Costs of public-private partnership

Preference for economic window dressing harms public welfare

Fahd Rehman July 17, 2017
Employees working in an office. PHOTO: REUTERS

LAHORE: Successive governments have continued privatising government assets since 1990s. The outcome is a ‘small government’ which is quite fashionable in many capitalist countries. From the perspective of a developing country, ‘small government’ is not a good outcome specifically when a large chunk of population is illiterate and impoverished.

The proponents of small government vehemently argue that a government should reduce its functions while the role and influence of the private sector should increase in an economy. Since a government takes control of certain services and performs them according to its style, critics argue that these services should be handed over to the private sector under the garb of public-private partnership.

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There are a variety of forms of this kind of partnership. The most popular one is Build, Operate, Own and Transfer (BOOT) where the private party designs, builds, owns and maintains a project and finally hands it over to the government say after 20 or 25 years, while the entire life of the project could be 40-50 years. Here a question arises why a project is beneficial for the private sector now and would be suitable for the government and becomes its property after the stipulated time span?

During the stipulated time period, the private party has to cover the cost and even earn profit on that particular project. In order to secure profit, the private party has to raise prices periodically which make the project expensive for the masses. If a government itself builds that particular project, it won’t raise the prices periodically as the government will spread its cost keeping in view the longer time horizon. In addition, the cost of capital for the private party is much greater than the government since the government can finance and fund a project at much lower cost.

There is also a need to lure the private sector and make the project profitable by allowing certain exemptions and concessions. For instance, a toll road is under the BOOT scheme for 20 years. The private sector would require the guarantee of its long term investment from the government. In this way, the government has to provide an advance commitment of future decisions i.e. increase in fare to the private party.

This advance commitment normally ties the hands of the future governments. In a democratic set up, the future governments have to honor those commitment regardless of follies committed by the predecessors. If a future government takes an adverse decision, it has to compensate the private party at all cost. Such commitment reduces the flexibility of decision making on the part of the government.

There are certain costs associated with the public private partnership such as contract negotiation, contract enforcement, monitoring and gauging the quality of service. The services are notoriously difficult to monitor as there is no real measure of their quality. There is a high probability of deterioration in the quality of the service as has happened in the US, the UK and Australia etc.

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The public private partnership is in vogue at the moment. The Civil Aviation Authority (CAA) intends to hand over the management, operation and maintenance of the Lahore, Islamabad and Karachi international airports to the private parties. If CAA has run these airports successfully for so many years, why the shift to the private sector? The supporter would argue that private sector would bring in efficiency. However, research has shown that the governments cannot allow the disruption of essential services such as air traffic control and have to bail out the firms when a crisis erupts.

In spite of these obstacles, why are public private partnerships still popular? These schemes become popular due to the mantra of reduction in the budget deficit. A typical government finds a way to reduce the budget deficit by handing over the projects to the private parties and pay nothing for the time being. In this way, it achieves a short term political gain at the cost of long term economic loss. The very question is whether budgetary considerations and ‘small government’ are more important for society than an increase in social welfare.

The writer is an Assistant Professor of Economics at SDSB, Lahore University of Management Sciences (LUMS)

Published in The Express Tribune, July 17th, 2017.

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