A paper by Fabre and Straub (2023) examines how public-private partnerships (PPP) have worked in practice. Why would linking public and private provisions of goods and services be useful? One reason is that the public sector might have policy goals (e.g., providing health care to the poor), which the private sector may not provide in a free market system. On the other hand, the private sector may be better at delivering goods and services more efficiently. The article notes that the government’s ability to effectively contract out goods and service provision to the private sector depends on five key factors.
- Sunk costs. Because part of any sunk costs that are incurred may be difficult to redeploy (e.g., they may be relation-specific), and because full cost recovery requires that a sustained stream of quasi-rents to be redistributed to the concessionaire, a larger amount of such costs is likely to lead to opportunism by the parties
- Innovation potential. One reason to use the private sector is their potential ability to deliver cost savings and/or quality improvement. If the private sector is not more efficient then the public sector, there may be little reason for the government to contract out the work. Alternatively, it may be difficult for the government to link reimbursement to quality. In health are, quality of health outcomes are often observed by the patient and physician, but government payers only observe care quality at the crudest levels (e.g., mortality, hospitalizations)
- Commitment problems. If one or both parties have a limited ability to commit to a contract, there will be a hold-up problem in the case where outcomes are non-verifiability; soft budget constraints will be problematic when governments are unbenevolent or corrupt.
- Multitasking. The authors give an examine where bundling construction and operations together may generate new agency issues. In the case of health care, contracting on the quality of one service, may lead private sector health care providers to increase quality of care over the measured dimension but decrease quality for other, unmeasured types of care (see Holmstrom and Milgrom 1991, my previous blog post on P4P).
- Market test. In the private sector, good investments are known because people are willing to pay for the goods and services that are produced. However, some investments may not have a market test. Specifically, projects with large capital costs and low levels of fee-based cost recovery–according to the authors–“are routinely wrongly implemented based on flawed forecasts that combine demand over- and cost underestimation.” For instance, demand for prisons is not subject to a market test since the users of the facility (i.e., prisoners) clearly have no interest in paying for this ‘service’.
The authors have a brief review of PPP in health and write:
Overall, the various forms of interventions reviewed in this paper help draw general lessons regarding the potential for PPPs in health to improve service utilization and health-related outcomes. First, it seems important that incentive payments are linked not only to the volume of services offered but also to their quality. Second, a strong consensus also emerges regarding the necessity of combining demand- and supply-side policies to effectively increase both health-care utilization and health-related outcomes.
Addressing demand-side constraints appears to be a necessary condition for the success of health PPPs. It is crucial that a proper diagnosis of the situation is made ex ante to understand the reasons for service underutilization and…to “identify where the most important bottlenecks to service use are.” Is the issue a lack of demand for health services? If yes, is the lack generated by the costs of the services, their poor quality, the distance between individuals and health centers, or by a lack of awareness of the benefits of health care? The answers to these questions will help choose the adequate type of PPP to implement.
The full article and discussion of PPPs in other industries is here.