A Range of the Amount of Public Assistace in PFI Projects

Abstract

Since both central and many local governments in Japan have been in financial crisis, they are required to reduce public expenditure. It is getting difficult for them to provide all the public services by themselves even if these services are strongly needed from their taxpayers. For this reason, PFI option is being developed as a new procurement measure to enable them to achieve both reducing their public expenditure and providing necessary public services needed.Key factors in PFI project are optimal risk allocation among the various parties participating in the project, and appropriate public assistance to concessionaire. Under an advantageous PFI contract to public sector, there is a risk that the contract itself may not be finalized, and, even if it is concluded, the risk that the concessionaire may default is still remained. On the contrary, under an advantageous PFI contract to concessionaire, there is also a risk that Moral Hazard may spoil the efficiency of the projects. Therefore, it is very important in PFI projects to design contracts, especially on risk allocation and public assistance. In this study, we focused on public assistance and examined the range of the amount of public assistance.Conditions of successful PFI project are that the project is decided worth undertaking as a result of Cost Benefit Analysis and that three main parties in the project (public sector, investors and financiers) can achieve their own purposes in the project. The latter one can be described three conditions as follows:(i) Public sector can reduce net expenditure or split expenditure to reduce expenditure of each fiscal year on the project, (ii) investors can make profit on the project, and (iii) financiers can be ensured that all the principal for the project and its interest can be repaid without fail.We examined the range of the amount of public assistance on the three assumptions as follows:(i) Public sector can fix the amount of public assistance to the concessionaire in the contract previously, (ii) there is no uncertainty in the utility of beneficiaries and (iii) optimal risk allocation is achieved.As a result of our analysis, the range of the amount of public assistance is shown in the table. And we confirmed that this result could also be derived from Benefit Incidence Table.In practice, the amount of public assistance depends on the public sector's requirement level to reduce expenditure, investors' requirement level of profit, and financiers' requirement level of interest through their negotiation. However, it must be determined within the range of our result.We derived the result described above on some assumptions of risk allocation, risk cost, and uncertainty of utility in our study. However, the range of the amount of public assistance depends on them. Therefore, we must model the uncertainty of utility and risk cost, and analyze the optimal risk allocation in each PFI type in economic model after this. Moreover, we must make this analysis consistent with Benefit Incidence Table approach theoretically and develop its practical use.