Theory of Public–Private Partnership: Contract Design, Corruption, and Renegotiation
/Overview
Infrastructure encompasses roads and bridges connecting cities, water mains delivering water to households, hospitals, and schools supporting communities, and similar systems that serve as backbones of a society. As pointed out by the American Society of Civil Engineering (ASCE) in their annual Infrastructure Report Card, “Every family, every community and every business needs infrastructure to thrive.”
Despite the importance of infrastructure, there is a significant deficit in supply. Taking the U.S. road system as an example, in 2013 32% of U.S. major roads were in poor or mediocre condition and 42% of U.S. major highways were congested. Similar examples can be found in developing countries (ASCE, Infrastructure Report Card). For example, the World Bank reports that only one-third of people in sub-Saharan Africa live within two kilometers of an all-season road, compared to two-thirds in other developing regions.
A deficit in infrastructure indicates that the demand for infrastructure exceeds the supply, that is, the level of infrastructure available. The delivery of infrastructure and services remains one of the biggest challenges in public procurement, as it usually involves economic, political, social, and technical considerations. Contracts are complex and prone to changes and renegotiations. The design is usually highly localized and therefore requires decentralized procurement. Therefore, infrastructure procurement is regarded as one of the areas that can easily breed corruption-related problems, especially in developing countries.
Infrastructure procurement can be further broken down into funds invested in infrastructure and the procurement efficiency of those funds. On one hand, there is a severe deficit of funds invested in the infrastructure system. The Federal Highway Administration has estimated that between 2008 and 2028, annual investment in the U.S. road system should be at least $170 billion; however, the actual investment is expected to be only $91 billion. On the other hand, the procurement efficiency of funds invested in infrastructure is never satisfying. For example, corruption consumes a large portion of such investment. According to Initiatives (2012), 10–30% of the total investment in public infrastructure may have been lost through corruption. Annual losses in the construction industry through inefficiency and corruption could reach $2.5 trillion worldwide by 2020.
In this book, we focus on how to improve infrastructure financing and investment by addressing the aforementioned problems. The first problem, the lack of funds invested in infrastructure, could be dealt with by attracting private funding in the procurement process. One typical and popular approach is through public–private partnership (PPP), which features construction, operation, and management of public infrastructure or service by government and private business working in partnership and sharing revenue, risk, and technology.
The second problem, low efficiency in procurement, can’t be solved with PPP alone. Without a well-defined contract between the public and private parties to a PPP, problems such as cost overruns, unnecessary renegotiation, and collusion will arise, with undesirable consequences for the public welfare. Therefore, in this book we study contract design, corruption, and renegotiation in PPP and ways to promote more effective policy-making and regulation.
This book develops the theoretical framework and basic derivations for modeling of contracts that avoids corruption and unnecessary renegotiation in a PPP and constructs possible solutions to various problems for use by decision makers and policy makers. In a PPP, stakeholder management, decentralized procurement, and agency problems are three key issues that should be addressed by modelers. In this book, we introduce an approach to building a principal–agent model that incorporates all of these factors. Models that address all possible issues in PPP projects, such as brown field highways, cost overruns, renegotiation, and corruption, are addressed. The reader will not only be able to directly apply these models to their research and practice, but also use the theories and techniques presented in the book to build their own models and solutions for various PPP problems not covered in it.
Research framework of Theory of Public–Private Partnership