Water, transportation, energy and telecommunications infrastructures are essential building blocks of a nation. Infrastructure plays a vital role in supporting a high standard of living and facilitating trade, thereby extending a country’s global reach. But some governments are not equipped to make the necessary investments. Thus, many government organizations are tapping the private sector’s capital, technology and expertise in financing, developing, and managing public sector infrastructure projects.
These public-private partnerships (PPPs) can benefit all involved. Governments meet obligations without debt, the public receives better services, and the private sector is presented with a wider market. Further, when coupled with the right policies and institutional environment, PPPs can become catalysts for economic growth. The opportunity to drive such growth is particularly rich in the Middle East and North Africa (MENA) region, where many governments are under pressure to develop infrastructure with limited resources.
Relaxing budgetary constraints
The idea of private investment in public infrastructure may seem incongruous. After all, the need for affordable water and electricity and the protection of public interests have historically made infrastructure a natural fit for public-sector management. But governments face a number of challenges in delivering such services: public pressure for lower prices causes services to lose money; mismanagement and corruption result in budget shortfalls; available funds, technology and human resources don’t keep pace with change.
Private sector partners, which can offer funding and other resources, may provide the remedy. Partnerships generally fall into one of four major categories: leases and contracts, concessions (e.g. rehabilitate, lease/rent and transfer), greenfields (e.g. build, operate and transfer), and divestitures (e.g. partial privatization). “Greenfield” agreements, which focus on new facilities, are the most common PPPs because they offer the best opportunities for governments to divest risk and for investors to earn a significant return.
Sectors and geographies
A necessary service to which the public has an inherent right is considered a ‘public good’, but projects with a greater degree of public good tend to have lower returns, inspiring less interest from investors.
Fresh water, for example, must be affordable to the public. Its low ROI makes it unattractive to the private sector. Transportation infrastructure projects are also a public good; however, with a dependable cash flow, they attract a larger percentage of private dollars. Energy, broken into subsectors, creates numerous possible ventures. Telecommunications has a high rate of return. Investments track these patterns: The greatest number of PPP projects are undertaken in the energy sector, but the greatest amount of investment occurs in the telecom sector.
In terms of regional distribution, the largest share of PPP arrangements is still found in OECD countries, followed by East Asia and Latin America. Despite the fact that PPP agreements remain in their infancy in the Middle East, with more reformed regulatory systems and opening up of economies, PPP investments are expected to increase in number and value.
Fueling economic growth
PPPs can free up government resources and fuel growth if certain factors are in place. The first one is the right number of PPP contracts. The more launched, the higher the rate of gross domestic product (GDP) growth. The second is the right value of PPP projects. Higher-value projects inject financial resources into the economy and help decrease government expenses. Third is the right type of PPP contracts. The extensiveness of the PPP contract has the greatest influence on economic growth; as private- sector involvement increases, so does the quality of the project and the knowledge transfer.
PPP projects can bring many improvements. Countries with a large number of such projects generally enjoy better infrastructure, resulting in a higher standard of living and elevated levels of productivity. PPPs foster service expansion, as private partners invest more resources in customer service to generate more profits. PPPs operate with greater efficiency, as investors introduce practices that reduce waste and improve revenue collection. Private investors also have the capital to invest in specialized training, resources and technology. Finally, PPPs can distribute risk in the ways most advantageous to all parties.
While infrastructure PPPs can offer win-win-win results for the public, private, and community arenas, they carry a fair amount of risk for their investors due to their large, lengthy and capital-intensive natures. PPPs are often funded in foreign currency, particularly in developing countries that lack liquid financial markets, yet revenues are collected in local currency, which may be less valuable in global currency markets. They also present a commercial risk triggered by tariff restrictions. Costs to enter into a PPP agreement are typically high, and it is often difficult to form an exit strategy — for instance, selling a bridge is not always an easy prospect.
For these reasons, private firms are naturally selective of the environments in which they invest their capital. Their modes of entry and their investment choices in general are a representation of their ‘risk-return’ tolerance and affect their willingness to commit resources (physical, financial and intangible know-how). In general, investors will enter into countries with large markets and low political and economic risks.
If a government wants to help determine how potential investors answer those three questions, it must:
• Minimize economic and political risks: The government can attract more PPPs to its market by minimizing risks to the private investor where possible. Governments with well- established and enforced policies against corruption, combined with low business transaction costs, a transparent legislative system and exchange rate and monetary stability are far more attractive to the private sector, particularly for projects that require a sizeable investment of capital and knowledge.
• Optimize private-sector commitments to maximize the PPP’s positive effect on the economy: The government needs to promote contractual agreements that encourage the private sector to invest more money, transfer more expertise, and increase accessibility and product choice.
• Secure a sound regulatory system to maximize resource commitment and transfer of know-how: Competitive markets yield benefits for consumers and government alike, but the government must also establish policies that encourage competition.
The groundwork for global development
PPPs can positively influence a nation’s GDP. However, they are not magic bullets. Their influence on economic growth is entirely dependent on the number and value of PPPs in the country, the type of PPP contract, and the policy and institutional environment. With the right circumstances in place, PPPs can prove to be a win-win-win partnership (public, private, and community arenas):
• The government meets its obligations without debt on its balance sheet, reduces its deficit, and lays the foundation for economic development.
• The public receives services that are often more reliable and of a higher level of quality than services provided solely by the public sector.
• The private sector finds a new and wider market in which to expand and invest its finances in a stable, long-term cash flow.
Rabih Abouchakra is a partner and Mona Hammami a principal at Booz & Company