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Economics & Management of Privatization Professor Simon Hakim [email protected] edu 1
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 2
The Research Process 1. 2. 3. Definition of the Problem Significance of Problem Choice of client, Research Questions, and/or Objectives of Study 4. 5. 6. 3 Description of Alternative Evaluation of Alternatives Selection of Preferred Alternative
Structure of paper Cover Page 4 : 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. 5
Public Administration: Economic Definition A move of an asset or activity from bureaucratic government monopoly towards competitive markets. 6
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. 7
Public Intervention in Marketplace • Pure Public Good: Collective consumption (non-divisible) • • 8 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. 9
Mapping of Public And Private Goods 10
Dichotomy of Goods & Services EXCLUSIVE RIVALRY 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. 11 Pure Public
Exclusion & Consumption Properties of Goods & Services 12
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. 13
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 14
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. 15
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. 16
Equity Requires government intervention. Efficiency VS. Equity. Shortcomings of perfect competition. Voluntary activities to reduce inequity. Progressive taxation. 17
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 Aerospacefinal 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). 18
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. 19
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. 20
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 21
Forms of Privatization I. By Divestment A. Sale B. Free Transfer C. Liquidation II. By Delegation III. By Displacement 22 A. Contract B. Franchise C. Grant D. Voucher E. Mandate A. Default B. Withdraw C. Deregulation 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) 1.
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. 23
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). 24
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. 25
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. 26
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. 15 B its downtown meters system in 2009, and earlier 4 downtown parking garages for $563 M. 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. 27
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 France. 28
Forms of Privatization q By Withdrawal: Gov’t shuts down failing public enterprise or accommodates private sector expansion. q By deregulation: State monopoly vs. competition. Privatization if the private sector challenges a gov’t monopoly and even displaces it. Packages and express mail. 29
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”. 30
Contracting Out Success in waste management: collection, disposal, 31 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. CH 2 M-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. 32
Contracting Out: Steps 33 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 34 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 $15 K 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 35 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 1. 2. 3. 4. 5. 6. 7. 8. 36 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. 37 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. 38
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. 39
Contracting Out: 7. Prepare bid specifications • Contract wording should be in ordinary language, accurate and • • 40 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. 41
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. 42
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. 43
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. 44
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. 45
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. 46
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. 47
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. 48
2 nd key: Council on Efficient Gov’t Single independent decision-making body to manage 49 initiatives. Good example, Florida Council on Efficient Gov’t. 2004 -2010: $550 M 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. 50
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. 51
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 52
Forms of PPP DB: A contract with a private contractor to provide architecture/engineering 53 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 54
Advantages for Gov’t of PPP Profit oriented businesses identify new projects that otherwise 55 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. 2. 3. 56 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). 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. 57 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. 58 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
BOT: Gov’t support 1. 2. 3. 4. 5. 60 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. 61 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. 62
PPP in Highways Problem: Maintenance of existing roads is short $20 B than available Federal, State and Local budgets. If we wish to accommodate expected economics growth then the shortage expands to $40 B than what public budget will be available. 63
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. 64
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). 65
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. 66
Rt. 91: Ca. Nature of PPP, Operation BTO. CPTC built, cedes ownership to State in exchange for 35 67 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 $326 M. $68 M initial investment by partners; of which $22 equity and $46 M guarantee against project risk. $202 M by consortium of 10 lending institutions. http: //americancityandcounty. com/mag/government_making_inroads_private/ 68
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 10 K vs. anticipated 30 K. In 1996, price lowered to $1– ridership grew to 17 K. In 1997, price increased to $1. 15. Toll collection below anticipation. 69
Lessons learned Drivers are reluctant of paying tolls that do not vary by distance and 70 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 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) 71 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 72 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. 5 M 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 $400 K 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. 73
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. 74
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. 75
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 operates it as charter school and offers additionally fee-based after-school programs: daycare, enrichment, and student services. 76
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. 77
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. 78
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 79
Privatizing Adoption @ Foster Care Services: Background 80 400, 000 in foster care in 1991, increasing annually by 4%. 542, 000 in 2001. 1. 5 million children or 2% of all children Average 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. 20 K in 2002; 40% of 50, 000 children adopted in 2002. 50% of int’l adoptions are infants while only 2% from foster care. Cost $7 K - 25 K. Private adoptions in the US include expenses for the birth mother, agency and court, and could exceed $30 K. 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. 81
Privatizing Adoption @ Foster Care Services in Michigan Six months exclusivity for the State agency, family independent 82 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. 83 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. 84
Privatizing Adoption @ Foster Care Services in Kansas: Evaluation During 4 first years, Kansas paid foster care contractors $105. 1 M above the 85 $178. 7 contracted, and to adoption providers $31. 4 M above the $37. 4 contracted. Adoption provider lost $5. 5 M in the first 2 years As a result, revision of contracts to $1, 958 -$2, 200 a month per child for 1 st 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 1 st year by 55% and over the 4 years by 78%. Ranked lowest 7 th 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. 86
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. 87
Privatizing Adoption @ Foster Care Services in Illinois: Description Contracting started in 1997 to reduce fc population and achieve 88 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 3 rd year. Eventually, the rate declined due to the “hard core” of the difficult cases. 89
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. 90
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. 91
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. 92
Auctioning of Wives: Herodotus in Ancient Greece 5 th 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 wife the law allowed the return of the purchase money. Anyone who wished could come, even from a different village, to buy a wife”. 93
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. 94
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. 95
An Economic Auction Model: Method Auctioning is used by economists as a welfare maximization for the 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”. 96
An Economic Auction Model 1. 2. 3. 4. 5. 97 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. 98
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. 99