An economic cost-benefit analysis (CBA) allows the government to assess the net benefits to society of projects and select the one that generates more benefits. An economic CBA also minimizes public opposition by showing that benefits to society are the deciding factor in implementing a project.
Consider this scenario: A small Latin American country is about to launch its public-private partnership (PPP) program. The PPP promotion agency aims to select a highway project that will start the program on a positive note. To signal to the PPP community that it means business, the agency selected the rehabilitation and expansion of the existing highway that connects the capital city to the airport, known as the “Airport Link.”
This project is low risk. After all, traffic is high, users can afford the toll, and construction risk is low. It’s also financially viable because revenues exceed costs, requiring no fiscal contributions. The motivation behind this selection is straightforward: implementing a project that is unlikely to fail will set a good national precedent and increase the attractiveness of PPP programs in general.
During the agency’s presentation to the government ministry that would implement the project, the minister raised the point that the main challenge to the PPP program wasn’t to capture the interest of the PPP community, but to ensure citizens’ support for this new way to develop infrastructure. He then urged the PPP promotion agency to consider prioritizing a project with high economic returns to show the general public that PPPs increase community wellbeing.
To support this theory, the minister proposed the “Regional Connector,” a greenfield highway in a region of the country with great, yet unexploited, production potential due to its poor highway infrastructure. Also, this project is a section of a regional highway corridor that is key to increased trade among countries in the region. However, this project has much higher risks—construction and traffic risks especially—and has no chance of being financially viable without government intervention.
Which project should the government select?
Comparing PPP projects
The answer is clear. An economic cost-benefit analysis (CBA) allows the government to assess the net benefits to society for each of the projects and select the one that generates more benefits. It leads us to the conclusion that the Airport Link is not economically viable, despite being financially viable. Here’s why: Based on the current traffic, user fees/tolls on this highway, without any improvements, could raise $150 million (net present value) through tolls—that is, the present value of the tolls that users would be willing to pay even though they currently don’t. (The numbers used in this article are made up, but based on historical case studies.)
With the proposed rehabilitation and expansion, the toll revenue could increase to $200 million. Drivers would be willing to pay more because of the time savings, increased safety, and other benefits that the improved highway would provide. However, the cost of the expansion and improvements is $100 million. Therefore, although the project is financially viable (revenues of $200 million – investment $100 million = $100 million) and low risk, it is not economically viable (marginal increase in toll revenue $50 million > $100 million investment). This is likely to generate opposition from the public, who will feel they are overpaying for the additional benefits that they are receiving.
Economic viability vs. financial viability
The Regional Connector, however, is economically viable although it is not financially viable. The project costs $400 million, while the expected revenues for the investor are $200 million. Therefore, to attract private capital, the project will require a government subsidy of $200 million.
Here’s a critical point: the project will be economically viable if the total benefits that society derives from the project are greater than the total cost to society—the subsidy being one of the costs to society. In the case of the Regional Connector, the government estimated—through an economic CBA—that the competitiveness benefits to the local producers in the region amount to $100 million, while the benefits to the country from the increased regional trade are $150 million. These benefits, plus the expected revenues—which reflect the direct benefit that users perceive—add up to $450 million. This is greater than the total cost of the project ($400 million). Therefore, the $200 million subsidy for the Regional Connector is justified, and the project is economically viable.
The main danger in subsidizing a PPP project is that the government may be transferring too much taxpayer money to the PPP investor—that is, the investor will receive more than the benefit that it provides to society. This would trigger public opposition, as the government will be perceived to be a defender of the interests of the private investor rather than the public interest.
But an economic CBA can give government the information needed to dispel these concerns. It can also be an effective tool earlier on in the process—that is, when deciding whether to implement a highway project as a PPP or through the traditional public financing alternative.
When deciding whether to implement a highway project through a PPP, many governments implement the U.K.-style Value for Money (VfM) analysis. This is a rather complex analysis that looks at the costs of both alternatives and recommends the lower cost alternative—assuming that the value of the project is the same under both alternatives. The deciding factor in this calculation is the cost ascribed to the risks that the government would transfer to the private party under the PPP arrangement. This is a methodologically difficult calculation, particularly in frontier markets where the data sets are not available or unreliable. This is why certain countries—such as New Zealand—have adopted the comparative CBA.
By using comparative CBA, government analysts avoid having to ascribe costs to risks. Instead, they directly estimate costs under each delivery model—PPP or Public Finance. Also, in comparative CBA, they directly estimate the benefits of projects, which may vary under each alternative. This is particularly significant in developing countries where assets may not be maintained and, therefore, some of the benefits may not be delivered under the public alternative.
In the comparative CBA, the government selects the option that generates the largest net benefit to society, rather than the one that costs least.
Minimizing public opposition
As foreseen by the ministry in charge of highways, public opposition—particularly in emerging markets such as the small Latin American country under consideration—is a sure-fire way to derail a PPP project, and even a newly established PPP program. Opposition can be powerful enough to stop the government’s PPP approval process, cause delays during construction, or even threaten revenues during implementation.
Economic CBA can help mitigate these risks by showing that benefits to society are the factor determining the decision to implement a project. This analysis can also justify the use of subsidies by letting people see the value that they get from the subsidy. Furthermore, the government can involve the beneficiaries in determining the value of benefits and costs to society to ensure ownership of the results. Then, by socializing the results of the “validated” CBA, the government can further reduce the likelihood of public opposition, mitigating one of the key threats to PPPs in frontier markets. That’s a scenario worth pursuing.