Popularity of PPP
Most developed and developing countries need more infrastructure, yet their fiscal resources are limited.
To fill the gap between demand and supply of infrastructure finance, an increasing number of countries are implementing (or considering the possibility of) public private partnership (PPP) projects. It is undeniable that PPP is viewed as a good option for infrastructure development. Moreover, multilateral development banks 1 try to support and promote PPP in various ways. In these circumstances, the experience of Korea may offer some valuable lessons to various actors in PPPs.
Performance of PPP in Korea 2
The legal framework of the PPP system in the Republic of Korea was first put in place in 1994 with the passage of the Act on Promotion of Private Capital Investment in Infrastructure. At the beginning of the 1990s, Korea found itself with a serious shortage of infrastructure facilities, such as roads, railways, seaports, and airports. Considering the fiscal limits to its ability to fund the needed infrastructure construction, the Korean government realized the need to induce private sector participation in infrastructure investment 3. The government began to push for PPP projects in earnest with the August 1994 law. However, there was not much PPP activity until 1998 for several reasons. The public sector was reluctant to initiate PPPs, since it was inexperienced and afraid to be criticized for “favoritism” toward its private partners. Also, the public sector frequently selected unprofitable projects as PPP candidates for Korea has implemented more than 600 projects since the 1997 Asian Financial Crisis, partly due to the introduction of these government support measures, including its generous risk sharing measures.
In December 1998 (following the 1997 financial crisis), the 1994 law was revised and superseded by the Act on Private Participation in Infrastructure (PPP Act). The revision strengthened risk-sharing mechanisms such as the Minimum Revenue Guarantees (MRGs), buyout rights, and sharing of foreign exchange risk. The government’s willingness to share more of the project risks encouraged the private sector’s participation in infrastructure development. In addition to a construction subsidy, the government provided an operational revenue subsidy through the MRG. Basically, the MRG scheme is a means for the private sector and the government to share the risk of inaccurate revenue forecasts. The higher the MRG level (or the narrower the guarantee and redemption band), the more risk is transferred to the government from the private sector. Korea has implemented more than 600 projects Infrastructure since the 1997 Asian Financial Crisis, partly due to the introduction of these government support measures, including its generous risk sharing measures. Of course, Korea’s experience with PPPs has not been problem-free. For example, transport PPP projects in Korea largely relied upon the MRG scheme. But this scheme placed an excessive fiscal burden on the government, which was aggravated by overly optimistic demand forecasts. As a result, in 2009, we saw the demise of this powerful scheme to induce private sector participation. By 2011, the total government burden for 36 PPP projects with MRGs was estimated at some US$ 2.6 billion. Naturally, after the MRG was abolished, the level of private sector participation in infrastructure development significantly declined.
Expected Effects of PPP
Generally, the public sector intends to promote public private partnership (PPP) projects because it has difficulties in mobilizing public financing. Also, it can take advantage of the private sector's creativity and efficiency in delivery and due diligence in operation of infrastructure facilities.
The promotion of PPP projects is expected to have significant effects on the national economy through three channels: economic growth resulting from the inflow of private capital, increased social welfare resulting from the timely delivery of social services and the early realization of social benefits, and reduction in the government’s fiscal burdens through better “value for money” (VFM).
Of course, some countries also promote implementation of PPPs as a fiscal stimulus. Interestingly, many countries tried to utilize PPP as a fiscal stimulus when responding to the Global Financial Crisis around 2009. Those countries include France 5, Thailand 6, Taiwan 7 and Korea.
PPP-related Challenges
Several challenges arise from the use of PPPs. Private sector investment requires that governments borrow money from future budgets; therefore, support to the private sector can be seen as a loan to be paid off in the mid- and long-term. This implies that PPP implementation requires borrowing from future generations to enhance the present infrastructure. As we need to consider the legacy of PPPs, the challenges of fiscal management may grow as more PPP projects are implemented.
Thus, there is an inherent tension in the PPP agenda. For example, Korea initially put a high priority on PPP promotion, but rapidly shifted toward another priority: fiscal discipline. Currently, the Korean government faces this tension in its efforts to reinvigorate the PPP market. On the one hand, in order to mobilize private sector resources for PPPs, the public sector should offset more risks of or provide support for the private sector. On the other hand, taking such measures will jeopardize fiscal soundness.
PPP implementation requires borrowing from future generations to enhance the present infrastructure. As we need to consider the legacy of PPPs, the challenges of fiscal management may grow as more PPP Projects are implemented.
In managing PPP projects, it is not only necessary to construct a facility on time and within budget, but also to sustain the quality of service during the operational period. So, in the partnership, the private sector must have sufficient incentives for sound performance during the operational period as well as the construction period. This requires the design of sophisticated and elaborate mechanisms in the PPP contract along with an appropriate system of performance monitoring by the public sector.
Determining tariff levels can be challenging too. The tariff for PPP transport facilities tend to be higher than public ones, since the relevant facilities should have sufficient profitability to induce private participation. When PPP projects are implemented, users bear a greater share of life cycle costs than is the case with public works. As PPP projects are not distributed evenly throughout the population, the big discrepancies between tariffs of PPP facilities and public ones may result in some citizens bearing proportionally more costs than others.
Discussing Arguments on PPP
Based upon PPP experience and research, some important arguments can be set out:
- PPPs are not a “must”
As we are aware, the PPP is just one of various options available for infrastructure delivery. Therefore, we need to ask why PPPs should be pursued. The answer can be resource mobilization from the private sector, fiscal stimulus, maximization of value for money or enhancement of efficiency. However, each and every country should clarify and build a consensus regarding the primary reasons for implementing PPPs. When the priority in favor of PPPs is clearly set, the country must also consider and implement a support scheme to induce private participation.
The tariff for PPP transport facilities tend to be higher than public ones, since the relevant facilities should have sufficient profitability to induce private participation.
Lessons from Korean PPP experience show that PPP implementation should be pursued wisely – that is, by considering fiscal management along with economic development (or short-run fiscal stimulus).
- PPPs are not free
Implementation of PPPs is not cost-neutral. Indeed, the public perception is that the PPPs are more costly than public works. While public investment in infrastructure is crucial to economic development, fiscal management should be the highest priority. Lessons from Korean PPP experience show that PPP implementation should be pursued wisely – that is, by considering fiscal management along with economic development (or short-run fiscal stimulus).
What about PPPs as fiscal stimulus?
While PPPs can offer a fiscal stimulus 9, their effects should be assessed carefully. Some research 10 reveals that private investment via PPPs crowds out public investment. This indicates PPP investment just tends to replace conventional government expenditure, so the PPP offers a very limited fiscal stimulus, if any.
Despite the long and rich history of PPPs around the world, more research is needed. Designing and implementing PPPs in certain countries should be based upon research and evidence. To that end, experience and lessons from Korea’s PPPs offer an important source of information and potential guidance.
1. By announcing “Strategy 2020”, Asian Development Bank (ADB) plans to scale up private sector development and private sector operations in all operational areas, reaching 50% of annual operations by 2020. World Bank Group stresses bringing in more private sector financing into infrastructure in “Transformation Through Infrastructure, World Bank Group Infrastructure Strategy Update, FY 12-15”.
2. This part is mostly based upon “Case Studies from the Republic of Korea on Public-Private Partnership Infrastructure Projects” (Jayhyung Kim et al. Asian Development Bank, 2011).
3. Another measure was setting up the Transportation Infrastructure Special Account. To find stable financing sources, an ear-marked tax was introduced in 1994 -- specifically a gasoline consumption tax. This ear-marked tax revenues and the relevant special account aim to facilitate the expansion of transport infrastructure, and to ensure the efficient management and operation of the infrastructure facilities. The life of the tax, which was renamed as Transport, Energy and Environment Tax, has been extended multiple times and is still active.
4. Those effects were identified and evaluated in Korea. For the details, see “Case Studies from the Republic of Korea on Public-Private Partnership Infrastructure Projects”(Jayhyung Kim et al. Asian Development Bank, 2011) or “Evidence of Public-Private Partnership Contribution to the National Economy”, (Jungwook Kim, Journal of Budget and Policy, 2012.5.).
5. See “What are countries doing under the crisis: the case of France”, (Francois Bergere, ASEM PPP Conference, 2009).
6. See “SP2 & Government's Initiatives to facilitate Public-Private Partnerships in Thailand", (Theeraj Athanavanich, Director, Public Debt Management Office, Ministry of Finance, Thailand Infrastructure Forum: Public Private Partnerships and Private Finance Initiatives, 2009.11)
7. See “2010 Investor Manual", (Public Construction Commission, Taiwan Government).
8. The Value for Money test was for instance introduced in 2005 to appraise PPP projects.
9. See “Did Fiscal Stimulus Lift Developing Asia out of the Global Crisis? A Preliminary Empirical Investigation", (Seok-Kyun Hur et. al., ADB Economic Working Paper Series, No. 215, August 2010).
10. See “Macroeconomic Effects of Private Sector Participation in Infrastructure”, (Campos, Estache, Martin and Trujillo, 2003) for Latin American cases. Also see “Private Participation in Infrastructure and Macroeconomy: The Experience of Korea”, (Lee, Hangyong and Changyong Rhee, Performance Evaluation and Best Practice of Public-Private Parnerships, KDI, 2007) for Korean case.
The article was published in the E-Newsletter G20 and the BRICS UPDATE