P3: The contract is key

Public private partnerships (P3) have been negotiated in Canada for decades, yet the concept is highly controversial

The idea of allowing private industry a foothold in what traditionally has always been the domain of the public sector, causes concerns of profit over people.

Michael Maschek, PhD, from the University of the Fraser Valley’s department of economics, said private enterprise is seen as more fiscally responsible than the public sector, but that doesn’t mean people shouldn’t be apprehensive about P3s.

“It may compromise service quality, that’s the biggest concern.”

But he added efficiency is gained, as the project is usually built “better, faster and cheaper.”

A P3 agreement allows the private sector to finance a large portion of a public project, relieving government from having to put all the money up front. Maschek said that allows the government to invest less money while keeping investment coming into the city.

In return, the government agrees to pay the private corporation for building, and in many cases operating the facility. The contracts are commonly 20 to 25 years in length.

Maschek believes the contract is the key to any successful P3 plan.

“If you could write the perfect contract, there would be no problem.”

But it is unlikely that every possible situation can be accounted for in the agreement and because of the lengthy term, the contract  is usually reworked.

“Renegotiation is highly likely for two highly related reasons: One, the long duration of the contract period, and two, the fact that PPPs are prone to contractual incompleteness. The contract itself is very difficult to negotiate; economists refer to this as a high transaction cost,” he explained.

Asked if P3s work, Maschek was non-commital. He said a lot has been learned about P3s and how they can be a success or a failure.

“Essentially, what I mean here is that there are projects where the costs associated with negotiation are outweighed by the productive efficiency increases associated with private involvement.

“The private sector exhibits higher productive efficiency when involved in PPPs over public sector counterparts for three reasons related to improved incentives.”

Those are: With a principal agent, problems are somewhat smaller; bundling different phases may reduce a project’s life-cycle costs; the transfer of risk goes from the public to the private sector.

“However, these benefits are often outweighed by the higher costs associated with them ... Only where the increase in benefits (efficiency) outweigh the increase in costs (transaction costs) these partnerships make sense.”

Asked if the Abbotsford water supply plan will work as a P3, Maschek said he did not have enough information to make an educated decision.

“I do not know many of the details particular to this potential project. However, it does fit conceptually with projects that are potential candidates where PPPs increase net benefits over and above straightforward public provision. Whether or not the project should progress as a PPP depends on whether the main cost associated with these endeavours – the transaction cost associated with contractual negotiation and enforcement – is outweighed by the benefits associated with PPPs, increased productive efficiency.”

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