Significance of Demand in making Decisions about Private (Co)Financing of Public Services

Scientific Essay , 2009 , 18 Pages

Economics - Other

The paper is focused on factors influencing the choice of a public service provider. The significance of demand in decision-making about private (co)financing of public services is being analyzed. The first part of the paper is concentrated on economic approach to private provision and private (co)financing and economic character of public service as well. The second part is devoted to user charges and importance of demand elasticity. Finally, the possibility of private providing and limitations of private (co)financing of the concrete public services are being formulated. The authors conclude that the economic nature of the service does not directly affect the mode of delivery of a service in question, or more precisely that the nature is not the principal determinant of the delivery mode.

Abstract

The paper as focused on factors influencing the choice of a public service provider. The significance of demand in decision-making about private (co)financing of public services is being analyzed. The first part of the paper is concentrated on economic approach to private provision and private (co)financing and economic character of public service as well. The second part is devoted to user charges and importance of demand elasticity. Finally, the possibility of private providing and limitations of private (co)financing of the concrete public services are being formulated. The authors conclude that the economic nature of the service does not directly affect the mode of delivery of a service in question, or more precisely that the nature is not the principal determinant of the delivery mode.

JEL: H4, H41, H42, H44

Key words: demand for public services, demand elasticity, public service provision, privately financed projects, Public-private Partnerships

Introduction

Provision of public services in the context of current social regimes deserves attention for several reasons. Public services are ‘vital for survival‘, both literally and figuratively; their content and form markedly influence citizens’ quality of life in all modern types of states. Even if we reduce our study of public services and the way of their provision only to economic aspects we still have to cope with a number of serious problems and research issues to be solved.

This article primarily focuses on the issue of decision-making about the practice of delivering services and the possibilities of their financing. We analyze the properties of services, which to a certain degree determine or eliminate concrete methods of their delivery and financing.

The service provided should be good and of high quality in the best interest of consumers, service guarantors and service providers as well; but all involved parties can understand the meaning of those concepts in a different manner. Le Grand (2007) identifies features of a good service. According to him a ‘good’ service must be:

- High quality,
- Operated and managed efficiently,
- Responsive to the needs and wants of users,
- Accountable to taxpayers,
- Delivered equitably.

We can both agree with or argue about this specification but it is not our goal to analyze individual features. When delivering a public service, however, we do not take into account only its output (or the fact of having provided the service) but also how the service has been delivered. Thus the whole process of service delivery is deemed important.

1. Private provision, private (co)financing

The last few decades saw the shift from the government as the major direct producer towards alternative, private providers, even in case of delivering the services that traditionally used to be the domain of public providers. Privatization of public services can have various forms and it does not have to involve change in the ownership or delegating responsibility for public services, their volume, structure and quality (Řežuchová, 2009). This article deals with the situation when various institutions, whether private or public, for-profit or non-profit compete or with more precision can compete to provide the service under conditions specified by the given public service guarantor.

Bailey (2002, 145-146) comments on the traditional preferences of monopolistic public service providers: Monopoly power was not restricted to the public sector. In whole areas of the economy, the public sector has been either the only supplier or so large in relation to total provision that its monopoly was near absolute. Rather than being the result of overwhelming economies of scale (and therefore efficiency), such monopolies were often the result of statutory constraints (e.g. formerly in public transport and energy) or of tax-financed provision free at the point of consumption (with the result that private producers found it virtually impossible to compete in education and health care).

This statement is obviously true not only about post-communist economies but also about a whole array of standard market systems. It expresses rigidity and certain protraction of public service delivery systems.

This rigidity on one hand and the growing need for new investment in the infrastructure coupled with a limited capacity of public resources on the other made many countries launch an initiative to enhance the role of the private sector in providing public services. The results of the initiative have been reflected in an increasing share of services provided through contracting but also in an effort to involve private investment on a larger scale or to increase the share of private (co)financing of public services.

Private financing or co-financing of public services is implemented by means of cooperation of public and private subjects on the basis of selected types of Public Private Partnership (PPP), such as DBFO (design-built-finance-operate), BOOT (build-own-operate-transfer) or using licences. In such cases a private subject provides public service^[1] and at the same time bears the costs incurred in this process by collecting user charges, and such like.

User charges revenues serve to cover operating costs of the provider, enables them to repay credits or possibly make a profit^[2]. If the charge is lower than the average costs then the public contractor has to make regular payment to the private producer. If the nature of the public service makes it possible, a private subject can perform non-core activities and a part of the revenue generated by the activities is used to partly finance concrete public service costs, which the private subject undertook to provide.^[3]

Financial mechanisms or forms of financial participation of private and public subjects are different in individual PPP types. Forms and level of participation depend on the nature of the concrete public service delivered. Cooperation and contingent private (co)financing in the motorway section operation, bridge construction, waste collection or building and running of some sports resort or hospital facility. This variability and ambiguity is very demanding for public contractors, particularly as far as the public services management is concerned, mainly the ability to precisely define the outputs, to conclude contracts, monitor and check the delivery of the service.

Generally speaking, contracting^[4] can be used if the costs of the public service are lower than those of the service provided by the public sector through its employees or organizations and if a comparable quality of service is maintained. It means if transaction costs related to seeking a suitable provider are low enough and the same applies to the costs linked with the process and output monitoring of the given public service. Contracting is also feasible if a private subject can provide the service at high quality, in other words if they can bring a higher ‘value for money’.

As in many other European countries it is necessary for the public sector in the Czech Republic to prepare a feasibility study prior to implementing PPP projects. Then possible ways of delivering the given service are compared. Existing methodologies recommended by responsible institutions of the Czech public sector explore using PPP rather from the process point of view, warn about individual risks of this concept^[5] and try to provide the methodology for prevention or minimizing the risks. They also highlight good practice cases and areas suitable for using of PPP. In common with the relevant legislation, mainly the public tender act and the concession act, they stipulate how a public sector subject should proceed in contracting.

How to determine which public services are suitable for private co-financing, or even complete and exclusive financing by the private sector ? This question should be answered before the public contractor commissions a feasibility study, which is rather costly. The answer is also indispensable for specifications needed for the public tender notice.

Due to the challenges of PPP projects we cannot always rely on the ‘good practice’, the method of analogy may not work here. PPP projects are characterized by their unique nature and they should be treated as such by the public contractor. In spite of the uniqueness of individual projects certain common features or factors can be identified by analysing implemented projects and pinpoint those, which accompany and influence the private (co)financing of concrete public services.

Our aim is to assess, under which circumstances it is suitable and possible to use private financing of public services. More concretely, if it is appropriate to apply some of the PPP types. The object of our research is to find the factors that influence private investment in the public service delivery. In the absence of generally recognized or universally valid factors we recommend to study mainly elasticity of demand for the public service and the possibility to impose user charges on the service. Analysis and discussion are performed with regard to the economic nature of the public service. They will result in formulating propositions that can be applied by guarantors and designers of individual public services.

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^[1] E.g. they construct and maintain infrastructure, collect household waste, etc.

^[2] Whilst private sector provision of public services is being encouraged, private companies must demonstrate that they can offer better value for money than any in-house providers. (Bailey, 2002, 150)

^[3] An example can be construction of a sports centre, where in addition to the centre’s operation; the private provider offers refreshment, runs a restaurant or sells souvenirs, leases the centre for commercial activities etc.

^[4] That is provision of public services by private providers or more exactly by the winner of competitive tender.

^[5] Operation risk, construction risk, political risk, demands risk, etc.

• College: Masaryk University
• Authors: Vladimir Hyanek (Author), Markéta Řežuchová (Author)
• Publication Year: 2009
• Pages: 18
• Catalog Number: V178723
• ISBN (eBook): 9783656009207
• ISBN (Book): 9783656009061
• Language: English
• Tags: significance, demand, decisions, private, public, services