1.5.1.1 Alternative ways of funding -

Public vs. Private Project Funding

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The way of financing investments of the public infrastructure is a very important issue. In the past, many project ideas ended up in a drawer or in the bin for the simple reason of lack of public funds.

Therefore, it is recommended that the design team of the project (refer to 1.4.3) in cooperation with the project owner should examine all possible alternatives of financing the investment/ project, e.g. possibilities of private financing and operation of an investment.

For carrying out infrastructure investments to meet public needs, there are basically three options:

the traditional public-financed approach
the EU financing or co-financing approach and
the alternative private-financed approach

Whilst the public and EU financing approaches are in the focus of this Guide, the alternative approach of public-private arrangements will be presented briefly below for reasons of completeness.

As the consequence of funding constraints, the public administration in developed countries followed a new policy: to move from the classical system for the delivery of (traditionally public) services and investment in the infrastructure to a system where the (traditionally public) services are offered to the public and related investments implemented by the private sector. Where possible and deemed appropriate the state limits its participation in financing investments and offering services and creates, to a large extent, “pluralistic markets” consisting of  public, private and “non-profit” organisations producing and offering respective services to the public. The competition between the service providers is supposed to bring about better and more cost-efficient solutions. The basic principles of such change are:

1.The state remains responsible for delivery of public services or for the public infrastructure responsibility for provision.
2.Financing the infrastructure can be partly or fully shifted to private sources (private firms and financial institutions).
3.Potential suppliers of any ownership type have the right to compete for the opportunity to deliver/produce the services to the public and to build and maintain the necessary infrastructure.

 

The traditional approach to infrastructure investments

Traditionally, investment into the public infrastructure is done by using public funds. Like a caring father, “the state” plans, designs, builds, runs, maintains, and, if necessary, replaces facilities of the physical and social infrastructure: Among these services are public utilities (supply of water, sewerage, electricity, communication), roads, public transport (by air, rail, boat, bus), education (kindergarten, primary, secondary, and tertiary education and research facilities), health care facilities (hospitals, Physical Therapy Assistance [PTA], rescue services), cultural and recreational facilities (museums, theatres, parks, television, radio), public security services (police, jails), consumer protection (product information and expertise in cases of disputes with a supplier), social security (pensions, health insurance, nursing care insurance, welfare).

The general idea is: public funds, basically tax payers money, are used for building and maintaining the infrastructure. “Father state” then provides the services of the infrastructure to the public; sometimes at cost, but often subsidised, or even free of charge. Citizens could feel in the role of beneficiaries. The main advantage of the traditional approach is that it can be used as an efficient development tool. A good infrastructure attracts businesses, people, generates jobs, taxes and, if used as a development tool, can avoid “desertification” of rural areas and problematic degrees of urbanisation.

However, the traditional approach has, among others, the following disadvantages:

1.Free or subsidised services lead to careless use of services and to deformation of the needs profiles. For example: cheep subsidised tap water of drinking quality may entails waste and misuse for all sort of purposes (car wash, irrigation, cleaning walkways, etc …) and, hence, lead to over-sized water works.
2.The lack of competition prevents innovation and cost-efficient operation of the infrastructure.  For example: Only the exposure to competition of formerly state-controlled telecommunication services accelerated innovative services at better prices.
3.Slow improvement of the infrastructure due to limited public funds.

Under monopoly conditions, without competition and with subsidised services the infrastructure does not generate enough refund for reinvestment.  If this situation persists for long, the degradation of the infrastructure or its collapse is inevitable and alternative solutions have to be found.

 

EU financing or co-financing approach 

According to the provisions of EU Regulations and the Treaty for the Accession of Cyprus in the EU, Cyprus is eligible to receive financing from the EU Structural Funds i.e European Regional Development Fund (ERDF), European Social Fund (ESF), Financial Instrument for Fisheries Guidance (FIFG)7 [ The Financial Instrument for Fisheries Guidance is going to be replaced by the European Fisheries Fund (EFF) for the Programming period 2007 – 2013. ] and Cohesion Fund.

More specifically, the EU funded Programmes in Cyprus are those presented in the following Table:

Table 1-2: EU funded Programmes in Cyprus

Programme

EU Fund

Target 2  - Areas with structural problems

European Regional Development Fund (ERDF)

Target 3 Human Resource Development

European Social Fund (ESF)

Fisheries

Financial Instrument for Fisheries Guidance (FIFG)

Community Initiative INTEREG III Transboundary Cooperation

European Regional Development Fund (ERDF)

Community Initiative  EQUAL Fighting discrimination and inequalities in the Labour Market

European Social Fund (ESF)

Cohesion Fund Infrastructure Projects in Sectors of Transport and Environment

Cohesion Fund

It should be mentioned that the EU co-funding is coming up to 50% of the total public expenditure.

The selection of the projects to be financed is done with transparency and according to the provisions of the EU Regulations. More specifically, the Intermediate Bodies (Ministry of the Interior for the Programme of Target 2, Ministry of Labour and Social Insurance for the Programme of Target 3, Ministry of Agriculture, Natural Resources & Environment for the Fisheries Programme) are calling the potential Implementing Agencies for expressing interest and submitting the relative applications. The projects are selected according to criteria, which are predefined from the Monitoring Committees. The detailed analysis of the procedures for selecting projects eligible for funding is presented in the Circular of 28/07/2004 issued by the Managing Authority (Planning Bureau).

Useful information and guidance regarding the Programmes of the Structural Funds are provided by the Planning Bureau (www.planning.gov.cy).

 

Alternative approach to infrastructure investment

During the last decades, new models for infrastructure investment have been developed. Many such models, under different names, can be found these days in developed and also developing countries. The European Union uses the term Public-Private Partnership - PPP8 [ Public Private Partnerships (PPP) is the umbrella name given to a range of initiatives which involve the private sector in the operation of public services. The Private Finance Initiative (PFI) is the most frequently used initiative. The PFI model was first used by the British Government to permit the modernisation of the public infrastructure through recourse to private funding. The same model is used in other Member States, sometimes with major variants. For example, the PFI model inspired the development of the “Betreibermodell” in Germany. The key difference between PFI and conventional ways of providing public services is that the public does not own the asset. The authority makes an annual payment to the private company who provides the building and associated services, rather like a mortgage. ]. Such models shift most of the roles and responsibilities for infrastructure investment from the public sector to the private sector.  The assumption of this new approach is that the private sector can plan, finance, build, operate, maintain, and replace facilities in a more efficient way than the public sector, thus providing better infrastructure services to the public.  However, better services might have, this goes without saying, their price.

At present we witness an ongoing trend towards private service production and mixed or private financing by public providers in the fields of energy supply, water supply, waste treatment. Security services and operations of prisons are already privatised or in the process of privatisation. The state is on its retreat in virtually all sectors of the physical and social infrastructure. As a consequence, the citizen has mutated from a beneficiary to a customer sometimes to his advantage, sometimes not.

Positive effects appear, when, due to competition, better services are rendered at lower prices. Telecommunication services are a shining example. However, the customers face negative consequences when, after involvement of the private sector, a monopoly persists in the market. In these cases, prices can be fixed at maximum level, even though the services are poor.  Some recently privatised railway companies in Western Europe give evidence for this phenomenon. If public utilities still enjoy a monopoly position and are prevented from external competition, services are cut in unprofitable areas, whilst overall prices go up.

With private production and private financing, profit becomes a key concern of the investment. One of the inevitable consequences is the risk of cherry picking: profitable projects for private investors and less gainful investments for implementation by the public administration. It has to be taken in mind that the private sector has to make profit and has to pay interest to banks financing the investment. This extra cost has to be compensated by savings elsewhere. Some of these savings may come from better management and higher efficiency claimed by the private sector. But why must management and efficiency be less efficient in the public sector? Thus, and even if the financial deal between the private and the public sector is concealed to the beneficiary-customer, there is always the question whether or not  new private arrangements are a better deal for the general public.

Decisions about private investments in the public infrastructure (utilities) are in the first instance a political issue. Contracts with private investors who build (and maybe operate) facilities of the infrastructure are long-term commitments for typically 25-30 years. The cost-benefit-analysis and the risk management of these instruments have to be based on forecasts for the development of many economic parameters such as: birth/mortality rate, migration rate, tax income in the territory, unemployment rate, inflation rate, etc. Predictions for these parameters can only be assumptions. Hence, the risks for the profitability of a private investment are high and need to be covered, either by large margins, comfortable price adjustment clauses, or by latent cuts into the services.

Infrastructure contracts with the private sector are normally high-value contracts, very often concluded with international partners or consortiums. Therefore, such contracts are generally more complicated than traditional procurement contracts and require highly specialised economists and lawyers. Risk sharing and risk management is a very important issue. A public administration may have difficulties to install a project design team, to appoint a negotiation group with expertise in this field, and to find persons who will execute the contract management issues properly. Where such human resources and skills do not exist public administrations may seek advice from consulting firms specialised in this area, but such expertise is very expensive. Thus transaction costs to create and execute the contract may prevail over benefits from private involvement.

Much more than any other contract, a PPP contract has to pre-empt different worst-case scenarios over a long period of time: It has to make provisions for all sorts of thinkable developments: What if, …. what if …. what if ….

According to the existing European Union Green Paper on Public Private Partnerships and Community Law on Public Contracts and Concessions, published by the Commission on the 30th of April 2004 the public-private partnership (PPP) is not defined at community level. In general, the term refers to forms of cooperation between public authorities and the business community which aim to ensure the funding, construction, renovation, management or maintenance of an infrastructure or the provision of a service.

The following elements have normally to be addressed in PPPs:

the relatively long duration of the relationship, involving different aspects of the cooperation between the public partner and the private partner for a planned project;
the method of funding the project, in part from the private sector, sometimes by means of complex arrangements between the various players. Nonetheless, public funds - in some cases rather substantial may be added to the private funds.
the roles of the partners who participate at different stages in the project (design, completion, implementation, funding); the public partner concentrates primarily on defining the objectives to be attained in terms of public needs and outputs, quality of services provided and pricing policy, and takes responsibility for monitoring the compliance with these objectives;
the distribution of risks between the public partner and the private partner to whom the risks traditionally borne by the public sector are transferred; however, a PPP does not necessarily mean that the private partner assumes all the risks, or even the major share of the risks linked to the project; the precise distribution of risks is determined case by case, according to the respective ability of the concerned parties to assess, control and cope with this risk.

The European Union proposes to make a distinction between:

PPPs of a purely contractual nature, in which the partnership between the public and the private sector is based solely on contractual links, and
PPPs of an institutional nature, involving cooperation between the public and the private sector within a distinct entity.

Frequent PPP contract forms are:

Design-Build-Operate (DBO) contracts,  e.g. for waste water treatment;
Design-Build-Operate-Finance (DBOF) contracts, e.g. for designing, building/rehabilitating, operating, and financing an airport;
Concession contracts, e.g. for designing, financing, building, operating, maintaining a toll road/bridge/tunnel.

 

Table 1-3: Web links for information on PPP/PFI

Some more detailed but still general guidance on PPP/PFI can be found from sources such as:

http://ec.europa.eu/internal_market/publicprocurement/ppp_en.htm

http://www.environ.ie/en/DevelopmentandHousing/PlanningDevelopment/PPP/

http://www.ppp.gov.ie/

http://www.balfourbeattyppp.com/balfourbeattyppp/what/pfidefinition/

http://www.hm-treasury.gov.uk/documents/public_private_partnerships/ppp_index.cfm

http://www.pppcentrum.cz/index.php?lang=en&cmd=page&id=1152

http://www.fhwa.dot.gov/ppp/defined.htm

http://www.centre.public.org.uk/outsourcing-library/

http://www.pppforum.com/

http://www.ppp.gov.za/

 

Example 1-3: PPP/PFI in the National Health Service (NHS) of the UK

PFI was and is frequently used in many public service delivery areas in UK (health, education, prisons, highways, etc.). In the area of hospital services PFI means:

-design, build facilities and operate non-clinical services;
-in some case also operate clinical services;
-consortia of builders, bankers and service operators are involved;
-land owned by NHS is sold or “given” to private operators (lease for more than 150 years);
-NHS leases back buildings and services (lease for 30-60 years).

PPP contracts mean increased transaction costs for pricing, contracting, administration, overheads, marketing, monitoring and billing. These extra costs are not always “repaid” by increased efficiency.

The success of PFI generally differs from case to case. According to the Treasury research 88 % of PFI projects were implemented in time or earlier and with no costs overruns for the public sector.  70 % of non-PFI projects were late and 73 % of non-PFI projects ran over budget.

The success of PFI in hospital projects is too early to asses. It has to be judged on the base of final outcomes. However, in all investigated cases the final costs overran significantly planned estimates the increase was from 33% in Wellhouse to 229 % in Swindon.

PFI has impacts on main capacity indicators the number of beds, nurses and doctors in all investigated hospitals is decreasing. Would this imply shortened services to citizens? At this point in time, it is impossible to predict this.

General short term conclusions based on findings about PFI in UK hospital sectors are as follows:

-PFI increases capital costs and leads to capacity reductions;
-Private involvement in health sector increases;
-The financial crisis of NHS deepens.

It remains to be seen, whether the long term consequences are more optimistic or not.


© 2007 Republic of Cyprus, Treasury of the Republic, Public Procurement Directorate
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