This chapter studies the effect of PPPs on incentives. We compare PPPs with public provision and outright privatization, in terms of providing satisfactory service quality at a reasonable cost. As discussed earlier, the defects of public provision of infrastructure include white elephants and pork-barrel earmarks, lack of transparency in public work contracts, deficient maintenance and service quality, and even corruption. When the current trend of PPPs began some 20 years ago, its proponents believed that private participation in infrastructure alone would improve on these sorry results. Since then, PPPs have been used to provide traditional public infrastructure such as roads, bridges, tunnels, airports, and seaports, as well as complex infrastructure facilities such as schools, hospitals, prisons, and information technology. In light of this experience, the initial enthusiasm looks somewhat naïve: PPPs are one possible organizational form, and the appropriate organizational form depends both on the institutional and financial environment and on the characteristics of the project.

This chapter is divided into two parts. In the first, we study the project characteristics that make PPPs the preferred organizational arrangement. The second part examines alternative risk allocations between the government, private firms, and users of the infrastructure to see how they affect incentives in PPPs. In the first section, we assume a benevolent and efficient government that does not suffer any of the normal failures of real governments. This assumption is unrealistic, but it allows us to isolate the effects of the economic environment (e.g., whether returns to scale are increasing, constant, or decreasing) and of organizational form on incentives. In the remainder of this book, we make more realistic assumptions about governments.