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Jean Tirole is an influential, respected, and by all accounts gracious man who won this year’s Nobel Prize in economics. Bertha is a 7,000-ton tunnel boring machine that’s been stuck under Seattle for nine months—but is still tweeting—as state officials and a private contractor battle over who should pay to get her out.
What do Prof. Tirole and Bertha have in common? They show the strengths and weaknesses of public private partnerships. P3s refer to all kinds of contractual arrangements, but the key feature is a transfer of risk from the public to the private sector. The idea is that by bundling risks—for example by soliciting private bids to build and maintain a road—governments can reap efficiency gains.
Although these deals are not free money (investors need to get a return from somewhere, and that usually means higher tolls or user fees), the Congressional Budget Office finds P3s tend to come in cheaper and faster than public projects. And contracts may be written to avoid self-inflicted damage like costly renegotiations.
P3s also hold undeniable appeal for people worried about the nation’s estimated $1 trillion infrastructure gap, Congress’s ongoing failure to pass a highway bill, and the reluctance of many state and local governments to issue new debt despite historically low interest rates. But P3s can also create real headaches.
That’s where Tirole comes in. He specializes in headaches known as incomplete contracts. Most people would probably accept that no agreement can specify every possible contingency. And unanticipated circumstances have plagued P3s since the beginning. Some of the earliest canal projects went belly up in the financial crisis of the 1840s. Just last month the Indiana Toll Road declared bankruptcy after rosy traffic projections failed to materialize in part because drivers stayed home in the Great Recession.
Tirole has studied a more subtle problem: contingencies that are “observable but not verifiable” or enforceable in a court of law. That’s Bertha. No one foresaw that she would be stopped when she bumped into an 8-inch pipe after going only 1,000 feet, and now no one can agree on whose fault it was and who must pay. Importantly, in cases like Bertha or the Indiana Toll Road, the private contractor can walk away, but the state cannot.
Tirole is not arguing that incomplete contracts are a deal-breaker. But their risks must be taken into account when P3 deals are structured. The message from both Prof. Tirole and Bertha is: Contracting is rough business. States and localities need help thinking through all of the challenges, especially in the blinding light of what may look like easy money.
The Obama Administration recently kicked off a Build America Transportation Investment Center to help state and local officials work through these thorny issues. Regional groups, such as the West Coast Infrastructure Exchange, can also help.
However, for all the attention they’ve received, P3s may never represent more than their current share—less than 2 percent—of all U.S. highway investment. We will have to look elsewhere to close the infrastructure gap.
Full disclosure: I worked on the White House initiative while serving as a senior economist with the Council of Economic Advisers from September 2013 to August 2014.
Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.