Fri | Jun 23, 2017

Peter-John Gordon | Public-private partnerships feasible

Published:Sunday | May 14, 2017 | 5:00 AM
Peter-John Gordon

All governments are involved in the provision of goods and services. There is no reason why some of these should be produced by public enterprises because market forces on their own would provide them. Others, however, need the government if they are to be adequately provided. These include public goods and goods with positive externalities.

A public good is one in which it is impossible to exclude people from consuming, e.g., city streets. No private individual on his own would provide public goods since there is no way for him to be paid. The other class of goods and services in which the State would become involved is those that have positive externalities.

An externality occurs when one person's consumption or production of the good affect, someone else's well-being. An example of a positive externality would be having a bee farm next to an orchard since the bees will increase the productivity and profit of the orchard. The social and private benefits of the beehives are different. The bee farmer looks only at the private profit he makes from his bee farming and not at the benefits to the owners of the orchard next door because there is no way for him to appropriate those benefits. His profit maximising number of bees will be less than the socially desirable number. If the bee farmer also owned the orchard, he would produce more bees since the social and the private benefits would be the same.

 

BETTER SOCIETY

 

This externality argument is what causes governments to subsidise education and health services as a more educated and healthier society has benefits that go beyond the private benefits to individuals - more order, better parenting, greater democracy, etc. Individuals will, however, only invest up to the point where the cost is equal to the private benefit. They have no intention of paying for benefits that will not accrue directly to them.

Many infrastructure projects could be provided by the private sector because it might be possible to exclude persons who do not pay, for example, a toll road. The externality argument still holds. The providers of these infrastructure projects are likely to underprovide from a social standpoint. The North-South leg of Highway 2000 makes possible economic activities that would not occur without it, for example, cruise passengers landing in Ocho Rios can spend the day in Kingston and Spanish Town viewing sights, patronising restaurants, etc. People now find it possible to live on the north coast and work in Kingston.

All of these benefits must be compared with the cost of the highway to ascertain whether the society gains from its construction. Unfortunately, a private developer of the highway who is saddled with the entire cost of the project receives only a fraction of the benefits. Only if his private benefit outweighs the entire cost will he provide it. He is unconcerned if the social benefits are greater or less than the cost.

Governments the world over have sought to partner with the private sector in public-private partnerships (PPP) in the provision of the goods and services that are best provided by the State because of the public good nature or the externalities. Infrastructure projects, health, education, and even prisons have been provided by the PPP model.

Why have governments sought the assistance of the private sector and not proceeded by themselves to provide these goods and services? The answer is that governments see a clear benefit in engaging the private sector because the private sector often brings to the process something that is difficult for the Government to provide. Private-sector participation can lead to greater efficiency in the delivery of these goods and services, hence lower costs. In many instances, governments are unable to finance the projects from current taxation and/or borrowing. PPPs allow projects to go ahead that would otherwise not be undertaken.

The private sector might have skills that would be difficult for the Government to acquire and properly monitor. Private-sector participation also allows risk sharing. The PPP model often involves construction and operation by a private entity that is paid either by the Government over time, or from direct collection from consumers, or both. The externality argument would mean that the entity would require some kind of subsidy from the State if the good or service is to be adequately supplied.

 

NOT VIABLE

 

In the case of the North-South Highway, it is unlikely that the traffic flow and feasible collection of toll would ever make the project financially viable. Business people, in deciding whether to invest, look on the rate of return on their capital and the length of time in which they would be able to recoup their investment. If the rate of return is too low or the length of time too long, the project would not be undertaken.

The Government of Jamaica would have wanted the North-South Highway to be built if it assessed that the social benefits were greater than the cost. Given that the private benefit is less than the cost, the only way the project would proceed is with a subsidy from the Government. Being cash-strapped, the Government used land as an instrument to subside the project.

There are advantages in having a single entity involved in the financing, construction, and operation of a project. Should this occur, it is likely that overall cost would be reduced. An entity that is only responsible for construction may not employ methods that minimise total cost since it will not be responsible for maintenance. A single firm responsible for financing and construction is likely to reduce delays and cost overruns.

Many voices have raised the issue of the toll rates, suggesting that the toll operators should lower the toll rates in order to increase volume. The same suggestion could be made to hotels: Why don't they lower their rates and attract more visitors? It is true that lower rates would increase usage and may even increase revenue, but it will simultaneously increase (maintenance) costs, and most likely, would reduce profit. Businesses seek to maximise profit, not revenue.

The recent discussions around PPPs have suggested that all unsolicited proposals should be rejected, suggesting, instead, that the Government invite tenders. The Government can only go to tender if it knows exactly what it wants. Suppose a person discovered a new way of distributing water that is cheaper, should he not make a proposal to the Government? Or should the Government, after discovering this new technology from him, invite competitors to bid? This might sound far-fetched, but there was a time when telephone service without cables running along the roadside was also far-fetched.

- Peter-John Gordon is a lecturer in the Department of Economics,UWI, Mona. Email feedback to columns@gleanerjm.com.