Soft Budgets and Renegotiations in Public-Private Partnerships
Public-private partnerships (PPPs) are increasingly used to provide infrastructure services. Even though PPPs have the potential to increase efficiency and improve resource allocation, contract renegotiations have been pervasive.
We show that existing accounting standards allow governments to renegotiate PPP contracts and elude spending limits. Our model of renegotiations leads to observable predictions: (i) in a competitive market, firms lowball their offers, expecting to break even through renegotiation, (ii) renegotiations compensate lowballing and pay for additional expenditure, (iii) governments use renegotiation to increase spending and shift the burden of payments to future administrations, and (iv) there are significant renegotiations in the early stages of the contract, e.g. during construction. We use data on Chilean renegotiations of PPP contracts to examine these predictions and find that the evidence is consistent with the predictions of our model. Finally, we show that if PPP investments are counted as current government spending, the incentives to renegotiate contracts to increase spending disappear.
We thank Eduardo Bitran, Jose Luis Guasch and Roger Noll for insightful conversations, useful comments and suggestions and Manuel Hermosilla for research assistance. Financial support from the Corporacion Andina de Fomento (CAF) is gratefully acknowledged. Fischer and Galetovic gratefully acknowledge the financial support of Instituto Milenio "Sistemas complejos de Ingenieria". Galetovic gratefully acknowledges the financial support of the Tinker Foundation and the hospitality of the Stanford Center for International Development (SCID). The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.