The Good and the Bad of Public-Private Partnerships

RANDAL O’TOOLE, CATO INSTITUTE

President Trump has reportedly expressed reservations about public-private partnerships, but White House economic advisor Gary Cohn is still enthusiastic about building the administration’s fabled infrastructure plan around them. Not everyone realizes, however, that there are two very distinct kinds of public-private partnerships, which I call the good kind and the bad kind. I’d like to believe that it is the bad kind that worries Trump while it is the good kind that encourages Cohn.

The good kind of public-private partnership is more formally known as a demand risk partnership. In this case, the public partner essentially gives the private partner a franchise to build a road or some other infrastructure. The private partner is allowed to collect tolls or other revenues from the infrastructure for a fixed period of time, usually three or four decades, after which ownership and management of the infrastructure is turned over to the public partner (who may contract it out again). The key is that private partner accepts all of the risk that the revenues may not cover the costs. The I-495 Capital Beltway express lanes are a demand risk partnership.

The bad kind of public-private partnership is more formally known as an availability payment partnership. As with the good kind, the public partner designs the project and the private partner builds and, usually, operates it. Unlike the good kind, the private partner takes no risk that the project might not pay its way. Instead, the public partner contracts to pay the private partner enough money over several decades to completely repay the private partner’s costs regardless of whether anyone is actually using the infrastructure.

Availability payment partnerships might make sense in the case of infrastructure that no one expects to earn user fees, such as common schools. But in most cases, such partnerships are formed mainly to allow the public partner to sidestep legal debt limits. For example, euro nations are supposed to limit their debts to a fixed percentage of GDP. Some nations, such as Italy, have built high-speed rail and other infrastructure using availability payment partnerships so that the debts appear on the books of the private partners, not the government.

For the same reason, Denver’s Regional Transit District (RTD) formed a public-private partnership to build a billion-dollar rail line to the airport. Voters had approved a sales tax increase for the rail line but set a debt limit. When cost overruns made it impossible to build the line without exceeding the debt limit, RTD entered into an availability payment partnership so the debt wouldn’t appear on its books. Of course, it was still contracturally obligated to pay the private partner enough to repay its debt.

Demand risk partnerships are good because the need to cover costs out of user fees creates a discipline that insures that projects are worthwhile and costs do not get out of control. User-fee funded projects are also better maintained because managers know users will stop paying if the project becomes dangerous or unreliable.

Availability payment partnerships are bad because they offer little incentive to insure that projects are worthwhile or to control costs. Denver’s airport rail line was originally projected to cost $315 million and ended up costing over a billion dollars. Nor did that billion dollars buy a quality product: more than a year after it opened, the builder still has not got the automatic grade crossing gates working, a technological problem that the private railroads solved more than 80 years ago.

Until the Trump administration releases its infrastructure plan, we won’t know if it will make a distinction between demand risk and availability payment partnerships. But it should favor the former over the latter to protect taxpayers and insure that the infrastructure we build is both worth having and well maintained.


Used with permission. Cato Institute / CC BY-NC-SA 3.0


Randal O’Toole is a Cato Institute Senior Fellow working on urban growth, public land, and transportation issues. O’Toole’s research on national forest management, culminating in his 1988 book, Reforming the Forest Service, has had a major influence on Forest Service policy and on-the-ground management. His analysis of urban land-use and transportation issues, brought together in his 2001 book, The Vanishing Automobile and Other Urban Myths, has influenced decisions in cities across the country. In his book The Best-Laid Plans, O’Toole calls for repealing federal, state, and local planning laws and proposes reforms that can help solve social and environmental problems without heavy-handed government regulation. O’Toole’s latest book is American Nightmare: How Government Undermines The Dream of Homeownership. O’Toole is the author of numerous Cato papers. He has also written for Regulation magazine as well as op-eds and articles for numerous other national journals and newspapers. O’Toole travels extensively and has spoken about free-market environmental issues in dozens of cities. An Oregon native, O’Toole was educated in forestry at Oregon State University and in economics at the University of Oregon. Email: [email protected]