Public Private Partnerships for Infrastructure and Business Development

Public-Private Partnership (hereafter PPP) is a blurred concept, with several meanings (Linder 1999; Wettenhall 2003; Hodge and Greve 2005; Khanom 2010), spanning from a specific contract or arrangement to a wider policy (Bovaird 2004).

The links between infrastructure and development are well established. They include the impact of infrastructure on poverty alleviation, equity, growth, and specific development outcomes such as job creation, market access, health, and education (Straub 2008; Calderón and Servén 2004, 2008, 2010). These relationships are complex and dynamic; even with respect to growth and job creation, infrastructure’s effects are felt through multiple channels.¹ The demand for infrastructure is rising with the accelerating pace of globalization and urbanization. Every month in the developing world, more than five million people migrate to urban areas. This trend is compounded by the growing need for low C0₂ and climate-resilient investments to combat the challenges of climate change (Fay and Toman 2010; Bhattacharya et al. 2013).

In many countries, interest has been growing in forms of Public-Private Partnership (PPP) in which private companies are contracted to design, build, finance, and operate new social and economic infrastructure on behalf of government agencies (Farquharson et al. 2011). In large part, the economic case for the PPP model resides in its ability to effectively allocate the risks of infrastructure delivery, thereby creating incentives that can improve the planning and implementation of projects. The economic salience of this issue cannot be overstated. In its latest World Economic Outlook, the International Monetary Fund argues that the efficiency of public sector investment in infrastructure is a major driver of a country’s economic development and growth (Warner 2014). Efficiency entails that not only are assets produced at the lowest possible cost but also that investment decisions serve to maximize the benefits from the available resources. This chapter draws on theoretical and empirical research to evaluate the extent to which PPPs can contribute to these objectives.

Most countries are experiencing pressing infrastructure needs. This demand is driven by growing populations, economic growth, and rapid urbanization in developing countries and by aging legacy infrastructure assets and green upgrades in developed countries. Though needs are rising, the supply of new infrastructure is restricted, as government budgets remain tight in the wake of the global financial crisis. The mismatch between demand and supply involves a global investment gap of at least US$1.0 trillion per year—with all the dire consequences for economic growth and social progress.¹

The problem of public financing of infrastructure is a topic on top of policy makers’ agendas worldwide (OECD, 2007). Budget constraints, past experiments of poor public spending, and inefficiencies in managing infrastructure on the public side have led to a reconsideration of the need to shift the investment effort to the private sector and to the development of Public Private Partnerships (PPPs) (Hammami et al. 2006; Grout 2008).¹

Infrastructure development is one of the main priorities of governments across the world: infrastructure are undoubtedly a catalyst for economic growth, but the gap between needs and actual provision is still wide, and it may affect the competitiveness of countries.

A vast network of Interstate highways, state roads, local streets, bridges, overpasses, and tunnels forms the backbone of the US surface transportation system. The system includes 46,000 miles of Interstate highways, which, along with roughly 117,000 miles of major roads, forms the National Highway System. In 2013, the US road system supported almost 3 trillion truck and car miles traveled, making it one of the nation’s most valuable public assets (US Department of Transportation 2013). That valuable network is, however, dogged by an array of persistent problems. The problems include both the demand- and supply-side dimensions of the system. They are sufficiently severe to warrant a new approach to the funding, financing, operation, and maintenance of America’s extensive road transportation system. A key demand-side system problem is high and rising traffic congestion. US traffic congestion wasted almost 3 billion gallons of fuel in 2011 while generating roughly 56 billion pounds of additional carbon dioxide emissions, or about 380 pounds per auto commuter (Schrank, Eisele, and Lomax 2012). The overall financial cost of traffic congestion was $121 billion, or about $818 per US commuter in that year (Schrank, Eisele, and Lomax 2012). The costs of congestion are growing rapidly. For example, annual hours of delay per peak-time traveler increased 136 percent between 1982 and 2009 in the country’s 14 largest urban areas.

Governments around the world are increasingly turning to Public-Private Partnerships (PPP) and public concession models to help build and finance infrastructure initiatives.

Public-Private Partnership (PPP) has become the most valuable instrument for green energy projects financing. It overcomes the shrinkage of available public financial resources and makes it possible for the development of energy infrastructures. Cooperation between private and public actors is often pivotal in green energy investment decisions, since through cooperation parties compensate each other to their mutual advantage by sharing risk: the private sector needs guarantees to face the policy and the financing risks entailed by the time gap between a project’s planning phase and its actual implementation, whereas the public sector needs capital investment and management expertise.

Since the fifteenth UNFCCC Conference (COP) held in Copenhagen in 2009 convened, parties reaffirmed the urgency of adequate financial flows in order to support both climate change mitigation and adaptation efforts. This year, in Warsaw, during COP 19 developed nations confirmed the commitment to reach the financial goal of US$100 billion investments per year by 2020 from developed to developing countries.

In many OECD countries, the 2008–2009 global financial crisis exacerbated the financial constraints typically experienced by small- and medium-sized enterprises (SMEs) and entrepreneurs. Business loans and SME loans declined markedly during the recession, and, in some countries, half a decade after the crisis, the amount of SME financing had not yet returned to the precrisis level. The challenging mac-roeconomic environment, characterized by subdued growth and demand, severely affected profits for SMEs and reduced availability of internal funding. At the same time, the financial sector continued the deleveraging process started in the aftermath of the crisis, with banks endeavoring to meet Basel III capital and leverage ratio requirements through a combination of asset reduction and capital raising. In some countries, the sovereign debt crisis further increased the deficiencies in capital adequacy. This has squeezed credit availability for the entire banking system, but has impacted SMEs more than large firms.

Small and medium-sized enterprises (SMEs) have a central role in the European economy, accounting for more than 99.8 percent of all euro area nonfinancial firms, employed 86.8 million people (two-thirds of euro area workforce), and generated about 57.7 percent of value added (European Investment Fund 2014).

The Organization for Economic Co-operation and Development (OECD) (1996) has argued that the financing of entrepreneurship and innovative ideas will facilitate economic growth and the competitive advantage of nations in the twenty-first century. Much evidence, albeit not all, indicates small high-tech firms contribute disproportionately to innovation and economic growth (the World Bank 1994, 2002, 2004; see also Industry Canada 2002, 2006). The primary source of capital for these small growth-oriented high-tech start-up firms is a specialized form of financing called venture capital, and venture capital has been found to facilitate the success of firms that eventually list on stock exchanges. For example, while venture capital averaged less than 3 of corporate R&D in the period 1983–1992, it was nevertheless responsible for more than 8 percent of United States’ industrial innovations in that decade (Kortum and Lerner 2000).

The synergic interactions between private equity activities and public intervention are becoming an increasingly important subject of attention in all European countries and may represent one of the main drivers for a new economic policy, based on the use of market instruments for general economic and social purposes, with very limited use of public debt and mainly based on private capital funding. In an economic context such as the European one, characterized by an excessive level of public debt and by the mandatory need to reduce it, the intervention tools combining public interest and the use of private capital may prove to be extremely effective and advantageous and, if well put into effect and accurately used, may represent a new and important frontier for the industrial policies aimed at supporting European companies’ development and growth, with special regard to small and medium-sized enterprises (SMEs). However, in the context of the initiatives aimed at stimulating investments involving public and private resources, it is of fundamental importance to understand exactly and correctly the main characteristics of the industry in which to operate in partnership and what are the economic and social impacts of the activity object of intervention. This will certainly help to address the interventions in the best possible way, making them consistent with the institutional economic policy objective and avoiding crowding-out effects, as it may happen when the increased public sector spending replaces, instead of stimulating, the private sector investment. In the case of public initiatives, which involve the private equity industry taken into consideration in this chapter, it is of fundamental importance to understand the characteristics and dynamics of this sector in order to optimize the specific tools used by public authorities in their actions.

Impact investing is the current trend, and it is garnering an increasing attention from society, institutions, and businesses. From one side, actually, contemporary society is looking at impact investing as a new paradigm to cope with the economic crisis and the curtailed public budgets and answer to the more and more diversified needs of its citizens. From the other side, private investors are searching for new investment opportunities to channel the enormous liquidity available. Globally, indeed, private wealth has never been so high: in 2013 total global financial assets grew to US$225 trillion, tripling the world’s GDP (McKinsey Global Institute 2014), even if only 22 percent of them are represented by equity investments, whose CAGR in the period 2007–2012 was -5.5 percent; high-net-worth individuals’ (hereafter HNWIs) financial wealth reached its peak of US$52.6 trillion worldwide in 2014, of which 13.5 percent is invested in alternative assets, with an increase of 3.4 percent from 2013 (Capgemini 2014). It is also important to notice that driving social impact is important for 92 percent of HNWIs; this trend is lead by younger investors (under 40 years) and by those located in emerging markets.

The economic role of governments has, of course, been evolving rapidly over the past several decades. States have always and everywhere regulated private businesses to a greater or lesser degree, but many also chose to enter business as owners. Mostly from the Great Depression onwards, governments around the world launched (or nationalized) companies that produced goods and services sold to the nation’s populaces, often under monopolistic regimes (Shleifer 1998; Megginson 2005). As these state-owned enterprises (SOEs) spread and citizens experienced the often poor quality of their output, disillusion with SOEs prompted governments to adopt a new policy of privatization. Since its introduction by Britain’s Thatcher government in the early 1980s to a then-skeptical public, privatization now appears to be accepted as a legitimate—often a core—tool of statecraft by many of the world’s over 190 national governments. Since 1977, governments around the world have raised over US$2.5 trillion by selling state-owned enterprises to private investors and corporations (Megginson 2013).

Italian Cassa Depositi e Prestiti (hereinafter CDP), German Kreditanstalt fuer Wiederaufbau (hereinafter KfW), and French Caisse des Dépots et Consignations (hereinafter CDC) are typical examples of financial institutions with a mixed public-private investments’ structure concerned primarily with providing a link between the government and the market with an emphasis on long-term projects of public interest. Their main characteristics are:

Since the beginning of the 1990s, International Links and Services for Local Economic Development Agencies organization (ILS LEDA)¹ has been supporting local and national institutions in establishing structures aimed at boosting their economies: the Local Economic Development Agencies (LEDA).