The Need for A Novel Solution in Infrastructure Finance (Part 2) | srei

The Need for A Novel Solution in Infrastructure Finance (Part 2)

Benefits of public private partnerships (PPPs) over traditional procurement process arise from (potential) efficiency gains associated with the private sector managing the construction and operation of the infrastructure asset. The main issue concerning the PPP model relates to its inflexibility. This lack of flexibility is necessary in order to mitigate the time-inconsistency problem, but can be a constraint, especially when projects involve very uncertain prospects over the long term.

The RAB model overcomes this problem by having a regulator to periodically assess the performance of the private sector provider. The wider economic benefits of infrastructure can be realised only if projects are approved and receive sufficient financing. This requires that the government is able to issue debt. The following however constraints on the provision of capital by the public sector might suggest that this is not possible.

Investor demand: The cost of credit and ability of government to place certain amounts of debt in the market, given investor’s demand for government debt.

Cost of debt: The cost of credit, default risk and the credit rating of the government debt.

Government/supranational limits—For example, limits on debt and deficit introduced in the EU.

Long-term fiscal policy—Requirement for sustainable levels of debt and deficit in the long term given the target level of indebtedness and projections for tax revenues and expenditure.

As Helm (2009) notes, simply relying on the private sector to provide infrastructure investment is likely to lead to underinvestment due to market failures (market power and externalities).There are multiple market failures, which together are sufficient to conclude that the private sector, left to its own devices, will produce a seriously sub-optimal level of provision. Put simply, there will be inadequate energy, transport, communications and water networks, to the detriment of consumers and industry.

In a bid to overcome these difficulties, governments are seeking private investment in transport infrastructure from ‘novel’ sources (including sovereign wealth funds, pension funds, and other investors) and governance models. Since the early 1990s, this has often taken the form of PPPs, which have involved long-term contracting between the public and private sector. Under these contracts, the private sector has been required to provide the up-front financing for the infrastructure, and has then received payment from the public sector for providing it with a stream of services.

More recently, there have been calls for alternative models. The RAB adopted in the regulation of utilities in the UK, and subsequently further afield, is one proposed model that has garnered increasing attention. Market failures result in the private sector not being able to cover the investment requirement itself. The government failures associated with intervention and PPPs offer options in overcoming these failures.

The government initially can provide a guarantee to investors ensuring recovery of costs associated with the investment, only to renege subsequently and to expropriate rent from the private sector. PPPs and the RAB model both represent a way in which the time-inconsistency problem may be mitigated.