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Concession contracts for private entities to

operate publicly-owned infrastructure are

almost universally considered to be an

institutional innovation for realising the

efficiency gains of the private sector. Given the

usually competitive nature of the bidding

process, the assumption of some private risk,

and the concessionaire‟s profit motive, it seems

tautological that there is a greater role for the

market in concession contracts when compared

with discretionary regulation.

This article takes a different approach to the

conventional wisdom in an attempt to remind us

of some important „broader truths‟ about the

innately political nature of concessions. While

certainly market forces are more evident in the

operation of concession contracts, in practice

they are awarded within a wider institutional

construct designed specifically to achieve the

government‟s preferred set of policy objectives.

In short, while concession contracts attempt to

function like a market, their structure is set in

accordance with politics. Moreover of genuine

concern for achieving optimal policy is the

ability of political considerations to override the

concession process if the government does not

prefer the likely concessionaire: The costly

problem of political risk. A final insight is that

concession contracts can and do substitute for

market forces but they are not necessarily a

substitute for political forces or for discretionary

regulation.

Market in Function, Political in Structure

The structural characteristics of a concession,

and critically the method by which a concession

is awarded, are primarily the product of a set of

pre-defined political objectives. One

government might have a policy preference for

deficit reduction over containing the „cost of

Markets and Politics in Awarding Infrastructure Concession

Contracts

Markets and Politics in Awarding Infrastructure Concession

Contracts

Jonathon Flegg j.c.flegg@nus.edu.sg

Jonathon Flegg j.c.flegg@nus.edu.sg

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living‟, while for a different government the

relative importance of these policy objectives

might be in the opposite order. The government

that has placed a higher priority on deficit

reduction is likely to award the concession

contract to the firm that can operate the

infrastructure with the lowest government

subsidy or highest concession fee, while

governments concerned about the costs to

customers might award the concession to the

firm who will charge the lowest user charge or

tariff.

The awarding of a concession, if through an

auction and with an adequate number of

competitive bidders, is thought to be a

reasonably close substitute for a free market

solution1. Specifically those auctions that award

the concession to the bid offering the lowest

consumer price are generally considered most

efficient, as price is generally how firms

compete within the spot market (Kerf et al 1998;

OECD 2007). However here it is important to

note that when the bidding process functions in

a market-like way it is still conditional on the

political objectives that determine the auction

structure.

1 A vast literature exists on the optimal design of auction

processes (Kerf et al, 1988), as the design is critical to

achieving an efficient outcome. Inappropriate design can result

in winning bids below that do not reach the fully competitive

outcome, or can give rise to strategic voting or coordination

among bidders.

This point is most obvious when the politics

behind concession auctions generate an

obviously sub-optimal outcome. For instance

the New South Wales Government‟s 2002

concession to build and operate Sydney‟s

Cross-City Tunnel was offered to the bidder

who could supply the Roads and Traffic

Authority with the highest “upfront fee”. The

remarkable winning sum ended up being A$97

million, which was passed onto motorists

through higher tolls, and eventually sunk the

contract after less than two years of operation

(Baker and Davies, 2006).

In contrast the policy goal of deficit reduction

evident in the Argentinian concessions on

urban railways and waterways during the 1990s

seems to provide a better solution when the

minimum subsidy bid criteria was coupled with

a fixed price (Gómez-Ibáñez, 1997).

Pro-poor political motives can also sink a

concession. The 1997 water and sewerage

concession for the Bolivian capital of La Paz

was awarded to the private operator willing to

connect the largest number of households in

the poor neighbouring city of El Alto (Komives,

2001; Estache et al 2002). The resulting tariff

charged by the concessionaire together with the

particularly exorbitant connection fee, resulted

in mass protests and the cancellation of

concession.

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Direct Political Intervention and Political

Risk

Politics not only sets the structure of the bidding

process but also interferes within the process,

including measures designed to promote or

prejudice specific bidding firms.

In 2005 the Croatian Premier ordered the

nation‟s Telecommunications Agency

deliberately ruled out Adriacella, an Arab

consortium, from being granted a mobile

telecommunications concession because of

speculation about their “cooperation with the

narcotics trade” (Cvitić, 2005). A 2009

concession contract awarded to build and

operate a light rail project on the congested

French island of Reunion was cancelled

because of an opportunistic campaign directed

at the concessionaire by a newly-elected

regional council (Thomson, 2010).

Because governments control the entire bid

structure they still have the capacity to appoint

or deny potential concessionaires in an

uncompetitive or non-transparent way. This is

even more the case in structures for choosing

concessionaires that are themselves non-

transparent, such as by negotiation or beauty

contests. When governments circumvent their

own tendering or contractual procedures in this

way the result is political risk, and is an

additional cost borne by firms as soon as they

decide to invest in the expensive bidding

process.

Concessions Rarely Substitute for

Regulation

On the menu of possibilities for dealing with

natural monopolies in infrastructure,

discretionary regulation is a more political

option because of the risk of regulatory capture.

The conventional wisdom generally views

concession contracts as a less political

substitute for discretionary regulation (C.

Kessides, 1993; I. N. Kessides, 2004; Gómez-

Ibáñez, 2003):

By establishing an explicit contractual

relationship, concessions limit the

government’s discretionary powers and can

reduce the risk of political expropriation (I. N.

Kessides, 2004: 105).

However in practice many network

infrastructure concession contracts do not

actually replace discretionary regulation

(perhaps with the exception of the highway

sector). This important point has been noted by

the OECD (2007):

Concessions are not substitutes for regulation.

Where there is a need for regulation, as in a

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situation of natural monopoly, a regulatory

regime may be created along with the

concession.

Most jurisdictions that utilise concessions for

water, sanitation, telecommunications and

energy networks, also make the contracts

subject to a regulatory body. For instance, in

1992 the end of Buenos Aires state-owned

water and sewerage utility, Obras Sanitarias de

la Nación, was not only accompanied by the

introduction of widespread water and sewerage

concessions, but also a new peak concession

regulator, Ente Tripartito de Obras y Servicios

Sanitarios (Delfino et al 2007).

Similar coupling of regulation and concessions

is common in many economies in Latin

America, East and South-East Asia, the United

States and Australia. So to the extent

concession contracts do not substitute for

regulation in the real world, they cannot be

viewed as operationally free from political

forces.

“Competition in the Politics”

A useful distinction is often made between

competition in the market and competition for

the market. A concession contract is

fundamentally different from the free market

solution because it is an example of the later.

But if concessions do not reside in the market,

where do they reside? Unlike private contracts

it is clear that they still belong in the public

realm, or at least to a sphere of “competition in

the politics”.

At best concessions function like a market,

within a bidding structure determined by

politics. Rarely however do they operate in such

an ideal way. In most jurisdictions, particularly

in developing economies but also in developed

ones, the competitive process itself has very

little integrity, given that the government

reserves the right to intervene specifically within

the process to ensure the concession is

awarded to a firm with similar preferences.

Finally, the idea that a concession contract

creates a market-like bubble unsusceptible to

politicised regulation is an exception rather than

rule.

To start the change governments committed to

implementing concession contracts must

understand the costs that political risk place on

the private sector (and by incidence, end-

users), and seek in an enlightened way to „bind

their own hands‟ and allow competitive,

transparent bidding to take place without

interference.

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