Module 05: Identifying Constraints

5.2 What are the possible constraints on the PPP?

As a first step, governments can evaluate existing legal systems to ensure that their country's enabling legislation has the appropriate corporate and commercial laws in place to support private investment. Even where the appropriate legal environment is present, the government may lack experience in terms of preparing, negotiating and implementing this type of arrangement. Such a lack of capacity can also be an issue. In this regard, governments need to consider carefully the specific type of PPP that they wish to pursue and promote in light of the particular legal and economic conditions that already exist in their country.

Some potential constraints on PPPs are described below under the following headings:
1. Legislative and regulatory environment
2. Institutional constraints
3. Financial constraints
4. Contract-related constraints
5. Capacity constraints
6. Public sector experience
7. Perception
8. Time frame

1. Legislative and regulatory environment

Aspects of the broader legal and regulatory environment for services can act as significant barriers to the PPP. For example, accounting laws and practices, laws governing construction contracts, public works laws and conventions and so on may be inappropriate for private sector participation. Where this is the case, such laws and practices should be reviewed carefully and, if necessary, amended or modified to accommodate and encourage private sector involvement.

Distortions in the overall incentive environment (the tax regime, import restrictions, labour laws, along with banking, foreign exchange and foreign investment restrictions) and excessive regulation and restrictions can also inhibit private sector participation. The cumulative effect of regulation is of profound importance. A single restriction or barrier may not constitute a particularly important impediment, but the cumulative effect of many even indirect barriers can be such as to deter the active entry of new firms to the market.

Therefore, before a particular partnership opportunity for the implementation of a project is approved, the service must be examined in detail to ensure that there are no legislative or regulatory barriers to the PPP. If this step is ignored, significant investment in time and money can be spent developing a partnership only to find that it cannot proceed in the current environment.

In particular, parties to a partnership arrangement should understand how the regulatory regime affects the delivery of services to the poor, and should take this into account when designing their activities. Thus, partners should seek to understand:

◊ what regulatory constraints or barriers may affect planned partnership activities? and

◊ what regulatory constraints or barriers are currently affecting the main service provider’s ability to serve the poor?

This should allow the partnership to either ensure that the PPP activities will not be subject to a regulatory barrier, or to frame their objectives and activities in a way that addresses existing regulatory constraints directly, or circumvents such constraints altogether [Tool 15].

New role of the private sector

In many countries, private sector involvement in the provision of basic services is a new concept. As a result, policies need to be adapted in such a way that they actually promote these innovations.
First and foremost, the legislative framework should set out to provide the local government with considerable flexibility to enter into public-private partnerships. Second, different degrees of legal sophistication are required depending on the extent of the private sector involvement that is desired.

For instance, whereas some private firms may be willing to enter into operations and maintenance contracts without the appropriate enabling environment, few firms will be willing to make long-term investments where the legal framework does not specifically address their ability to provide public services. In cases where the legal framework is inadequate, there has been an increased focus on concession contracts as a means to enable the government to enter into long-term contractual agreements for the delivery of public services.

Similarly, many legal systems do not allow lenders to take security on public assets, which makes it difficult for commercial banks to extend long-term finance to these types of projects. In general, lenders are reluctant to provide long-term finance if a country's legal system does not allow assignment of the rights of the concession or some sort of “step in” arrangements in the event of default on a loan.

Taxation framework

In determining whether an opportunity is suited to a public-private partnership, the government needs to recognise the interests of the potential private sector partner. One of the incentives that will attract private partners is the ability to minimise the amount of tax they will be required to pay.

It is likely that municipalities will have to investigate tax-related obstacles on a project-by-project basis. As these issues are complex and subject to ongoing change, the PPP management team may wish to seek outside assistance for this part of the analysis.

Establishing the rules of the game

A clear definition of the ground rules is essential if the operation of the project is to be successful. If organisational and individual roles are not defined explicitly, this may cause problems during the implementation of the project.

The major reason for the difficulty in establishing a level playing field between public and private companies is that the private contractor’s costs for service provision are often different from those taken into account by the public sector. Private service providers are often at a competitive disadvantage when compared to public sector providers since they have to recover all their costs, as well as pay taxes and make a reasonable profit. Public utilities, by contrast: often operate at a loss; receive subsidies in the form of grants, concessionary loans, use of public land, staff time and other resources; do not usually pay taxes; and receive abundant assistance in project planning, design and financial packaging from external lending institutions. Competition for public utilities may be infeasible unless they are subject to a non-subsidised, full-cost recovery regime.

Local government policy

The local government’s policy for the provision, financing and cost recovery of services will be a key factor in assessing whether or not it views public-private partnerships as an acceptable approach to service delivery.

If, based on the government’s fundamental values and policies, public-private partnerships are not seen as a viable or accepted approach to service delivery, it is clearly not in the community’s best interest to proceed with individual public-private partnerships. More commonly, local governments will establish policies that identify the circumstances (for example, the type of service, or a particular component of the service system) under which public-private partnerships may be considered.

In addition to the local government’s servicing and financing policies, municipal managers must also consider the implications of the partnership for other policies, including land use and development policies, human resources and economic development. Efforts should be directed only toward advancing proposals that are consistent with established local government policies.

2. Institutional constraints

Institutions are central to partnerships – barriers that evolve at this level are often linked to the internal organisational and bureaucratic structure of the partners.
Institutions that are focussed on the delivery of services often prioritise project activities ahead of partnership exercises. Thus an unwillingness to commit resources (including both funding and time) to partnership building – as opposed to project development – has proven to be an issue for many projects. Recognising a situation whereby resources can be pooled specifically to further partnership development can help address this.
Other barriers exist in terms of institutional processes. Those documented in partnership literature include:

– poor planning;
– a lack of information (or an unwillingness to share information);
– a lack of leadership;
– unequal involvement of members; and
– a lack of commitment and negative publicity.

Strong, equitable governance structures and deliberate attention to partnership processes (as discussed in this Toolkit) can help reduce these obstacles.

Turnover of officials

Replacement of the officials involved might cause there to be little internalised learning around the key issues, nor around the opportunities and constraints of the partnership. In any contract, a gap in skills is created when those responsible for launching the partnership arrangement are voted out of office. The officials left making decisions about the contract need to be supported with targeted capacity development.

3. Financial constraints

Affordability

Deregulating, implementing new structural reforms and managing private entry are both politically and technically difficult, particularly as many infrastructure services such as district heating, electricity and water are heavily subsidised. Although governments recognise the long-term economic need to raise tariffs to allow for cost recovery and long-term sustainability, it is frequently politically impossible for them to raise tariffs quickly. As a consequence, governments may wish (in the short-term) to provide subsidies to support cost recovery in some of projects [Tool 13].

Private financing

Municipal financial constraints and a desire to leverage public funds are often primary motivations for the PPP. However, there may be a number of barriers to the successful financing of the project by the private partner. For example:

◊ private sector financing may not be able to compete with public sector financing for the type of service or project being considered (in such cases, public financing or borrowing could be a better option);

◊ the project might not be financially self-sufficient;

◊ the support (co-financing, subsidies, supplies, equipment), which the private sector expects from the government, might not be available; this would make the financial costs prohibitive for the private partner.

Public financing

Although there are some PPPs where the public sector's role is limited to that of regulator, in others the public sector plays a more commercial role, either by providing subsidies or by acting as a commercial counterpart.

1. The public sector may provide subsidies where it is politically impossible to raise tariffs. Here there is a need for multi-year budget appropriations, which can increase the perceived risk of the project, particularly if there is no history of PPPs in a country.

2. Where the public sector acts as a commercial counterpart, contractual commitments need to be with creditworthy state entities. For entities that are not creditworthy, support from an appropriate entity within government in the form of a guarantee or a direct agreement will be needed.

Capital markets

Where funds are to be borrowed on the capital markets, there are possible constraints that relate to both the domestic and international capital markets.

◊ The domestic capital markets could be weak and unable to provide long-term financing for infrastructure projects that have long pay-back times.

◊ International capital markets, on the other hand, are sensitive to exchange rate fluctuations.

4. Contract-related constraints

Most of the problems discussed below are important potential constraints; however, many can be resolved or at least mitigated through well-specified contract design [Tool 17].

The danger that bidding may fail to be competitive

The provision of most basic services requires specialised expertise, so there may be very few competitors because of a scarcity of the requisite skills. There is also always a danger of collusion between bidders, especially if they are few in number and/or if the bid is taking place in a country that does not have a history of competitive markets.

Lack of a cost benefit analysis

One of the keys to political motivation is cost. The government tries to provide services of the highest quality at the lowest cost. It is therefore essential that a cost-benefit analysis be carried out which itemises all costs and benefits and enables a proper comparative assessment of alternative delivery approaches. Such a study should compare operator performance with international benchmarks. Accurate cost information will strengthen the municipality’s position whatever the findings of the analysis. If private sector costs are indeed found to be high, the council will be in a strong position to negotiate.

If they are found to be low, this knowledge will create a more receptive and conducive operating environment in which a more appropriate contract can be developed.

Contract size

Smaller contracts often contain a number of limitations. For example: they offer fewer possibilities to exploit economies of scale; average household income tends to be lower than in large municipalities, so restricting returns; municipal capacity is inevitably weaker than that in large cities; and the system itself is often relatively complex and divided for such a small population.

Transaction and bidding costs

Projects involving the private sector typically incur high transactions costs. These costs amount on average to some 5 to 10 per cent of total project costs. This can be a prohibitive factor and since the burden of these high transaction and bidding costs will eventually trickle down to the taxpayers, the onus is on the various institutions responsible for awarding these projects to keep these costs down.

5. Capacity constraints

An imbalance in the capacities of the public, private and community partners is the most common limitation on successful PPP arrangements. Capacity deficiencies affect ongoing partnership arrangements, as well as any reforms that may be necessary due to lack of confidence. More on capacity development can be found in Tool 21.

Strategic understanding of public-private partnerships

The most significant capacity constraint is usually with respect to the strategic understanding of public-private partnerships. Training in PPPs and exposure to the development of PPPs elsewhere in the region is likely to result in a broader understanding of their potential in terms of social and institutional aspects in the municipal context; such training will also aid understanding of the implications of long-term partnership arrangements.

Difficulties in contract specification and administration

If there is technological or market uncertainty in relation to the service in question, then contract specification will be a complex task. It could well be impossible to cater for every eventuality that might occur in the life of even a medium-term contract, let alone to foresee how such eventualities will relate to investments or costs.

As a result, for all but the simplest of services generally there will be a continuing role for the public sector in contract administration – that is, in monitoring, administering and enforcing the contract during its lifetime and bargaining over unspecified contingencies. Difficulties in contract specification also underline the need to include in contracts clauses allowing both parties to renegotiate terms in the event of significant unexpected changes. Such difficulties also highlight the importance of parties to the partnership being able to count on a capable and independent judiciary or other mechanism to arbitrate disputes between the government and the utility [Tool 18].

The difficulties of contract specification suggest that short-term contracts may have advantages, because fewer future contingencies then need to be catered for. Longer-term contracts provide, however, an opportunity for greater efficiency gains and have other advantages. For example, longer contracts give contractors more time to recover costs and enable them to increase the scope of services and to offer employment to displaced public workers. An important problem of shorter-term contracts, meanwhile, is that they may reduce incentives for maintenance and deter the incumbent from making investments in sunk assets; hence short contracts may result in underinvestment.

Lack of tendering and contracting capacity

Two of the obstacles to the wide adoption of contracting arrangements are lack of experience in development of contract conditions and lack of data and guidelines upon which contract specifications should be based. In order to overcome these difficulties, governments in several countries provide their officers with advice about different contractual arrangements, such as a list of standard specifications that should be built into contracts.

The basic principle of PPP – the provision of value for money for public services – can only be satisfied when a fair and transparent procurement process is in place. Many government officials have little experience in negotiating and managing concession contracts, which can lengthen the contract award process and increase the costs of bidding. Decision-makers might also lack the confidence to renegotiate the contract such that it meets the redefined objectives of the municipality.

Lack of action on the part of officials might also be attributed to: a lack of detailed provision for renegotiation in the contract; an imbalance in perceived negotiating skills; lack of access to “objective” support; and/or a fear over the implications of decisions made. Capacity development in negotiation is essential if the public sector partner is unwilling to accept the support of skilled specialists.

Financial analysis and planning

Another fundamental constraint to the effective implementation of a contract could be a lack of financial analysis and planning on the part of the municipality specifically in relation to the services under consideration. The reason for this lack of analysis of the PPP might stem from a narrow understanding on the part of the contract itself – that is, it is inflexible – and a strong view amongst the local government’s financial team that such an exercise would be pointless. A comparison with international benchmarks could be of use where this is the case.

Community capacity

It is necessary to strengthen community structures and processes and to expedite the setting up of ward committees under the harmonized legislation to support community mobilisation for the project.

6. Public sector experience

Although the international investment community has a strong interest in PPPs, investors are unwilling to invest if the returns do not provide sufficient compensation for the perceived level of risk. One of the greatest risks is uncertainty as to how the government will react as a counterpart. Ideally, the confidence of prospective investors can be built up if a period of macroeconomic stability can be combined with regulatory and structural reforms. Nonetheless, in markets where there is a limited history of private investment, governments may need to initially take on more risk as a means to demonstrate their commitment to reform. However, once there is one successful PPP, other operators and financiers are usually willing to assume more risk, resulting in greater risk transfer.

7. Perceptions

Despite the growing acceptance of public-private partnerships as a legitimate means of providing municipal services, a great deal of mistrust and misunderstanding continues to exist in all three sectors of the partnership – in the public and private sectors, and among community members. While education and communication may go a long way to reduce resistance, in some cases there may be insurmountable obstacles to a PPP.

In particular, the capacity for the municipality to work effectively with the private sector might be affected by people’s attitudes. Whether these attitudes pre-existed or developed through experience, they can have a serious effect on the partnership. Various causes can be identified, and capacity development efforts will need to address these causes to bring about the change in attitudes necessary if the partnership is to work towards a pro-poor outcome.

Individuals play a key role in setting up and managing a partnership, hence their outlooks and attitudes to partnering are crucial elements in determining its success or failure. Tri-sector partnerships can require significant changes to established work practices/processes, practices that can differ significantly between the public, private and civil society sectors. Change is often resisted by individuals and research into partnerships has frequently observed feelings of “fear, apathy and cynicism” amongst individuals, along with a certain level of defensiveness. These feelings may be prompted by:

◊ philosophical differences;

◊ a lack of understanding (due to differing professional language);

◊ differences in organisational culture; and/or

◊ previous experience with a “failed” partnership.

Good communications and time are the two most important elements in overcoming such barriers. Therefore, allowing time and encouraging ongoing dialogue, especially during partnership building, certainly facilitate understanding and smoother relations in the long term.

Attitudes caused by an ideological disagreement to private sector involvement in service provision cause much of the early resistance to the partnerships. Understanding the constraints to private sector involvement in municipal service delivery can be very useful in ensuring that arrangements, processes and relationships are beneficial.
Additional constraints with respect to people’s perceptions come from the fact that consumers are increasingly expected to pay fees and tariffs to use formalised services. These barriers make cost recovery a challenge for most projects. They need to be overcome before governments will be able to charge for services and consumers will be willing to pay for them. These constraints include, among others:

◊ cultural beliefs that some services (such as water provision) should be free;

◊ consumers’ lack of confidence in historically unreliable services; and

◊ the availability of some form of alternative service provision (from informal vendors, and so on).

8. Time frame

Time frames relating to political (electoral) cycles may force authorities to resolve a service delivery problem using methods of project implementation that are more familiar than PPP arrangements.

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