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Private finance initiative in incomplete contracts: Theory and evidence from Japan

Author

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  • Fukuda, Yukari

Abstract

Private finance initiative (PFI) is a way of creating "public–private partnerships" (PPPs) where private firms are contracted to complete and manage public projects. The purpose of this paper is to investigate how to achieve a desirable procurement contract in PFIs. In the first part, we develop an incomplete contracting model to analyze the effectiveness of PFIs. We show that an appropriate fixed compensation is important in disentangling adverse selection. In the second part, we test the validity of this theoretical implication by case study of “Thalasso Fukuoka” and by cross-sectional analysis on Japan’s PFIs. The case study indicates that adverse selection under overestimated value for money (VFM) was a major reason for why the project failed. The cross-sectional analysis also shows that when the local government had overestimated the initial VFM, adverse selection discouraged private companies with higher reservation profits to apply for the project. It suggests that the overestimated initial VFM could make the project less productive even if it did not lead the project to bankrupcy.

Suggested Citation

  • Fukuda, Yukari, 2019. "Private finance initiative in incomplete contracts: Theory and evidence from Japan," Japan and the World Economy, Elsevier, vol. 50(C), pages 56-65.
    • Handle: RePEc:eee:japwor:v:50:y:2019:i:c:p:56-65
    DOI: 10.1016/j.japwor.2019.04.002
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    Cited by:

    1. Yukari Fukuda & Jun-ichi Nakamura, 2021. "Economic Analysis of Public-Private Partnerships in Japan: Theoretical and Empirical Analyses Focusing on Adverse Selection and Synergy Effect," Public Policy Review, Policy Research Institute, Ministry of Finance Japan, vol. 17(2), pages 1-27, November.

    More about this item

    Keywords

    PFI; Incomplete contract; Adverse selection; VFM;
    All these keywords.

    JEL classification:

    • H40 - Public Economics - - Publicly Provided Goods - - - General
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate
    • H72 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Budget and Expenditures
    • H83 - Public Economics - - Miscellaneous Issues - - - Public Administration

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