A short article arguing against the common perception of concession contracts as being a more market-friendly way of dealing with natural monopolies in network infrastructure. The broad truth about concessions is that they can function like a market, but the structure of a concession is always going to be designed around achieving the government's political objectives.

1. Markets and Politics in Awarding
Infrastructure Concession
Contracts
Jonathon Flegg
j.c.flegg@nus.edu.sg
Concession contracts for private entities to In short, while concession contracts attempt to
operate publicly-owned infrastructure are function like a market, their structure is set in
almost universally considered to be an accordance with politics. Moreover of genuine
institutional innovation for realising the concern for achieving optimal policy is the
efficiency gains of the private sector. Given the ability of political considerations to override the
usually competitive nature of the bidding concession process if the government does not
process, the assumption of some private risk, prefer the likely concessionaire: The costly
and the concessionaire‟s profit motive, it seems problem of political risk. A final insight is that
tautological that there is a greater role for the concession contracts can and do substitute for
market in concession contracts when compared market forces but they are not necessarily a
with discretionary regulation. substitute for political forces or for discretionary
regulation.
This article takes a different approach to the
conventional wisdom in an attempt to remind us Market in Function, Political in Structure
of some important „broader truths‟ about the
innately political nature of concessions. While The structural characteristics of a concession,
certainly market forces are more evident in the and critically the method by which a concession
operation of concession contracts, in practice is awarded, are primarily the product of a set of
they are awarded within a wider institutional pre-defined political objectives. One
construct designed specifically to achieve the government might have a policy preference for
government‟s preferred set of policy objectives. deficit reduction over containing the „cost of
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2. living‟, while for a different government the This point is most obvious when the politics
relative importance of these policy objectives behind concession auctions generate an
might be in the opposite order. The government obviously sub-optimal outcome. For instance
that has placed a higher priority on deficit the New South Wales Government‟s 2002
reduction is likely to award the concession concession to build and operate Sydney‟s
contract to the firm that can operate the Cross-City Tunnel was offered to the bidder
infrastructure with the lowest government who could supply the Roads and Traffic
subsidy or highest concession fee, while Authority with the highest “upfront fee”. The
governments concerned about the costs to remarkable winning sum ended up being A$97
customers might award the concession to the million, which was passed onto motorists
firm who will charge the lowest user charge or through higher tolls, and eventually sunk the
tariff. contract after less than two years of operation
(Baker and Davies, 2006).
The awarding of a concession, if through an
auction and with an adequate number of In contrast the policy goal of deficit reduction
competitive bidders, is thought to be a evident in the Argentinian concessions on
reasonably close substitute for a free market urban railways and waterways during the 1990s
solution1. Specifically those auctions that award seems to provide a better solution when the
the concession to the bid offering the lowest minimum subsidy bid criteria was coupled with
consumer price are generally considered most a fixed price (Gómez-Ibáñez, 1997).
efficient, as price is generally how firms
compete within the spot market (Kerf et al 1998; Pro-poor political motives can also sink a
OECD 2007). However here it is important to concession. The 1997 water and sewerage
note that when the bidding process functions in concession for the Bolivian capital of La Paz
a market-like way it is still conditional on the was awarded to the private operator willing to
political objectives that determine the auction connect the largest number of households in
structure. the poor neighbouring city of El Alto (Komives,
2001; Estache et al 2002). The resulting tariff
1
A vast literature exists on the optimal design of auction
charged by the concessionaire together with the
processes (Kerf et al, 1988), as the design is critical to particularly exorbitant connection fee, resulted
achieving an efficient outcome. Inappropriate design can result
in winning bids below that do not reach the fully competitive in mass protests and the cancellation of
outcome, or can give rise to strategic voting or coordination
among bidders. concession.
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3. Direct Political Intervention and Political additional cost borne by firms as soon as they
Risk decide to invest in the expensive bidding
process.
Politics not only sets the structure of the bidding
process but also interferes within the process, Concessions Rarely Substitute for
including measures designed to promote or Regulation
prejudice specific bidding firms.
On the menu of possibilities for dealing with
In 2005 the Croatian Premier ordered the natural monopolies in infrastructure,
nation‟s Telecommunications Agency discretionary regulation is a more political
deliberately ruled out Adriacella, an Arab option because of the risk of regulatory capture.
consortium, from being granted a mobile The conventional wisdom generally views
telecommunications concession because of concession contracts as a less political
speculation about their “cooperation with the substitute for discretionary regulation (C.
narcotics trade” (Cvitić, 2005). A 2009 Kessides, 1993; I. N. Kessides, 2004; Gómez-
concession contract awarded to build and Ibáñez, 2003):
operate a light rail project on the congested
French island of Reunion was cancelled By establishing an explicit contractual
because of an opportunistic campaign directed relationship, concessions limit the
at the concessionaire by a newly-elected government’s discretionary powers and can
regional council (Thomson, 2010). reduce the risk of political expropriation (I. N.
Kessides, 2004: 105).
Because governments control the entire bid
structure they still have the capacity to appoint However in practice many network
or deny potential concessionaires in an infrastructure concession contracts do not
uncompetitive or non-transparent way. This is actually replace discretionary regulation
even more the case in structures for choosing (perhaps with the exception of the highway
concessionaires that are themselves non- sector). This important point has been noted by
transparent, such as by negotiation or beauty the OECD (2007):
contests. When governments circumvent their
own tendering or contractual procedures in this Concessions are not substitutes for regulation.
way the result is political risk, and is an Where there is a need for regulation, as in a
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4. situation of natural monopoly, a regulatory But if concessions do not reside in the market,
regime may be created along with the where do they reside? Unlike private contracts
concession. it is clear that they still belong in the public
realm, or at least to a sphere of “competition in
Most jurisdictions that utilise concessions for the politics”.
water, sanitation, telecommunications and
energy networks, also make the contracts At best concessions function like a market,
subject to a regulatory body. For instance, in within a bidding structure determined by
1992 the end of Buenos Aires state-owned politics. Rarely however do they operate in such
water and sewerage utility, Obras Sanitarias de an ideal way. In most jurisdictions, particularly
la Nación, was not only accompanied by the in developing economies but also in developed
introduction of widespread water and sewerage ones, the competitive process itself has very
concessions, but also a new peak concession little integrity, given that the government
regulator, Ente Tripartito de Obras y Servicios reserves the right to intervene specifically within
Sanitarios (Delfino et al 2007). the process to ensure the concession is
awarded to a firm with similar preferences.
Similar coupling of regulation and concessions Finally, the idea that a concession contract
is common in many economies in Latin creates a market-like bubble unsusceptible to
America, East and South-East Asia, the United politicised regulation is an exception rather than
States and Australia. So to the extent rule.
concession contracts do not substitute for
regulation in the real world, they cannot be To start the change governments committed to
viewed as operationally free from political implementing concession contracts must
forces. understand the costs that political risk place on
the private sector (and by incidence, end-
“Competition in the Politics” users), and seek in an enlightened way to „bind
their own hands‟ and allow competitive,
A useful distinction is often made between transparent bidding to take place without
competition in the market and competition for interference.
the market. A concession contract is
fundamentally different from the free market
solution because it is an example of the later.
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5. Bibliography Kerf, M., Gray, R. D., Irwin, T., Levesque, C.,
Taylor, R. R., and Klein, M. (1988).
Baker, J. and Davies, A. (2006, June 1). Concessions for infrastructure: A guide to their
“Taxpayers to pay twice for tunnel”. Sydney design and award. World Bank Technical
Morning Herald. Retrieved from: Papers 399. Retrieved from: http://rru.
http://www.smh.com.au . worldbank.org/Documents/Toolkits/concessions
_fulltoolkit.pdf .
Cvitić, P. (2005, July 18). “Sanader forbids
granting of concession to Adriacella”. Nacional Kessides, C. (1993). Institutional options for the
(505). Retrieved from: http://nacional.hr/ . provision of infrastructure. World Bank
Discussion Papers 212. Washington DC: World
Delfino, J. A., Casarin, A. A., Defino, M. E. Bank.
(2007). “How Far Does it Go? The Buenos
Aries Water Concession a Decade After the Kessides, I. A. (2004). Reforming Infrastructure:
Reform”. Social Policy and Development Privatization, Regulation and Competition.
Programme Paper No. 32: United Nations Washington, DC: World Bank.
Research Institute for Social Development.
Komives, K. (2001). “Designing Pro-Poor
Estache, A., Foster, V., and Wodon, Q. (2002). Water and Sewer Concessions: Early Lessons
“Making Infrastructure Reform in Latin America from Bolivia”. Water Policy 3(1): 61-79.
Work for the Poor”. CEPAL Review 78: 101-18.
OECD (2007). “Competition Policy and
Gómez-Ibáñez, J. A. (1997). “Privatizing Concessions”. Retrieved from: http://
Transport in Argentina”. Kennedy School of www.oecd.org/dataoecd/12/47/38706036.pdf/ .
Government Case Study CR1-96-1363.0.
(2003). Regulating Infrastructure: Monopoly, Thomson, A. (2010, April 22). “How politics
Contracts, and Discretion. Harvard: Harvard derailed a PPP”. Infrastructure Investor.
University Press. Retrieved from:
http://www.infrastructureinvestor.com/ .
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