GCC nations must pass clear laws to make public-private partnerships work

The skylines of major Gulf Cooperation Council cities are marked by great feats of engineering, yet infrastructure development across the region is not without challenges. For the region to continue blazing architectural trails, development requires diversification and policy changes — and with investment at its highest level ever, the time for action is now.

Large-scale development work is accelerating across the GCC, offering a favorable environment for foreign investment and partnerships. The Emirates continue to invest heavily in their infrastructure, as are Saudi Arabia and Qatar, while Bahrain has announced ambitious plans for years ahead.

So, what’s the problem? Around the world large-scale building projects have typically been undertaken by the public sector, yet the government machine is not always the most efficient operator, sometimes resulting in cost overruns, delays, and lost opportunities.

Of course, there are notable exceptions — such as Singapore and Dubai — but worldwide, projects run by the state tend to cost more, waste more, and deliver less. In other words, for the price of running two bridges, the public sector will typically run one.

Why then, do governments take on the responsibility for developing roads, utilities, and other mega-projects? First, the initial financial outlay on infrastructure projects is immense, and the returns can lie a decade — or, even two — into the future. Second, those returns are often indirect, taking the form of new jobs, gross domestic product growth, or higher tax revenue. For national governments, it makes perfect sense, but private firms simply can’t afford to wait tens of years to make back their money, while indirect returns just don’t make for a viable business.

Bottom line incentives for the private sector are in short supply when it comes to government-run projects, a problem that is exacerbated by often unfavorable terms laid on the table for firms. Governments have historically worked on the assumption that private firms need the public sector more than the public sector needs private companies. In the process, they have burdened businesses with the lion’s share of risk and financial responsibility.

But there is good news. The solution to the problem is within reach — and it lies in a revamp of public-private partnerships. It goes without saying that no two countries are the same, but some fundamental principles can be applied across the region to make public-private partnerships the key to unlocking infrastructure potential.

Three fundamental principles should be remembered when approaching these partnerships.

The first is that the right party should be in charge of risk. For example, if the risks associated with currency exchange variation or oil price fluctuation are put on the private sector, then companies will increase their costs to absorb them. The public sector is better placed to address such risks more cheaply — reducing the overall cost of the project.

Second, revenue must be guaranteed. Governments need to guarantee minimum appropriate revenue to the private sector. For instance, in the case of a public-private partnership to build a toll road, a private company cannot be asked to guarantee the traffic that will pass through. Instead, the government should estimate the number of vehicles, and if the actual number falls short, it should pay a sum to the private sector partner.

This might sound like a bad deal for the state, but the opposite is true. After all, if the public sector passes the responsibility on to private firms, they will increase — or, even double — their costs to cover any shortfall. Obviously, if the public sector is guaranteeing minimum revenue, they can then go on to ask for a higher share of any profit from the road, which is fair.

Finally, governments should pass regulations that reassure private firms. As infrastructure projects often run for 10, 20, or even 25 years, the private sector can be left feeling uneasy about the implications of a change in leadership over that time. To quell this fear, governments must give confidence to the private sector that commitments will be honored. This can be achieved through robust regulations, insurance policies, or a change in mindset that will leave companies at ease.

India’s toll roads illustrate what can happen when such reassurance is absent. The Indian government canceled contracts as the revenue to the private sector turned out to be three to four times higher than expected. As a result, the private sector is now hesitant to enter public-private partnerships for toll roads in the country.

Last year, Saudi Arabia worked to understand why public-private partnerships had previously failed in the Kingdom and began developing policies and frameworks to set it on course for success. The result is an updated by-law, which supports what now counts as the most active public-private partnership market in the Middle East and North Africa region.

A key step is that the public sector offers much-needed incentives and guarantees to private businesses. After all, the benefits of good infrastructure far outweigh the little extra required to incentivize private firms to build these major projects.

• Thomas Kuruvilla is managing partner at management consultancy Arthur D. Little, Middle East