slide1 n.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
Efficiency vs. Flexibility in Public-Private Partnerships Thomas W. Ross and Jing Yan Sauder School of Business Univer PowerPoint Presentation
Download Presentation
Efficiency vs. Flexibility in Public-Private Partnerships Thomas W. Ross and Jing Yan Sauder School of Business Univer

Loading in 2 Seconds...

play fullscreen
1 / 39

Efficiency vs. Flexibility in Public-Private Partnerships Thomas W. Ross and Jing Yan Sauder School of Business Univer - PowerPoint PPT Presentation


  • 86 Views
  • Uploaded on

Efficiency vs. Flexibility in Public-Private Partnerships Thomas W. Ross and Jing Yan Sauder School of Business University of British Columbia October 2013. Economists have noticed PPPs. Previously studied issues by theorists: Efficiency of bundling tasks

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'Efficiency vs. Flexibility in Public-Private Partnerships Thomas W. Ross and Jing Yan Sauder School of Business Univer' - sierra


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
slide1

Efficiency vs. Flexibility in Public-Private PartnershipsThomas W. Ross and Jing YanSauder School of BusinessUniversity of British ColumbiaOctober 2013

economists have noticed ppps
Economists have noticed PPPs

Previously studied issues by theorists:

  • Efficiency of bundling tasks
  • Effect of non-contractible elements (e.g. quality)
  • Private vs. public financing
  • Transaction costs in PPP procurement

Efficiency vs. Flexibility in PPPs

UNIVERSITY OF BRITISH COLUMBIA

2

recognized potential advantages of ppps
Recognized potential advantages of PPPs
  • Greater productive efficiency through use of the high-powered incentives available in the private sector.
  • Greater efficiency through the exploitation of economies of scale or access to key skills using the private sector.
  • Benefits from bundling tasks to recognize complementarities of some tasks
  • Greater innovation and dynamic efficiency from private sector.

Efficiency vs. Flexibility in PPPs

UNIVERSITY OF BRITISH COLUMBIA

3

challenges for ppps
Challenges for PPPs
  • High transaction costs with such long (sometimes > 50 years) contracts.
  • May be very difficult to assure all key aspects of service delivery via contract – i.e. some important elements may not be contractible (e.g. quality)
  • Some loss of flexibility for government – decision-making authority allocated to private partner and adapting to changing circumstances done in bilateral (i.e. non-competitive) environment

This paper is about challenge 3

Efficiency vs. Flexibility in PPPs

UNIVERSITY OF BRITISH COLUMBIA

4

this paper
This Paper
  • Explores in a simple, but formal way, the trade-off between efficiency and flexibility that exists in PPP contracts.
  • Closest paper is by Bajari and Tadelis (2001)
  • The flexibility challenges in PPP arrangements are well recognized in the literature and by practitioners:
      • National Audit Office (2008)
      • OECD (2008)
      • PwC (2005)
      • Yescombe (2007)

Efficiency vs. Flexibility in PPPs

key idea
Key Idea
  • Strong incentives lead private sector to greater productive efficiency
  • As long as competition is intense, these savings are transferred to the government (and taxpayers) through lower bids
  • However, if contract needs to be renegotiated, this is not done in a competitive environment – it is two-party bargaining under which some of the benefits are likely to flow to the private parties

Result: An important trade-off – PPPs bring productive efficiency but, when they need to be renegotiated, they can be costly for taxpayers

Efficiency vs. Flexibility in PPPs

model overview some basics
Model Overview: Some Basics
  • The government (G): the principal, wishes to procure certain public services over an extended period of time
  • The “firm” (F): the agent, bids to deliver these services --
    • could be a public sector agency/department, or a private sector firm
  • F is taxed on its profits at a rate t
  • Contract changes will be negotiated via Nash bargaining with weights λ for G and (1-λ) for F

Efficiency vs. Flexibility in PPPs

two special cases
Two Special Cases

We can use two special cases of this model to explore the differences between PPPs and traditional public procurement (PUB)

PPP: 0 < λ < 1 (both parties with bargaining weight)

0 ≤ t < 1 (not all F’s profits taxed away)

PUB: λ = 1 (all bargaining power to G)

t → 1 (all profits collected by G)

Efficiency vs. Flexibility in PPPs

basic set up costs
Basic set-up: Costs

.

  • The cost function of the project:
    • K: the innate cost of the project
    • e: cost reducing effort (non-verifiable)
    • δ > 0: e’s marginal productivity (private information of F)
    • monetary costs of this effort

Efficiency vs. Flexibility in PPPs

basic set up benefits
Basic set-up: Benefits

.

  • Benefit of Project (not contractible):

Right project b0 > 0 Wrong project b1< b0

  • With probability μ an unexpected change in demand happens – current project becomes the wrong project.
  • If changes are needed they are negotiated via Nash bargaining
  • After the contracts are settled, F picks its level of effort, costs are incurred, contracts honoured and payoffs received.

.

Efficiency vs. Flexibility in PPPs

objective functions
Objective Functions
  • Firm: makes decisions to maximize its after-tax profits subject to honouring its contracts.
  • Government: two possibilities – differences depend on treatment of transfers
    • social welfare or total social surplus (TSS)

TSS = benefits minus real economic costs (not transfers)

2) “value for money” (services of the quality desired are provided at lowest cost to the ultimate payers) (VFM)

VFM = benefits – costs to government (net of tax receipts)

Or in expected value terms:

E (VFM) =(1-μ) [benefits - costs]no changes + μ[benefits - costs]changes

Efficiency vs. Flexibility in PPPs

timing
Timing

.

  • Government puts project out for bids.
  • Firms bid, it is awarded to the firm offering to provide it at the lowest fixed fee, .
  • Nature may move to change demand – if no change, proceed to 5.
  • If demand changes, is renegotiated (to ) via (weighted) Nash bargaining and the design is changed, both parties incur switching costs .
  • F chooses level of effort, .
  • Benefits are realized and the government honours its contract.

Efficiency vs. Flexibility in PPPs

solving working backwards starting with effort choice
Solving: working backwards starting with effort choice

.

  • Government taxes supplier’s profit at rate t, so F maximizes:
  • Maximizing this w.r.t. e yields:

Efficiency vs. Flexibility in PPPs

renegotiation nash bargaining
Renegotiation: Nash Bargaining

.

A method of allocating the surplus to be created by a renegotiated agreement. Splits the new surplus between the two parties. Key factors in this division:

1. Parties’ threat points (what if there is no agreement)

2. Bargaining weights

Efficiency vs. Flexibility in PPPs

axioms of nash 2 party bargaining
Axioms of Nash 2-Party Bargaining

.

Bargaining solution should satisfy:

  • Individual rationality (no one accepts less than he/she can get by disagreement)
  • Invariant to linear transformations (units don’t matter)
  • Pareto Optimality (cannot make everyone better off)
  • Independence of Irrelevant Alternatives (when you compare two outcomes it does not matter what other alternatives are available)
  • Symmetry (both parties treated the same by process)

Efficiency vs. Flexibility in PPPs

typical form of solution
Typical form of solution

.

Notation:

S1, S2 = amounts going to party 1, party 2 respectively

D1, D2 = disagreement payoffs for party 1, party 2 respectively

Basic solution will be S1, S2 that, subject to being viable, maximizes (where NP = “Nash Product”)

NP = (S1 - D1) • (S2 - D2)

or with bargaining weights added:

NP = (S1 - D1)λ• (S2 - D2)1-λ

Efficiency vs. Flexibility in PPPs

solving renegotiation
Solving: renegotiation

.

  • G threat-point:
  • F threat-point:

Efficiency vs. Flexibility in PPPs

nash product
Nash Product

.

NP =

Efficiency vs. Flexibility in PPPs

renegotiated price
Renegotiated Price

.

  • Maximizing this with respect to yields:

Efficiency vs. Flexibility in PPPs

initial price
Initial Price

.

  • Important Assumptions:

Competitive Bidding with Limited Liability

  • Substituting for e* = (1-t)

Efficiency vs. Flexibility in PPPs

so now we have solved the model
So now we have solved the model

.

  • We know:
  • The initial price (α0);
  • If there is renegotiation what the new prices will be (α1);
  • That the right project will always be implemented; and
  • The effort that the firm will exert (e*) and therefore what the real costs of providing the service will be.

Efficiency vs. Flexibility in PPPs

objective is to maximize expected vfm
Objective is to maximize expected VFM:

.

E(VFM) = (1-μ)[b0 – α0] + μ[b0 – α1]

  • = b0 – [(1-μ)α0 + μα1]
  • Where α0 and α1 will depend on the procurement method used.

Efficiency vs. Flexibility in PPPs

putting it together expected vfm here
Putting it together: expected VFM here

.

Efficiency vs. Flexibility in PPPs

result 1 general case
Result 1: General Case

.

Expected VFM will be greater:

  • the lower is the cost of the project (K);
  • the greater is the gross benefit ( and );
  • the greater is the cost reducing effect of effort (;
  • the smaller is the probability design will need to change;
  • the smaller is the switching cost (); and
  • the lower the tax rate ().

Assuming net benefit of renegotiation ( ) is always positive – (i.e. renegotiation is efficient and always occurs when there are changes in demand) -- VFM is higher when the government is in a stronger bargaining position (i.e. when λ is greater).

Efficiency vs. Flexibility in PPPs

special cases ppp
Special cases: PPP

.

PPP: t= 0 and 0 ≤ λ≤ 1

, ,

Efficiency vs. Flexibility in PPPs

special cases pub
Special cases: PUB

.

PUB: t →1 and λ = 1

Efficiency vs. Flexibility in PPPs

comparing ppp and pub
Comparing PPP and PUB

.

Result 2: Under the VFM standard, PPP will dominate PUB when:

PPP is more likely to dominate procurement under PUB:

  • the greater is the cost reducing effect of effort (;
  • the smaller the probability project design will need to change
  • the greater is the switching cost (); and,
  • the smaller the difference between values .

Assuming that the net benefit of renegotiation () is always positive, then the VFM of a PPP is relatively higher when government is in a stronger bargaining position (

Efficiency vs. Flexibility in PPPs

illustrating the flexibility efficiency trade off
Illustrating the flexibility-efficiency trade-off:

.

Efficiency vs. Flexibility in PPPs

extension 1 tss standard
Extension 1: TSS Standard

Need to add shadow cost of taxation: if government pays Z to firm it costs government (1+γ)Z

Efficiency vs. Flexibility in PPPs

comparing ppp pub under tss
Comparing PPP/PUB under TSS

Result 3: Under the TSS standard, a PPP will dominate PUB when:

As before, a PPP approach is more likely to dominate PUB

  • the greater is the cost reducing effect of effort ,
  • the smaller is the probability the project design will need to change ,
  • the larger is the switching cost , and,
  • the smaller is the difference between the project values and
  • the greater is the deadweight loss of government finance (γ).

Assuming that the net benefit of renegotiation [] is always positive, so renegotiation always occurs when there are changes in demand, the TSS of a PPP is higher when government is in a stronger bargaining position.

Efficiency vs. Flexibility in PPPs

differences between vfm tss
Differences between VFM & TSS

Result 4: When the public and private partners have different bargaining weights the following cases become possible:

  • When the government has the greater bargaining weight (i.e. λ > ½) it is possible for a PPP to maximize VFM while PUB maximizes TSS;
  • When the government has the lesser bargaining weight (i.e. λ< ½) it is possible for a PPP to maximize TSS while PUB maximizes VFM; and;
  • When the government and firm have equal bargaining weight (i.e. λ = ½), comparisons under are the same as those under TSS.

Efficiency vs. Flexibility in PPPs

extension 2 toll contract
Extension 2: Toll Contract

Could a toll contract change renegotiation incentives?

  • In many PPP arrangements, private parties are paid according to the use of the services.

e.g. road and bridge projects funded by tolls

  • With a toll contract, private partner has stronger incentive to change project if it means meeting more demand

Efficiency vs. Flexibility in PPPs

toll contract
Toll Contract

Our extension: under PPPs contract, the fraction of the benefit that F gets (via usage fees) is

  • incentive compatibility constraint:
  • participation constraint:

Efficiency vs. Flexibility in PPPs

toll contract changes in demand
Toll Contract: Changes in Demand
  • G's threat point:

G has stronger bargaining position compared with baseline.

  • F’s threat point: assume F can walk away. So F's threat point still generates zero profits (in this case via exit).

Nash Bargaining result:

Efficiency vs. Flexibility in PPPs

toll contract comparisons with availability contract
Toll Contract: Comparisons with Availability Contract

Compare the toll contract and the availability contract

Efficiency vs. Flexibility in PPPs

toll contracts results
Toll Contracts: Results

Result 5: When the objective of the government is to maximize VFM, the toll contract dominates the availability contract. Advantage of toll contract is greater:

  • The more likely change is needed (μ);
  • The greater is cost K;
  • The lower is the productivity of effort (δ); and
  • The greater the percentage difference between good and bad projects [(b0-b1)/b0] .

So PPPs more likely to dominate PUB if tolls can be used!

Efficiency vs. Flexibility in PPPs

summary the ppp trade off efficiency vs flexibility
Summary: The PPP Trade-off Efficiency vs. Flexibility

PPPs more likely to dominate PUB when:

(i) effort more important (i.e. δ larger)

(ii) probability of change ( µ) lower

(iii) switching cost (s) higher

(iv) difference betweenright and wrong projects (b0-b1) smaller

(v) governments have greater bargaining power

(vi) toll contracts (not availability contracts) used

And choice can depend on government’s objective.

Efficiency vs. Flexibility in PPPs

future work possibilities
Future work: possibilities
  • How do parties try to reduce these costs?
    • Contracts contingent on signals
    • Arbitration rights in renegotiation
    • Better incentives in public sector
  • Risk aversion
  • Other functional forms
    • e.g. what if effort affects demand, not just costs?

Efficiency vs. Flexibility in PPPs

slide39

Thank you

tom.ross@sauder.ubc.ca

Efficiency vs. Flexibility in PPPs