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MIT OpenCourseWarehttp://ocw.mit.edu

1.040 Project ManagementSpring 2009

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1.040/1.4011.040/1.401

Project ManagementProject ManagementSpring 2009Spring 2009

PrivatizationPrivatization

Fred MoavenzadehFred Moavenzadeh

James Mason Crafts ProfessorJames Mason Crafts Professor

Massachusetts Institute of TechnologyMassachusetts Institute of Technology

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Transfer of responsibilities from public sector to private secto Transfer of responsibilities from public sector to private secto r for:r for:

ConstructionConstruction

OperationOperation

ManagementManagement

Maintenance of InfrastructureMaintenance of Infrastructure

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PUBLIC PRIVATE

Own-Finance-Construct-Operate ------------------

Own-Finance-Construct Operate

Own-Finance-Operate Construct

Own-Finance Construct-Operate

---------------- Own-Finance-Construct-Operate

Sectoral Allocation of ProjectSectoral Allocation of ProjectResponsibilities by StagesResponsibilities by Stages

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Argument Against Public Ownership Argument Against Public Ownership

Private Sector Provides Greater Incentive for Efficiency Private Sector Provides Greater Incentive for Efficiency

Public Managers Have Weak Performance Standards and IncentivesPublic Managers Have Weak Performance Standards and Incentives

Public Managers are Encouraged to Maximize BudgetsPublic Managers are Encouraged to Maximize Budgets

Public Enterprises are not subject to Market Controls:Public Enterprises are not subject to Market Controls:Bankruptcy Bankruptcy

Takeover Takeover

Public Enterprises do not have to Borrow in the Capital MarketPublic Enterprises do not have to Borrow in the Capital Market

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Potential Advantages of PrivatizationPotential Advantages of Privatization

Reduce Public Sector Borrowing RequirementsReduce Public Sector Borrowing Requirements

Transfer development risks to the private sector Transfer development risks to the private sector

Increase operating efficiency Increase operating efficiency

Promote market competition and accelerate growthPromote market competition and accelerate growth

Reduce size of public sectorReduce size of public sector

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Why Privatization? Why Privatization?

Economic Argument:Economic Argument:

Lower CostLower CostImproved Quality Improved Quality Increased Economic ChoiceIncreased Economic Choice

More Efficient Allocation of ResourcesMore Efficient Allocation of ResourcesIdeological ArgumentIdeological Argument

Role of Government is to Oversee the Provision of Services,Role of Government is to Oversee the Provision of Services,Not their ProductionNot their ProductionReduce Government Spending, Thus Limiting GovernmentReduce Government Spending, Thus Limiting Government ssRole in the Economy as a WholeRole in the Economy as a Whole

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Proponents Argue that Private SectorProponents Argue that Private Sector

is Driven by:is Driven by:CompetitionCompetition Lower Cost or Better ServiceLower Cost or Better Service

Economy of Scale, Scope, and ExperienceEconomy of Scale, Scope, and Experience Lower Unit CostsLower Unit Costs

Easier Access to CapitalEasier Access to Capital Upgrading Equipment and FacilitiesUpgrading Equipment and Facilities

Incentive Driven ManagementIncentive Driven Management More Flexibility in ManagementMore Flexibility in Management

Government Should Set Policies that make Private Sector AlternatGovernment Should Set Policies that make Private Sector Alternat iveiveMore Attractive than Government ProductionMore Attractive than Government Production

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Critics Argue that Privatization Creates:Critics Argue that Privatization Creates:

Inequity or Distributional EffectsInequity or Distributional Effects

Monopolistic BehaviorMonopolistic Behavior

Lack of Concern with ExternalitiesLack of Concern with Externalities

Disruption of Services Due to Bankruptcy Disruption of Services Due to Bankruptcy

Private and Public Sector Seem to Chase the Same set of Private and Public Sector Seem to Chase the Same set of ProjectsProjects

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Forms of Privatization:Forms of Privatization:

Alternative Service Delivery Alternative Service Delivery

DenationalizationDenationalization

PublicPublic--Private PartnershipPrivate Partnership

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Denationalization:Denationalization:

Government Sells its Assets to Private Sector:Government Sells its Assets to Private Sector:

Sell Assets/Firms to Private IndividualsSell Assets/Firms to Private Individuals

Sell Assets/Firms to Private CompaniesSell Assets/Firms to Private Companies

Sell Assets/Firms to Management and EmployeesSell Assets/Firms to Management and Employees

Sell Assets/Firms to the Public with Equity IssueSell Assets/Firms to the Public with Equity Issue

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PublicPublic --Private Partnerships:Private Partnerships:

Sharing the Risks and Responsibilities of a ProjectSharing the Risks and Responsibilities of a Project

Degree of Risk and Responsibilities Taken by EachDegree of Risk and Responsibilities Taken by EachParty Determines the Type of PartnershipParty Determines the Type of Partnership

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Nature of Risk:Nature of Risk:

Construction Risk: Normally Taken by Private SectorConstruction Risk: Normally Taken by Private Sector

Operational Risk: Public Sector, Transferable to PrivateOperational Risk: Public Sector, Transferable to PrivateSector Conditionally Sector Conditionally

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GovernmentGovernment s Role:s Role:

Shift from Production to RegulationShift from Production to Regulation

Effective Contract, Monitor Performance, EnforceEffective Contract, Monitor Performance, EnforceContract StandardsContract Standards

Payment Based on Outcome or Goals Rather than onPayment Based on Outcome or Goals Rather than on

Inputs and CostsInputs and Costs

Example: Weapon ProcurementExample: Weapon Procurement

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A Typology of Goods A Typology of Goods

Exclusion

Possible Not Possible

Joint Toll Goods CollectiveGoodsConsumption

Individual Private Goods Common-

Pool Goods

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Service Delivery AlternativesService Delivery Alternatives

Service Delivery

Gov Production

Arranges Service

Gov

Supplier

Gov

Pays Supplier

N/A

Contracting Gov Private Gov

Franchise Gov Private Consumer

Grant or Subsidy Gov & Consumer Private Gov & Consumer

Voucher Consumer Private Gov & Consumer

Market Consumer Private Consumer

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Effectiveness of Service Delivery MethodsEffectiveness of Service Delivery Methods

Nature of Gov Contract Franchise Grant of Voucher MarketIndustry Supply Subsidy

Service Quality/ Quantity notEasily Specified

Most Least Least Somewhat Somewhat Somewhat

CompetitionAmongProducers

Least Most Least Somewhat Most Most

Economies ofScale Somewhat Most Most Somewhat Somewhat Somewhat

ConsumerComparisonShopping

Least Least Least Somewhat Most Most

Few ProducersSomewhat Some-what Most Somewhat Least Somewhat

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Privatization Goals and Service Delivery MethodsPrivatization Goals and Service Delivery Methods

Goals Gov. Contract Franchise Grant or Voucher MarketSupply Subsidy

Reduce Gov Costs No Yes Yes Maybe Maybe Greatly

Reduce Consumer

Costs

No Maybe Maybe Yes Yes Yes

Increase Consumer Choice

No No No Maybe Yes Yes

Increase Competition No Maybe No Maybe Yes Yes

Improve Quality No Maybe Maybe Maybe Yes Yes

Limit Size of Gov No Somewhat Somewhat Somewhat Somewhat Greatly

Distribution goals Yes No No Yes Yes No

Other Policy Goals Yes No No Somewhat Yes No

Direct Contact No No Yes Yes Yes YesBetween Consumersand Suppliers

Decrease Potentialfor Service Disruption

No Yes Yes Maybe Maybe Maybe

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Delivery Systems and Government CostsDelivery Systems and Government Costs

Type of Good

Common-Private Toll Collective

Pool

Govt. Service 4

Contract 5 3

Franchise 2

Grant 2 3 1

Voucher 2 3 1

Market 1 1

2

1

A r r a n g e m e n

t

F k f F ili i P iF k f F ilit ti P i t

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Framework for Facilitating PrivateFramework for Facilitating PrivateParticipation:Participation:

Response in Four Complementary AreasResponse in Four Complementary Areas

Conducive

Policy,Legal and

RegulatoryFramework

Capital MarketsDevelopment

and TermFinancing

Unbundlingmitigation andmanagement of

risks

GovernmentDecision-Making

& ProjectFacilitation

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Funding Structure of BOT ProjectsFunding Structure of BOT Projects

Equity Funding Equity Funding

Loan (Limited Recourse Finance)Loan (Limited Recourse Finance)

Credit FacilitiesCredit Facilities

Eventual Flotation of SharesEventual Flotation of Shares

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Legal Framework of BOT ProjectsLegal Framework of BOT Projects

Enabling Legislation Usually StipulatesEnabling Legislation Usually StipulatesFranchise (rights to design, finance, construct & operate)Franchise (rights to design, finance, construct & operate)Concession periodConcession periodCapital StructureCapital StructureDirectorshipDirectorshipRoyalty to GovernmentRoyalty to GovernmentCompletion PeriodCompletion Period

Approval of design, method of construction & conditions of Approval of design, method of construction & conditions of contractcontractPower to make by Power to make by --laws for traffic regulationlaws for traffic regulationPower to collect tollsPower to collect tollsLevel of tolls/mechanisms for adjustmentLevel of tolls/mechanisms for adjustment

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Risks of BOT ProjectsRisks of BOT Projects

Sponsor RisksSponsor Risks

Sovereign RisksSovereign Risks

Political RisksPolitical Risks Technical Risks Technical Risks

Income RisksIncome Risks

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MTRC EHCC NHKTC H.K. Govt

Independent

CheckingEngineer

LendersEngineer

Lenders

ShareholdersShareholders

Main Contractor

DesignEngineers

NamedContractor

ProjectManagement

Company

Credit Agreements

Road OperatingAgreements

Road & Rail

Franchises

Shareholders Agreements

Construction AgreementsDesign Agreements


ConsultantsAgreements


Rail OperatingAgreements

Rail FranchisingAssignments

Design & ContractAgreements

CreditAgreements

I d d

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Tunnel Operation& Management

Organization

Tates CairnTunnel Company H.K. Govt

IndependentCheckingEngineer

LendersEngineer

Shareholders

Main Contractor(A joint venture Co.)

Designers Subcontractors

ProjectManagement

Team

Credit Agreements

Tunnel Franchise


Sub ContractsDesignAgreements



Operation Function

Design & ContractAgreements

Relationship of parties to the Tates Cairn Tunnel, Hong Kong

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Example:Example:

Specific Case of HighwaySpecific Case of Highway


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Cost of Bad Roads in Vehicle Wear and TearCost of Bad Roads in Vehicle Wear and Tear

PavementCondition Small Auto

2-AxleVehicle

5-AxleVehicle

Very Good 0.0% 0.0% 0.0%

Good 2.0 1.1 2.5

Fair 11.0 6.1 10.9

Poor 29.0 15.3 26.6

Very Poor 38.0 22.2 39.8

Estimated percentage increase in auto operating costs as a function of pavement condition.

Highway Mileage in the United States byHighway Mileage in the United States by

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Highway Mileage in the United States byHighway Mileage in the United States by Administrative Responsibility Administrative Responsibility

Administrator

Federal Agency

No. of

Agencies5

Miles

262,403

State Agency 50 934,696

County Agency 2,500 1,577,420

City, Town and Township

Other Local (onlyResidential streets)

10,000

25,000

486,575

605,153

Toll Highway Authority 35 4,773

Total 38,000 3,871,020

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The Policy Challenge: The Policy Challenge:

? How to Avoid

Tolls too High

Quality too Low

While Still Obtaining:Production

Efficiency?......

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Arguments for Government Provision Arguments for Government Provision

1.1. NonNon EconomicEconomicMilitary, PoliticalMilitary, Political

2.2. EconomicEconomicNonNon --ExcludableExcludable Shadow TollsShadow TollsImperfect CompetitionImperfect Competition Oligopoly Oligopoly high priceshigh pricescan be exactedcan be exacted

ExternalitiesExternalities Air pollution, health, vehicle wear & tear, congestion Air pollution, health, vehicle wear & tear, congestion

T diti l Hi h S l tiT diti l High S l ti

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Traditional Highway Solution: Traditional Highway Solution:

Government OwnershipGovernment Ownership

Market Failure&

Laissez-Faire

Tolls Too High

Quality Too Low

P ibl Eff f G O hiP ibl Eff f G O hi

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Possible Effect of Government OwnershipPossible Effect of Government Ownership

PPF

H

M

H= highway (quality & quantity)

P.P.F = Production Possibility Frontier

E v e r y t

h i n g e l s e s o c i e

t y m u s

t p r o d u c e a n

d / o r w a n

t

Argument for Privatization: ImproveArgument for Privatization: Improve

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PPF

H

M

Argument for Privatization: Improve Argument for Privatization: Improve

Production EfficiencyProduction Efficiency

Economic Argument for Privatization ofEconomic Argument for Privatization of

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Economic Argument for Privatization of Economic Argument for Privatization of

Highway OwnershipHighway OwnershipEconomic Efficiency Rationale*

Feasibility of Implementation wrtEconomic Efficiency **

*Auction highway at bids that are above the production of government,thus their buyers believe that they could reduce the cost of production this is anImportant economic efficiency arrangement.

**How can we have our cake and eat it to? Different kind of government interactionAnd regulation is necessary.

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M

H

W2W1

W2W1

C

W0

W0

a

b

The policy challenge:How to obtain a cInstead of a b?.......W equal welfare contour

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SubSub Optimal Quality ProblemOptimal Quality Problem

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SubSub --Optimal Quality ProblemOptimal Quality Problem

Two Solutions (Complementary): Two Solutions (Complementary):

1.1. Legalistic:Legalistic:Covenants, Performance BondsCovenants, Performance Bonds

2.2. MarketMarket--Like:Like:PigouvianPigouvian Subsidy, Incentive FeeSubsidy, Incentive Fee

S = F + P/ES = F + P/EF=Fuel Tax per VMTF=Fuel Tax per VMTP=Total User Cost per VMTP=Total User Cost per VMTEE--Price Elasticity of Demand for usage of the highway Price Elasticity of Demand for usage of the highway

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