The PPP crisis. Part Two: History

ASCENT AND DEBACLE OF A PUBLIC PROCUREMENT MODEL

Private participation in (or the privatization of) infrastructure is usually addressed from the public perspective, based on the fact that we dealing with public goods, which therefore deserve a differentiated treatment. Consequently, the natural state of infrastructure is public and private participation is a break off from this natural state towards a situation that must be regulated. This vision is logical in the welfare state and constitutional law that accompany modern economic development, which recognizes access to many of the services related to infrastructure as a basic right.

However, to better understand the fundamentals behind the current debates and controversies about PPPs, it is worth taking perspective and observing that private participation in infrastructure provision has historically been a markedly cyclical process. This leads us to differentiating the ownership of the service from its provision, its financing and its final delivery.

As a matter of fact, private participation in infrastructure provision has frequently preceded the public sector. From the mid-nineteenth century to the Second World War, many of the great new transport infrastructure (mainly railways) and electricity generation and transport in Europe and the United States were financed, built, operated and owned by private companies. As the service became universal, the monopolistic nature of infrastructure assets and the potential downsides to the users gradually revealed: monopolies can -and often do- abuse their market power. This was one of the determining factors - although not the only one - that led to the global wave of nationalizations after the Second World War and until the 1970s.

Diagram above: Historical evolution of infrastructure provision models. Own elaboration inspired on Regulating Infrastructure. José A. Gómez Ibá?ez. Harvard University Press (2003).

The demands and expectations of citizens regarding how much infrastructure and services the public sector must provide have grown steadily ever since, much faster than the public resources needed to satisfy them. Between the 1970s and 1990s, this growing deficit led many governments in Europe and Latin America to the privatisation of water and energy distribution companies under the supervision of a regulator. Other governments decided to contract out the construction and operation of transport infrastructure (French, Spanish or Chilean concession model), and the United Kingdom adopted an innovative model for the provision of so-called 'social infrastructures', such as education and health: the Private Finance Initiative (PFI).

The PFI can somehow be considered the precursor of PPPs as we know them. This model gradually strengthened the application of financing with limited resources to the project (Project Finance) to public infrastructure -until then, it had been limited to private investments in the oil industry and power generation projects. In the PFI model, the private company finances, builds and maintains the infrastructure and equipment that support the provision of the service, while the government continues to provide the direct service to the user with public resources (doctors, nurses, teachers, etc.).

The global financial and fiscal crisis that began in 1997 in Asia and later extended to Russia, Argentina and Brazil was an inflection point for PPPs, because many of the investment projects developed in these regions used PPPs with US dollar-denominated lending that lacked the risk coverage and guarantee instruments that are considered fundamental today.

Between 1997 and 1999, private investment in infrastructure fell almost 40%. In fact, the investment level of 1997 would not be reached again until eleven years later.

Figure above: Evolution of infrastructure PPPs. Source: Own elaboration with data from the World Bank

In the first decade of the 21st century, processes of economic reform took place in emerging economies whose external debt went into default; these processes were supported by multilateral financial institutions such as the World Bank, the Inter-American Development Bank, the Asian Development Bank, the European Bank for Reconstruction and Development and the International Monetary Fund. This period saw the growth and maturing of complex financial instruments such as sovereign guarantees, partial credit guarantees, export credits, project co-financing and public infrastructure PPPs.

Concessional loans or grants to emerging countries have come along the promotion of PPPs, including legal and institutional reforms that facilitate the implementation of this procurement model. The multilateral banks and other institutions such as the OECD are, in fact, the institutions that have most actively promoted the current PPP model. The confluence of an economic boom and the promotion of PPPs between 2002 and 2012 helped private investment in infrastructure grow by ten times, as shown in the graphs below, with a particular marked growth in Latin America and South Asia.

Figure above: Evolution of infrastructure PPPs by region. Source: Own elaboration with data from the World Bank

It is surprising, then, to observe a drastic change in trend -both in number of new projects and in total investment- of PPPs since 2012, despite the economic recovery in Europe and the United States. One could argue that certain effects of the global financial crisis may have hindered the growth of PPPs, for instance:

• The aversion to the risk that payment for infrastructure use is insufficient. This is the so-called "demand risk", which arises when the number of users is lower than anticipated or when the fees paid are not enough to offset the costs;
• More stringent regulatory requirements on commercial and investment banking: Basel processes, which impose significant limitations on the operations that banks can lend to;
• The growing indebtedness and fiscal deficit of developed countries.

However, these processes alone do not explain the investment debacle in PPPs that we are witnessing.

Global GDP has increased by approximately 30% since 2012 and government investment in infrastructure has remained at around 2% of GDP per annum, while the proportion of it that goes to PPP investment has plummeted from 8% to less than 1%.

Figure above: Investment in total infrastructure and proportion of PPPs. Own elaboration with data from the World Bank, IMF and Global Infrastructure Hub

In the meantime, the capacity and technical resources available to governments and the private sector to articulate PPPs has increased considerably. Between 2002 and 2017, the number of countries that had enacted specific laws for PPPs went from 16 to 144, which shows the remarkable interest that this form of public procurement has attracted, as well as the level of effort from the multilateral institutions that promote it. In many countries, the enactment of laws for PPP has been accompanied by the creation of the so-called 'PPP units', interministerial public agencies responsible for coordinating the institutional framework for planning and developing PPP projects. Multilateral institutions have also established strong training and accreditation programs for PPP practicioners.

Although commercial banks have reduced their participation in PPP financing since 2008, private capital for infrastructure investment has increased threefold, mainly through the so-called “institutional investors” that include pension funds, sovereign funds, endowments, private investment funds and insurance firms. In 2018, no less than 85 billion dollars were raised by specific private investment funds for infrastructure, an amount equivalent to all the public and private joint investment in PPPs during 2017. It should be clarified that these sources of capital normally shy away from new construction projects, looking for already built infrastructure that has a proven track record of demand and performance.

Figure above: Capital raised for private infrastructure funds vs. actual investment in PPPs. Source: Own elaboration with data from the World Bank, IMF and Global Infrastructure Hub

We must consider the possibility that globalisation and technology have brought an explosion of maturity and knowledge about the actual performance of PPPs, driving both the public and private sector to more conservative positions.

On the other hand, the Global Infrastructure Hub -the G20 initiative that aims to increase the quality and availability of information about infrastructure worldwide- estimates that the investment to develop and maintain the infrastructure that is needed to achieve the sustainable development goals is approximately 15 trillion (millions of millions) of US dollars above current levels, i.e. on top of what is currently being invested.

I then ask the following question: Given the needs; the availability of more and better information; greater knowledge; more institutional capacity -including regulatory and operational frameworks; greater public investment in infrastructure; and wider availability of capital and interest from the private sector, why is PPP investment decreasing in relative terms? Furthermore, how can we reverse this paradoxical disagreement between the public and private sectors and realise the public-private collaboration that is so much talked about?

In the next chapter of this monographic series, I will examine the current PPP model in search of answers.

<- Go back to Part One: Intro.

Go to Part Three: The Current Model->

This article is the English translation of a post originally published by Jose Cordovilla in his Spanish-language blog Infraestructuras y Gobernanza, where he writes about governance issues in infrastructure. All the articles in this PPP monographic series have been registered by the author on Safecreative under Creative Commons License conditions for sharing - Attribution, NonCommercial, ShareAlike 4.0