Public-Private Partnership and Private Finance Initiative - Essay Example

? PPP/PFI Projects- Concept, efficiency and prevalence PPP/PFI Projects- Concept, efficiency and prevalence Introduction PPP/PFI- Public private partnership/ Private Finance Initiative, a fast growing concept in the field of project management, is a kind of procurement practice that helps in mitigation of risk or simply transfers risk to the private sector till the point of initiation of operations. Even after the completion of the project the private sector offers DBOM (Design, Build, Operate and maintain) and in lieu receives payment for the accumulated cost over a long term period, generally 25 years (Grimsey and Lewis, 2005). Most of the governmental infrastructural projects and constructions are done through PPP/PFI, thanks to the initiation of this practice by Australia and then the UK. PPP/PFI basically works like any other project whose construction costs are borne by another party, completed and handed over to the client, only on a very large scale. In case of failure in the design structure, non-compliance with the project particulars, etc. the risk is assumed by the financing party. This project risk transfer method is seen as an extension of outsourcing and privatization. However, it is different from privatization because the private entity hands over the project to the government after completion and the government runs it as state owned facility/site. PPP/PFI differs from conventional procurement because the total payment is not made by the government after the completion of the project. It is paid over the course of time and several years of operations. This facilitates both the public and the private sector, because eth public sector does not have to make the payment and thus the cost is spread over a number of years. The risk of project failure is transferred to the private entity responsible for the project. The private sector gets a sure payment plan spread over a number of years and the chance to bag more governmental projects over due course, this kind of procurement is generally undertaken for state owned projects related to construction and operation of highways, bridges, hospitals, schools etc. There are several concerns and contrasting views about the feasibility of a PPP/PFI funded project. This is because the element of risk transfer also adds to the government’s borrowing costs. At its completion if the project is successful, the private sector gets to enjoy super normal profits at the expense of the government and the mass public in general due to taxation levied to pay off the debt. Thus, in order for the success of a PFI funded project to be deemed successful, it is imperative that the benefits derived from the project can be valued to be more than the borrowing cost (Ismail, 2011). PPP/PFI in UK The government of UK introduced PFI in the year 1992 (Wilson and Game, 2002). Even though the practice had been already implemented by countries like Australia previously, the UK gave it a more solid framework by specifying policies that would govern such financing practices of the government. Implementing the PFI practice at large for capital investments allowed the UK to hone it into an ideal framework that could be taken as benchmarks by the other governments of the world. Not long after it had this system running, the National Audit Office in the UK demanded that even though there was no question of its effectiveness, this procurement transaction had to be shown in the governments’ financials and a much hyped controversy emerged regarding which accounting head it should be put under and the accounting that it was to imply. It was however decided that the future payments for the PFI during the concession period should be taken into account for budgeting for the years to come, leading to effective assessments that can be reflected in the budget. The terms PPP/PFI are used interchangeably all over the world but PFI gives a clearer picture to the concept. During the credit crisis of 2008, many private sector banks stopped their financing to the government due to their high costs of lending. This had a major effect on the infrastructural projects planned and those which had their initiation phase came to an abrupt halt. According to the 9th report of the “Financing PFI projects in the credit crisis and the Treasury's response” published by the UK house of commons, as many as 110 PFI projects came to a stop as a result of the credit crisis whose worth was valued at ?13 billion pounds, out of which 30% was for waste treatment facilities, 15% for schools, 12% for transport and 11% for housing (Morse, 2010). As one can comprehend, this brought a loophole in the provision of welfare facilities to the public at the rate planned and thus, the government also faced hefty disruption as a result of the credit crisis. In 2009, banks started lending to the government again but in smaller amounts. In order to tackle this situation, the government formulated a unit by the name of the Infrastructure Finance Unit (IFU) through which the government was able to lend the deficit amount to the private sector, negotiate financial terms, evaluate alternatives and work towards smarter selection of private entities for government projects . The treasury realized that in order for the government to bring down the infrastructural cost they had to look for less expensive alternatives. Several alternatives were proposed by the treasury to the government as well as to banks to come up with a solution to this problem. One of the major developments under way at present is the idea of grouped PFI projects to form a portfolio that could be refinanced over time. In this way it opened up more financing options like insurance companies, banking syndicates, pension fund providers etc. This improved the bargaining position of the government and also increased the % gain for both the parties (public and private) over time. Thus, several highs and lows in the form of project successes and failures enabled the UK government to come into the forefront as far as the developing the concept and working of the PPP/PFI was concerned (Li and Akintoye et al., 2005, pp. 459--471). Example- The Channel Tunnel Rail Link- UK The Channel Tunnel Rail Link commonly referred to as the CTRL project is an interesting example to take up due to its two significant features (Stannard, 1990, pp. 49--62). Firstly, it is a cross border project involving France and England. Secondly, due to the cutting edge technology and construction expertise that had to be employed, the cost was abnormally high even for a government infrastructural project. The project involved the construction of a rail tunnel that could link London and Paris by only a distance of 140 minutes. It was constructed under the wings of Eurotunnel, a company that came into being for the exclusive construction and successful running and maintenance of this project. Since its official operations initiated in the year 1996, the channel tunnel has experienced a variety of mishaps and accidents. The most hyped of these are the 3 recurring fires that have occurred in its relatively short course of operations. The first one took place in 1996 where the fire burned for over 7 hours. In 2006 and 2012 short fires closed down the tunnel for a short period of time. In 2008, the channel tunnel had another fire incident that lasted for about 16 hours. The reasons behind these incidents have been highlighted as unidentified in some cases, exploding locomotives or carriages, ignition due to friction under the Lorries etc. the 1996 fire took about 6 months to be repaired and the repair cost were estimated to about ?200million. The 2008 fire is said to have destroyed 6 carriages and one locomotive many passengers were evacuated and several complained of respiratory problems for months to come. The fire itself took 2 hours to extinguish. The Eurostar, the name of the transporting tunnel rail, runs up to 17 trips daily from London to Paris and is the longest under-sea tunnel in the world. Having had an 80% over budget cost and a price of about ?10billion pounds today, the company Eurotunnel has experienced significant monetary debts since its inception. The occasional incidents that add to the existing costs push the company further down the debt lane. Now the government is responsible to ensure that the investors get their return on investment. The initial idea was to construct shopping complexes and mall in the area but the idea was rejected due to feasibility issues. The economic failure of this project is dependent upon many factors like not deciding interest rates before hand for time intervals to come, political intervention in the form of changing regulations leading to time and cost constraints etc. Thus, no matter how attractive the system looks, PPP is fruitful if executed with proper planning (Alex and Ersson et al., 2007). Otherwise, it can also yield negative results like inefficient, under-utilized and loss incurring transportation entities like the channel tunnel. There are several advantages and disadvantages of PPP/PFI ventures. On the up side it ensures timely completion, mitigates risk, allows re-direction of government risks to other development areas, reduces the tax rate, allows more return on investment due to scope for innovation and technology and since the project is meant to comply with a carefully formulated project proposal, it is bound to be accurate and have a longer life (Rodriguez, 2013). On the other side, PPP/PFI comes with a negative side as well, the government being subjected to covering risk costs over time, welfare projects tend to yield slow and minimal returns, less private entities that undertake PPPs make the bargaining power of the government weak etc. The growing attention that is being attributed to PPP/PFI by the developed and developing countries of the world has brought into light several important critical factors through extensive research. The ambiguity associated to the vague concepts of risk transfer and value of money lead to a distortion in the rationality of this funding approach. Studies have revealed several success factors and cost benefit analyses that clarify the checklist particulars which can point towards a project’s feasibility. Research also assesses the sectors that have a better history of successful PFI projects that can help in improving its application in other areas and develop its usage in the successful sectors. The underlying success criteria is constituted of several factors like stable macroeconomic environment, political and social environment, dispute resolution mechanism, agreement of shared responsibility between the public and private sector, allocation of variable risk, limitation on liability, government control etc. (Chan & Lam et al., 2010). These can be insured through an agreement like the code of conduct issued by the government of UK, which is agreed upon by many companies for the funding, investment and completion of a project (Gov.uk, 2013) Even though the aim of this funding initiative is decreasing the government’ risk and increasing the incentives for the private sector to make use of their resources to deliver cost efficient and durable socially beneficial projects, many factors that are subliminal in nature have to be studied and identified critically to ensure the effectiveness of the overall project plan (Boussabaine, 2007). Conclusion PPP projects need to be profit yielding for the private participants as well otherwise; the private sector will refrain from such advances burdening the public sectors with the costs (Link and Scott, 2001, pp. 763--794). Thus, the government needs to incentivize the process to attract them. Formulating guidelines that propose contingency plans in case the projects go wrong, risk mitigation, economic goals and options for renegotiations can be a welcome step for the strengthening the relationship between the public and private sector. The PPP should be applied on the basis of feasibility in terms of productivity, allocative efficiency, and proper use of resources for both the parties. In this way, planning can ensure that the hefty investment that goes into such projects is not wasted and fulfills its intended purpose for all the stakeholders. References: Alex, Ersson, G. and Hult\'En, S. 2007. Prospects And Pitfalls Of Public-Private Partnerships In The Transportation Sector--Theoretical Issues And Empirical Experience. Thredbo. Rodriguez, J. 2013. Public Private Partnership (P3): Public Private Partnership Pros and Cons. [online] Available at: http://construction.about.com/od/Government/a/Public-Private-Partnership-Pros-And-Cons.htm [Accessed: 29 Dec 2013]. Li, B., Akintoye, A., Edwards, P. J. and Hardcastle, C. 2005. Critical success factors for PPP/PFI projects in the UK construction industry. Construction management and economics, 23 (5), pp. 459--471. Morse, A. 2010. HM Treasury. London: The Stationery Office. Wilson, D. and Game, C. 2002. Local government in the United Kingdom. London/Basingstoke: Palgrave Macmillan. Grimsey, D. and Lewis, M. 2005. The economics of public private partnerships. Cheltenham, UK: Elgar. Stannard, C. J. 1990. Managing a mega-project—the Channel Tunnel. Long Range Planning, 23 (5), pp. 49--62. Link, A. N. and Scott, J. T. 2001. Public/private partnerships: stimulating competition in a dynamic market. International Journal of Industrial Organization, 19 (5), pp. 763--794. Gov.uk. (2013). Code of conduct for operational pfi/ppp contracts - publications - gov.uk. [online] Retrieved from: https://www.gov.uk/government/publications/code-of-conduct-for-operational-pfippp-contracts [Accessed: 2 Jan 2014]. Chan, A. P., Lam, P. T., Chan, D. W., Cheung, E. & Ke, Y. (2010). Critical success factors for ppps in infrastructure developments: chinese perspective. Journal of construction engineering and management, 136 (5), pp. 484--494. Ismail, S. (2011). A systematic review of research on the private finance initiative (pfi) and public private partnership (ppp). Boussabaine, H. A. (2007). Cost planning of pfi and ppp building projects. New York: Taylor & Francis. Read More