Soft Budgets and Renegotiations in Public-Private Partnerships: Theory and Evidence

Produced by: 
Universidad de Chile
Available from: 
July 2015
Paper author(s): 
Eduardo Engel (Universidad de Chile and NBER)
Ronald Fischer (Universidad de Chile)
Alexander Galetovic ( Universidad de los Andes)
Topic: 
Financial Economics
Politics and Economy
Year: 
2015

Public-private partnerships (PPPs) are an increasingly popular organizational form of providing public infrastructure. They can increase efficiency and improve resource allocation, yet pervasive contract renegotiations cast doubts on whether they should be preferred over public provision.

Renegotiating a PPP contract allows the present government to extract resources from future governments in exchange for current infrastructure spending by the PPP. This option is not available under public provision. We develop a model that formalizes this idea and predicts that government will use renegotiations to anticipate spending and shift payments to future administrations. Regulating renegotiation procedures so as to avoid opportunistic behavior does not avoid the use of renegotiations to anticipate government spending, changing fiscal accounting rules does.

We analyze data from Chile, Colombia and Peru, comprising 59 highway PPPs and 535 renegotiation processes, to conclude that the evidence is broadly consistent with the predictions of our model. We find that the magnitude of renegotiations is substantial: renegotiations per concession year average 9.5% of the initial investment in Colombia, 3.6% in Peru and 1.3% in Chile. With concessions that last many decades, this suggests that the magnitude of renegotiations will end up being larger than the initial investment for many concessions, as is already the case for 11 out of the 25 concessions in Colombia. Most of the cost of renegotiations falls on future administrations and in the three countries more than 45% of renegotiations, as measured by volume, occur during the construction phase, which can be interpreted as evidence against incomplete contract models of renegotiations and in favor of our model.

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Research section: 
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