Soft Budgets, Renegotiations and Public-PrivatePartnerships

R. Fischer

CEA-DII, Universidad de Chile
October 27, 2014

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Acknowledgement

This paper is joint work with:

Eduardo Engel U. de Chile
Alexander Galetovic U de los Andes

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Acknowledgement

This paper is joint work with:

Eduardo Engel U. de Chile
Alexander Galetovic U de los Andes

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Introduction

Cynics suspect that the government remains keen on PFI not
because of the eciencies it allegedly oers but because it allows
ministers to perform a useful accounting trick. The Economist,July 2nd 2009.

This paper: renegotiation of PPPs/Concessions can be used as anaccounting trick to anticipate spending for political purposes (As well as forpolitical campaign funding).
The reason PPPs allow something traditional provision does not:Bundling of nance and construction
Defective scal accounting rules.
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Example: the rainwater drains

In 2001: ooding in Santiago ⇒ political pressures on government to invest in
main collectors.
Government unwilling to budget these resources, or increased indebtedness.
Renegotiated contracts of urban highways under construction so they would build
the drains.
Involved US$ 100's MM, but payments scheduled for several years in the future.
Note that: Additional expenditure not included in the budget, with positive
political impact. Costs paid by future administrations.

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San Antonio Bypass

Port hampered by lack of dedicated access for trucks.
Three options to provide bypass:1

Fund it with current scal resources (they were ample).

2

Through an independent PPP charging tolls.

3

As a non/tolled extension of Route 78 Santiago/San Antonio.

As candidate, President promised not to impose toll on bypass.
Preferred to renegotiate contract, valuing the project at US$45 MM
Tolls increased on Route 78 to cover the cost of the bypass.
Note that: No independent valuation of bypass.

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Why only under PPPs?

Under PPPs, there is bundling of nancing, construction and operation.
Long term contract lasts beyond current administration.
Resources to repay: either future availability payments or future user fees.
The government can borrow from the PPP to add additional,
non-budgeted items.
In most countries, these borrowings not included in scal balance sheet.

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The Model

A simple two period model with no discounting.
There is an intertemporal balanced budget so intertemporal infrastructure
spending equals taxes:

I1 + I2 = T1 + T2 = 1

The social welfare function is U = u(I1 ) + u(I2 ), u'>0, u<0.

∗Not all investment in the rst period: I1= I2∗ = 21 .

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The government's utility function

It is:

G (I1 , I2 ) = u(I1 ) + p(I1 )u(I2 ), p ′ > 0, p ′′ < 0p is the probability of reelection, which depends on infrastructure
investment.

1

Government only cares about social welfare if reelected.
This biases government towards current spending.
Congress authorizes I1 =and PPP.

12 , but cannot supervise agreements between PWA

1Note that we can write p(I1 ) ≡ P(u(I1 )), the original reelection function, withP ′ > 0, P ′′ < 0 ⇒ p ′ > 0, p ′′ < 0.

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Soft Budgets, Renegotiations and Public-Private Partnerships

Budgetary restrictions and Conventional Provision

Congress can make the government respect its budgetary restrictions.
At the end of each period, contruction rms must be paid.
Since debt and expenditure are controlled, government cannot spend morethan1.
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Budgetaruy Restrictions under PPPs

Firm makes bid of B ≤1 to be paid in the two periods.
2In renegotiation, government gets W in additional works in exchange for R
to be paid in period 2.
Thus governemnt exceeds the spending limit.
In equilibrium B, R, W can be determined.

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Optimal choices of governmment

Maximizing government utility we obtain:dG (I1 , 1 − I1 )= u ′ (I1∗ ) − p(I1∗ )u ′ (1 − I1∗ ) + p ′ (I1∗ )u(1 − I1∗ ) = 0,dI1
Clearly I1 >

(1)

1′′′
2 . To see this, consider the simple case when p = p = 0.

The equation simplies tou ′ (I1p ) − pu ′ (1 − I1p ) = 0.
Dierentiating with respect to p , we have dI1 /dp < 0 so I1pp> 12 .

Eect is reinforced, because p increases with investment.

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Renegotiation and implementation of the government's
optimum

Government auctions contract for I1 =1.
2Firms know that renegotiation will add W in exchange for R .
Utility of incumbent is:u( 12 + W ) + p( 21 + W )u(1 − (B + R))
If the rm obtains a rent in the renegotiation process, competition means
lowballing by that amount.

L = 21 − B is the extent of lowballing.
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Achieving the incumbent's optimum with no bargaining
power

Lowballing L is a transfer to the incumbent, and not part of therenegotiation.
Ecient bargaining + competition ⇒ incumbent attains her optimal choice.
Case 1: Firm has all the bargaining power, incumbent gains nothing.
Problem for the bidder:max{W ,L}

R −W

s.t. u(Utility of no renegotiation(2)³¹¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ · ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹ ¹µ1 + W ) + p( 1 + W )u( 1 + L − R) = u( 1 ) + p( 1 )u( 1 + L)
2
2
2
222

⇒ FOC of this problem are that same as FOC of incumbent!
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Predictions of the model

The results apply for any bargaining power of incumbent. Thus:
1Governments include additional works during renegotiations.

2

Renegotiations occur early (during construction),3

The cost of renegotiations passed onto future administrations.

4Firms may make lossmaking bids, which they recover during
renegotiations.

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Extensions: Case of certain reelection in some cases

Suppose government is certain of being reelected in some cases, anduncertain in others.
In rst case, prefers not to distort optimal allocation of expenditure (norenegotiation).
Bidders bet on the possibility of renegotiation. There is lowballing.
In case certain reelection, incumbent better o (unless all bargaining power
belongs to incumbent there is no lowballing).
Increased distortion in case of uncertainty of reelection.
If there are bargaining dierences among rms, government dos not achieve
its best choice.
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Accounting for PPPs

Eurostat 2004 assigned PPPs to scal balance sheet if private party bore
some risks. Led to PFI in UK.
Eurostat 2010: the control approach: who is in ultimate control determine
if PPP in balance sheet.
Alternative: go back to the Rirye rules and include all PPPs in scalaccounts.
Eurostat 2013 now includes contingent obligations in a separate account.
Chile, Colombia apply standard nancial tools to value these liabilities.

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Evidence from LA

In 2009, we did a detailed examination of PPPs in Chile up to 2006 (12year program).
50 PPPs, worth US$11+ Billion. Renegotiations were more than 30% ofinitial value.
We conrmed that predictions of model held: substantial fraction ofrenegotiations during construction, additional works, loaded unto futuro
governments.

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Evidence from Bitran, Nieto and Troncoso (2013)

Use data on highways in Chile, Colombia and Peru up to 2010.

Table: Characteristics of renegotiations in each country
Chile

Colombia

Total road concessions
2125
Avg. initial value (2009 MM USD)
243
263
Avg. term length
25.2
16.7
Mean length
114
195
Mean concession years elapsed
12.5
9.0
Concessions with renegotiations
1821
Total number of renegotiations
60430Avg. time rst renegotiation
2.7
1.0
Avg. cost of renegotiations per road 47.2
255.8
Avg term increase
0.9
6.3
Avg. length increase (km)054.6
Source: Bitran, Nieto, Robledo 2013.

Peru
15266
22.1
383
4.6
1153
1.4
28.8
0.8
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Renegotiations during construction

80%
70%
60%
50%
40%
30%
20%
10%
0%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21Chile

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Renegotiations during construction

700%
600%
500%
400%
300%
200%
100%
0%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
Colombiacea

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Renegotiated amounts by age of PPP

Chile
0,3

0,25

0,2
promedio
mediana

0,15

pctil 25
pctil 75

0,10,0501234567891011121314151617cea

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Renegotiated amounts by age of PPPColombia
109876promedio

5medianpctil 254pctil 75
32
10
12

34

5

6

78

910

11

12

13

14

15

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Renegotiated amounts by age of PPP

Peru
0,35
0,30,25
promedio

0,2median0,15

pctil 25
pctil 75

0,10,050
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Type of Renegotiation

Most renegotiations reach a mutual accomodation: there is no conict in
83% cases in Chile, 98% in Colombia and in all cases in Peru.
In Chile and Peru, most renegotiations led by government; in Colombia, if
we add those led by government and of joint leadership, includes mostrenegotiations.
In general, accomodation transfers more costs onto future than arbitration,
which might explain choice.

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When do they occur

In standard interpretation, more renegotiations as time passes.
In the three countries, more than half more than half of renegotiations took
place in rst four years.
Interpretations:
Incompetence and cover up by incumbent
Add works and avoid budgetary process
Firms wants to recoup from lowball oer (last two in model).

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When are they paid?

Peru: only 14% of costs on incumbent government.
In Chile, 90% of renegotiations have some cost on future governments.
In Colombia, most costs fall on current governments, but the 6% ofrenegotiations involve future costs, and represent 60% of all scal transfers.
Term extensions impose future costs: Chile and Peru, less that 1 year onaverage. Colombia: 6.5 years.

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What do they pay for

In Engel at al (2009), we showed that 84% of contracted amounts were for
additional investments.
16% of amounts were payments for originally contracted works (i.e., costoverruns due to lowballing?).
In Colombia, in 5% of cases, paid for road extensions, which were also latyer
renegotiated, so costs could be higher than registered (Bitran et al 2013).

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Conclusions

Given scal accounting loopholes, PPPs have allowed incumbents to exceed
infrastructure spending limits (PFI).
A further political economy motive for PPP's is that contract
renegotiations allow additional spending.
Our analysis led to a series of predictions; these were broadly consistent
with the observations in Chile, Peru and Colombia.
The data also show substantial dierences among countries on themagnitude of renegotiations.
Dierences in institutional settings?

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