37540 noTE no. 4 ­ APRIL 2006GRIDLINES Sharing knowledge, experiences, and innovations in public-private partnerships in infrastructure Is the public sector comparator right for developing countries? Appraising public-private projects in infrastructure James Leigland A frican officials have shown new tor (PSC) for each project. This approach with soinvolving interest inprivate infrastructure projects participation. But plays a key role in project development little experience with such projects, in such countries as Australia, Canada, these officials often have limited knowl- the Netherlands, and the United King- edge about how best to assess their "value dom, the country where it originated in for money." Some experts have suggested the early 1990s. that developing countries use the method centering on the public sector comparator, Officials in some of these countries have already adopted by South Africa. But this recommended wider use of the PSC method has come under criticism in some method in developing countries, to help industrial countries. The debate about its ensure that PPP projects clearly demon- use in the industrial world raises questions strate affordability and value for money about whether it is appropriate in developing before public partners enter into contracts. countries. Yet the method has come under grow- Among public officials in Africa interest ing criticism in the past few years in such in public-private partnerships (PPPs) in countries as Australia and the United infrastructure appears to be reaching new Kingdom. This criticism raises questions heights. Yet the limited experience with about whether the technique is appropri- PPP projects in the region means that offi- ate under developing country conditions. cials in most African countries have limited PPIAF-funded research on this issue, knowledge of how to prepare them. For though still ongoing, allows some prelimi- the projects that have been completed, nary conclusions (Shugart forthcoming). appraisal methods have been left largely to consultants. So there has often been little How the method works consistency in the methods used across The PSC method is meant to meet the projects, and almost no effort to build need to make a compelling argument in up a body of knowledge about which favor of using private participation rather methods produce successful projects and than traditional public works approaches. which do not. Its quantitative approach has been used effectively in many countries to counter South Africa has been a notable exception. critics unconvinced by theoretical argu- In 2000 it adopted one of the techniques ments in favor of private participation. most widely used in the industrial world for quantitative appraisal of PPP projects, PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY an approach that centers on preparing James Leigland is PPIAF's regional program leader for East and assessing a public sector compara- and southern Africa. Helping to eliminate poverty and achieve sustainable development through public-private partnerships in infrastructure PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY The method also documents the original ited method" (Roe and Craig 2004, p. rationale for using private participation 42). in a project, useful if the project needs to be renegotiated or if similar projects are Among the key criticisms are these: considered. · Inaccuracy. Even industrial countries The PSC method does all this by allow- have little objective data on which to ing a quantitative comparison between a base cost estimates. Without such data, PPP project and a public sector project calculating with any accuracy how much that would deliver the same services. The a project will cost to run over 25­30 PSC is a risk-adjusted financial model of years is almost impossible. There have the hypothetical public sector project. It also been difficulties in standardizing estimates the total costs to the govern- methods for determining the "normal ment of achieving the targeted outputs, way" in which the public sector imple- assuming that the project is handled in the ments a project, and the "reasonably" normal way, with reasonably foreseeable foreseeable efficiency improvements efficiency improvements. that public officials might make. The comparison can be made at two points · Omitted risks. Some risks involve huge in project development. First, it can be potential effects on project costs, but done before bids are received, usually as a also great uncertainty. These risks are way to determine whether to move forward difficult to estimate. One such risk is with expensive procurement processes. In contract renegotiation, especially in this case the PSC is normally compared the developing world. Another is that with a hypothetical PPP project (the PPP a government will bail out a private reference), a risk-adjusted financial model contractor rather than let a project that estimates the total cost to government collapse. Expected project costs are of having a private company deliver the rarely adjusted for such risks. Is the PSC targeted outputs. method just an Second, the comparison can be made after · No consensus on discount rate. The comparison between the PSC and the expensive way the bids are received, as a way to deter- PPP project is made in terms of pres- of endorsing mine theoretically whether any of the bids are acceptable. ent values, so the discount rate used is the choice critical. Since PPP costs to the public of private What the problems are partner are spread out over more time, using a higher discount rate will favor participation? In the United Kingdom there has been growing recognition in the past several the PPP project, and the comparative years that the PSC method has serious gains in PSC efficiency must be greater problems--and that in at least some cases to make the PSC approach attractive. it has become an expensive way of endors- Unfortunately, no clear consensus exists ing the choice of private participation. A among economists, policymakers, or U.K. Audit Commission report (2003, practitioners about what the rate should p. 37) concluded that "the PSC has lost be and whether it should be the same for the confidence of many people, and risks the two projects. Countries that have being seen more as a hoop to jump through adopted the PSC approach use a wide on the way to government funding than range of approaches to determining the a valuable exercise that can help ensure discount rate. better VFM [value for money]." · Manipulation. Much of the PSC Problems with the method have convinced depends on subjective judgment, and some U.K. commentators that it should be small adjustments for risk or in discount scrapped: "The PSC has become a discred- rates can have dramatic effects on cost Is the public sector comparator right for developing countries? estimates. Because of this, some U.K. provision "is not a reasonable option" experts were unsurprised when a parlia- (Fitzgerald 2004, p. 31). mentary committee found several cases involving "manipulation of the What the U.K. reforms do underlying calculations and errone- In response to criticisms like these, in ous interpretation of the results" (U.K. 2004 the U.K. Treasury initiated reforms House of Commons, Committee of in how the PSC method should be used: Public Accounts 2003, p. 7). · There should no longer be a bias toward · High costs. The financial modeling private participation; more open-mind- The original required for PSCs and PPP references edness toward conventional public logic for using can be enormously expensive and time procurement is encouraged. PSCs remains consuming. · The systematic tendency for appraisers valid--but · Second-guessing. The PPP reference to be overly optimistic in estimating key today's for the prebid comparison has been parameters for PPP projects should be criticized as a futile attempt by govern- method for explicitly countered through empirical ment officials and their consultants to evidence of this "optimism bias" from doing so estimate what the private sector will do. past projects. may not be Australia's leading state government authority on methodologies for PPP proj- · After bids have been received, there the best ect development, Partnerships Victoria, should be no comparison with the PSC, has recommended not wasting resources and no questions about whether the PPP on this: "The construction of a theoreti- approach is appropriate. The emphasis cal [PPP] model requires government to will be on getting the most from the deal second-guess the multiple assumptions with the preferred bidder. included in the private sector bid and the resulting figure is generally meaning- · The quantitative comparison should be less" (2003, p. 5). considered just one aspect of appraisal, to be used only in conjunction with a · Postbid results too late. The bidding qualitative analysis that looks at a proj- process establishes the PPP costs with ect's potential distributional effects and muchmoreaccuracythanaPPPreference the track record of similar projects. As does. But by the time bids are received, the U.K. National Audit Office put it: canceling the procurement process on "PSCs should be used alongside a range the grounds that the bid price is higher than the PSC costs is almost impossi- of other information when assessing the ble. In countries like Australia and the value for money of [public-private] proj- United Kingdom this is almost never ects" (2002, p. 29). done except when departments simply The focus in the U.K. government now do not have the budgetary resources seems to be on making good use of they need to make required payments to the contractor. databases in estimating project costs. Departments are encouraged to refer to · No public sector alternative. The these databases and use standard spread- PSC may be hypothetical, but it must sheet models to prepare preliminary PSCs refer to a project that could actually in-house, relying less on consultants to do be implemented if private financing costly PSC modeling. was unavailable. If public funding is unavailable, the PSC is largely irrel- What about developing countries? evant. In Australia the Fitzgerald report The original logic for using PSCs remains recommended against carrying out the valid and is especially important in devel- PSC comparison where public sector oping countries: governments need to think through and document their ratio- costs associated with a PPP alterna- nale for using the private sector rather tive and determines whether its likely than traditional public sector methods for efficiency savings would compensate delivering infrastructure services. The PSC for those costs. On the basis of these also forces sponsoring agencies to think representative PSCs, guidance could be through how much it now costs to provide prepared for the routine appraisal of similar services, what risks are associated projects of each type. with a project, and how these should best be managed in an eventual PPP project. · In some situations it might be sensible to use the PSC more as a way to achieve But the PSC method, particularly as used consensus among stakeholders about in some industrial countries, may not be what features a project should have than the best way to do all this in developing as an expert judgment for convincing countries: stakeholders that a project is afford- able and offers value for money. That · Many African countries lack public is, governments could fully acknowledge funding for infrastructure projects, so the subjectivity of the PSC estimates developing and using PSCs in any mean- while using the PSC as a starting point ingful way is generally not feasible. In for soliciting inputs on project design. these cases a comparison can still be made, and documented, between the net economic benefits of the PPP project and References those of the status quo alternative (or Fitzgerald, Peter. 2004. Review of Partnerships Victoria Provided perhaps a less costly, remedial project). Infrastructure. Final Report to the Treasurer, State Government of Victoria, Australia. · Where public funding for a project is Partnerships Victoria. 2003. "Public Sector Comparator." Supplementary Technical Note. Department of the Treasury available and a PSC possible, the revised and Finance, State Government of Victoria, Australia. U.K. approach may not be appropriate. Roe, Philippa, and Alistair Craig. 2004. Reforming the Private Finance Using databases to estimate costs and Initiative. London: Centre for Policy Studies. counter optimism bias, and shifting more Shugart, Chris. Forthcoming. Quantitative Methods for the Preparation, Appraisal and Management of PPI Projects in Sub-Saharan Africa. analytical work to in-house staff, are not Washington, D.C.: PPIAF. easily done in developing countries. U.K. Audit Commission. 2003. PFI in Schools. London. U.K. House of Commons, Committee of Public Accounts. 2003. · The earlier U.K. approach may be more Delivering Better Value for Money from the Private Finance Initiative. appropriate, with its shortcomings offset London. by simple but specific procedural rules U.K. National Audit Office. 2002. Redevelopment of MOD Main Building. Report by the Comptroller and Auditor General. for using conventional costing methods London. and informed expert judgment and for GRIDLINES countering optimism bias. Gridlines share emerging knowledge · Doing PSC comparisons for on PPP and give an overview of a wide one or several representative selection of projects from various regions of projects of different types the world. Past notes can be found at www. ppiaf.org/gridlines. Gridlines are a publication might also make sense. of PPIAF (Public-Private Infrastructure Advisory Often this could be an Facility), a multidonor technical assistance PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY facility. Through technical assistance and abbreviated PSC that knowledge dissemination PPIAF supports the efforts estimates the transaction of policymakers, nongovernmental organizations, research institutions, and others in designing and implementing strategies to tap the full potential of private involvement in infrastructure. The views are those of the authors and do not necessarily reflect c/o The World Bank, 1818 H St., N.W., Washington, DC 20433, USA the views or the policy of PPIAF,the World Bank, the World Bank, Phone (+1) 202 458 5588 FAX(+1) 202 522 7466 or any other affiliated organization. PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY generAl eMAIl ppiaf@ppiaf.org weB www.ppiaf.org