Infrastructure Project Finance: How Government and Private Investors Collaborate

Governments and private investors work together on infrastructure projects, typically through Public-Private Partnerships (PPPs), which utilize private sector expertise and resources while the government provides land, regulatory assistance, and, in many cases, financial guarantees. Private debt and equity, as well as public funding and multinational institutions, are used to support projects. This collaboration enables projects to be completed, attracts finance to industries that require large investment, and assigns risks to the party best qualified to manage them.

Public-private partnerships are agreements between a government agency and a private-sector enterprise to finance, build, and run projects such as public transit networks, parks, and convention centers. Financing a project through a public-private partnership can either speed up the completion process or make the project possible in the first place.

Public-private partnerships may involve the transfer of tax or other operating revenue, liability protection, or partial ownership rights over nominally public services and property to private sector, for-profit entities.

Public-private partnerships can be arranged in several ways. Here are just a few:

• Build Operate Transfer (BOT): A government hands overall construction and operations to a private party for a set number of years (often several decades or more). After that period of time, it is transferred to the government.
• Build Operate Own (BOO): The same as a BOT, but the private entity is not required to ever transfer the project to the government.
• Design-Build (DB): A government contracts with a private party to design and construct a project for a fee. The government retains ownership and may either operate it itself or contract out operations.
• Buy Build Operate (BBO): a government sells a pre-existing project that has already been completed and may have been operated by the government for some time to a private party, who will take it over fully. The private party may need to invest in rehabilitating or expanding the project.

How Does Public-Private Partnerships Work?

A city government, for example, may be severely in debt and unwilling to undertake a capital-intensive building project; nevertheless, a private firm may be willing to pay its development in exchange for obtaining operating profits once the project is completed.

Public-private partnerships often have contract terms of 20 to 30 years or more. The private sector contributes to the financing, but the public sector and/or users must pay throughout the course of the project’s existence.

The private partner participates in designing, completing, implementing, and funding the project, while the public partner focuses on defining and monitoring compliance with the objectives.

Risks are dispersed between public and private partners through a negotiating process, ideally, but not always, based on each’s ability to analyze, control, and manage them.

Although public works and services may be paid for through a fee from the public authority’s income budget, such as hospital projects, concessions may include the ability to direct user payments, as with toll highways.

Payments for services, such as highway shadow tolls, are based on actual usage. When wastewater treatment is involved, payment is made through fees collected from users.

Public-private partnerships are common in transportation infrastructure such as highways, airports, railroads, bridges, and tunnels.

Water and wastewater facilities are prime examples of municipal and environmental infrastructure. Schools, jails, student dormitories, and entertainment/sports facilities are examples of public service accommodations.

Read Also: Mining and Natural Resources: How Project Finance Fuels Large-scale Operations

Infrastructure projects, such as the construction of toll roads and highways, sometimes involve public-private partnerships. One example is Canada’s 407 Express Toll Route (407 ETR). This 67-mile stretch of highway was a public-private partnership (PPP) between the provincial government of Ontario and a private consortium responsible for the highway’s design, construction, financing, and maintenance, with a 99-year lease term during which they are permitted to collect tolls from users of the roadway. However, the government did not guarantee traffic volumes or toll income.

Pros and Cons of Public-Private Partnerships

Pros

Partnerships between private companies and governments benefit both parties. Private-sector technology and innovation, for example, can contribute to increase the operational efficiency of public service delivery.

The public sector, for its part, offers incentives to the private sector to complete projects on time and within budget. Furthermore, economic diversification improves the country’s competitiveness by facilitating infrastructure development and promoting linked construction, equipment, support services, and other industries.

Cons

There are some drawbacks, too. Participating in a public-private cooperation may expose the private party to additional risks. Physical infrastructure, such as roads and railways, entail building hazards. If the product is late, costs more than expected, or has technical flaws, the private partner is usually held responsible.

Furthermore, the private partner suffers availability risk if it is unable to deliver the promised service. A corporation may fail to achieve safety or other applicable quality criteria, such as while operating a prison, hospital, or school.

Demand risk occurs when there are fewer users than expected for the service or infrastructure, such as toll roads, bridges, or tunnels. However, this risk can be shifted to the public partner, if the public partner agrees to pay a minimum fee no matter the demand.

Public-private partnerships also create risks from the general public’s and taxpayers’ point of view. Private operators’ partnership with the government may insulate them from accountability to the users of the public service for cutting too many corners, providing substandard service, or even violating peoples’ civil or Constitutional rights.

At the same time, the private partner may enjoy a position to raise tolls, rates, and fees for captive consumers who may be compelled by law or geographic natural monopoly to pay for their services.

Lastly, as with any situation where ownership and decision rights are separated, public-private partnerships can create complex principal-agent problems.

This may facilitate corrupt dealings, pay-offs to political cronies, and general rent-seeking activity. This would happen by attenuating the link between the private parties who make important decisions over a project, from which they stand to benefit, and accountability to the taxpayers who foot at least part of the bill and who may be left holding the bag in terms of ultimate liability for the project’s outcome.    

Last Thoughts

To fund projects, governments form public-private partnerships with private-sector enterprises. While these types of partnerships have both advantages and disadvantages, governments continue to employ them to fund transportation, municipal, and environmental infrastructure, as well as public-service initiatives.