Markets and Politics in Awarding                  Infrastructure Concession                          Contracts            ...
might be in the opposite order. The government                    obviously sub-optimal outcome. For instancethat has plac...
Direct Political Intervention and Political                   additional cost borne by firms as soon as theyRisk          ...
situation of natural monopoly, a regulatory              But if concessions do not reside in the market,regime may be crea...
Concessions for infrastructure: A guide to theirBibliography                                      design and award. World ...
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Markets and Politics in Awarding Infrastructure Concession Contracts


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A short article arguing against the common perception of concession contracts as being a more market-friendly way of dealing with natural monopolies in network infrastructure. The broad truth about concessions is that they can function like a market, but the structure of a concession is always going to be designed around achieving the government's political objectives.

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Markets and Politics in Awarding Infrastructure Concession Contracts

  1. 1. Markets and Politics in Awarding Infrastructure Concession Contracts Jonathon FleggConcession contracts for private entities to function like a market, their structure is set inoperate publicly-owned infrastructure are accordance with politics. Moreover of genuinealmost universally considered to be an concern for achieving optimal policy is theinstitutional innovation for realising the ability of political considerations to override theefficiency gains of the private sector. Given the concession process if the government does notusually competitive nature of the bidding prefer the likely concessionaire: The costlyprocess, the assumption of some private risk, problem of political risk. A final insight is thatand the concessionaire‟s profit motive, it seems concession contracts can and do substitute fortautological that there is a greater role for the market forces but they are not necessarily amarket in concession contracts when compared substitute for political forces or for discretionarywith discretionary regulation. regulation.This article takes a different approach to the Market in Function, Political in Structureconventional wisdom in an attempt to remind usof some important „broader truths‟ about the The structural characteristics of a concession,innately political nature of concessions. While and critically the method by which a concessioncertainly market forces are more evident in the is awarded, are primarily the product of a set ofoperation of concession contracts, in practice pre-defined political objectives. Onethey are awarded within a wider institutional government might have a policy preference forconstruct designed specifically to achieve the deficit reduction over containing the „cost ofgovernment‟s preferred set of policy objectives. living‟, while for a different government theIn short, while concession contracts attempt to relative importance of these policy objectives1|Page
  2. 2. might be in the opposite order. The government obviously sub-optimal outcome. For instancethat has placed a higher priority on deficit the New South Wales Government‟s 2002reduction is likely to award the concession concession to build and operate Sydney‟scontract to the firm that can operate the Cross-City Tunnel was offered to the bidderinfrastructure with the lowest government who could supply the Roads and Trafficsubsidy or highest concession fee, while Authority with the highest “upfront fee”. Thegovernments concerned about the costs to remarkable winning sum ended up being A$97customers might award the concession to the million, which was passed onto motoristsfirm who will charge the lowest user charge or through higher tolls, and eventually sunk thetariff. contract after less than two years of operation (Baker and Davies, 2006).The awarding of a concession, if through anauction and with an adequate number of In contrast the policy goal of deficit reductioncompetitive bidders, is thought to be a evident in the Argentinian concessions onreasonably close substitute for a free market urban railways and waterways during the 1990s 1solution . Specifically those auctions that award seems to provide a better solution when thethe concession to the bid offering the lowest minimum subsidy bid criteria was coupled withconsumer price are generally considered most a fixed price (Gómez-Ibáñez, 1997).efficient, as price is generally how firmscompete within the spot market (Kerf et al 1998; Pro-poor political motives can also sink aOECD 2007). However here it is important to concession. The 1997 water and seweragenote that when the bidding process functions in concession for the Bolivian capital of La Paza market-like way it is still conditional on the was awarded to the private operator willing topolitical objectives that determine the auction connect the largest number of households instructure. the poor neighbouring city of El Alto (Komives, 2001; Estache et al 2002). The resulting tariffThis point is most obvious when the politics charged by the concessionaire together with thebehind concession auctions generate an particularly exorbitant connection fee, resulted1 A vast literature exists on the optimal design of auction in mass protests and the cancellation ofprocesses (Kerf et al, 1988), as the design is critical to concession.achieving an efficient outcome. Inappropriate design can resultin winning bids below that do not reach the fully competitiveoutcome, or can give rise to strategic voting or coordinationamong bidders.2|Page
  3. 3. Direct Political Intervention and Political additional cost borne by firms as soon as theyRisk decide to invest in the expensive bidding process.Politics not only sets the structure of the biddingprocess but also interferes within the process, Concessions Rarely Substitute forincluding measures designed to promote or Regulationprejudice specific bidding firms. On the menu of possibilities for dealing withIn 2005 the Croatian Premier ordered the natural monopolies in infrastructure,nation‟s Telecommunications Agency discretionary regulation is a more politicaldeliberately ruled out Adriacella, an Arab option because of the risk of regulatory capture.consortium, from being granted a mobile The conventional wisdom generally viewstelecommunications concession because of concession contracts as a less politicalspeculation about their “cooperation with the substitute for discretionary regulation (C.narcotics trade” (Cvitić, 2005). A 2009 Kessides, 1993; I. N. Kessides, 2004; Gómez-concession contract awarded to build and Ibáñez, 2003):operate a light rail project on the congestedFrench island of Reunion was cancelled By establishing an explicit contractualbecause of an opportunistic campaign directed relationship, concessions limit theat the concessionaire by a newly-elected government’s discretionary powers and canregional council (Thomson, 2010). reduce the risk of political expropriation (I. N. Kessides, 2004: 105).Because governments control the entire bidstructure they still have the capacity to appoint However in practice many networkor deny potential concessionaires in an infrastructure concession contracts do notuncompetitive or non-transparent way. This is actually replace discretionary regulationeven more the case in structures for choosing (perhaps with the exception of the highwayconcessionaires that are themselves non- sector). This important point has been noted bytransparent, such as by negotiation or beauty the OECD (2007):contests. When governments circumvent theirown tendering or contractual procedures in this Concessions are not substitutes for regulation.way the result is political risk, and is an Where there is a need for regulation, as in a3|Page
  4. 4. situation of natural monopoly, a regulatory But if concessions do not reside in the market,regime may be created along with the where do they reside? Unlike private contractsconcession. it is clear that they still belong in the public realm, or at least to a sphere of “competition inMost jurisdictions that utilise concessions for the politics”.water, sanitation, telecommunications andenergy networks, also make the contracts At best concessions function like a market,subject to a regulatory body. For instance, in within a bidding structure determined by1992 the end of Buenos Aires state-owned politics. Rarely however do they operate in suchwater and sewerage utility, Obras Sanitarias de an ideal way. In most jurisdictions, particularlyla Nación, was not only accompanied by the in developing economies but also in developedintroduction of widespread water and sewerage ones, the competitive process itself has veryconcessions, but also a new peak concession little integrity, given that the governmentregulator, Ente Tripartito de Obras y Servicios reserves the right to intervene specifically withinSanitarios (Delfino et al 2007). the process to ensure the concession is awarded to a firm with similar preferences.Similar coupling of regulation and concessions Finally, the idea that a concession contractis common in many economies in Latin creates a market-like bubble unsusceptible toAmerica, East and South-East Asia, the United politicised regulation, is an exemption ratherStates and Australia. So to the extent than rule.concession contracts do not substitute forregulation in the real world, they cannot be To start the change governments committed toviewed as operationally free from political implementing concession contracts mustforces. understand the costs that political risk place on the private sector (and by incidence, end-“Competition in the Politics” users), and seek in an enlightened way to „bind their own hands‟ and allow competitive,A useful distinction is often made between transparent bidding to take place withoutcompetition in the market and competition for interference.the market. A concession contract isfundamentally different from the free marketsolution because it is an example of the later.4|Page
  5. 5. Concessions for infrastructure: A guide to theirBibliography design and award. World Bank Technical Papers 399. Retrieved from: http://rru.Baker, J. and Davies, A. (2006, June 1).“Taxpayers to pay twice for tunnel”. Sydney _fulltoolkit.pdf .Morning Herald. Retrieved from: . Kessides, C. (1993). Institutional options for the provision of infrastructure. World BankCvitić, P. (2005, July 18). “Sanader forbids Discussion Papers 212. Washington DC: Worldgranting of concession to Adriacella”. Nacional Bank.(505). Retrieved from: . Kessides, I. A. (2004). Reforming Infrastructure:Delfino, J. A., Casarin, A. A., Defino, M. E. Privatization, Regulation and Competition.(2007). “How Far Does it Go? The Buenos Washington, DC: World Bank.Aries Water Concession a Decade After theReform”. Social Policy and Development Komives, K. (2001). “Designing Pro-PoorProgramme Paper No. 32: United Nations Water and Sewer Concessions: Early LessonsResearch Institute for Social Development. from Bolivia”. Water Policy 3(1): 61-79.Estache, A., Foster, V., and Wodon, Q. (2002). OECD (2007). “Competition Policy and“Making Infrastructure Reform in Latin America Concessions”. Retrieved from: http://Work for the Poor”. CEPAL Review 78: 101-18. .Gómez-Ibáñez, J. A. (1997). “Privatizing Thomson, A. (2010, April 22). “How politicsTransport in Argentina”. Kennedy School of derailed a PPP”. Infrastructure Investor.Government Case Study CR1-96-1363.0. Retrieved from:(2003). Regulating Infrastructure: Monopoly, .Contracts, and Discretion. Harvard: HarvardUniversity Press.Kerf, M., Gray, R. D., Irwin, T., Levesque, C.,Taylor, R. R., and Klein, M. (1988).5|Page