The (ir)relevance of value-for-money analysis in PPP feasibility studies in emerging markets and developing countries
Public-private partnership and financial modelling expert Stephane July argues emerging markets and developing countries (EMDEs) should change the way they do value-for-money analysis in delivering infrastructure.
Value-for-money analysis explained
Value-for-money (VfM) analysis in public-private partnership (PPP) feasibility studies refers to calculating the “merit” of delivering an infrastructure project via a PPP scheme. This is usually done by comparing the PPP option with traditional public procurement—defined as the public sector financing, building and operating the infrastructure by itself.
VfM analysis proceeds in two steps:
- Establish a public sector comparator, which estimates how much the government would need to pay if it delivered the project alone.
- Assess risk transfer, which speculates if the private sector can safely take on risks otherwise assumed by the public sector.
VfM analysis is a popular tool in developed economies, which often have the luxury to choose between a PPP or traditional public procurement to deliver infrastructure projects.
Value-for-money analysis in emerging markets and developing countries
Recognizing the prominence VfM analysis enjoys in developed economies, emerging markets and developing countries (EMDEs) have sometimes uncritically adopted it to compare PPPs with public procurement to deliver infrastructure.
However, using VfM analysis this way is misplaced:
- Most EMDEs cannot afford public procurement in the first place.
- Most EMDEs do not have sufficiently robust data to assess risk transfer.
These two realities ultimately make this kind of VfM analysis useless for EMDEs.
VfM analysis when there is no public procurement?
EMDEs are using VfM analysis to decide between a PPP and traditional public procurement when the latter is usually not an option.
This makes the VfM analysis pointless. Like pushing on an open door, the PPP option will evidently come ahead as the government often lacks the financial resources and technical capacity to develop, deliver and operate infrastructure projects in the first place.
As such, VfM analysis in EMDEs should not be about choosing between a PPP or traditional public procurement.
VfM analysis relies on poor data and unproven assumptions
Developed countries with mature PPP markets also use VfM analysis to calculate whether the benefits of risk transfer outweigh the increased transaction costs of private financing.
This exercise involves:
- Assessing the costs of the risks, such as increased construction costs resulting from construction delay.
- Determining the probability of each risk happening, such as the probability that the construction can be delayed.
The problem is that the assumptions underpinning this quantitative evaluation are typically invalid in EMDEs, where:
- PPPs are a relatively new procurement method.
- Experience in public procurement is scarce.
- Public authorities lack the data to quantify the costs and the occurrence of risks.
Furthermore, even developed economies with ample experience in public procurement have been questioning the methodology for quantifying risk transfers. In particular, reliance on complex probabilistic and stochastic calculations such as Monte Carlo analysis has often been criticized for lacking the data to justify these calculations.
This criticism is all the more damaging for EMDEs, which often have even less experience with public procurement.
Value-for-money analysis in PPP infrastructure delivery remains conceptually valid
That being said, looking at VfM in PPP infrastructure delivery is in principle a good practice. The problem is less the concept itself than how policymakers in EMDEs are demonstrating VfM using a methodology unfit for purpose.
VfM analysis in EMDEs should instead focus on two questions:
- The public sector should ask if the PPP-delivered infrastructure project is affordable and makes economic and social sense.
- The private sector should ask if the PPP-delivered infrastructure project is financially and commercially viable.
For the public sector, a PPP project is worthwhile when:
- The public sector can fund its part of the project and meet its financial responsibilities over the project lifecycle (project affordability).
- The project contributes to national or regional economic development, which is typically measured by a cost-benefit analysis (CBA).
- The project improves or preserves natural resources and positively impacts the social environment, which is usually analyzed in the environmental and social impact assessment (ESIA).
For the private sector, a PPP project is worthwhile when:
- Required funding and financing over the project lifecycle is available (financial sustainability).
- Revenues generated by the project are likely to meet the private sector’s commercial and financial objectives (commercial viability).
The right way of doing VfM analysis
Comparing a PPP with traditional public procurement in VfM analysis should be left to developed economies and mature markets with rich experience and data in both delivery modes.
EMDEs should focus solely on whether a PPP-delivered infrastructure is a sensible choice. Affordability, CBAs, ESIAs and commercial viability and financial sustainability are all arguably more pressing questions for EMDEs.
Only then can EMDEs know if they are likely to get their money’s worth in delivering public infrastructure through PPP models.