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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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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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Why is infrastructure of such significance?

Evaluating Public–Private Partnerships and Other Procurement Options

Darrin Grimsey and Mervyn K. Lewis

Since this volume is concerned with public infrastructure we need to make clear in this chapter what this term comprises. Infrastructure used to be seen as the tangible capital stock owned by the public sector. Now, it embraces intangibles such as personal entrepreneurial or commercial skills and the legal system and business culture. Moreover, many tangible capital assets, such as ports, power networks, water and telecommunications are in private hands. Despite the significant role of private ownership of infrastructure, there exists the belief that public infrastructure is an area in which government economic and social policy is required, and that public infrastructure is different from most other goods and services in the market due to network services, public goods, externalities, scale and monopolistic elements, even when procured under public-private partnerships (PPPs) and concessions. Infrastructure is seen as having a disproportionate impact on the economy, and the chapter then reviews econometric and other evidence of the productivity of public investment. These studies have been bedevilled by the problem of two-way causation: that is, does public investment lead or follow economic development? In this respect, a particularly instructive example comes from China in terms of the consequences of a new railway for regional development. The chapter concludes with eight different dimensions that delineate the significance of infrastructure investment.

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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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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).

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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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Risk analysis in procurement

Evaluating Public–Private Partnerships and Other Procurement Options

Darrin Grimsey and Mervyn K. Lewis

All forms of procurement involve the estimation and assessment of risks, and three main questions arise: Risk identification. What are the risks that a specific project entails? Can they be appropriately priced, managed and mitigated? Risk allocation. Who bears the final consequences if the risk happens, or can they be transferred to a third party such as an insurer? Risk management. How is the risk integrated into the working of the entity? What measures are taken to avoid or reduce the risk or its financial consequences? These three issues provide the basic framework for the chapter. However, some special issues arise which are more intractable. One is the Knightian distinction between risk and uncertainty. The presence of uncertainty muddies the waters considerably, as explored further in Chapter 9. The other problem area is the distinction between ‘project’ or ‘idiosyncratic’ risk vis-à-vis systemic risk as reflected in the discount rate. Choosing an appropriate discount rate has bedevilled the methodologies employed by various jurisdictions. Our own research analysis on this matter, reported in the chapter, suggests that – at least in the Australian context – systemic risk is misstated, jeopardizing the ability of public_private partnerships to demonstrate value for money.

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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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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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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.