Partnering Up: Public-Private Partnerships
Partnering for value can be great for a state or city, but the devil is in the details.
According to William Eggers, author of the study Partnering for Value, the number of conferences about public-private partnerships (PPPs) dwarfs the actual number of partnerships. Like Eggers, we've noticed lots of talk and little action about PPPs. Over the last few months, we've attended multiple meetings in which PPPs have been presented as a public-sector fiscal messiah -- one that will appear after stimulus dollars cease to flow into state and local coffers. It's been said that billions of dollars are waiting on the sidelines, ready to partner up as soon as the capital markets loosen up.
With huge interest in these deals and few actually occurring, it feels like a good time to offer our 2 cents. We won't wax philosophical about the activity types most ripe for PPPs; we'll simply make one important point: In these deals, the devil is in the details, and as Shakespeare said, "The devil hath power to assume a pleasing shape."
One big problem is that governmental negotiating skills aren't on par with those of their private-sector partners. That can lead to various issues down the line. "Unless you go out and hire the same guys and give them the same incentives, it's going to be generally true that the private side will have better negotiators," says one Maryland attorney with much experience representing parties on both sides of PPPs.
What's more, the primary council for states or municipalities often is the investment banker. Though we certainly don't want to suggest that investment bankers can't be fair-minded, smart people, there's a potential conflict of interest. "You can judge for yourself whether you think that's a conflict: having people design the project who are going to profit from it," Eggers says. "But we're the only country in the world where that's true." He also adds that other countries tend to hire a big-four firm as their consultant.
The downside, of course, is that investment bankers may be inclined to portray the PPP in a particularly positive fashion. After all, it can be in their interests to see the deal go through. Why would cities and states buy in? One expert suggests that local governments want to see the immediate cash from PPPs to get over a one- to three-year problem. So they're inclined to accept rosier predictions from the other side because that will help them convince the public that they should go ahead.
Several studies have "found that during infrastructure procurements, public-sector entities tend to be overly optimistic about a project's costs and timelines," Eggers writes, "and about its potential to generate revenue."
These deals are done when a city or state is particularly hungry for cash -- and that tends to put government representatives in a weak negotiating position, especially when it comes to the arrangement's fine print. This disadvantage can easily lead to a willingness on the public sector's part to assume a great deal of the long-term risk. "The contractual provisions are going to make these deals work," says Rachel Weber, an associate professor of urban planning at the University of Illinois at Chicago. If the deal is for a highway, the contractual provisions must cover whether the private-sector partner can raise the tolls or whether the municipality can build a competing toll road. Many of these deals include non-compete clauses.
The list of issues continues: In the event of a default, does the asset revert automatically or does the government pay extra for that? Who is responsible for providing services? Is the municipality still collecting tolls? Who is supposed to pick up road kill on a road that's been leased for 99 years? Much of the success or risk in the deals rests "on the degree to which the municipalities find themselves with their hands tied behind their backs," Weber says.
Eggers' Partnering for Value piece points to a handful of common mistakes the public sector can make in these deals. One that seemed particularly significant is a phenomenon he calls the "Beetle versus the Ferrari." The idea is that public-sector leaders often view PPPs as a way to get better services than they had in the past. And that can certainly happen. But Eggers makes an important point: "Private partners are more than willing to provide high-quality service levels, but they expect to be paid for doing so." Failure to understand that can easily lead to sticker shock when bids actually come in.
What concerns us most about PPPs are the leases' length of time -- they often last 75 to 99 years. Dramatic changes over that time period are inevitable and will certainly lead to dislocations for both partners.
A century or so ago, the best way to get from Maine to Florida was the Quebec-Miami International Highway, which evolved into Route 1. Who at that time would ever have conceived that Interstate 95 would be started in the mid-1950s and that it would turn Route 1 into a local byway?