last three decades PPPs have spread to become an accepted means to procure public infrastructure. For example, in Europe PPP investment rose from almost zero in 1990 to almost €30 bn in 2006 (before falling by one third in the aftermath of the financial crisis; see (Engel et al., 2014b)). Similarly, in low and middle income countries, PPP investments rose from less than $20 bn p.a. in the early 1990s to between $50 bn and $90 bn p.a. in recent years (see (Engel et al., 2014b)). As Engel et al. (2014a) show, nearly three quarters of PPP investment is spent in transport infrastructure— mostly highways, but also bridges, tunnels, railways, airports, and seaports.1

The promise of PPPs is that private firms will deliver better transport infrastructure faster and at lower cost than conventional provision. It is claimed that these efficiency gains stem from bundling the design, financing, construction and operation of transportation projects in long-term contracts.2 With bundling, concessionaires optimize intertemporally over several decades to minimize life-cycle costs.3 Indeed, in a recent paper, Valero (2015) shows that the ability of governments to pre commit to a long-term contract is necessary to ensure the realization of the efficiency gains that PPPs promise. In addition, when quality of service is contractible, as is the case of highways, a PPP will lead to better maintenance. Nevertheless, it is well known that PPPs tend to be routinely renegotiated and that renegotiations may dilute the incentives that prompt concessionaires to deliver better performance