Economics & Management of
Privatization
Professor Simon Hakim
hakim@temple.edu
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Lecture 1
 Research Process and Paper Contents
 Definition: Political Science, Economics
 The Concept of Public Goods: Adam Smith
 Characteristics of Goods that Require
Intervention
 Techniques of Public Sector
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The Research Process
1.
2.
3.
3
Significance of Problem
Choice of client, Research Questions, and/or Objectives of Study
6.
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Definition of the Problem
4.
Description of Alternative
5.
Evaluation of Alternatives
Selection of Preferred Alternative
Structure of paper
 Cover Page
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: Name, Course, Term, Contact information
Abstract
: Problem, Significance of Problem, Alternatives, Major
Findings.
Introduction: Problem, Significance of Problem, the Client, Research
Questions or Objectives of Paper, Review of Forthcoming
Sections.
Historical or Literature Review, Background
Description of Alternatives. Include a summary table
Evaluation of Alternatives. Costs and benefits to each alternative. Include
a summary table.
Summary and Conclusions. The preferred alternative, rational for
selection, improvement of preferred alternative, policy implications, future
research.
References.
Definitions—Public Administration
1.
Relying more on private institutions of society and less on
government to satisfy people’s needs. Private institutions
include businesses operating in marketplace, voluntary
organizations (religious, neighborhoods, civic, cooperatives and charities), individuals, family, clan or tribe.
2.
Act of diminished role of government or increased role of
private sector in an activity or in the ownership of assets. It is a
strategy to lower the cost of government and achieve higher
performance and better outcomes for tax dollars spent.
Act of transferring government enterprise or assets to the
private sector
Webster’s: Making private, especially changing from public to
private control or ownership.
3.
4.
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Public Administration: Economic
Definition
A move of an asset or activity from bureaucratic government
monopoly towards competitive markets.
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Public Goods: Adam Smith
 The need for national defense
 The duty of protecting every member of society
from injustice or oppression of every other
member of society
 Establish and maintaining highly beneficial public
institutions and public works which are of
negative profit nature if supplied in small
quantities
 The duty of meeting expenses of ruling powers.
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Public Intervention in Marketplace
• Pure Public Good: Collective consumption (non-divisible)
•
•
•
•
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with non-exclusion, and non-rivalry in consumption.
MC=0. Motivation for free ridership.
Externalities: Positive and negative; Production and
Consumption.
Monopolistic Power.
Asymmetric information between the consumers and
producers in the market
Equity.
Pure Public
The case of MC=0 and constant is typical for pure public
good. A non-competitive provider will produce at
MR=MC and eliminate a significant part of Consumers’
surplus. Example, a road without congestion.
Degree of collective consumption VS. Size of relevant
interacting group.
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Mapping of Public And Private Goods
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Dichotomy of Goods & Services
RIVALRY
EXCLUSIVE
NON
EXCLUSIVE
Pure Private
Common Pool
Public domain ponds, rivers.
Regulation by licensing,
contracting-out.
NON-RIVALRY
Club
Swimming pools, toll roads,
country clubs. Membership,
tolls or users’ charges. Private
provision. contracting-out, and
vouchers.
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Pure Public
Exclusion & Consumption Properties of
Goods & Services
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Externalities
Definition: By-product of activities that escape the price
mechanism, and may be of positive or negative nature.
Government role is to internalize externalities such that
the price includes it.
 In case of negative externalities the product is overproduced
and at a lower price than it should (social).
 Positive externalities cause under production of the good at a
higher price than socially desired.
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Natural Monopoly
A single provider in the market.
• Absence of competition may be the result of significant
economies of scale, technological superiorities, and/or
asymmetric information that over time eliminated all
competitors.
• Entry of new competitors to increase supply and thereby lower
prices is usually infeasible.
• Gov’t intervention
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Natural Monopoly (cont.)
 Is aimed to control prices through regulation. Examples include
local utilities. Improved technology increase availability of close
substitutes and leads to elimination of the need to regulate.
 Natural monopoly results of economies of scale, technological
superiority, asymmetric information. Over time, one provider
prevails. Consumers’ surplus in the case of a monopoly is smaller
than that results in perfect competition. Government regulation
sets the price to be lower and as close as possible to that of perfect
competition. Action could be on the quantity.
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Asymmetric Information
 Examples: food contents, medicine, Enron,
corporate corruption
 Here the consumers have no knowledge on the
contents of their products while learning about it
requires very high cost. Government needs to
protect the consumers.
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Equity
 Requires government intervention.
 Efficiency VS. Equity.
 Shortcomings of perfect competition.
 Voluntary activities to reduce inequity.
 Progressive taxation.
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History of Privatization
Peter Drucker suggested contracting out. Milton
Friedman.
Thatcher elected 1979. BP (79), British Aerospace (81),
National Freight Corp (82), Cable and Wireless (83),
Jaguar (84), British Telecom (84), British Aerospace-final
portion of holdings (85), British Gas (86), British
Airways (87), Rolls Royce (87), British Airport
Authority (87), water utilities (89), electric utilities
(90), mandatory compulsory tendering (compet.
bidding) of local gov’t services (89).
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History of Privatization
United States
 Little privatization by sale by Fed.
 Few state owned enterprise.
 Contracting out: data processing, food services,
building maintenance, guard services.
 Local: waste collection, street cleaning, ambulance
service, park maintenance.
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History of Privatization
World
 Late 1980’s: Mexico, Brazil, Chile, Argentina elected
presidents who adopted strong privat. policies.
 China: Agriculture (78), eliminating state owned and
collective farms and allowing private farming. In the
80’s: private sector industrial and retail operations,
multi ownership, joint ventures.
 89: Collapse of socialist block.
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Political historical Discussion
 Rise of Communism and greater state involvement in
marketplace: Eastern block
 Rise of Socialism in Western Europe
 Rise of Fascist regimes in South and Central America
 Change of trend: Thatcher and Reagan
 Collapse of Eastern European block
 Liberalism in Western Europe and Americas
 The role of privatization
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Forms of Privatization
I. By Divestment
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A. Sale
B. Free Transfer
C. Liquidation
II. By Delegation
A.Contract
B.Franchise
C.Grant
D.Voucher
E.Mandate
III. By Displacement
A.Default
B.Withdraw
C.Deregulation
1.To Private Sector
2.To the Public
3.To Employees
4.To Users or Consumers
5.To Employees
6.To the Public
7.To Users or Consumers
8.To Prior Owner
1.Public Domain
(Concession)
2.Public Assets (Lease)
Why Privatize?
 Cost Savings: Ranges from 20-50 percent.
 Access to Enterprise: Contracting gives access as needed to
unavailable expertise.
 Better quality: Competition brings best performance.
Bidders have incentives to offer better quality in low prices.
 Improve risk management: Contractors, rather than
government, are responsible for delays, overrun costs.
 Innovations: Competition yield cutting esourcesdge
solutions.
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Why privatize?
 Meeting peak demand: Contracting out can satisfy
extra demand when public resources are unavailable.
 Timelines: Private contractors can hire part-time
workers or temporarily rent capital to meet
deadlines, avoid penalties or enjoy extra payments.
This option is often unavailable for government.
(Source: Gilroy Leonard and Adrian Moore, “Privatization”, in
The Patriot’s Toolbox, The Heartland Institute, 2010).
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Forms of Privatization
 Divestment: Shedding an enterprise or an asset. One time
affair. Sold or given away.
 Free transfer: Given away to employees, users, customers,
previous owners, or the public at large.
 Sale: to joint venture, private buyer, the public, employees,
users or customers. More than 100 airports were
sold/privatized including Buenos Aires, Frankfurt,
Johannesburg, London, Madrid, Paris, and Rome. The Empire
State Development Corp. sold the NY Coliseum, State parking
lots, armories, golf courses, State mental health campuses. This
generates, in addition, property tax base that did not exist
before.
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Forms of Privatization
• Delegation: Requires a continuing active role for gov’t.
Remains responsible for overseeing the results.
Contract: for part of service, for total management. Solid
waste collection, street repair, street cleaning, snow
removal, tree maintenance, loan processing, data
processing, audio visual services, food, mail and filing
services.
2. Franchise (concession): exclusive right to sell a service or
product to the public.
1.
a. Use of the public domain in the course of carrying out
their commercial activities– use of the public domain:
airwaves, air space, underground space. Examples,
broadcasting, airlines, bus and taxi co.'s, electric, gas,
water, telephone.
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Forms of Privatization
Delegation (continued)
b. A lease. Government owned tangible property is used by a
private lessee to engage in a commercial enterprise. Chicago
leased for $1.15B its downtown meters system in 2009, and
earlier 4 downtown parking garages for $563M.
3. Grant: private entity does the work-subsidy, grants for public
transit, low income housing, maritime shipping. To run a bus service,
to do research, to promote the arts. Contracts are more specific.
4. Mandate: Gov’t requires private companies to provide services at
their expense. Ex. Unemployment Compensation. Replacing Gov’t
by mandatory indiv retirement accts.
5. Vouchers: subsidize eligible consumers instead of producers to
purchase services in the market. Used for food, housing, education,
health, day care, transportation.
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Forms of Privatization
• Displacement: Passive process as markets develop to
satisfy needs.
 By default: Gradually the public looks for the private sector.
Ex. Municipal tennis courts and other rec. facilities.
Commercial ventures, voluntary groups like charitable, social,
philanthropic and community org. Ex. Police is replaced by
private guards. In transportation: gypsy cabs, commuter vans,
minibus systems and other unofficial or technically illegal trans.
Providers emerge as public means are inadequate. Private co.'s
finance, build, operating, owning roads, bridges, prisons. Ex.
tunnel connecting England and France.
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Forms of Privatization
 By Withdrawal: Gov’t shuts down failing public
enterprise or accommodates private sector private sector
expansion.
 By deregulation: State monopoly vs. competition.
Privatization if the private sector challenges a gov’t
monopoly and even displaces it. Packages and express
mail.
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Delegation: Contracting Out
 Most common in the US (28% of all services).
 Mandatory for municipal services in the UK.
 Managed competition: bidding for contracting
out that includes the gov’t agency.
 Goldsmith: “A city could run with its mayor, a
police chief, a planning director, a purchasing
agent, and a handful of contract monitors”.
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Contracting Out
 Success in waste management: collection, disposal,
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extracting energy and recyclables from the waste stream,
and to treat hazardous wastes.
 Principal-agent problem: The principal bears 1. the cost
of providing incentives to encourage the agent to pursue
the goals of the principal. 2. the cost of obtaining
information and monitoring the agent to reduce
opportunistic behavior. 3. the cost of any residual
opportunistic behavior by the agent.
 A gov’t with budget problems is a good candidate for
contracting out. Loss of hospital accreditation by the
State, court’s order the closure of a municipal landfill,
sudden need for a large public facility-- all necessitate
contracting out.
Contracting Out
Since 2005, 5 cities in metropolitan Atlanta, GA
contracted with private firms to deliver all its non-safety
related services (required under state constitution to be
provided by gov’t entities). Sandy Spring’s residents
incorporated as an independent city. CH2M-Hill OMI
overseas and manages daily city operations. Sandy Spring
maintains ownership of assets, and setting service levels.
Contractor is responsible for staffing and all operations.
Contract value is just above half of what Fulton County
charged in taxes the City.
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Contracting Out: Steps
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1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
Consider the idea of contracting out.
Select the service
Conduct a feasibility study
Foster competition
Request expression of interest or qualifications
Plan the employee transition
Prepare bid specifications
Initiate a public relations campaign
Engage in “managed competition”
Conduct a fair bidding process
Evaluate the bids and award a contract
Monitor, evaluate, and enforce contract performance
Contracting Out: Actual Process
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Wastewater treatment plants in Indianapolis, 1993.
1.
Mayor creates Review Committee (6 mayoral appointees, and 2 from City
Council)
2.
Review Committee issues RFQ to 28 Cos.
3.
7 Responses are received including one from the current managers of plant
4.
Committee reviews and cuts down to 5
5.
City provides $15K for consultants to help existing managers: Cost estimate
and preparation of RFP
6.
RFP are issued to 5 qualified teams
7.
Teams of all 5 qualifiers visit separately the plant
8.
5 qualifiers submit proposals and prices
9.
A technical and financial consultants are hired to help the Committee
10.
3 of 5 including existing management are rejected
11.
Each finalist briefs the Review Committee
12.
Review Committee visits plants operated under contract by 2 finalists
13.
Review Committee picks the winner
14.
Winner starts contract operation
Contracting Out:
2. Select the Service Criteria
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Service with no legal or contractual impediments to contracting
Easy to carry out competitive contracting
Hard services for which easy to write enforceable specifications
Stand-alone service
Can be segmented by location into 2+ contracts
Services that have been successfully contracted out elsewhere
“Yellow pages test”. Enough, responsible and experienced bidders
Services for which part timers can be used. Significant savings since
gov’t cannot readily employ part timers
Services where gov’t operation is overstaffed, poorly managed or could
be re-engineered.
Services that are subject to public complains
Services where employees and union resistance can be overcome
Services where overpowering political opposition will not result
Services where in-house monitoring expertise is available.
Contracting Out:
3. Feasibility Study
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1.
2.
3.
4.
5.
6.
7.
8.
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Establish current cost to establish a baseline against which to compare prices
Assess quality of current operation—complaints, measuring performance,
conducting surveys
Public cost relies on published budget. Need for ABC accounting which
includes:
Capital expenditures which often are not included in operating budgets
Interest costs on capital expenditures
Costs of supplies- fuel for vehicles that appear in a different category of
budget
Fringe benefits
Budgetary pensions
Cost of labor borrowed from other agencies or hired seasonally and are
not included in the analyzed budget. E.g. hierarchical and hidden costs.
Or, many attorneys budgeted by the DOJ work full time defending the
Bureau of Prisons against suits brought by litigating prisoners.
Foregone property tax and OC of building and land used by the activity
Cost of premiums paid for liability and fire insurance
Contracting Out: 4. Foster Competition
It is best to have multiple competitors. However, when there are marginal
competitors it is best to negotiate bids with handful of clearly eligible
contractors after the qualifying round. Best for contractors of
hospitals, prisons, social and professional services. Often due to
bureaucratic behavior of gov’t there are only few bidders and/or high
bids to compensate for it.
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To foster competition–
1. divide the geographical area to smaller units as long as econ of scale are not adversely
affected.
2. give a long lead time to bidders
3. publicize and use the web for the bidding
4. provide sufficient information
5. award enough contracts and permit a large number of bidders to get contracts.
6. Minimize “incumbent advantage” to encourage new contractors to bid. Philadelphia did
just that by including in the bid for the maintenance of street lighting detailed
information on equipment and practices used by the incumbent contractor
7. Avoid request for sensitive non-essential business information to the procurement like
profits, wages of managers/employees
8. Avoid restricted contracts for nonprofit organizations but keep it open for all. Such
restrictions are often used for local political patronage (e.g. social foster care agencies)
9. When service is site based like center for homeless, the owner of the facility has an
advantage in such a bidding. It is suggested to separate the rent from the operation to
encourage companies that could provide the service however do not own the (a) facility.
5. Contract out: Express Interest or
Qualifications (RFEI)
When initially considering privatization, gov’t may be unsure
about the exact nature of the proposed contract. So, it
announces RFEI to prospective bidders, pre-bid conference
to discuss the issues, checking the submission of the firms,
prepare a list of firms to which RFP or an invitation to bid is
issues.
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Contracting Out:
6. Plan the Employee Transition
Biggest problem is how to handle with redundant workers and
the prospect of labor unrest. Surveys showed that most
workers are hired by the private contractor, followed by early
retirement, severance pay, attrition, redeployment in other
public agencies. Only few are fired.
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Contracting Out:
7. Prepare bid specifications
• Contract wording should be in ordinary language, accurate and
•
•
•
•
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unambiguously.
The contract should not specify exactly how the work should be
done but merely the output quantitative specifications.
Gov’t should allow freedom of contractor to employ the people
at salaries and in procedures that achieve the contract specified
outputs.
“Hard” services that involve tangible and visible physical results
are easier to write specifications in output and lend themselves to
contracting out.
“Soft” services that involve social workers are more amenable for
contracting out.
Contracting Out:
8. Initiating Public Relations Campaign
Strong opposition is almost certain to surface by public
employee unions, private firms that want to avoid
competition, or special interest groups.
Aggressive campaign in support of privatization should
include a coalition of civic associations for better gov’t,
neighborhood groups dissatisfied with poor services,
minority businesses that see opportunity in providing
such services etc.
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Contracting Out:
9. Managed Competition
Effective for short term contract or where capital expenditures are
required
2.
Allows the management to work with its labor force
3.
Improves employees’ morale and builds community support
4.
Reduces the possibility of collusion among private providers
5.
Induces private firms to submit better bids
Mandatory competitive bidding by gov’t agencies for routine functions was
introduced in the UK. Also, requirement of gov’t agencies to
maintain separate accounts of income and expenditures and to
achieve a prescribed rate of return on the capital equipment they
employ. (Local Gov’t Act, 1988). Included refuse collection, street
cleaning, cleaning of public buildings, vehicle and ground
maintenance, and food services. Result: Many services were won by inhouse departments with savings of 20% and reduction in manpower of 2030%.
1.
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Contracting Out:
10. Fair Bidding Process
 Widely advertise the RFP
 Allow enough time between announcement and due date
 Hold a bidders’ conference to address questions
 Use internal team and an outside consultant to evaluate proposals
using clear criteria and an agreed upon score system
 Avoid asking for too many bid prices. (e.g. price for year 1, year
2…) This will create favoritism.
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Reasons for Privatization:
Political Science View
 Pragmatic: Greater efficiency in the production of G & S.
Dissatisfaction with gov’t performance.
 Ideology: Less gov’t. Gov’t plays a smaller role than the
private sector.
 Commercial: To do more work at profit.
 Populist: Better society by giving people greater power
through the marketplace while diminishing the power of
large public bureaucracies.
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Reasons for Privatization:
The Economist View
1. Improve economic efficiency
2. Strengthen the share of the private sector in the
economy
3. Reducing the role of government in the marketplace
4. Improve the financial stance of the public sector
5. Develop better capital markets
6. Use the revenues generated by the privatization for
other social, security or infrastructure purposes.
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Reasons for privatization varies by
economies
The relative importance of the reasons depends upon the
characteristics of the economy in question. In a nation
where capital markets are weak– reason 5 dominates. In
a nation that changes its structure (from Communism)
then reasons 2, 3, and 5 are central. In a developed
economy where the private sector is strong and so are
capital markets then reason 1 applies.
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Keys for Success (in Declining
Importance)
 Having committed political leader (s) to champion the
initiative. E.g. a governor, mayor, or several legislators.
Flexibility in adjusting strategies when problems arise in the
implementation. Maintenance of momentum.
 Establishing an organizational and analytical structure to
implement the initiative.
 Enacting legislative changes and/or reducing available resources
to encourage greater exposure to competition. Signaling
managers and employees that the restructuring efforts are real.
 Developing reliable Activity Based Costing (ABC) accounting to
determine performance of the gov’t agency and the feasibility
of private sector provision of service. Cost data on individual
activity and not the traditional agency wide accounting system.
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Keys for Success (Cont.)
• Involving employees and local unions in the privatization process.
Unions concerns and political influence led to legislation that made
privatization in MA more difficult. In Indianapolis, employees are
involved from early stage. Workers trained in ABC and allowed to
compete. Front line workers were given decision-making power. Some
supervisory jobs were eliminated, training to workers responding to
RFP, safety net for displaced workers.
• A 1989 National Commission on Employment Policy survey showed
that 24% of contracted out public services were transferred to other
gov’t jobs. 58% went to work for the private contractor, 7% retired,
and only 3% laid off.
• A monitoring body should be established by gov’t to assure compliance
with the designated contractual terms.
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2nd key: Council on Efficient Gov’t
 Single independent decision-making body to manage
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initiatives. Good example, Florida Council on Efficient
Gov’t. 2004-2010: $550M in cost savings through 130
privatization initiatives. The council should get the authority:
Develop a process for identifying & implementing
competitive sources.
A feasibility study of alternatives.
Develop performance-based contracting: focus on outputs
not inputs when choosing whether to privatize
Conduct an periodical inventory of gov’t activities
distinguishing between inherently public and possible public.
Problems with Traditional Contract Out
Model
Infrastructure controlled by gov’t:
1. Separate contracts with private agencies
2. Labor disputes
3. Disputes between the planners and the contractor
4. Lowest bidder contractor performs low-quality
workmanship
5. Concealed or unforeseen conditions
6. Huge task of renewing the public infrastructures, and
insufficient funds.
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Public Private Partnerships (PPP)
Definition: PPP is an arrangement of roles and relationships in which 2+ public and
private entities coordinate in a complementary way to achieve their separate
objectives through the pursuit of common objectives (s).
 Private design, finance, construction, maintenance and operation of a project for
public use for a specific period of time. When time expires, title reverts to gov’t.
 The private sector aids gov’t in identifying new private financed profit-making
facilities, and seek out new projects that otherwise have to wait until public funding
becomes available.
 The public sector investigates feasibility of project, execute the contract, choose the
private partner, regulate prices, establish and monitor performance standards.
 BOT is a general term for PPP. A concession is granted to a contractor to design,
finance, operate and maintain for 10-30 years. Contractor charges tolls for the use
of the facility.
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Forms of PPP
From mostly Public to mostly private
 Fully public
 DB: Design Build
 DBFO: Design, Build, Finance, Operate
 BOT: Build. Operate, Transfer
 BTO: Build, Transfer, Operate
 BOOT: Build, Own, Operate, Transfer
 BOO: Build, Own, Operate
 Fully Private
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Forms of PPP
 DB: A contract with a private contractor to provide architecture/engineering
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design and construction services
DBFO: Contractor responsible for these services and is compensated by
specific service payment by gov’t during life of project. No actual tolls are
collected by private contractor. Here payments by gov’t—cost to taxpayer.
Still efficient since construction & operation by a private entity
BOT: A concession is granted to a contractor to design, finance, operate, and
maintain for 10-30 years. Contractor charges tolls for the use of facility.
BTO: Build, Transfer, Operate. The gov’t then leases the facility back to
developer under a long term lease.
BOOT: Build, Own, Operate, Transfer. Ownership with the contractor until
the end of the concession period and is transferred free to the gov’t.
BOO: Outright privatization without a transfer of ownership to gov’t. At the
end of the concession, the original agreement can be renegotiated.
Wraparound addition: The private developer constructs an addition to an
existing public facility and then operates the entire facility for a fixed period of
time or until the developer recovers costs plus a reasonable return on
investment.
Reasons for PPP
 Greater efficiency in the use of public resources.
State and local gov’ts save 10-40 percent
 PPP are means of increasing investment in
infrastructure particularly utilities and transportation
 Needs for social infrastructure– hospitals, prisons,
schools, housing
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Advantages for Gov’t of PPP
 Profit oriented businesses identify new projects that otherwise
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wait till gov’t funds are available
Private sponsors and commercial lenders assure financial and tech
feasibility of project
Private sector can access private capital markets to substitute hard
to get gov’t sources
Private sector builds faster and more cost effective than gov’t.
Less bureaucracy and procurement rules
Private sector operates facilities more efficiently due to profit
motives
Private firms provide more tax revenues
Private sector shares or accepts risks otherwise borne by public
sector
Private sector transfers technology and provides training to gov’t
workers
6 Keys for Success of PPP
1.
Statutory and Political Environment:
A successful partnership can result only if there is commitment from "the top". The most
senior public officials must be willing to be actively involved in supporting the concept of
PPPs and taking a leadership role in the development of each given partnership. A wellinformed political leader can play a critical role in minimizing misperceptions about the
value to the public of an effectively developed partnership. Equally important, there should
be a statutory foundation for the implementation of each partnership.
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2.
Public Sector’s Organized Structure:
Once a partnership has been established, the public-sector must remain actively involved in
the project or program. On-going monitoring of the performance of the partnership is
important in assuring its success. This monitoring should be done on a daily, weekly, monthly
or quarterly basis for different aspects of each partnership (the frequency is often defined in
the business plan and/or contract).
3.
Detailed Business Plan (Contract):
You must know what you expect of the partnership beforehand. A carefully developed plan
(often done with the assistance of an outside expert in this field) will substantially increase
the probability of success of the partnership. This plan most often will take the form of an
extensive, detailed contract, clearly describing the responsibilities of both the public and
private partners. In addition to attempting to foresee areas of respective responsibilities, a
good plan or contract will include a clearly defined method of dispute resolution (because
not all contingencies can be foreseen).
Keys for Success of PPP (continued)
4. Guaranteed Revenue Stream:
While the private partner may provide the initial funding for capital improvements,
there must be a means of repayment of this investment over the long term of the
partnership. The income stream can be generated by a variety and combination of
sources (fees, tolls, shadow tolls, tax increment financing, or a wide range of additional
options), but must be assured for the length of the partnership.
5. Stakeholder Support:
More people will be affected by a partnership than just the public officials and the
private-sector partner. Affected employees, the portions of the public receiving the
service, the press, appropriate labor unions and relevant interest groups will all have
opinions, and frequently significant misconceptions about a partnership and its value to
all the public. It is important to communicate openly and candidly with these
stakeholders to minimize potential resistance to establishing a partnership.
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6. Pick Your Partner Carefully:
The "lowest bid" is not always the best choice for selecting a partner. The "best value" in
a partner is critical in a long-term relationship that is central to a successful partnership.
A candidate's experience in the specific area of partnerships being considered is an
important factor in identifying the right partner. The listing of NCPPP members
provides a logical starting point for the identification of potential partners or services
that might be required in the development of a partnership.
BOT Model
Usually a large project requiring consortium of designers,
builders, financiers and more. Contractor enters into
4 agreements:
1.
2.
3.
4.
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A concession agreement with host gov’t
A construction contract usually DB type. It may be a member
of the bidding consortium
An operation and maintenance agreement with operator of
facility. It may be a member of the bidding consortium
Loan agreements. Funds flow through concession co.
BOT Concession Agreement
Establishes concession rules and contractual rights of parties.
Issues Included:
1. Nature, length, scope of work, operation of completed
facility
2. Specification of what is provided
3. Extent of permitted variations to specification
4. Performance standards
5. Tolls, prices, payments to be charged
6. Concessionaire's rights if enabling legislation changes
7. Provisions for termination of contract
8. Circumstances where grantor takes over the concession.
59
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BOT: Gov’t support
1.
2.
3.
4.
5.
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Creating appropriate legislation that enables effective
operation
Setting tolls to allow reasonable IRR given level of
risk
Protecting concession companies from competition at
early years
Helping concession co. to overcome bureaucratic
opposition
Develop a clear and effective program to allow public
participation in the planning.
BOT: Advantages
1.
2.
3.
4.
5.
6.
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No or little cost to taxpayers
Little risk for gov’t. Sufficient bonds and letters of
credit that ensure completion if private sponsor
defaults
Private sector can move pre and construction more
rapidly than gov’t
Sponsors must operate and maintain facility for 20+
years
General taxes are unaffected and revenue bonds are
unnecessary
Only users of BOT facilities pay tolls. Thus, costs are
borne by beneficiaries and not by public at large
BOT: Risks
 LDC: Long term political instability
 Cost overruns. Project could come to halt
 Currency devaluations causing payback loans with
devalued revenue
 Drastic changes in demographics over the
concession period may affect revenues.
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PPP in Highways
Problem: Maintenance of existing roads is short $20B than
available Federal, State and Local budgets. If we wish to
accommodate expected economics growth then the shortage
expands to $40B than what public budget will be available.
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PPP: Highways
 Impetus: Intermodal Surface Transportation Efficiency Act
(ISTEA), 1991. Expanded toll facilities eligibility for Federal
aid for construction (re), resurfacing, rehabilitation,
conversion to toll roads. Allowed also State funding and
shared responsibility with private sector. Exception:
Interstate system.
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PPP Highways: Principles
 Always PPP where ownership shifts to public entities
 Always existence of non-toll alternative road
 Toll roads and private highways have been built in many
Asian, European, and Latin American countries. Since 2005,
gov’t run toll roads have been contracted out in Colorado
(Northwest Parkway), Illinois (Chicago Skyway), Indiana
(Indiana Toll Road), and Virginia (Pocahontas Parkway).
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Rt. 91 in Ca.
Description: 10 miles 91 express 4-lanes within the median
area of SR 91. Connecting 55 Freeway near Anaheim to run
east-west to the border of Riverside County. Affluent local
population, 8% annual increase in traffic—high congestion.
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Rt. 91: Ca. Nature of PPP, Operation
 BTO. CPTC built, cedes ownership to State in exchange for 35
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years lease to operate the road. Toll charged and 50% discount for
3+ people in car.
Demand sensitive pricing by time of day and distance.
Guaranteed 65 MPH otherwise money back
Fully automated operation
Immediate removal of non-operating vehicles.
Results: Profitable from first year. Average occupancy 1.65 where
20% of which are carpoolers (3+)
Dulles Greenway
 Built as BOT in 1995 in Virginia. 15 miles from Dulles Intern’l
Airport to Leesburg. 4 lanes and 250 ft. right of way. Private
consortium financed, built, and operates it. Connecting the Beltway
near D.C. (I-495) with Dulles Airport.
 Special legislation to establish prerequisites for construction &
operation of a private toll road
 A commission was set up to regulate applicants, supervise, control
operators, and approve/revise prices.
 Total estimated cost $326M. $68M initial investment by partners; of
which $22 equity and $46M guarantee against project risk. $202M by
consortium of 10 lending institutions.
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
http://americancityandcounty.com/mag/government_making_inroads_private/

http://americancityandcounty.com/mag/government_making_inroads_private/
Greenway: Features
 BOT. Transferred to State (VI) after 40 years. Subjected
to utility style regulation. Targeted return 21%.
 Prices fixed for all day and all 7 interchanges. In 1995
price $1.75 ridership 10K vs. anticipated 30K. In 1996,
price lowered to $1– ridership grew to 17K. In 1997,
price increased to $1.15. Toll collection below
anticipation.
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Lessons learned
 Drivers are reluctant of paying tolls that do not vary by distance and
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70
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time of day. Demand sensitive pricing (discriminatory prices) also
assure higher revenues, and avoidance of congestion.
Private toll road companies face difficulties in land acquisition and
managing environmental concerns. Rt. 91 had no land acquisition while
the Greenway suffered additional cost related to delay in land purchase.
DOT enjoys eminent domain provision in assembling land. Timely land
acquisition added to the cost of the Greenway.
Private companies unlike public entities cannot finance using tax exempt
securities. Thus, private companies pay higher interest.
Private companies unlike public entities do not enjoy sovereign
immunity. Full liabilities for accidents adding in case of BOT additional
operating cost.
Toll roads should enjoy existing demand and not be subjected to induced
development that will produce travel demand. The initial cost of toll
roads includes high land acquisition and construction while revenues are
low extending for a long period of time.
Lessons learned (Continued)
 Metropolitan roads that serve peak time traffic (e.g. Rt. 91)

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are more financially viable than intercity roads (e.g. the
Greenway).
Most private investments have alternative use in case of
failure. No alternative use for failed toll road which raises
uncertainty and higher financial costs.
Success requires one company to build and operate the toll
road for a long period of time.
Success requires simple and immediate land acquisition
Success requires a committed political champion
Problems with Dulles Greenway
 Fixed price for tolls. Demand sensitive prices over distance

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
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traveled, time of day, weekday-weekend
Excessive regulation by state/lenders for toll restructuring,
change of speed
Real cost of regulation in time and expenses
No tax exempt securities raising developer’s interest payments
Accidents and other liabilities absent for public roads that enjoy
sovereign immunity
No eminent domain provision to acquire necessary land.
Negotiations for land took time and additional resources adding to
cost
Expensive project that is contingent upon stimulation of land use
or induced traffic in the remote future with high risk
BOT Tunnel in Hong Kong
Feb 1988, the HK Gov’t granted a 30 year franchise to a private
consortium. Longest road in HK 4 KM twin tube 4 lanes
tunnel and approaching lanes. Completed 2 months ahead
of schedule at TC of $276.5M
1.
Financed completely by private sector
2.
Shareholders contributed equity 1 to 2.6 debt
3.
Risk for non-completion ran for just 18 months construction period.
Risk was low because the tunnel method used was well known.
Good reputation of contractor, and $400K per day penalty
4.
Cost overrun risk was overcome by several guarantees of
shareholders. To ensure project quality, a 10 year performance bond
to address performance risk was put up by contractor
5.
Post completion risks ran for 12 year loan period. Shareholders
purchased i.r. cap. Cash flow risk was mitigated by HK gov’t
approval to increase tolls.
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PPP for public schools
• PPP adopted to upgrade schools facilities at lower
costs and less time than gov’t.
• PPP are unbounded by regulations that govern public
sector bond offering, voter approval, and review of
competitive bids.
• A PPP school in Fl was built in less than 9 months
compared with 5 years by Fl gov’t.
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PPP for Schools
 Nova Scotia 41 schools constructed under Built-Lease-
Transfer-Maintain (BLTM). Private sector designs,
finances, and constructs. Leased back to Gov’t for
predetermined period of time at a pre-agreed rent.
When the lease starts, the school is operational.
 Advantages: speed of upgrade, and 15 percent savings
on lease. The school leases the facility for 20 years at
rent lower than the capitalized construction and
furnishing cost. Developer uses the facility when not
used; other time of the day, weekends, summer holidays.
Activities are predetermined like vocational education,
meeting space for civic and political groups.
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PPP for Public school: Pembroke Pines
Charter Fl.
 Haskell Educational Services (HES) designed and built
the school between 22 and 34 percent less cost than
other public schools in Fl. Unlike the previous case, here
Gov’t owns and leases the facility to the private entity.
 Public tax exempt bonds financed the building, owns it,
and leases it back to HES. HES operates it as charter
school and offers additionally fee-based after-school
programs: daycare, enrichment, and student services.
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Conclusions for PPP
 The traditional model of Gov’t contracting separately a
construction co (bid) and a designer has not been successful.
Often, the lower bidder uses low quality material where possible.
Also, the fragmented relationship and responsibilities among the
gov’t, the designer and the construction co. is a source of
problems where the gov’t plays a mediation role. In PPP, the
construction co. has vested interest in high quality construction
since it will operate the facility upon completion.
 DB is preferred to traditional model since a single organization
exists for both avoiding conflicts.
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Conclusions for PPP (Continue)
 BOT, and DBFO are used for major infrastructure projects like
roads, and power generators. Attract new private investment
without recourse to gov’t funding. BOT reduces the common cost
overruns experienced by gov’t. Only the users of BOT facilities
pay tolls. In DBFO services charges are paid by public sector; no
user charges.
 Hospitals and schools use BLMT (Build, Lease, Maintain,
Transfer). Facility is leased back to gov’t. PPP can be used to
acquire many different types of facilities with various contractual
arrangements.
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Privatizing Adoption @ Foster Care
Services: The Problem
Higher incidents of criminal behavior when growing
up without family ties and lack of permanency.
 90% of Rochester NY who endured 5+ family
transitions became delinquent.
 17% of all local jail inmates are former foster care
children.
 Annual pubic cost of per child foster care is $17,500
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Privatizing Adoption @ Foster Care
Services: Background
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80
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400,000 in foster care in 1991, increasing annually by 4%. 542,000 in 2001.
1.5 million children or 2% of all children
Average age 10.1 in 2001 and the average child remains in fc 44 months
Special subsidy is available for special needs children: Emotional and Physical
problems, siblings, age, and ethnic belonging.
International adoption becomes common. 20K in 2002; 40% of50,000
children adopted in 2002. 50% of int’l adoptions are infants while only 2%
from foster care. Cost $7K - 25K.
Private adoptions in the US include expenses for the birth mother, agency and
court, and could exceed $30K.
Minorities in fc and awaiting adoption comprise a greater % than their
respective share in the population. Blacks are 17% of population, 49% of
adopted and 55% of those awaiting adoption.
Number of children is foster care rises, length of time in pipeline is long, and
few children are being adopted.
Privatizing Adoption @ Foster Care
Services: Objectives
 Reduce the number of children in fc and increase
permanency
 Reduce the period of time in pipeline
 Federal Adoption and Safe Family Act (ASFA) offers
incentive payments to States that increases adoption from
fc above the national standards. Incentives appeared
effective in raising the rate of adoption.
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
Privatizing Adoption @ Foster Care
Services in Michigan
 Six months exclusivity for the State agency, family independent
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agency or fc provider to place an eligible child in adoption.
Within 3 months, the adopting parents need to be identified. If
not, the child is publicly listed.
Once publicized, the 53 licensed private agencies can compete.
These companies provide both fc and adoption services.
Fixed prices are paid for placing children based on outcome, time,
and the difficulty of the case.
The State imputes estimated cost for 8 prototype cases and adds an
incentive component. The adoptive family can act as a fc family
for the child for up to 150 days.
Private agencies handle 60% of adoption services and the rest are
managed by the state agency.
Privatizing Adoption @ Foster Care
Services in Michigan
No obvious success to the privatization efforts:
1.
2.
3.
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1991-99: total number of children adopted higher by 83%.
However, number of children available for adoption increased 116%.
Ranked 5 lowest among the 50 states.
Advantages: introduced some competition to the process and
dissemination of information on Internet. Private companies have an
incentive to search for high quality and many adoptive parents.
Greater choice to prospective parents now than before when a state
agency ran the program.
Shortcomings: Prices set by the State and are not market sensitive.
The State provides identical services for the private providers that
compete with it. The cost per child for the State is of no concern;
thus no managed competition features. No justification for the 6
months exclusivity awarded to the company. Immediate competition
of all agencies could reduce time to adoption with no cost to the
child.
Privatizing Adoption @ Foster Care
Services in Kansas: Description
Privatization started in 1996 to benefit the children and
save resources following a suit by Civil Liberties Union.
Description:
1. The State was divided into 5 regions for fc. Bidding in each for 1 contractor for
4 years period and prices negotiated. Important that the child remains close to
biological parents for possible visitation and reunification.
2. Foster Care: Fixed amount per child and ranged among regions $12,860 and
$15,504. Over time, prices were changed and adapted for children with special
needs.
3. Adoption: Bidders compete for a statewide contract. Lutheran Social Services
had 12 sub-contractors throughout the State.
4. Kansas Dept. of Social & Rehab Services established performance standards that
will be used for contract renewal or subsequent bidding. FC Standards include
max 3 placement moves and 65% achieve permanency within 12 months of
initial referral.
5. Adoption standards require 70% are placed within 180 days of referral and 90%
of adoptions be intact for 18 months from finalization.
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Privatizing Adoption @ Foster Care
Services in Kansas: Evaluation
 During 4 first years, Kansas paid foster care contractors $105.1M above the
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$178.7 contracted, and to adoption providers $31.4M above the $37.4
contracted.
Adoption provider lost $5.5M in the first 2 years
As a result, revision of contracts to $1,958-$2,200 a month per child for 1st
year. The initial contract was unrealistic. Children in foster care more than 6
months yield loss to contractors since 32% remain in fc 1-2 years.
Privatization led to better data collection of cost and performance for both fc
and adoption. Quality of both services has improved with 178% rise of budget.
Number of adopted children rose on the 1st year by 55% and over the 4 years
by 78%. Ranked lowest 7th among the 50 states.
Improved service: case workers available 24/7 and 71% of fc children were
now in their own or continuous county. % children in fc home rather than
group homes and institutions grew from 67 to 85%. Unsuccessful adoptions
were 2.4% compared with 12% nationally. Social workers can spend more
time investigating leading to an increase uncovering child abuseng abused
children.
Privatizing Adoption @ Foster Care
Services in Kansas: Conclusions
 Fixed fee contract failed due to unknowable medical costs and
delays by judicial procedures outside the contractors’ control.
Changed to a per month fee which lacks incentives for prompt
placement. Performance, however, is still a base for renewal of
contract.
 Separation of the many fc providers and the one adoption provider
creates inefficiency in the care of the children that experience a
shift in their contact social worker. Allowing integration of both
services could raise competition.
 Longer contracts increase incentives to compete for a contract,
leading to lower bid prices and/or better service. Longer
contracts leads to more resources provided by contractors to
improve efficiency. However, longer contracts enable contractors
to exercise monopolistic power and reduce service.
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Privatizing Adoption @ Foster Care
Services in Illinois: Background
 Illinois had the highest number and rate of
children in fc. Number of children in fc per
1,000 was 17.2 compared with 6.9 for the
nation as a whole, 1996.
 Social worker’s caseload was 60 compared with
25 nationwide.
 The median of length of time in fc grew from 8
months in 1986 to 40 in 1996.
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Privatizing Adoption @ Foster Care Services in
Illinois: Privatizing Adoption @ Foster Care
Services in Illinois: Description
 Contracting started in 1997 to reduce fc population and achieve
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permanency.
Case confined to Cook County which comprised 75% of the state
cases.
Private agencies paid $394 per case
The private agency was expected to move 24% to permanency
The 24% standard was aimed to reduce the average stay in fc from 56
to 48 months; a 25% exit from fc each year
If more than 24% of its cases, paid still the same per child and receive
more children. In non-Cook County, bonus of $2000 for all children
adopted above standard
If placement less than 24%, funding is the same for a larger number
of children under the agency’s care and the State did not provide the
agency additional children
Privatizing Adoption @ Foster Care
Services in Illinois: Evaluation
 The FC caseload diminished from 51,000 in 97 to 22,000 in
03 (-57%)
 Adoptions increased from 1600 in 97 to 3100 in 03 (+94%)
 In the 9 years pre 97, 2-4% reached permanency. In the 5
years post 97, 12-23% reached permanency. In the first year it
grew 200% and reached 300% in the 3rd year. Eventually, the
rate declined due to the “hard core” of the difficult cases.
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Privatizing Adoption @ Foster Care
Services in Illinois: Evaluation (Cont.)
 Median duration in FC diminished from 40 months
in 96 to 25 in 02.
 Total nominal funding declined in 03 compared with
96 by 3.5%.
 In 97 there were 42 private agencies and 3 state
offices, In 03, only 26 private agencies and one state
office: exit of inefficient providers and more
adoptions. Illinois was ranked near the top states in
achieving permanency.
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Privatizing Adoption and FC in Illinois:
Lessons Learned
Effective performance contracting brought good results:
 More children achieved permanency
 Lower caseload to social workers leading to better services for children
remaining in FC
 Growth of better performing private agencies and elimination of
inefficient providers.
 Realization of economies of scale.
 The system where private agencies provide both FC and adoption
services led to economies of scope, and avoidance of duplicating services
and disruption to children.
 Elimination of 2 public agencies and transfer of service to private
providers.
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Adoption Services: An Economic
Auction Model
Problems:
 Lack of resources for adequate FC of older, disabled, minority children.
 Shortage of healthy infants leading to black markets and/or queuing for
7 years. Surplus of children with less desired attributes.
 Public system is inadequate and inefficient while partial privatization
does not resolve the above two problems.
 Gov’t management is inefficient and does not address special needs due
to lack of market signals. Privatization partially improves the delivery of
children. However, still greater efficiency could be achieved with
ubiquity of information, and allowing prices to better match children
and adopting families.
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Auctioning of Wives: Herodotus in Ancient Greece 5th
Century BC
“In every village once a year all the girls of marriageable age were collected
together in one place, while the men stood around them in circle; an
auctioneer then called each one in turn to stand up and offered her for sale,
beginning with the best looking and going on to the second best as soon as
the first had been sold for a good price. Marriage was the object of the
transaction. The rich men who wanted wives bid against each other for the
prettiest girls, while the humbler folk, who had no use for good looks in a
wife, were actually paid to take the ugly ones. The money came from the
sale of the beauties, who in this way provided dowries for their ugly or
misshapen sisters. It was illegal for a man to marry his daughter to anyone
he happened to fancy, and no one could take home a girl he had bought
without first finding a backer to guarantee his intention of marrying her. In
case of disagreement between husband and wife the law allowed the return
of the purchase money. Anyone who wished could come, even from a
different village, to buy a wife”.
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An Economic Auction Model: Objective
 To increase quality of matching between adopted
children and adopting families.
 To produce resources that will improve quality of
life for children that are difficult to adopt and
remain in FC.
 Adoption is not a vehicle to improve equity of
adopting families.
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An Economic Auction Model: Background
 The three states that partially privatized the service introduced
economic incentives to private entities that do nor exist in the
public sector to fasten the service and/or improve the permanency
of placement.
 The privatization, however, does not increase the exposure of the
children to more potential families and retains the excess
supply/shortage of children.
 Adoption of market forces could improve the matching of
children, increase the number of participants, and prevent excess
supply/shortage.
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An Economic Auction Model: Method
 Auctioning is used by economists as a welfare maximization for the
96
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buyer and seller. It is applied for first time sale, thinly traded
goods and services. Generally auctions are designed to best match
and at the same time to clear the market. A fix price, like is
currently experienced, causes years of waiting for the most
desired children, black markets of children, and losses for families
that withdraw from the process.
 Potential parents are attributed by wealth which is observable and
fitness which is only known to the parents. A test needs to be
conducted in order to determine the condition of the baby. If
potential parents have no test results and obtain an unhealthy baby
then potential parents will be reluctant to adopt. The “market for
lemon”.
An Economic Auction Model
1.
2.
3.
4.
5.
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Make a health test of each child and make results available to potential
parents.
Make a national market to increase the number of children and
potential parents; improves matching.
Bid all children at one time. Sequential bidding leads to more
conservative bidding at the beginning since the attributes of later
children are unknown. Simultaneous bidding leads to more aggressive
bidding of less desirable units.
Ascending prices bidding. Capped prices induces more participation
of lower income families. Lowe income will bid higher in case of a
capped price.
For the market to be most efficient, it should provide incentives that
will reduce the other markets of private agencies and individual
adoption.
Privatization of Adoption: Lessons
Learned
 Partial contracting out of adoption service delivery in MI, KS, IL, and FL
increased efficiency compared to Gov’t monopoly. However, the terms of
the contract causes biases in the outcome.
 In all 3 states increased the rate of permanency and reduced the time
children spend in FC.
 Kansas system of fixed price per child failed because of uncertainty in court
procedure and medical expenses. The revised system of per month payment
led to disincentive for prompt placement. It also created unnecessary
monopolies.
 Illinois’ performance contracting was highly successful in achieving
permanency. It reduced time spent in FC, eliminated inefficient providers,
and allowed more efforts in the hard to adopt children. It also raised
competition between the public and private sectors.
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Privatization of Adoption: Lessons learned
 All 3 privatization efforts still allowed large number of hard to
place children to remain in FC.
 The auctioning model a-la the ancient bride market in Greece
assures market clearance. It is efficient in preventing
shortage/excess children. It is claimed to be a slave market for
kids; but the end result is preferred to the kids. It reduces gov’t
involvement, simplifies the process by reducing the role of
intermediaries, and generates resources for adoption of the
difficult cases. Since all potential adopting parents are still
screened, the quality of the adoption does not deteriorate.
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