5.5 Conclusion

The literature on incomplete contracts has made a significant contribution to thinking about public-private partnerships. Studies of private construction and ownership of facilities associated with public services initially focussed on a simple trade-off between private investments in cost reduction and private investments in quality improvement. In this literature, the challenge with the use of the private sector in these initiatives was the design of contracts that reduced the incentives for the private sector to reduce costs excessively (resulting in unacceptable reductions in quality) and/or increased the incentives of public-sector managers to implement innovations that reduce costs or improve quality given that they personally would not benefit from that initiative.[28] The most recent contributions to this literature have added complexity to their models by building in renegotiation and residual value.

There is risk in public-private partnerships, but that risk is different from rather than greater than the risks associated with public procurement and management. The challenge is to determine how the contract should be structured to provide incentives that ensure that private-sector decision-making delivers benefits that are socially desirable as well as privately profitable. This means:

• Identifying those areas in which private investment in innovation is likely to have the strongest positive externalities for the construction and operation of a facility associated with a public service, including those areas in which uncertainties about the level of demand makes the value of the real option to delay or stagger investment high.
• Finding ways to internalise those aspects of performance which provide social benefit, such as making it profitable for private owners of prisons to manage prisons in ways that reduce re-offending rates, or retaining state control, where effective means of internalising these issues cannot be found.
• Maximising the incentives for private-sector value creation by avoiding build, own, operate and transfer (BOOT) schemes with compulsory hand-back to the public sector, since this truncates the benefits that the private sector obtains from value-enhancing innovations that have long-term positive impacts on the value of the facility (impacting on residual value).

• Providing options for renegotiation which will allow private owners to capture benefits from innovations not anticipated when the contract was first written. Renegotiation may be around payments during the course of the contract, or around the residual value at which the facility would be transferred back to private ownership and management (if there is a BOOT scheme or similar).

The focus of the literature reviewed in this section on the investment decisions at the construction stage abstracts from the “control versus lack of control” issue that will arise in relation to the delivery of services where contracts are incomplete. In the next section, we consider those issues relating to the delivery of services.