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Choosing amongst infrastructure procurement approaches

Evaluating Public–Private Partnerships and Other Procurement Options

Darrin Grimsey and Mervyn K. Lewis

A procurement options approach involves trading off one set of features of a contractual arrangement against those of others in order to choose the contract that best suits the infrastructure services being considered. The chapter begins with a simple example to illustrate the point, drawn from the 2014 Nobel lecture by the French economist Jean Tirole. He compares a ‘cost-plus’ contract with a ‘fixed-price’ one. Incentives are very different: in particular, the cost-plus contract shelters the contracting firm from fluctuations in its cost performance, while the fixed-price contract makes the firm fully accountable for it. In the latter case, the incentives to reduce costs are greater, but so is the potential to benefit from windfall profits. While instructive, the example is much too limited for our purposes, as we compare four ‘bundled’ approaches with five unbundled ones. The framework we propose incorporates five steps: (1) data gathering; (2) assessing the efficiency gains and risks; (3) benchmarking and market soundings; (4) a comparison in terms of price certainty, flexibility, risk transfer and incentive structures; (5) choosing a preferred option based on cost, time, quality and risk. Presentation and discussion of this framework is followed by a case study of a hospital project. Then, the ‘practical realities’ are illustrated by how desalination plants in Australia were procured in the decade of the 2000s.

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Comparing public infrastructure procurement models

Evaluating Public–Private Partnerships and Other Procurement Options

Darrin Grimsey and Mervyn K. Lewis

Undertaking comparative studies of alternative procurement models is a false trail for the various models have different drivers of value and merits. Consequently, the present chapter adopts a common approach to determine their characteristics and strengths. These models are: 1. Conventional unbundled procurement models Construct only Design and construct (D & C) / Design and build (DB) Engineering, procurement, construction (EPC) Design, construct, novate Construction management. 2. Other non-traditional unbundled models Managing contractor Alliance contracting Competitive alliance Early contractor involvement (ECI). 3. Bundled PPP models Design, build, operate, maintain (DBOM) Design, build, finance (DBF) Design, build, finance, operate (DBFO); Design, build, finance, maintain (DBFM) / Design, construct, maintain, finance (DCMF) Build, operate, transfer (BOT); Build, own, operate, transfer (BOOT); Build, own, operate (BOO). 4. The regulatory asset base model RAB model for new or improved infrastructure. Associated tables list their respective benefits and disadvantages, a comparison which leads directly to Chapter 8.

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Conclusions

Evaluating Public–Private Partnerships and Other Procurement Options

Darrin Grimsey and Mervyn K. Lewis

This chapter begins where Chapter 1 left off, by examining the very different trajectories of infrastructure spending in the world’s two largest economies (the United States being larger in terms of US dollars, China in purchasing power parity terms). China is pushing on wholeheartedly with its infrastructure-led growth strategy. Domestically, it is aiming to transform itself into a ‘high-speed rail economy’, extending the existing 4 x 4 network (4 north-south, 4 east-west) into an 8 x 8 system. Internationally, there is the ambitious Belt and Road initiative, likely to dwarf anything the world has seen, comprising: first, a series of land-based trade and transport corridors known as the Silk Road Economic Belt; and second, the Twenty First Century Maritime Silk Road traversing the South China Sea, the Indian Ocean and Africa, the Red Sea and the Mediterranean. China has committed $1 trillion to Belt and Road over the next decade, and as much as $3 trillion in all. By contrast, until now the United States has been neglecting infrastructure maintenance and free-riding on the efforts of earlier generations, although President Trump has committed to spend $1 trillion on boosting infrastructure. The chapter examines three dimensions and three levels of the problem, and how US infrastructure (and other countries playing ‘catch-up’) can be paid for. Finally, the chapter draws together the themes of the volume, and what we believe has been learnt about procuring public infrastructure.

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The evolution of infrastructure services

Evaluating Public–Private Partnerships and Other Procurement Options

Darrin Grimsey and Mervyn K. Lewis

The story of the evolution of infrastructure is one of innovation. A distinction is often made between demand pull and science push in driving innovations. In the case of infrastructure, the contribution of science and technology seems obvious, for example, with the steam engine and railroads in the first industrial revolution, electricity and the internal combustion engine in the second, and the internet in the third. On the demand side, the development of infrastructure has been spurred by the growth of empires and the cities and markets they spawned. One only needs think of the infrastructure demands from the growth of Tokyo-Yokohama to 38 million or Shanghai to 24 million. In Ancient Rome, infrastructure was provided by the state. From around 1500, privately financed infrastructure began to play a role in the Spanish, Dutch and British overseas colonies, and domestically with canals, turnpikes, the railroad construction boom and the ‘Tube’. However, after World War II, state provisioning came to the fore. Developments since then have brought a revival of private activity in the oil and gas and mining sectors, communications, and public-private partnerships (PPP) roads and hospitals. There is also a revolution in infrastructure under way with digital disruption in the form of electronic tolling, route information services, Uber and driverless cars and trucks. All of these shape cities and transport networks, and are examined in detail.

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Funding of infrastructure

Evaluating Public–Private Partnerships and Other Procurement Options

Darrin Grimsey and Mervyn K. Lewis

Due to its project financing heritage, much of the literature associated with infrastructure is concerned with financing, that is, the raising of money by the private sector to build the facilities. However, the finance for public infrastructure eventually has to be repaid by government. This is the funding of infrastructure, and poses the more difficult issues for government entities when procuring infrastructure. There can be resort to borrowing, but governments have been reluctant to increase debt and risk a credit rating decline. General revenues are a traditional source of funds, but raising taxes is unpopular, and cutting spending runs foul of the welfare lobby. For these reasons, governments have sought new funding sources. One is ‘value capture’, whereby a variety of methods are employed (betterment levies, property taxes, ‘city deals’, developer contributions) to gain revenue and levy charges upon those who benefit from an infrastructure project (for example, a light rail development that increases land values along the route). A case study is provided of what is undoubtedly the largest example of value capital, namely Crossrail in the London Underground system. A second source is ‘asset recycling’ whereby governments themselves construct the infrastructure and, after it has been ‘tested’ and its risk profile established, sell it off to investors willing to buy ‘mature’ infrastructure assets. The returns on the acquired infrastructure are governed by long-run incremental cost or by the regulatory asset base (RAB) model, as illustrated for the Thames Tideway Tunnel. Finally, there is potential for road pricing, needed to fill the gap created by the eroding base of dedicated road taxes.

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Global Developments in Public Infrastructure Procurement

Evaluating Public–Private Partnerships and Other Procurement Options

Darrin Grimsey and Mervyn K. Lewis

There is widespread acceptance of the importance of infrastructure, but less agreement about how it should be funded and procured. While most public infrastructure is still provided in-house or by traditional procurement methods – with well-researched strengths and weaknesses – the development of service concession arrangements has seen a greater emphasis on lifecycle costing, risk assessment and asset design as featured in a variety of public private partnership (PPP) delivery models. This book examines the various procurement approaches, and provides a framework for comparing their advantages and disadvantages. Drawing on international experience, it considers some of the best and worst examples of PPPs, and infrastructure projects generally, along with the lessons for improving infrastructure procurement processes.
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Implementing a partnership agenda

Evaluating Public–Private Partnerships and Other Procurement Options

Darrin Grimsey and Mervyn K. Lewis

The public sector traditionally has obtained new assets (roads, bridges, schools, hospitals, buildings, and so on) separately from the associated services. A partnership agenda offers a different approach because the acquisition of infrastructure assets and associated services is accomplished with one long-term contract. Due to this bundling, before the contract can be put out to tender, decisions need to be made up front about who is responsible for what, and what to include or leave out: Services. What are the ‘core’ services that must be delivered by the facility? What are the non-core services? Finance. Who is best positioned to provide the finance? How quickly and at what cost could private finance be raised? Would it be quicker and less costly for the government itself to undertake the financing? Risks. What are the project risks? Which ones should be transferred contractually to the private party, or retained by the public sector or shared? How is uncertainty to be handled? Public interest. Are the public likely to get good value for money from the PPP? Do the outcomes satisfy the public interest test? These questions frame the content of the chapter along with some issues that have surfaced recently, namely commissioning and contestability, evidence on value for money, the relative cost of government and private finance, prompted by the argument that suppliers of private finance have greater, not less, ability to diversify risks than taxpayers.

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Infrastructure provision

Evaluating Public–Private Partnerships and Other Procurement Options

Darrin Grimsey and Mervyn K. Lewis

This introductory chapter begins by considering the infrastructure challenge posed by what former US Treasury Secretary Larry Summers calls the ‘Age of Secular Stagnation’ and International Monetary Fund managing director Christine Lagarde terms the ‘new mediocre of growth’. Both advocate increased infrastructure spending as the solution, but there are considerable differences between infrastructure policies in three of the largest economies. After decades of neglect, the United States and even Germany are saddled with once advanced, but increasingly outmoded infrastructure assets, while China keeps on building and has become an exemplar of modern urban transit, with ports, expressways, railways, subways, airports, and by far the world’s largest high-speed rail network. Nevertheless, a 2016 Oxford study challenges the efficacy of China’s infrastructure-led growth strategy. Upon examination, however, their study has serious defects and, contrary to their arguments, China’s infrastructure megaprojects appear less wasteful than those authors claim, and they have laid the foundations for Chinese growth, supported by a later case study.

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The problems of large (mega)projects

Evaluating Public–Private Partnerships and Other Procurement Options

Darrin Grimsey and Mervyn K. Lewis

Megaprojects in infrastructure are marked by considerable time delays and cost overruns. Two studies in 2002 drew attention to these features. For the present chapter, two new databases are added. The transport study has been extended to 1927-2009, covering 806 projects. In the other study, information is given on 172 megaprojects involving PPPs, covering 2000-2016. From our knowledge of these projects, a small number have failed, and some cost overruns and time delays have occurred. These results would seem to confirm Bent Flyvbjerg’s ‘iron law of megaprojects’: over budget, over time, over and over again. Why is this so? He drew much attention to deception and delusion so as to get projects off and running, engineers with a ‘monument complex’, and ‘empire-building politicians’ pursuing ‘vanity projects’, all undeniable. Our contribution in this chapter uses the insights of behavioural economics, and the systematic biases when people form beliefs and make decisions, notably overconfidence, optimism and belief perseverance. To these, from psychology, can be added confirmation bias. Further support comes from ‘groupthink’ and ‘cognitive dissonance’, the latest theories of ‘motivated reasoning’, and the 2016 hypothesis of a ‘psychological multiplier’ and possible multiple social cognitions, creating mental traps whereby benefits are overestimated and costs underestimated. The chapter concludes with suggestions for overcoming these errors. It also returns to the problem of uncertainty, which plagues megaprojects, and what can be done in terms of real options analysis, Bayesian theory and various practical responses.

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The promise of public–private partnerships

Evaluating Public–Private Partnerships and Other Procurement Options

Darrin Grimsey and Mervyn K. Lewis

Public-private partnerships (PPPs) were prompted by dissatisfaction with the bureaucratic, dirigiste nature of public provision of infrastructure, and the belief that PPPs could combine the best features of private and public approaches. The chapter examines the mechanics of a PPP and three issues are addressed. One is what a PPP can and cannot do. It can bring private sector efficiency, regulation through competition, economic pricing of services, filter out ‘white elephants’, and free up public (that is, ‘free’) services, but cannot bring in additional finance for infrastructure except in the case of ‘user pays’ tolls and charges. A second issue is the theoretical basis of a PPP. Economic theory suggests that performance differences relative to traditional procurement lie in ownership rights, the bundling of construction and operation into a single contract, and the transfer of risks of design, construction overruns and time delays to the private body. Finally, the third aspect examined concerns the criticisms surrounding PPPs. These arise from refinancing, the drag on government budgets from the unitary charge, incomplete (or no substantive) risk transfer from the public purse, the public’s access rights to tolled facilities, the difficulties of allowing for technological change over the lengthy and inflexible contracts, the significant procurement costs involved in PPP projects and their potential to be ‘gamed’ by some participants (including public sector procurers).