public-private-partnerships: a tool for improving public
TRANSCRIPT
Public-Private-Partnerships: a tool for improving public transportation
infrastructure in developing countries
A thesis submitted to the Bucerius/WHU Master of Law and Business Program in partial fulfillment of the requirements for the award of the Master of Law and Business (“MLB”) Degree
Natasha Mina July 26, 2013
14.553 words (excluding footnotes) Supervisor 1: Prof. Dr. Ralf Fendel
Supervisor 2: Prof. Dr. Burcin Yurtoglu
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TABLE OF CONTENTS
I. Introduction ........................................................................................................................... 1
II. Forms of undertaking public infrastructure projects .............................................................. 3
A. Public Procurement: traditional public works .................................................................... 3
B. Contracting out ................................................................................................................. 4
C. Privatization ..................................................................................................................... 5
III. Public-Private Partnership: Overview .................................................................................. 5
A. Difficulty in defining PPP................................................................................................. 5
1. Broad Range.................................................................................................................. 5
2. Public- Private Partnerships and Concessions ................................................................ 6
B. Historical Development .................................................................................................... 7
C. Forms of PPP.................................................................................................................... 8
D. Need for Intelligent Transportation System ..................................................................... 10
E. Why Public-Private Partnership? ..................................................................................... 12
F. Which PPP? .................................................................................................................... 15
G. Best practice drivers ....................................................................................................... 15
IV. Developing countries: background .................................................................................... 17
A. Current situation ............................................................................................................. 17
B. Observable roots to the problem...................................................................................... 18
1. Bad Governance .......................................................................................................... 18
2. Inadequate regulatory and legislative frameworks ........................................................ 19
3. Inefficiency of operations ............................................................................................ 20
V. Financing Structures in PPP ............................................................................................... 21
A. Project Financing Structure............................................................................................. 23
1. Special Purpose Entity/ Special Purpose Vehicle ......................................................... 24
2. Sources of funding ...................................................................................................... 24
3. Value for Money in PPP .............................................................................................. 26
B. Assessment of risks ........................................................................................................ 27
VI. Applicability to Colombia ................................................................................................. 28
A. Current Situation in the public transportation system: the example of Bogotá .................. 28
B. Legislative and regulatory framework ............................................................................. 30
1. Law 1508 of 2012/Law 80 of 1993 .............................................................................. 30
2. Case of Transmilenio ................................................................................................... 31
3. Mobility Masterplan .................................................................................................... 33
C. Form of investment ......................................................................................................... 33
III
1. FDI in Colombia and modes of entry for foreign investors ........................................... 34
2. Proposition for the structure of the SPV in the Colombian case .................................... 34
D. Key elements of the project ............................................................................................ 35
1. VFM ........................................................................................................................... 36
2. Joint-Venture............................................................................................................... 37
3. Sufficient demand ....................................................................................................... 39
4. Tariff ........................................................................................................................... 40
VII. Conclusion ...................................................................................................................... 41
IV
List of Abbreviations
BOO Build-Own-Operate
BOT Build-Operate-Transfer
FDI Foreign Private Investment
DBFO Design-Build-Finance-Operate
IPTS Integrated Public Transportation System
NPV Net-Present-Value
O&M Operation & Maintenance Contract
PFI Private Finance Initiative
PPP Public-Private Partnership
PPPIRC PPP in Infrastructure Center (Worldbank)
SPV Special Purpose Vehicle
TM Transmilenio
TNC Transnational Company
VFM Value-For-Money
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I. Introduction
Infrastructure is a main driver of citizen’s quality of life, as its main objective is to
satisfy households’ needs for different services needed to survive. People not only need
efficient and sustainable transportation means, they are dependent on them. Indeed,
urban transportation belongs to the category of economic infrastructure needed by a
country to function (Vuksanović & Milojčić, 2011). The World Bank has stated that
“the adequacy of infrastructure helps determine one country’s success and another’s
failure” (The World Bank, 1994). The latter reflects the urgency in identifying failures
in provision of economic infrastructure and demands an analysis of the existing wrong
patterns in order to correct them and adapt to changes to overcome what is commonly
known as the “infrastructure gap” (Guasch, 2004). Not without reason, many
alternatives for providing infrastructure have been set forward on the grounds that new
models are needed in the interest of overcoming the pitfalls encountered by inadequate
infrastructure. Public-private partnership is a broad concept that brings together all of
these alternatives. It refers to the involvement of a private company in designing,
financing, constructing, owning and/or operating a utility or service that has
traditionally been procured by the public sector. The partnership blends the special
skills from both the public sector as client and the private sector as supplier, with the
purpose of achieving a more efficient outcome that would not be reachable if each party
were to work independently (Akintoye, Beck, & Hardcastle, 2003).
Among many other things, the gap between developed and developing
economies is noticeable when looking at different transportation systems. Developing
cities have faced a lack of proper public service delivery–especially in transportation–
due, most of all, to the absence of an intelligent transportation system, which is key to
attain sustainable modes of mobility that satisfy users’ needs and improve their quality
of life.
The latter situation sets the need to attract private investors with large experience
and financing capacity to realize these projects in collaboration with the government.
That said, the large range of options for mixing public and private funds requires an
appropriate supporting environment represented in proper regulation and guidance, so
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as to fully explore the different options available for public-private partnerships and
comprehend how they can successfully work. The definition of public-private
partnerships falls short in providing an adequate understanding of the concept. Being an
extensively broad concept, the understanding of the model needs to be facilitated by
proper regulation and legislative frames that fully reflect their innovative aspect and
presents decision-makers with viable options when bringing public and private forces
together. This is especially true considering the uncommon and new trait of the PPP
model that needs to mature enough to be implemented efficiently.
Ultimately, this paper will contribute to the arguments that nowadays, private-
public partnerships seem to be a more suitable way to undertake public infrastructure
projects in developing countries, by setting an easily attainable scenario for
incorporating and transferring the know-how of highly effective mobility systems from
developed countries, through applicable contractual figures that combine both private
and public budgets. This hypothesis will also respond to the analysis of the financial
viability of PPPs, which is ultimately defining when identifying whether PPP is the
right choice. Different forms, as well as trends, exist when it comes to private
involvement in infrastructure. Studies have shown that private participation does
improve the efficiency of a service delivery, for many reasons, among them because
politicians and governments are less likely to intervene in the activities of private
entities, which will not be subject to governmental manipulation, which is often the case
in developing countries. The issue however remains on achieving users’ welfare by
improving performance and efficiency together with lower tariffs and increase coverage
while generating returns to investors (Guasch, 2004).
To document the latter, this paper is organized as follows. Section 2 will review
the forms of undertaking public infrastructure projects from different scholars with the
purpose of showing the vast range in which both private and public forces can be
combined. Section 3 will provide an overview of the different arrangements in which a
PPP can be formed and will lay out the main advantages of this model that have been
presented by different scholars. Section 4 will provide a background on the current
infrastructure scenario in developing countries, to reflect on the inefficiencies
experienced by traditional models. Section 5 will provide an overview of the main
elements of the financing structure of a PPP, specifically the project financing model
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and how value-for-money (VFM) in these models can be calculated. Finally, we will
discuss the applicability of a PPP model in the case of public transportation systems in
Colombia.
II. Forms of undertaking public infrastructure projects
The existing literature and research on the subject offers a large range of classifications
for undertaking infrastructure projects from entirely public procurement to wholly
private methods. Below is a gathering of different forms, arranged into different
categories to help achieve a better understanding. At the end of the day, we face
different ways of bringing together the public and the private sectors depending on two
main drivers, namely a direct versus an indirect role played in the provision of the
service. Operation and maintenance would correspond to the first kind of role and
ownership and finance to the second one (Batley, 2001). Thus, the difference between
purely public, purely private or a combination of both will depend on how these
different roles are split between the public sector, on the one hand, and the private
sector on the other.
A. Public Procurement: traditional public works
Within the traditional model of public procurement, a state entity takes on the
responsibility of designing, financing, operating, and maintaining public infrastructure
projects. Some private participation can come in the form of outsourcing any or a
specific part of the project, but no responsibility or risk is allocated to that party
(European Commission, 2003). This is especially true for service contracts, through
which public entities can benefit from the expertise and know-how of private entities for
specific tasks within a project.
In the instance where the service is procured as traditional public works, while
construction and operation are procured separately from two different private sector
firms, this scenario reflects a traditional public procurement form. When construction
and operation are bundled together, the project develops into a PPP (Blanc-Brude,
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Goldsmith, & Valila, 2006). As will be discussed later, bundling can represent both an
advantage, as well as a disadvantage when it leads to the creation of monopolies.
Richard Batley (2001) argues that public procurement is not very justifiable on
the surface, when it comes to the technical consideration of goods and services, but it is
more plausible in the case of services that have a tendency to become monopolies that
need large-scale investments and that have a profound effect on society (Batley, 2001).
In the pure public procurement model, the public sector plays all four roles in the
provision, i.e. operates, maintains, owns, and finances the service.
B. Contracting out
In these kinds of projects, government bodies remain responsible for providing the
services in an indirect way, i.e., some elements of its production or delivery are
outsourced to the private sector. The public sector finances the project and remains the
owner of the assets while remunerating the private sector according to a fixed sum and
not on an efficiency and performance basis (Batley, 2001). This is a way of involving
the private sector in public infrastructure projects in situations where it would seem very
difficult in principle to delegate the full provision and production to it given the
likelihood of a market failure occurring (Batley, 2001).
Operation & Maintenance (O&M) contracts are a typical form for these
agreements. While they could, in principle, be regarded as public-private partnerships,
they are included here in a different category responding to the PPP wave observed
since the 1990s, which has moved towards attracting more private commitment in
investment. However, O&M contracts do not imply a private responsibility towards
investment obligations. Additionally, the worldwide trend for transportation projects
leans more toward the use of other types of contractual arrangements rather than O&M
contracts (Estache & Serebrisky, 2004).
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C. Privatization
Under this form, assets are divested to a private entity entirely. In fact, under this model,
the private sector becomes accountable for the provision of the public service before the
users (UNECE, 2008), the most common example being the provision of
telecommunication services. Outright privatization results in the transfer of ownership
of public assets to the private sector and does not have a limited period of time, which
differentiates them from the concession type (Guasch, 2004). Contrary to this form, in
concessions, revenues generated by the project are the only assets that the private
operator owns. Land, plans, machinery, and other elements remain state property and
cannot be pledged by the private party against a loan (Guasch, 2004).
III. Public-Private Partnership: Overview
A. Difficulty in defining PPP
To provide an exact definition of this concept is a very difficult task, taking into
consideration that PPP is a dynamic concept involving any form of contractual
arrangement between the government and a private entity to embark on a specific
project, and moves along a spectrum initiating in completely public supply and
operation to complete private supply and operation (Guasch, 2004).
1. Broad Range
Does the definition of a PPP vary to the degree of involvement of the private entity?
What is the difference between PPP and other forms of private involvement such as
concession models that existed prior to the concept of PPP being introduced in the
public infrastructure arena? Does the difference lie on a mere technicality? Some
authors use the word PPP and concession interchangeably while some others make a
distinction. For instance, one difference between both concepts is that users pay
directly for services in concessions (Blanc-Brude et al., 2006). When the government
pays to the private party undertaking the project on the basis of agreed standards of
quality would not be considered to be a concession. Again, this depends largely on the
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interpretation given to the different models in different jurisdictions and studies.
Likewise, while some scholars treat the models located in the almost completely private
supply end of the financing spectrum as privatizations, some others still refer to them as
PPP.
The way to approach the difference, if any, will largely depend on the country
where the project is to be commenced, and the different national regulations and
policies that will have to resolve the potential pitfalls arising out of misunderstandings
of the concept. Notwithstanding the above, there is general consensus that a PPP is any
form of private involvement in a project that would normally show—and has
historically shown—to be the sole responsibility of public authorities. To narrow it
down further, private finance is considered the core element used to distinguish between
PPP and traditional public procurement, because it clears “risk allocation and incentive
mechanisms, which are defining characteristics of PPP” (Blanc-Brude et al., 2006, p. 3).
2. Public- Private Partnerships and Concessions
The World Bank makes a distinction between public contracts, such as concessions
where the private party provides a service directly to the public taking end-user risk,
from PPPs where the private party delivers a service to a public party in the form of a
bulk supply.1
On the contrary, authors like Luis Guasch (2004) do not make use of the term
public-private partnership in some of their works; instead in Guasch’s case, he refers to
“private participation in infrastructure” and argues that it can come in many forms,
ranging from management contracts to full privatization as well as a variety of
concession form . Also, when it comes to concessions, Guasch pinpoints four main
categories, namely management contracts, leasing, franchise, concessions and build-
operate-transfer, that are situated somewhere in the spectrum mentioned above.
However, Batley (2001) refers to a parallel split of functions in partnerships
between public and private providers rather than the hierarchical form of splitting roles
1 See World Bank PPP in Infrastructure Center, available at www.worldbank.org/ppp
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observed in arrangements where the public sector contracts, leases, or gives in
concession to a private party. As per the definition of a partnership, public and private
sectors are shareholders who share a joint purpose and put together different sources
(Batley, 2001). However, contracts such as franchises, leases or concessions are treated
as PPP by many other scholars even if a hierarchical division of roles exist.
Finally, the definition for PPP may vary from country to country, according to
different laws and different experiences.
B. Historical Development
A good way to understand the applicability or the origin of PPPs is to go back to its
roots and identify the moment where the model was born. Some changes and evolutions
are crucial in the process of introducing PPP as a way of financing public infrastructure
projects. Mainly, public unsuitability has driven economies to turn to private entities for
their support. By the time private participation was introduced, some governments had
failed in the provision of critical infrastructure services to the population, showing
symptoms of “chronic inefficiency, poor pricing policies, and corruption” (Harris,
2003, p. 4) that prove the failure of governments to provide these services. Furthermore,
as utilities were progressively being privatized, multinational utility operators were
developing, and public spending underwent a general review, the path to the
introduction of PPP advanced (European Commission, 2003).
Five stages can be identified in the evolution towards implementation of private
investment in public infrastructure. First, infrastructure development was directly linked
to economic growth and poverty reduction. Second, as infrastructure was, for the most,
funded by public sources, at a third stage it was observed how public investment in
infrastructure in developing countries proved to be largely deficient and incapable of
meeting citizen’s demands, particularly the needs of the poor. Fourth, state-aid was not
in the capacity to make up for the gap in financing, and fifth, the private sector showed
that it had the potential to make a difference (WSP,2007).
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C. Forms of PPP
As mentioned, Public-Private Partnerships move along a continuum, whose evolution
depends on the degree of involvement of the private entity regarding ownership of the
assets, investment level, operation, and level of responsibility. Other studies refer to the
degree of development and property rights, as well as the period during which the
private entity is involved. (Kwak, Chih, & Ibbs, 2009). While most agree that ownership
of the assets is a decisive element in determining the form of PPP, one of the best ways
to identify the relevant form, as previously mentioned, is to observe the split of the roles
of operation, maintenance, finance, and ownership.
Therefore, there is not one rigid structure of PPP, and each project will require a
certain configuration tailored to the specific needs and traits of the project. (European
Commission, 2003). Furthermore, as legislation and regulations are progressively being
established around the concept, the models of PPP remain very dynamic and subject to
constant re-design. Hence, different policies adapt to changes and to new
understandings and implementation of the concept. Nonetheless, some main categories
can be identified, despite the fact that there is no standardized descriptive nomenclature
and that the different expressions are often used interchangeably (European
Commission, 2003). Kwak, Chih and Ibbs (2009) made a comprehensive study of PPPs
and proposed the following categorization:
At the left end of the spectrum, the type of PPP known as Operation-
Maintenance is a form where the private sector is responsible for all aspects of the
operation and the maintenance of the project. The private sector may or may not take
the responsibility of financing the project. Its responsibility in the financing of the
project may be very low or very high (Kwak et al., 2009).
As we move across the spectrum, in the Design-Build-Operate (DBO), the
“private sector is responsible for the design, construction, operation, and maintenance of
a project for a specified period prior to handing it over to the public sector” (Kwak et
al., 2009, p. 54). In addition to the operation and the maintenance functions, which are
typical of the first model, the private sector is also responsible for designing and
constructing the project. Nothing is said about the financing task (Kwak et al., 2009).
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Through the Design-Build-Finance-Operate (DBFO), the private concessionaire
is in charge of the financing, design, construction, operation, and maintenance of the
project (Kwak et al., 2009). Within the next type of PPP, the model and the degree of
involvement of the private entity remains in essence the same, but a concession period
(during which the private entity does not own the asset), is added so that the asset is
returned to the government at the end. This form is known as Build-Operate-Transfer
(BOT). (Kwak et al., 2009).
Additionally to the development rights from the previous types of PPP, some
property rights are factored in. When the private sector remains owner of the asset in
perpetuity, the model is called Build-Own-Operate (BOO) and in this instance, the
government agrees to purchase the services from the private sector (Kwak et al., 2009).
Both BOT and BOO have been categorized by the World Bank’s database
among the so-called “Greenfield Projects”, consisting of a Joint-Venture between a
foreign company and a local company to undertake a project2. Contrary to the
definitions presented above, the World Bank includes concessions in a separate
category. This differentiation is also made by Estache Juan and Trujillo (2007).
Basically in Greenfield Projects, the private sector is in charge of financing,
developing, and operating the facility for a period sufficiently long to repay debt and
generate a return. Assets are then transferred to the government. Thus, BOT, BOO,
BOOT, DBFO are all classified as Greenfield Projects. Concessions, on the other hand,
give the private sector a mandate to operate and/or expand an existing facility while
assuming the commercial risks of the business. No investment is needed, unless a sub
greenfield contract is signed covering additional investment on behalf of the private
sector and no assets are transferred from the public sector to the private and then vice
versa (Estache, Juan, & Trujillo-Castellano, 2007).
There is another concept when it comes to understanding public private
partnerships called the concession type, defined by the World Bank as a lease of certain
2 Please refer to the “Private Participation in Infrastructure Database” from the World Bank Group, available at: http://ppi.worldbank.org/resources/ppi_glossary.aspx
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assets from the public sector to the private party for the provision of services. This
arrangement, whereby the private party takes on the responsibility for financing new
fixed projects, extends for a defined period of time , after which, the new assets revert to
the public sector (The World Bank, 1994). Some studies treat BOT, BOO (assuming
there is a concession period that is extended indefinitely) and concessions as being the
same, while for others, BOO is a privatization type of form, given that the
concessionaire owns the assets. On the other hand, the European Commission (2003)
defines the DBFO model described above as a concession model. Both models demand
some financial contribution from the private sector, whether not it is complete or to
some extent.
However, this assimilation to the concession concept may not always work for
different countries, as we will see in the specific case of Colombia, where both a law
regulating concessions and a law regulating public-private partnerships coexist
separately, which has raised several inconsistencies. According to the definitions of
The World Bank, BOT, contrary to concessions, do not require the establishment of
independent regulatory bodies because regulatory procedures are specified in the
underlying contract. This may be an alternative when too much regulation becomes an
obstacle to an efficient performance by limiting the freedom of actions that can be taken
by the private party. It may be the case that only certain standards are mentioned in the
contract without investing the effort of regulation, which most often than not, in the case
of developing countries, is issued by poorly managed institutions (The World Bank,
1994).
The key word describing all models is operations, leading to the conclusion that
the added value of making use of PPPs is that the private sector will take care of
operating and making the project function in the most efficient way. Such a delegation
from the public sector to the private sector seems to be the key important factor.
D. Need for Intelligent Transportation System
For a transportation system to be sufficient certain parameters must be met and fulfilled
to address the users’ needs for comfort, convenience, environmental responsibility, and
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safety. Smooth mobility is one of the key drivers to the quality of life experienced by
citizens in a city. When citizens feel good riding buses and other means of public
transportation, they make more use of it and hence increase the sustainability of public
transportation. In fact, transportation systems remain sustainable in the long run only if
there are sufficient users.
In some countries, especially in the United States, public transport has become
irrelevant for a majority of car owners. On the other hand, in developing megacities, the
quality of public transportation has not attained the standards necessary to attract private
transport users. Hence public transport has not been able to compete with private
transport. A vicious circle has formed in which tariffs get reduced, resulting in
financially stressed operators providing significantly poor quality service. Urban
transport in developing cities has been stigmatized as the “mode of poor people”. The
goal of a sustainable and optimal transportation system should be measurable in the
ability to attract high-income users and therefore attaining high level of ridership. Thus,
achieving an optimal intelligent transportation system involves a change in the mind set
of car versus public transport. (Acharya & Morichi, 2013).
While many studies advocate for competition in the provision of urban
transportation, the bus industry in developing countries presents a different picture.
Contrary to the normal rule, public transportation has been characterized by a
liberalization and privatization experience with a recent shift to state intervention.
Indeed, competition leads to many market failures that require regulatory intervention
(Estache & Gómez‐Lobo, 2005). In the case of urban transportation, an oversupply has
been identified due mainly to: a) unclear definition of property rights, b) fares set above
the equilibrium price, c) congestion, and d) pollution (Echeverry et al., 2005). Because of
improper property rights, any competitor on the road can “take away” a passenger as
there is no strict organization in the different routes. Bus owners are drawn to overcharge
for the service given that market competition attracts passengers, who, when waiting for a
bus out on the road prefer to get on the first one that comes along even when they know
that a cheaper one is expected to arrive a while later. This cost-of-waiting is what permits
bus owners to charge more (Evans, 1987). Consequently, bus operators can charge more,
making returns on investment attractive. In addition, for a new bus operator to enter the
market is rather easy due to a lack of proper bidding system. The entry into the market is
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only subject to obtaining a permit from the authority to circulate and to getting a route
assigned. Both attractive rates of returns and ease of entry into the market lead to a high
number of bus operators wanting to become suppliers (Estache & Gómez‐Lobo, 2005).
E. Why Public-Private Partnership?
Before the 1990s governments owned, operated, and financed nearly all infrastructure
because of the public interest involved in it and the nature of the services, in which the
economies of scale involved were thought to require monopoly (The World Bank,
1994). Usually, services and infrastructure imply economies of scale which are often
more satisfied by the creation of monopolies, where one entity will be better suited to
supply a local market at a lower cost (Chris Chan, 2009). These reasons do not seem to
have relevancy any longer as experience has shown.
Experience shows that the amount of investment cannot be the exclusive focus
of policy in the infrastructure sector. Quality is also vital in infrastructure services (The
World Bank, 1994). Moreover, improvements in infrastructure performance have shown
to rely largely on aspects like innovation in technology and regulatory markets, as well
as social and environmental sustainability, which is largely possible by shifting from
direct government provision to private sector provision. There is no need to continue
with the paradigm of public services being provided only by the government, as results
now show that in developing countries this is not the most effective way.
Private entities have a more business-oriented focus, which, as will be discussed
later on, is critical in ensuring an efficient and responsive infrastructure to end-users. A
business focus is generally more oriented towards customers’ needs. To the contrary,
the modus operandi in public provision has proven to be extremely bureaucratic,
making the decision process extremely slow and tiresome. The autonomy held by
private entities gives room to a more effective and rapid decision-making process that
addresses customer demand and runs the project as a service (The World Bank, 1994).
Moreover, by transferring some of the responsibility in the provision of public
services to private parties, the monopolistic structure that normally results from the
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economies of scale present in infrastructure shifts toward a competitive market where
the users can choose among a range of suppliers (The World Bank, 1994). And because
the PPP model focuses on outputs with the main goal being to achieve the provision of
a sustainable and efficient service, standards and requirements are set forward in PPP
contracts (EPEC,2010).
However, while studies have often fought for the existence and implementation
of competitiveness, this must be carefully analyzed. The distinction between
monopolies and competition and the promotion of one or the other depends on how the
PPP initiative is structured. The case for public transportation where the entry and exit
of different providers is relatively simple, facilitates competition (The World Bank,
1994). However oversupply happens when too many operators provide the service in a
given network, such as the case of public transportation in Bogotá, Colombia, which
will be discussed further on. Neither this situation nor the extreme in which a single or
only a few operator(s) provide a service is ideal. These scenarios must be addressed by
effective regulations and an adequate model (Gómez-Ibáñez, 2003). Often, neither pure
public procurement nor pure private models will be flexible enough to address these
problems and regulation of the public authorities with private initiative must be
combined in an amicable fashion.
Indeed, when analyzing the public sector’s involvement in infrastructure,
specifically via regulation, Estache and Serebrisky (2004) described the above evolution
toward PPP in transportation, in six steps, namely: (i) Initially, private initiative works,
(ii) external shocks alter this situation, (iii) public sector enters the picture, (iv)
problems arise from the public sector trying to get the private sector back, which
ultimately leads to (v) finding a hybrid solution to the problem with the task of (vi)
defining how hybrid the model is and how much responsibility is granted to each party.
Now, the appearance of renegotiations within the contracts feed into the negative
feelings toward private participation in infrastructure because it implies divesting from
the original terms of the contract and thus breaking off promises that may be crucial for
users (Guasch, 2004). While renegotiation can be positive and increase general welfare
when addressing pitfalls or shortcomings from the original contract, in the instances
when it is not possible to foresee a deficiency in the original contract or unexpected
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events that require changes, then a high number of alterations can cause concern that
renegotiations are being used opportunistically by either the government or the private
operator. It is generally the case that renegotiations rest credibility from the project, thus
increasing mistrust among users. (Guasch, 2004).
A clear example of the above situation is the evolution of procurement for
infrastructure projects in the field of transportation where the trends of private versus
public investments shift somehow in a conversely way. For the past century, in a
significant number of cases, including the situation in Colombia, private involvement
has been the key element in urban transportation where the main providers are private
operators. While competition has been thought to give consumers choices and put
pressure on suppliers to be efficient and accountable to users, competition among the
different suppliers has also led to opposite results and public involvement has become
necessary. The call for PPP responds to the necessity of involving the government in
the regulation of a service that lacks some basic regulation to function properly (Estache
& Serebrisky, 2004). Furthermore, the many alternatives presented by PPP should also
serve the purpose of implementing an intelligent transportation system and integrate all
elements of urban transportation that are existent nowadays into a hybrid arrangement
that can only be possible if proper PPP regulations and guidelines are established.
Also, developing countries need to progress toward PPP, as the entrance of
foreign capital is more often permitted through private models. This entrance is
extremely important in order to gain the expertise from developed countries, whose
systems have proven to generate high welfare gains for households and in the overall
economy. National suppliers would benefit from technical gains resulting from
technological innovation from strong economies. In the field of public transportation,
complexity is a paramount element. Cutting edge advancements and innovation are
required in order to re-design the existent transportation systems that clearly do not
satisfy users’ needs in developing countries. The flexibility of the PPP model, if
incorporated correctly, could attract foreign private investors rather than keeping with
traditional models (UNCTAD, 2008).
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F. Which PPP?
It is essential to understand the distinctions between the various models of PPPs that can
be implemented in developing countries, especially in order to identify which party will
ultimately take on the roles identified above, i.e. operation, maintenance, ownership,
and financing of the project. Next, which form and which characteristics of the form are
best suited for achieving the goals set above for the public transportation system must
be determined. The DBFO type appears as the most convenient model for achieving
these purposes. At a first glance, ownership does seem to be vital when it comes to the
provision of the public transportation system. International examples must also be taken
into account when choosing the appropriate form for public transportation projects,
which not only demand infrastructure but also delivery of a service (Blanc-Brude et al.,
2006; Grout, 2005). In this sense, a sufficiently flexible PPP alternative providing for
increased freedom for the private party is more attractive. Moreover, the DBFO model
covers the largest number of functions (UNECE,2008).
G. Best practice drivers
In 1994, the World Bank issued a report listing drivers of public infrastructure welfare.
The trends from the past twenty years in developed as well as developing countries
reflect the pursuance of these elements. Examples of PPP practices in different
developed countries advocate for the fulfillment of the same benchmarks, namely: (i)
managing infrastructure like a business, and not like a bureaucracy, (ii) introducing
direct or indirect competition, and (iii) taking into account different stakeholders,
including users, in the planning, regulation, design, operation, and financing of
infrastructure (The World Bank, 1994). On the other hand, some more recent studies
have argued for specific PPP legislation, specialized regulatory bodies in the field,
selection of appropriate concessionaires, appropriate risk allocation, and sound financial
packages as some of the elements that contribute to creating a friendly environment for
the PPP model to develop (Kwak et al., 2009).
The choice of implementing these elements will largely depend on the situation
of the specific country. The success in developed countries does not necessarily mean
the same for other countries with cultural nuances, different mind-sets, state
16
organizations, and legislation, etc., but they surely represent a foundation upon which
developing countries can initiate a PPP culture to rely on. Ultimately, these examples of
best practices are in line with effective legislation frames, strong management of
finances, as well as responsiveness to citizens’ needs, by providing the right service
(effectiveness) in the right way (efficiency), and with the highest degree of
accountability (Kwak et al., 2009), Andrews & Shah, 2003).
One key feature about PPP found in many developing countries is the form of
remuneration that is received by the private sector. In the United Kingdom, for example,
payments are of an availability nature and they provide for deductions when
performance standards are not met. As deals normally transfer the usage risk to the
public party, the government has had a tendency to be very confident about sufficient
future demand when choosing where to invest long-term (Allen & Overy, 2010).
In the UK, there are public bodies outside of the central government that deal
with all PFI projects. However, potential investors often do not trust these bodies, as
they are not believed to be acting as agents and representing the Crown, making it
necessary for them to obtain some form of support (Allen & Overy, 2010). The HM
Treasury Taskforce is in charge of providing guidance and support and nowadays even
participates in projects themselves. Additionally, the Infrastructure Finance Unit lends
to PFI projects that cannot raise sufficient debt-financing, and Infrastructure UK is in
charge of building the private participation strategy (Allen & Overy, 2010).
In France, the line between public procurement and private participation has a
threshold of 30%. If more than this proportion of revenues does not come from
payments by end-users, the contract is seen as public procurement. If subsidies represent
less than 30%, the contract is a concession. These concessions are characterized by
having a single contractor for both the construction and operation phases (Allen &
Overy, 2010).
In Germany, there are some analogous PPP bodies, similar to the ones observed
in the UK, called PPP task forces. While the experience in the sector is a recent one in
Germany, specific enabling legislation has been recently enacted for certain projects in
particular. Germany also has an independent entity called the Toll Collect GmbH that is
17
in charge of collecting the distance-linked tolls from heavy traffic on motorways and to
invest it in the so-called A Model Projects. Another key feature known as the Factoring
type PPP solutions consists of a process in which the private sector invoices the public
sector after delivering portions of the contracted services. The authority accepts and
waives any possible objections to the invoice. This risk, which might be referred to as
the revenue risk is then passed onto the public sector, which then sells the invoice to a
third party investor or a lender seeking to divest its portfolio by adding public lending
risk. As in the UK, the tender documents focus on outputs, i.e., on the service delivery
specifications and not on inputs specifications. (Allen & Overy, 2010). This helps to
establish a more efficient and rapid decision-making process by granting more
independence to the private party to provide its services as it knows best.
IV. Developing countries: background
A. Current situation
It is not possible to give a general description of the status-quo of social infrastructure in
the transportation system generalized for all developing countries. The World Bank has
classified the different world economies into low-income, middle-income and high
income economies. Developing countries are comprised among the low-income and the
middle-income economies. However, this classification does not imply that all countries
are going at the same pace in terms of development (The World Bank, 1994). Within
the same category, noticeable breaches can be observed in the degree of development,
depending on the different sectors examined. For instance, according to the World Bank
classification, Chile is an upper middle-income country, as is Colombia; however,
improvements in social infrastructure in Chile are more noteworthy than in Colombia.
Chile is one of the region’s most developed economies, topping the index from the
Economist Intelligence Unit. One of the main reasons for Chile’s advancement was the
introduction of a new regulatory framework for PPPs, contained in the Public Works
Concession Law (Economist Intelligence Unit, 2010).
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B. Observable roots to the problem
Historically, many developing countries have been negatively impacted by poor
governance, both at the public level, as well as in the private sector, which have led to
the failure of many public infrastructure projects. Corruption can be identified as one of
the main pitfalls that infrastructure projects face. Many of these problems have its roots
on a lack of a proper unified policy on the matter, resulting in poor and simplistic goal-
setting. Thus, a fully comprehensibly defined system, where all stakeholders are
involved, is one of the ways to potentially overcome current shortcomings faced by
infrastructure projects and to attain an adequate PPP development (UNECE, 2008).
1. Bad Governance
Governance–i.e., the combination and the performance of processes, procedures, and
enabling institutions—has been identified as a main barrier in the implementation of
PPP in countries where the model is still infant, such as in developing countries
(UNECE,2008). Governance in developing countries has been subjected to a culture of
bureaucracies often seeking to augment their rents in detriment to delivering proper
services (Freire & Stren, 2001) and assuring that the public is the main beneficiary of
the project. An important element of good governance brought by Freire et.al is the
participation in the urban development of all stakeholders in a city (Freire & Stren,
2001), which also goes in line with the driving forces proposed by the World Bank.
When stakeholders are factored in, both accountability and transparency can be
improved.
According to Harry Kitchen (2005), there is a perception that local business
enterprises, i.e. state-owned companies in charge of delivering a specific service, are
more accountable because they run more like a business. Again, we encounter the
argument that running public infrastructure as a business is more likely to be more
efficient because it is treated as a commercial activity having the end users’ interest in
mind at all times. Moreover, it has been argued that management of public
infrastructure by local business firms may be more beneficial than by local politicians,
given the degree of specialization that these firms can attain, which is often not the case
19
for politicians responsible for a large number of social commitments. It is also
beneficial if the provision of the service is kept independent from political idealogy and
conflicts and instead focuses mainly on the citizens, taking into account also the high
levels of corruption encountered in some developing countries 3 (Kitchen, 2005).
However, Kitchen also takes the position that this is merely a misperception,
and, in fact, it is not often true that local business firms are more efficient and
accountable given their financial flexibility, which could permit them to undertake an
empire building approach and invest in projects that do not necessarily contribute to the
general welfare but rather augment the size of the business (Kitchen, 2005). Moreover,
these bodies are more likely to be problematic during the decision-making process and
in terms of transactional costs.
2. Inadequate regulatory and legislative frameworks
According to Estache and De Rus (2000), the main purpose of regulation is to control
prices, as well as service, in order to ensure that the monopolist does not lower quality
of services or increases prices for them, while still allowing for the private investor to
realize a return on his investment. This multiplicity of objectives acts as a constraint for
the politicians, who must do their best to harmonize all these interests (Estache & De
Rus, 2000). Observable symptoms of poor regulation can be noted when looking at how
the different interests of the various stakeholders involved collide in practice. Private
firms want a return on their investment and may fear that while governments may in
principle pursue favorable regulation towards prices that attract investors, they may in
the long-run, lower prices as a result of user pressure. The users, in turn, are dependent
on the services that normally do not have any alternatives. When it comes to urban
transportation, for instance, low-income users often do not have the option of any other
means of transportation and are usually skeptical that they may be over-paying for a
manifestly inefficient system. Thus, the government is concerned about private
3 In Colombia, for instance, the last phase of the mass transit system was in the midst of a controversy surrounding the mayor, the Urban Development Institute, and the private entity formed by the “Grupo Nule”. Corruption charges were leveled toward participants in what is known as the Carrousel of Public Contracts, in which contracts for infrastructure projects were granted not based on concessionaire’s capabilities but rather on personal grounds.
20
monopolies raising prices excessively and high above their actual costs (Gómez-Ibáñez,
2003).
Estache and Serebrisky found enough evidence to argue that, while competition
should be the general aim of public policy, residual regulation should be improved
(Estache & Serebrisky, 2004). The shift towards private participation in infrastructure
projects goes hand-in-hand with the increasing need to regulate this phenomenon.
3. Inefficiency of operations
When providing guidelines for good governance in PPP, the United Nations has defined
efficiency as “the extent to which limited human and financial resources are applied
without waste, delay or corruption or without prejudicing future generation” (UNECE,
2008, p. 14). Efficiency is also a strong parameter to measure how much prices can drop
and still generate returns from the project, while not compromising its financial liability.
This can in turn help define the maximum subsidy required from the government
(Estache & Serebrisky, 2004).
We have advocated so far for competition as an impetus for efficiency and,
hence, for decreasing regulation in order to attain efficiency standards, on the prima
facie basis that existence of competition stands for low levels of regulatory policies.
However, Estache and Serebrisky (2004) have looked at the evolution of the efficiency
levels in the transportation sector in order to assess whether deregulation or residual
regulation by public authorities is effective or not, finding that most often than not
inefficiency is linked with poor regulation.
From a user’s point of view, de-regulation may not be efficient, even in the
presence of competition, when the system becomes unmanageable due to excessive
liberalization, raising several issues, especially environmental and safety ones (Estache
& Serebrisky, 2004). The observable inefficient pattern can be seen in countries with
poor infrastructures, which is largely due to inadequate maintenance that reduces the
lifespan of infrastructure facilities and, therefore, the capacity to provide services. Thus,
more investments are then needed and resources are not used efficiently. Project
21
investments are also often misallocated, resulting in inappropriate infrastructure and
lack of proper infrastructure for the provision of services at the appropriate standards
(The World Bank, 1994).
Unresponsiveness is also present in the delivery of infrastructure services and
demands for services by businesses, households, and other users remains a challenge for
a large part of service. (The World Bank, 1994).
V. Financing Structures in PPP
The Project Finance model is different from the traditional corporate finance model in
that the former is highly leveraged in comparison to the latter, given the difficulty for
these initiating projects to raise equity (Engel, Fischer, & Galetovic, 2010). On the one
hand, PPPs have been thought by some to release government funds by circumventing
large sunk investments. Thus, the public budget is not affected, and the government is
able to finance other social projects. Engel et.al, on the other hand, argue that these are
alleged advantages and that in reality, PPPs do affect the government’s budgets to the
same extent that public provision does (Engel et al., 2010).
The government may save in up-front investment, but then it either relinquishes
future user fee revenue (if the PPP is obtaining a return on user fees) or future tax
revenue (if the project’s returns come from state payments over the life of the project)
(Engel, Fischer, & Galetovic, 2013; Engel et al., 2010). For instance, in the UK, the
main feature of the Public Finance Initiative (PFI) is that the private party funds and
builds the project and is in turn remunerated directly by the government with a fixed
payment (Grout, 1997) rather than from users’ tariffs. Again, this model shows how the
government’s budget is still affected even with the implementation of PPP. Indeed, it
may not be affected by the fact that it has to fund the debt portion of the financing, but
rather by having to comply with a service contract (Grout, 1997).
Therefore, it is very important to assess the benefits of using PPPs, by finding
efficiency gains that occur less on the financial side and more on the innovative aspects
of bundling construction, maintenance, and operations tasks.
22
Notwithstanding the above, it is still possible to observe some gains from a
financial point of view. According to Blanc-Brude, Goldsmith and Valila., the bundling
aspect gives the Special Purpose Vehicle (SPV) an incentive to make higher
investments in the construction phase in order to avoid overrun costs during the life of
the project. Additionally, if the private sector is only remunerated by the government
from public funds, i.e. tax-based and subjected to the service actually provided, then the
private sector will not be able to transfer the overrun costs to the government. The
decrease in investment today will result in greater operation and maintenance costs
tomorrow. Hence, in order to meet the safety and efficiency standards for the
availability payment (Blanc-Brude et al., 2006; Echeverry et al., 2005), private sector
will be more efficient in that they will want to reduce costs as much as possible without
being tempted to reduce quality, which ultimately will determine whether they receive a
return on their investment or not (Grout, 1997).
Grout also argues that the availability payment renders the investment in the
project riskier for the private entity because it is not possible to determine today what
will be the provision standards in twenty or thirty years (which is typically the length of
these contracts) (Grout, 1997). Hence, a significant number of renegotiations over the
life of the project may occur. In any case, the key advantage of a PPP model is that
private investors should always escape from cutting down on costs today.
These circumstances contribute to increased construction costs in PPP versus
traditional public works. Moreover, following a main principle of PPPs, which is to
allocate the risk to the party that is most able to bear it, the private party ends up taking
most of the risk from the project, which will evidently be priced by the SPV in the bid
(Blanc-Brude et al., 2006). However, private firms will make greater efforts to avoid
situations or events that can trigger price increases by bearing the majority of the risk.
Sounder risk management, in turn, leads to greater cost efficiency (House of Commons
Treasury Committee, 2010). Moreover, the concept of availability payment also
contributes to this construction risk, which is augmented since PPPs, as a general rule,
do not pay the private sector based on construction costs but rather on availability of the
infrastructure.
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When selecting a concessionaire, the government has to make use of certain
evaluation methods to assess the financial viability of the project, such as the Net-
Present-Value method. The NPV of a publicly financed project compared to the NPV of
a private financed project, is quite different. Now, the NPV of the first type of project is
usually an analysis of the cost stream that the public sector needs in order to fund a PPP
with a usually low rate of return, i.e. the rate of return used to discount cash flows will
be close to the risk-free rate of return. The NPV revenue stream that is calculated for
private funding projects, may be far riskier, given the uncertainty of future cash flows,
which, in turn, leads to higher rates of return in order to discount the cash flows of the
project that will also be higher (Grout, 1997).
From his findings, Grout states that PFI in England has failed to prove that its
model is more advantageous than public funding, but it is due to the fact that the criteria
used to assess their profitability when compared to financing projects with public
funding, is not an appropriate one (Grout, 1997). Indeed, comparing public and private
public sector costs with private revenue flows is an odd comparison and does not take
into account important social measures, such as the consumer surplus generated by such
projects, which should also be a factor in decision-making (Grout, 1997). However, the
scope of the research of this paper does not quantify the potential welfare effects to both
consumer and suppliers because of lack of proper surveys and estimation of suppliers’
costs. Moreover, the discount rate used may differ from a public analysis to a private
one; it will depend on which other project is used as a benchmark. The bottom line is
that a financial test falls short in assessing the true value of a PPP project, and while it
may be the main element to take into account, social welfare both from the consumer
and supplier side, independent from profitability, must also be taken into account
(Grout, 1997).
A. Project Financing Structure
The concept of Project Finance refers to a way of financing a specific project, - for the
purposes of this paper an infrastructure project, by relying on the expected cash flows of
the same to act as security for the financiers of the project (Grimsey & Lewis, 2004)
Below are the standard elements normally present in such a structure.
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1. Special Purpose Entity/ Special Purpose Vehicle
In a project finance structure, a Special Purpose Vehicle is funded with the sole purpose
of undertaking the project. The new company is managed by a sponsor, who invests in
the equity of the company and then seeks funds from different lenders. The sponsor can
be an industry operator (Engel et al., 2010), with the purpose of establishing a company
to run a project sufficiently profitable so as to create enough revenues to pay off debt
and generate dividends for the shareholders of the company.
The SPV needs to enter into various contracts to function and operate properly.
Engel et. al compare these arrangements to the ones that the PPP itself has to enter into,
namely: (i) a fundamental agreement with the procuring authority; (ii) another
agreement with users of the service provided by the PPP; (iii) a third agreement with
building and operation contractors; (iv) and lastly, an agreement with the investors and
financiers of the project. The SPV is a suitable way of involving different stakeholders
in the decision-making process of a specific infrastructure project and, therefore, in
creating an accountability environment (Engel et al., 2010). Moreover, in the case of
urban transportation the SPV would act as as a true transport firm seeking to earn a
return on its capital that is comparable to what it would receive in any other business of
similar risk (Echeverry et al., 2005).
2. Sources of funding
Throughout the evolving life cycle of a project, financing comes from different
institutions. As far as the project develops, so does the risk structure and allocation, and
so do the sources of financing (Engel et al., 2010). Not all lenders have the same risk
profile. While some may be more risk averse, others might be inclined toward lending
capital during the far riskier construction phase. Indeed, more changes and unforeseen
events are likely to occur during this phase than during the operation phase of the
project, where the potential for risks is basically linked to whether or not the project
generates cash-flows.
25
Construction phase
During the construction phase, the sponsor will finance the costs providing
equity, which in turn can be combined with loans from banks or subsidies from the
government. This form of combining financing sources and types applies especially in
the case of projects which derive returns from users’ fees, such as urban transportation
projects, in which the so-called “farebox” recovery ratio corresponds to the operating
expenses that are met by the tariff paid by users for using the service (Leber & Perrott,
2012). However, the need for subsidies does not always arise as has been the case with
rapid mass transit systems operating in Bogotá, where the contract stipulates that the
system is a self-sustainable one. Even in transport projects, public and private sectors
can agree on a payment from the government to the private party undertaking the
project, if certain requirements of efficiency are achieved.
Operations
The Operation phase follows the construction phase and occurs after
“completion and ramp-up” of the project (Engel et al., 2010). During this phase, long-
term bonds substitute for bank loans, and the sponsor may sell the SPV to an operator or
to another investor, much like any other business (Engel et al., 2010). During the
operations phase, when cash starts to flow in, bond holders might be likely to make their
entrance into the financial scene as they are interested in those revenue streams to
collect their annual coupons (Engel et al., 2010). However, while construction risks
should be transferred to the private sector during the construction phase in order to
incentivize a more efficient investment on its side, demand and revenue risk of the
operation phase needs to be transferred to the government. Demand risk is bore by both
bond and equity holders because their return on the investment depends on the volume
of demand, so when risk is high, their expected return will also increase. To the
contrary, if risk is transferred to the government, the return from the project to sponsors
and creditors will also decrease (Engel et al., 2010).
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3. Value for Money in PPP
It is essential to determine if at the end of the day, PPPs are more worthwhile than
undertaking projects via traditional public works. In turn, to assess profitability, a
comparison between the costs of conducting a specific project to the public sector
versus the same costs to the private sector is necessary. This is known as a Value-For-
Money Test (VFM) (Grout, 1997). Both profitability and community welfare, where
users benefit from the project, are the main criteria to assess the success of an
infrastructure project. The way risk is managed in a project is also a key feature to
achieving efficient financing; allocating the risk to the party best suited to take them on
will reduce the overall cost of the project, therefore making it more efficient. If a PPP
vehicle is chosen to undertake the project, this option must be the one that results in a
highest return compared to the return that would be obtained by public procuring the
project (Chris Chan, 2009).
The VFM for private procurement must be proven to be more profitable to the
government and society than traditional public procurement since, in principle,
government has the capability to obtain cheaper funding than the private sector. (House
of Commons Treasury Committee, 2010).
Given its high-risk profile, the Weighted Average Cost of Capital of a PFI, i.e.,
the discounted rate to which cash flows of the project are discounted, is double that of
government gilts. PFI only provides VFM if cost savings and efficiencies during the life
of the project outweigh the increment in the cost of capital (House of Commons
Treasury Committee, 2010). Furthermore, in the likely scenario that introducing a
subsidy becomes necessary, the VFM will be affected, of course, and the efficiency
savings from the project will need to be large enough to compensate for this input
(EPEC,2010). Innovation and applied know-how from the private investor are key
issues in achieving high levels of efficiency in the provision of the services, which will
likely increase earnings of the projects, thus reflecting the quality of service provided.
This could largely compensate for a lesser VFM, if any. It is fair to say that given the
high capital expenditure coming from the private sector, the same should be
remunerated by collecting the benefits resulting out of these initial expenditures, either
27
by the fare collected from users’ services or by subsidies coming from the government
when levels of demand are not met, albeit achieving efficiency standards.
Sometimes when facing low user charges, VFM in infrastructure projects can
decrease due to the need for the government to subsidize the project (Chris Chan, 2009).
For public transportation, in particular, subsidies may be required when determining the
tariff must take into account low-income sectors of the population. The true cost of
urban transportation service is comprised of: (i) costs of civil works (ii) costs of
equipment and machinery, and (iii) operation and maintenance costs. The first two costs
are said to be non farebox, i.e. they will not be met by the tariff paid by users and,
therefore, have to be covered by government subsidy (Leber & Perrott, 2012).
B. Assessment of risks
The main principle set forward when defining risk is that it should be allocated to the
party that is best suited to manage it (Engel et al., 2010). Guasch agrees that the less
risk-averse party should be assigned the risk (Guasch, 2004).
Guasch and the European Commission identified eight main categories of risks,
namely:
a) Revenue risk: basically this arises out of changes in tariffs or changes in demand
and is usually allocated to the project company (Guasch, 2004)
b) Risk related to the selection of the private sector partner: a badly vetted private
party might turn out not to be sufficiently competent or might prove to be
corrupt-prone, thereby unable to meet the initial specifications
c) Construction costs risks comprise overrun in the life-cycle of the project and
delays in completion
d) Financial risks can emerge from fluctuating foreign exchange rates or variable
interest rates
e) Political risks or performance risks
f) Sustainability risk
g) Public acceptance risk
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The assessment of the different types of risks will help determine the discounted
rate to which the cash-flows of the project must be discounted. If risks are more likely
to occur during one phase of the project than another, the financial analysis
corresponding to the latter phase perhaps should be discounted to a near risk-free rate of
return (European Commission, 2003). The appropriate allocation of risks is extremely
important in order to assess the financial viability of the project, which ultimately is the
starting point to define whether the project should be undertaken by means of private
funds, public funds, or a combination of both.
VI. Applicability to Colombia
A. Current Situation in the public transportation system: the example of Bogotá
The vehicles belonging to the public transportation system in Bogotá are hardly
aesthetic and very old as they do not comply with the replacement norms and hence
they do not maintain the equipment in working conditions. This has led to both
environmental as well as safety issues. The equipment has become obsolete to be
operated in a big city such as Bogotá. Moreover, the buses do not comply with the
minimum safety rules; thus, this form of transportation is creating traffic chaos and
innumerable accidents every day.
Another main issue facing the transport system in Bogotá is the operating
flexibility granted to the private sector. The lack of a central authority and of a unified
legal policy imposed on owners and operators of the transport system has led to chaos.
The companies render this service work on an affiliate system, i.e., their object is not to
operate per se but to simply acquire as many buses as possible and have them running
along the different routes that have been assigned to them by the government. This
situation creates strong competition between the different providers and results in an
excess of supply of transport (Echeverry et al., 2005). The bus owners join different
transport companies and unions and pay the drivers proportionately according to the
number of passengers that they pick up instead of based on a labor contract (Echeverry
et al., 2005). Moreover this atomization of the ownership structure has resulted in an
exceeding number of buses making it difficult to exploit economies of scale.
29
Congestion, pollution, and traffic accidents, not to mention a decrease in aesthetic value
resulting from old and poorly maintained equipment, permeate the city’s public
transport (Echeverry et al., 2005).
There are three main actors in the public transport system: the company, the
vehicle owner, and the driver–all of them pursuing their own personal interests above
any general consumer welfare. The public transportation system has been treated as a
lucrative business rather than as a public service. Therefore, the actors in the public
transportation sector have had an immense and traditional capacity for lobbying
sponsored and agreeable politicians. Bureaucracy has prevailed, interfering with a more
efficient business focus.
In addition to the chaotic present bus system, there is a notable increase in the
number of private vehicles owned by households. While measures to overcome this
overabundance of privately owned vehicles have been implemented, high-income
citizens continue relying on their automobiles and relying less on public transportation,
while decreasing revenues in the sector and increasing traffic congestion in the city.
The case for urban transportation in Bogotá does not fit the argument of
competition as a source of efficiency in the provision of infrastructure. Competition
alone is not advantageous if it is not accompanied by effective price setting procedures.
An out-on-the-road type of competition (Echeverry et al., 2005), as the one that was
observed prior to the introduction of the mass transit system and is still in existence
today can result in a highly dangerous city environment.
Alongside the public transportation system, Transmilenio (TM) a rapid bus
system, opened in December 2000, as a massive transit system based on the model used
in Curitiba, Brazil. TM consists of several interconnecting bus lines, each composed of
numerous stations located in the center of a main avenue. This has shown to be a very
effective system for a city such as Bogotá that uses buses to provide a faster and a more
efficient service than the traditional old bus line. The system differs from the prior
version in that it works as a hybrid model, where the public authorities lean more
toward playing a critical role in monitoring the quality of service and in keeping the
30
collection of revenue, and the general operation of the system clearly separated
(Echeverry et al., 2005).
B. Legislative and regulatory framework
The efforts made by the Colombian government in incentivizing private participation in
public infrastructure have had their impact on how the environment for private investors
looks like nowadays. As a result, the Economist Business Intelligence has graded
Colombia on the high scale within the “emergent” category (Economist Intelligence
Unit, 2010).
1. Law 1508 of 2012/Law 80 of 19934
The difficulty in defining the scope of PPP precisely becomes even more latent when
we look at the Colombian example. Though the most recent PPP law was issued in
2012, most of the main concept remains unclear in many aspects. While partnerships
between entities from the public sector and entities from the private sector with the
purpose of involving the latter in the provision of construction and infrastructure
services was possible, either by entering into agreements or forming new entities, the
concept of PPP was only introduced in the legal landscape of Colombia by Law
1508/12. Public contracts had been previously governed by Law 80/93. Under
Colombian Law, concessions are a form of PPP and are not treated differently but
complementarily, regardless of the fact that PPP receive their returns from user fees.
Law 1508 provides for the application of infrastructure projects in the field of services.
Furthermore, the right to collect the resources for economic exploitation of the project,
to receive disbursements of public funds or any other consideration, is dependent on the
availability of infrastructure, on the compliance with quality service standards at
different stages of the project, and other requirements determined by the regulations.
Another important feature of Law 1508 is as a result from the fact that infrastructure
projects can originate from either private or public initiatives.
4 This section draws upon the regulatory and legislative framework of public-private partnerships in Colombia, namely Law 1508 of 2012, available at: http://wsp.presidencia.gov.co/Normativa/Leyes/Documents/Ley150810012012.pdf and Law 80 of 1993, available at: http://www.alcaldiabogota.gov.co/sisjur/normas/Norma1.jsp?i=304
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Law 1508 provides a developed regulatory framework in order to streamline the
entrance of the private sector in the provision of public infrastructure, by introducing
new forms of financing as well as new requirements. In addition, this new law regards
public infrastructure projects much like a business, in which the private investor is
incentivized to get a return on its investment by attaining some specific requirements.
The new ruling aims to attract long-term investors that are sufficiently financially
capable to construct, operate, and maintain public works that the country is in need of. It
also introduces the availability payment and the service level. In essence the new PPP
projects covered by this Law are a new generation of the model of concession which
was already laid out by the former Law 80 (Political Science Institut, 2012).
2. Case of Transmilenio
The service is provided by means of concession, and both local and foreign transport
providers can associate and participate in the tender process. Construction for the
designated lanes has been divided into three main phases. Tendering processes are open
for both the construction of infrastructure, as well as for operations and fare collections,
which are meant to be run by the private sector. Transmilenio S.A.5, a publicly owned
company, is in charge of the planning, management, and control of the system. Both the
public and private sectors share the financial responsibility. Indeed, the public sector is
responsible for investing in the physical infrastructure of the system, such as lanes,
stations, terminals, while the private sector finances the bus fleet, ticket sales, and the
validating system (Grütter, 2006). TM functions like a BOO or BOT type of PPP.
As remuneration, the concessionaire is entitled to the rights, tariffs, and a
participation in the financial running of the project, which is granted to it. In addition, it
is remunerated a sum periodically, which may be a unique sum or calculated according
to a percentage scale. The return of the private investor’s investment is an element of
the contract but is not fully guaranteed. In this sense, this model of PPP sets a
distribution for risks between the government and the concessionaire, in which the latter
is not guaranteed to get a return on its investment. Moreover, all risks have been
5 S.A. stands for Sociedad Anónmima and is the Spanish word for corporation
32
transferred to the concessionaire. These are inherent risks in the project’s activities, as
well as risks resulting during the regular course of business, namely financial risks,
demand risks, cash flow risks and return on the investment risks. Nonetheless, the
concessionaire is entitled to a fixed payment from the government in case offer is not
met by demand, subject to the degree of efficiency and high quality standards to which
the service is provided6.
The buses, both trunk and feeder, that comprise the system are provided by
private entities under independent concession contracts, awarded within bidding
processes. Local companies also participate in the contractual scheme; they joined the
new system as operators to supply services in under-served TM corridors. The private
investors own the buses, hire drivers, and take care of maintenance duties (Echeverry et
al., 2005). An independent company has been awarded a concession to conduct the fare
collection and is responsible for the management; it is also in charge of collecting
revenues and depositing them in a trust fund, from which the different system agents are
paid according to the conditions set out in contracts. The city government is in charge of
maintaining the infrastructure and conducting complementary infrastructure
improvements when needed (Cracknell, 2003).
As innovative as TM may have been, the system is not, however, as completely
efficient as it should be. First of all, passengers jamming into the buses during peak
hours is now an observable phenomenon, which creates long waiting times and forces
users to wait twenty minutes or more to board a train. Echeverry presented some NPV
results for different discount rates that reveal negative net benefits from the first phase
of TM, amounting to US $64 million for a discount rate of nine percent. This is due
mainly to high infrastructure investments not being recovered by fares and an increase
in travel times for users of traditional systems, as a consequence of the relocation of bus
routes (Echeverry et al., 2005). Second of all, the last phase has been developed in the
midst of unfortunate events, due largely in part to poor governing structures from both
the public and the private sectors, resulting in corruption scandals that have diminished
the image of the system. 6Contrato de concesión para la prestación del servicio público de transporte terrestre masivo urbano de pasajeros en el sistema Transmilenio (Draft). Retrieved from the PPPRIC website available at: http://ppp.worldbank.org/public-private partnership/sites/ppp.worldbank.org/files/documents/Transmilenio%20Fase%20I.pdf
33
Concerning the revenues of the system, two main features can be identified.
First, the system has been designed as an autonomous, self-sustainable system, meaning
that it relies on cash flow to sustain itself and does not require any form of subsidy
outside of its operation7. Users are charged an equilibrium tariff, which reflects the
variation of costs within the system while responding to standards of operations and
returns that the system requires, in order to provide the service under the pre-established
operation standards. To update the tariff, an independent body was created in the
contract for this specific purpose, so as to not allow the adjustment to the tariff to be
dependent on negotiations between the contractors. TM works both as a revenue-based
PPP and availability based payment. Second, a trust fund was created in order to
manage the revenues within a “patrimony of affectation”.8
3. Mobility Masterplan9
Ruling 319 of 2006, which contains the Master Mobility Plan, was issued by the then
Mayor of Bogotá to implement the Integrated Public Transport System. This new model
seeks to integrate all modes of transportation in existence within the city, i.e., buses, the
TM, and taxis into one system. Transmilenio S.A. is in charge of overseeing the whole
merger process. The Master Plan mandates the participation of the private sector in the
new system, by allowing vehicle owners to participate in the equity of the new
companies that will comprise the system. The projects that are already running will
maintain their scheme but will adjust to the new technical and operational conditions set
by the Master Plan.
C. Form of investment
In order to achieve an efficient transportation system, foreign know-how has to be
introduced in the country. PPP is a good way to do this, when taking into consideration
that a merely public provision would not open the doors to international investment and 7 Idem 8 In Spanish this is called “Patrimonio Autónomo” and implies that the assets produced by the system are not part of the general estate of the company and are therefore autonomous to it. 9 This section draws upon Decree 316/06. Available at: http://www.alcaldiabogota.gov.co/sisjur/normas/Norma1.jsp?i=21066
34
that private participation in the sector is not enough. As previously mentioned, the case
of public transportation in Bogotá shows how little private participation contributed to
the enhancement of the service. It is therefore necessary to draw from the best
worldwide examples of proper implementation, which indicates that the best way in
which to accomplish this is by having a successful foreign company invest and handle
the operation of the system.
1. FDI in Colombia and modes of entry for foreign investors10
We have argued so far for the inclusion of best practice from developed countries into
developing countries and for an injection of foreign direct investment in infrastructure
projects. FDI has shown to be an important vehicle in transferring technology only
when combined with a strong absorptive capability regarding human capital by the host
country. FDI can contribute highly to economic growth in the host country by bringing
advanced management skills and modern technology into the domestic market
(Borensztein, De Gregorio, & Lee, 1998).
In Colombia, FDI has increased during the last twenty years thanks to the
introduction of a more favorable regulatory framework for foreign investors. This
increase was made possible by an economic liberalization in the country followed by a
successful privatization policy. Foreign investment falls mainly under Law 9/1991 and
Decree 2080/2000. The purpose of both rulings is to encourage capital investments from
foreign economies in Colombia, within adequate control mechanisms and less complex
administrative procedures. Notably, both foreign and domestic investment are treated
equally by the law (Garavito, Iregui, & Ramírez, 2012).
2. Proposition for the structure of the SPV in the Colombian case
As described above, an SPV would be created to undertake the Integrated Public
Transportation System (IPTS) project as a whole. This firm is managed by a sponsor, an
10 This section draws upon law 9 of 1991, available at: http://www.banrep.gov.co/sites/default/files/paginas/LEY09DE1991CONHIPERVINCULOS-1.pdf and Decree 2080 of 2000, http://www.sice.oas.org/investment/NatLeg/COL/Dec2080_00_s.pdf
35
equity investor responsible for bidding, developing, and managing the project (Engel et
al., 2010). Given the structure of public transportation in Colombia, and the existence of
numerous operators, the SPV could be comprised of the various operators as
shareholders of the managing company. Currently, bus and mass transit systems in
existence and the traditional bus transportation system must be combined together and
be integrated together into a single IPTS project.
The idea of an SPV fits quite well with the objective of implementing an IPTS
for Bogotá. The establishment of such an entity would end the current inefficient
conditions described above and would help alleviate a system which is disorganized due
to a lack of coherence and harmony among the different players and their forms of
mismanaging the system. Furthermore, poor regulation has been a leading cause of the
problem because of weak legislative efforts in favor of community interests.
Additionally, operators are focused on a rent-seeking business that is held by politicians,
who in turn own the various controlling firms.
Three elements should be considered when undertaking the necessary
restructuring of the transportation system, namely: (i) the affiliating firms should
convert into true operating business firms, (ii) a public offering of shares from
Transmilenio S.A. should allow these new operating firms to become shareholders of
the latter, as well as the current vehicle owners, (iii) a reorganization of the current
routes and corridors should be undertaken, and (iv) the fare collection system should be
unified for all existing new companies that form part of Transmilenio S.A. (Villegas,
2008)
D. Key elements of the project
The Government of India, in connection with the World Bank, has set up a toolkit,
which can be very useful in identifying the steps required to establish a PPP.
36
1. VFM
As stated previously, in order to determine whether a PPP alternative is the best
option, it must first prove that it has a VFM higher than what is offered by publicly
funded projects. To determine this viability, its project revenues and the operational and
capital costs must be identified, in order to define an estimated return based on future
estimates. Even when the project is not viable on a standalone basis, it should not be
automatically discarded. Hence, feasible funding gaps could be considered so as to
make the project commercially viable subject, of course, to a qualitative analysis of the
same. The effects of public welfare, which should be achieved by a PPP alternative,
should offer high advantages in compensating for any source of financial support
coming from the government or any difference in VFM with a publicly funded project.
If a significant improvement can be achieved by the PPP model, the government should
in principle opt for it (CRISIL, 2009).
In order to build the financial model, some assumptions need to be made, i.e. in
regards to the project costs, grants or subsidies approved, revenues, and operation and
maintenance costs already identified. First, analysts must identify the revenues based on
those assumptions. Second, costs need to be identified and assessed in two main
categories, namely: (i) construction costs, arising ex ante of the project, and (ii)
operation and maintenance costs present during the life cycle of the project. The
assessment of revenues will then in turn help to determine the future cash-flows of the
project, with the help of profit and loss statements, projected balance sheets, and
projected cash-flow statements. In turn, the cash flow should be used for assessing the
financial viability of the project in terms of its appeal to potential investors who are
interested in the commercial feasibility of it meeting their expectation of an attractive
return on their investment. In corporate finance, NPV has been identified as one of the
best-suited tools to assess the viability of a project. (Brealey, Myers, & Allen, 2006).
While an argument can be made that PPP is the best way to achieve an efficient
infrastructure in transportation, the determination of the specific PPP structure also
offers complex steps and decision-making processes which need to be addressed,
especially bearing in mind that whichever structure is chosen, it needs to be integrated
into the existing structure of TM.
37
The studies conducted by the World Bank in the case of the city of Maharashtra
indicate that the first step after choosing a project to be part of a PPP financing
alternative is to define who holds the ownership of the assets. In Bogotá, both the public
and private sectors own the assets. The former owns the lanes and other infrastructure
facilities, and the latter owns the vehicles. As a second step, risks need to be identified,
allocated, and included in a contract model for the bidding to take place (CRISIL,
2009).
Considering the existent infrastructure and operating urban transportation
system, there are numerous projects down the pipeline, which need to be accounted for
by the IPTS project, which needs to build on these sub-projects and prioritize some key
areas.
2. Joint-Venture
For the project to be efficient in developing countries, some of the best practices from
countries where the models have worked and have shown positive outcomes must be
imported. It is obvious that in order to attain high standards, the status quo must shift to
other parameters, including psychological nuances that have proven to exist in
developing countries. It is undeniable that large cities like Berlin or London or even
Santiago have a far better transportation system than a city like Bogotá; therefore, it is
important for international private firms to be allowed to participate in the provision of
the service—alongside national ones—as they possess the necessary expertise and are
familiar with the types of innovative practices that need to be implemented.
The opportunities for Foreign Direct Investment (FDI) in developing countries
must then be incentivized. A Joint-Venture arrangement is one of these forms in which
oversees firms can enter domestic markets. A Joint-Venture would be a preferable form
of FDI because it would imply the joining of forces between the existing local
companies and the foreign company and advanced international know-how would
actually be transferred to the national companies that have proven not to have sufficient
technology to offer a high-quality system. A number of advantages can be identified for
38
transnational corporations (TNCs) to access markets in developing host countries
(UNCTAD,2008).
For instance, these foreign companies hold a competitive advantage by being
sizable and well established, with proven track records of large cash-flows and financial
capabilities, which makes them more inclined to raise funding for projects if they act as
sponsors of the SPV, both in the home-country market and in international markets
(UNCTAD,2008). They are also able to infuse advanced technological expertise into
host firms in developing countries. More specifically, the competitive advantages of
opening the door to TNCs for the provision of public infrastructure lies on the following
benefits: “specialist expertise, ability to organize and operate networks, engineering
skills, environmental know-how, project management capabilities, financial prowess
and managerial expertise” (UNCTAD2008, p. 21).
This form of FDI is also known as Greenfield investment, as opposed to cross-
border M&A. The suggestion of a joint-venture mode of entrance for TNC is important
because it relies on the transmission of their expertise to the whole industry in the host
country. This dissemination effect is not sufficiently achieved by wholly-owned foreign
subsidiaries. Cooperation is optimal, and it can only be achieved if the existing local
companies remain existent and can further apply the knowledge acquired. In the case of
an M&A, the local company would be squeezed out by the new foreign company
neglecting the results sought. Greenfield FDI may be undertaken in the form of a joint-
venture with local partners, be it public or private. Foreign investors become owners of
assets at the beginning of the project and build a new facility. The investor assumes the
revenue risk, as the government normally does not provide any guarantees for it, along
with the construction, operating, and market risks for the project. There are two types of
combined contracts: “Greenfield” projects, if the participation of the transnational
corporation involves a building from scratch task, or “Brownfield” projects, if private
participation is limited to rehabilitate existing facilities (Vuksanović & Milojčić, 2011).
Of course this will only lead to a competitive advantage if it can be proven that
TNCs do actually possess a higher level of expertise than do local firms. In the case of
public transportation in Bogotá, it appears quite clearly that the system, especially the
bus system, is not comparable to other systems managed by other firms worldwide.
39
3. Sufficient demand
This paper proposes that the best option is a revenue-based transportation system, in
which users pay directly for the service (EPEC,2010). As previously mentioned, such is
the case for TM, which has proven sustainable up to the moment, i.e., no financial input
from the local government has been necessary. For the IPTS to work, the local
government must examine the capacity and the willingness of users to pay for the
service, especially when taking into account the likelihood that tariffs will need to be
changed in order to cover operation and maintenance costs or meet cash-flow targets
(EPEC, 2010).
It is important to promote demand for public transportation as well as
improvements to the quality of service. Thus, the focus here has been to challenge the
act of promoting public transportation from the supply side by making it more efficient.
However, it is equally critical to promote transportation on the demand side. Awareness
of the advantages of using public transportation over privately owned vehicles must be
stimulated among the citizens in Bogotá. A challenge for project managers and public
authorities will be to adequately position the improved public transportation system
within the public transportation network, i.e., TM, taxis (Parikesit & Susantono, 2013),
by adapting it to the new infrastructure that would result from implementing a new PPP
model.
Sufficient demand that generates revenues is linked to added value, such as
efficiency, speed, safety, and others, that the private party can provide and which the
public party seems not to be able to. Bogotá, with its background of constant failure in
achieving these standards in the public provision, is proof that another type of model
will be capable of fulfilling the voids that exist nowadays. Private and foreign investors
will not be subject to political conflicts present nowadays. Moreover, a study conducted
in 2008 by the National Department of Planning exposed the favorable outcomes of the
PPP model and has set forward the main challenges faced by the infrastructure sector,
namely: (i) adjustment and development of pertinent political and regulatory frames; (ii)
appropriate analysis of the technical needs in terms of infrastructure; (iii) incentives for
development of new financial instruments in order to attract institutional investors to
invest for the long-term, and (iv) improvement of institutions (CONPES,2008). The
40
Government of Colombia agrees that public resources need to be optimized in order for
public debt not to be affected. Hence, innovative arrangements found in alternative
mechanisms must be introduced in the Colombian regulation to attract foreign investors
(Preamble Bill 160, 2011). On the grounds that PPPs lead to financial structures that
promote the use of capital markets, the establishment of Colombian PPP Law was
actually motivated by the urge to develop capital markets, which would finance public
infrastructure projects and alleviate the burden on the public debt.
Forecasting the demand as accurately as possible is also a challenge to be met, as
the risk for this demand is more difficult to assess, and particularly in developing
countries where low predictability of the economic growth makes forecasting demand a
difficult task (UNECE, 2008).
4. Tariff
Both the creation of the SPV and the partnership with a TNC will most likely lead to the
establishment of a monopoly that needs to be regulated since no competition would
control prices in the market. In this case, tariffs need to be regulated and set by the
government in order to ensure a fair price to users. Efficient regulation is needed in
order to avoid potential abuse by the monopolist. During the last decade, Colombia has
addressed this concern by expanding its competition policy, especially with the
introduction of Law 1340/09, which brought notorious improvements in dealing with
mergers and acquisitions. Tariffs should also remain flexible in order for their
adjustments to have minimal impacts on cash-flows and make the project financially
viable (Kwak et al., 2009). For Estache et.al (2004), price regulation should aim at
estimating as accurately as possible the average tariffs to be charged, reflecting as
accurately as possible all risks and still providing an incentive for investors to commit to
projects for the long run. Along this line, Guasch (2004) presents two main types of
regulation: the price cap and the rate of return. The first one is straight forward, and the
second one consists on setting the tariff to comply with the firms’ returns, which are
adjusted each year.
41
VII. Conclusion
The need for an improved and more efficient public infrastructure has been largely
responsible for the search of hybrid investment models, different from traditional ones,
whether public or private, to ensure a high quality provision of services that are
essential to the population. The traditional forms of undertaking public infrastructure
projects before the entrance of PPPs in the 1990s, namely public procurement and
privatization, felt short in completely addressing user’s needs. Numerous failures
became observable.
The evolution of private participation in the provision of public infrastructure
services has differed from country to country. The model remains novel and infant in
many aspects—still in a maturing period. The ways that a PPP can come into existence
extend largely and the broadness of the concept may be confusing when implementing
the same. However, some examples of best practices can be observed, especially in
developed countries, leading to the conclusion that a PPP, if properly implemented, can
create better outcomes than previous existent models. The crisis in urban transportation
systems in developing cities has created the need for changing the structure under which
these projects are being undertaken. Evolution in the provision of the service seems to
reflect that an overhaul of the system needs to take into account innovative and hybrid
models such as PPPs. The model might be helpful in overcoming the current less-than-
ideal conditions of infrastructure in developing countries and the problems of bad
governance, inefficiency of operations, and inadequate regulatory and legislative
frameworks.
A sound financial viability plan analyzed by assessing the VFM actually
afforded in PPP is the main element for those in charge to opt either for or against the
model when deciding on an infrastructure project.
All of the latter illustrates how these elements can be applied in the case of
Colombia, where PPP remains a misunderstood and confusing concept, but where
efforts are gradually being made to comprehend the model and its potential for
increasing efficiency when implemented for existing and new projects.
42
Notwithstanding the novelty and the positive aspects of the PPP model, whereas
they seem to provide very important advantages in comparison to traditional public
funding, it may not always be the case and it is important not to make this private
funding model a default one. For instance, in England, reports have shown that PFI-
funded projects were not necessarily of higher quality or more innovative than
traditional public works. Hence, the certainty of success in the applicability of PPP is
still to be determined and tackled.
43
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