A Macroeconomic Analysis of Investment under Public-Private Partnerships and its Policy Implications - the Case of Developing Countries

Abstract

The objective of the present dissertation is to propose a theoretical model of the decision to invest under a Public-Private Partnership (PPP) contract and to test empirically both the determinants of such investment and its economic impact. The basic theoretical model proposed in the dissertation outlines the conditions for the optimal timing and the scale of monopoly production associated with the decision to invest in a PPP project, in which the two partners fully cooperate. Based on the theory of irreversible investment under uncertainty, it concludes that the optimal decision to invest under a PPP depends negatively on the risk and uncertainty associated with the project, and the real cost of capital, while it could be underpinned when the government tax burden and the associated cost of taxation is high. Two extensions of the theoretical model conclude that PPP arrangements (i) have the potential to diversify risk, when risks facing the private and the public partners are correlated; (ii) may provide the private partner with the possibility to exit the contract at a later stage should economic conditions deteriorate; through contract renegotiation, explicit or implicit government guarantees, or bailing-out expectations, PPP offer a put option that induces the private partner to undertake the investment more readily or in a larger amount even under higher uncertainty. Together with the findings of the basic model, this results in an ambiguous effect of uncertainty on PPP investment. The theoretical predictions of what determines the decision to invest under PPP programs, as well as the potential economic impact of PPP investment, are tested empirically for the case of developing countries, using the World Bank database on private participation in infrastructure for the period 1990-2005. This is the largest database of this kind, which uses a consistent methodology across developing countries and time to record investment commitments in four infrastructure sectors: transportation, energy, water and sewerage, and telecommunication. As regards the determinants of investment under PPP, several predictions of the basic theoretical model are confirmed by the empirical analysis, while the evidence for the others is weaker or difficult to control for empirically. One measure of risk proves to be a robust determinant of PPP investment, that is, the political risk through its component of investment profile risk. Two other measures seem to be significantly associated with the number of PPP infrastructure projects initiated in developing countries over the period 1990-2005, that is, exchange rate uncertainty and uncertainty regarding public investment. Similarly, as indicated by the theoretical model, a higher tax burden is likely to induce governments to engage in larger PPP programs. Another prediction of the theoretical model—that the nominal lending interest rate is likely to have a negative effect on PPP investment—is weakly confirmed by the empirical model in the whole sample, but it turns more robust in the restricted sample of Latin America and Caribbean (LAC) countries where PPP programs are more developed. Finally, the empirical analysis provides evidence as to other significant determinants of PPP investment, that is: (i) the experience with PPP programs; (ii) the size of the economy; (iii) complementarity with private investment; (iv) external aid; (v) time and regional dummies. As regards the impact of PPP investment, at a macroeconomic level, larger PPP programs in infrastructure may induce, on balance, higher fiscal risks for governments in developing countries through the attached explicit or implicit contingent liabilities. However, they may also contribute to improving fiscal positions in the future through higher upfront payments to the government or by substituting part of public investment. In several countries of Latin America, private investment in roads may have been a factor associated with higher economic growth since the mid-80s. The qualitative analysis based on the literature review, as well as the results of the theoretical and empirical models, indicate that, while the experience with PPP in developing countries has been mixed, there is overall more evidence in favor of undertaking PPP investment.