Public-Private Partnerships and the Privatization of Financing: An Incomplete Contracts Approach

Abstract

Governments have begun to embrace public-private partnerships (P3s) as vehicles for providing public services. This paper considers the controversial question of when private financing of public projects is optimal. Private development can dominate public financing through more efficient termination decisions for bad projects, resolving soft budget constraint problems. Due to contractual incompleteness, on the other hand, private developers cannot commit to large debt repayments, and hence can finance only a subset of valuable projects. Public developers, who do not face the same commitment problems, can finance a larger set of projects.

Keywords: public-private partnerships, incomplete contracts, soft budget constraints

JEL Classification: H11, G32, D23, L20