Under which conditions is a PPP relevant for public spending
2018
Public authorities increasingly involve the private sector in financing, building and operating
new infrastructures. Many reasons are usually given to justify private sector involvement. One of
them claims that private operators can manage project construction and operation more
efficiently. Nevertheless, whether a public or a private operator, there is a target IRR, very close
to the standard notion of Weighted Average Capital Cost (WACC), which is higher in the case of
the private alternative because it must also include the operator's profit. The fundamental issue is
the result of two opposite effects: on the one hand, the effect of the higher efficiency of the private
operator; on the other hand, the effect of a lower WACC for the public operator. This paper
proposes a model of the determination of the need of public financing which formalizes these
two effects and allows analysing the conditions under which the PPP would be advantageous for
the public finances. Simulations estimate the efficiency gain from private operators needed to
compensate their higher WACC. Results confirmed the so-called ‘paradox of financial
profitability’: recourse to PPP is more relevant for public funds when the profitability of the
project is lower
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