Public-private partnerships in Mexico: Challenges and opportunities at local level

Article Public-private partnerships in Mexico: Challenges and opportunities at local level Hugo J. Fuentes Tecnologico de Monterrey, Mexico Gustavo Mendoza Instituto de Seguridad y Servicios Sociales de los Trabajadores del Estado, ISSSTE, Mexico Miguel A. Montoya and Ismael Aguilar Tecnologico de Monterrey, Mexico Abstract A specific challenge related to infrastructure creation that is faced by several countries has to do with the lack of participation to an optimal level of subnational governments in the development of Public Private Partnership (PPP) projects which, in turn, could offset the existing infrastructure limitations. In this article, we analyze the Mexican case, whose main feature is that, despite implementing the PPP scheme for almost 10 years and having technical assistance from international organizations to establish the required institutional framework (i.e. legal and technical dimensions), local governments have not been able to create the necessary competencies to carry out this type of project. In order to assess local governments on this subject, we conducted an analysis based on the model designed by the OECD in relation to the execution of PPP projects. A proposal to explain the lack of local government participation in PPP schemes, rests on the foundations of so-called ‘‘subnational authoritarianism.’’ Keywords Public private partnerships, infrastructure, Mexico, subnational Corresponding author: Miguel A. Montoya, Tecnologico de Monterrey, Escuela de Arquitectura, Arte y Disen ˜o, Av. Gral. Ram´ on Corona 2514, Zapopan, 45201, Mexico. E-mail: [email protected] Competition and Regulation in Network Industries 2021, Vol. 22(1) 35–52 ªThe Author(s) 2021 Article reuse guidelines: sagepub.com/journals-permissions DOI: 10.1177/1783591720987698 journals.sagepub.com/home/crn CRNI CRNI Introduction Despite counting on the PPP model as a strategy to generate public services and infrastructure since 2012, the Mexico has not attained the expected outcomes. The use of this scheme has been rather limited even though there have been meaningful steps to define the institutional and contractual design thereof, which has led Mexico to occupy the fourth place in Latin America since 2014 regarding its potential capacity to develop sustainable PPP programs. It is essential to bear in mind that, as it is a Federal Republic, Mexico deals with two different institutional frameworks: ‘‘federal’’ (applicable across the whole country) and ‘‘state’’ (specific to each state). In the case of the development of PPP projects, these two dimensions coexist to foster this funding mechanism. In this context, the works conducted by Wood (1991), Bullock et al. (2017), and Terman and Feiock (2015), highlight the relevance of the coexistence and implementation of both legal frameworks to explain either the success or failures of public policy performance. In Mexico, during the 2012–2019 period, 25 PPP projects were carried out. 100%of these were classified as federal projects. In light of this, it is necessary to draw our attention to subnational entities to understand the causes of their low participation. Mexico is a Federal Republic comprised of 32 subnational entities known as states, whose engagement in PPP projects can be regarded as meager. 1 The inexistent participation of subnational governments in PPP projects is not a problem exclusive to Mexico. As pointed out by Frank and Mart´ınez-V´azquez (2015), local governments often overlook the development of procurement systems and related capacities. They also underline the fact that the decentralization process, when not being accompanied by a robust accountability and transparency legal environment at the local level, is likely to foster corrupt practices. Reyes-Tagle (2018) and OECD (2018) also analyze the challenges related to national and subnational government coordination along with political commitment. A fact that must be stressed is the high likelihood for the initiated projects to be truncated or unfinished. This article, based on the Mexican case, shows that states have not intended to implement the required institutional conditions to generate PPP projects. The analysis that supports this idea stems from the OECD model to diagnose a government’s capacity to execute PPP projects. The OECD study is applied on a national level, whereas this paper replicates it for the subnational dimension in the Mexican Republic, assuming that the analyzed items represent the basic conditions for the institutional design in relation to the establishment of the PPP model. Likewise, this work has special importance within the Mexican context: a developing country, under a Federal model, facing large shortcomings in public infrastructure, with an acceptable institutional framework on PPP, that has not been able to take advantage of this scheme. The Mexican experience may become a valuable reference for other developing countries that seek to develop this investment model. It is worthwhile to mention that there was institutional support from several international organizations before and after 2012, aimed at fostering the suitable conditions to trigger investment initiatives under the PPP schemes. The outcomes did not meet expectations as they did not manage to capture the local governments’ interest to improve their technical, legal, and institutional capacities to generate PPP projects. 1. Each state in turn is comprised of municipalities. 36 Competition and Regulation in Network Industries 22(1) In order to explain the lack of participation of states in the development projects, this article alludes to the concept ‘‘subnational authoritarianism’’ (Gibson, 2013), which is focused on the institutional and political circumstances that lead the behavior and incentives of local authorities. This study is comprised of six sections: The first one develops a literature review on the relationship between the application of PPP models and subnational governments; the second section expounds the use of the PPP scheme in Mexico; the third presents the used methodology to assess the states capacities to develop PPP models; the fourth one includes a diagnosis of local government capacities to manage and implement the PPP model; the fifth carries out an analysis on the obtained results; finally, the six section draws out the main conclusions of the analysis. The development of the PPP model and subnational governments The PPP model is an alternative to the traditional schemes of infrastructure building. In 1992, the British Government launched two public investment schemes to encourage private sector participation: The Private Finance Initiative (PFI) and Public-Private Partnerships (PPP) (Cummings, 2007). These initiatives were directed toward the provision of services, such as transportation, defense, water, education, and health. In a PFI project, the government signs a long-term contract (15 years or more) with a private company to design, finance, construct, and operate schools, hospitals, roads, and prisons (among others). The advantages of this approach are that the government does not need to disburse the expenses for infrastructure all at once and the private counterpart takes charge of maintenance in exchange for a periodic payment. In theory, PPP projects provide several benefits as a financing option for governments. They contribute to generating basic infrastructure, taking advantage of the economies of scale and the experience of the private sector, while diminishing agency costs. Additionally, in the end, there are efficiency gains (Milgrom & Roberts, 1990). Through this scheme, there is access to multi-year projects that involve large-scale infrastructure, which are not affordable through public funds due to governments’ annual budget cycles and restrictions. Well-designed PPPs provide certainty to private agents as to whether governmental changes will affect previously agreed arrangements. For Middleton (2000), the long-term nature is fundamental for an effective, stable, and long-lasting relationship. Nevertheless, subnational participation has represented an obstacle that hampers the thorough application of PPP models in developing countries. As pointed out by Frank and Mart´ınez V´azquez (2015), the infrastructure in the subnational dimension has become one of the main challenges of contemporary public finance management and policy. According to Sood et al. (2012), despite the weight of the central/federal governments in the generation of PPP projects in developing countries, the role of subnational governments has gained ground in the making of these kinds of projects. Specifically, from the perspective of Sood et al., focusing on the regions that are encompassed by the Asian Development Bank (ADB), it is necessary to conduct substantial improvements to the financial information standards and performance of local governments (i.e., accountability, information, training and communication). These improvements are likely to help build more trust between the different stakeholders as a result of better information flow as well as the right design of incentive mechanisms to promote low costs and higher yields. The Economist Intelligence Unit (2017), referring to the Brazilian case, stresses that besides the need for developing the capital markets even more, and increasing the number of commercial banks and institutional investors (domestic and foreigners), a meaningful challenge is linked to the development of technical capacities to evaluate and structure the PPP projects on a local Fuentes et al. 37 government level. Furthermore, it also emphasizes the requirement for transparency and accountability standards to be strengthened as a way to protect public infrastructure projects from the corrupt mechanisms observed in 2016. Reyes-Tagle (2018) points out that complexities and risks of PPPs are even more clear at the subnational level. too many local PPP laws at the state level may have the effect of fragmenting the PPP market and discouraging investment. Subnational government entities often have limited capacity for PPP project development and procurement. In this sense, OECD (2018) also emphasizes challenges on coordination, management capacities, political commitment and accountability. The main aspects to analyze are the figures of PPP model implementation at the states as well as their institutional capacities to undertake this kind of projects. Public-private partnerships in Mexico High population growth exerts pressure on investment to finance infrastructure. Notwithstanding the efforts made, public investment has not kept pace with this additional demand. This limitation of public investment has been aggravated by the usual budget cuts produced by the fall in oil prices. Moreover, there is a serious tax evasion problem (Fuentes et al., 2014). Despite the fight to diminish this evasion, it is still largely occurring and brings about a sharp reduction in income for the government. The reductions in the federal government’s infrastructure spending affected the position of Mexico in the world ranking of infrastructure. According to the 2017–2018 Global Competitiveness Report (WEF, 2017, p. 203), the country was positioned 62 out of 137 nations (from 57 one year earlier, 59 in the year 15/16, and 65 in the year 14/15). This decrease has negative impacts on business and the economic environment. The report shows that economies smaller than Mexico’s have grown faster in terms of infrastructure quality. The evolution of the federal normative framework in Mexico to promote public-private participation in the development of infrastructure, has had different phases. The privatization program implemented in the 1980s was conceived as a cure to the inefficiencies of state companies, but actually had the goal of balancing federal government public finances (Ram´ırez Cedillo, 2007). The mixed results of this privatization process caused the search for new mechanisms. At the end of the 1990s, contracts for public works financed by the private sector emerged to trigger investments, especially in the energy sector (the Federal Electricity Commission and Mexican Petroleum para-state company). This type of contract is known as Programa de Inversio ´n de Impacto Diferido en el Gasto (PIDIREGAS, in Spanish). The use of PIDIREGAS, which basically meant constructing now (by private agents) and paying later (by the government), has brought about criticism due to the lack of fiscal transparency (Del Castillo & Frank, 2003). Over the years, this program has been perceived as a masking of long-term debt in public accounts. In order to improve transparency, in 2002 the Ministry of Finance (SHCP) implemented the following actions: a report on public sector borrowing requirements (SHCP, 2011a); a key ratio for the analysis of the fiscal stance that incorporates off-budget transactions and detailed information on the state of implementation; and the financing of PIDIREGAS projects. These measures improved the country’s risk position and they were also aimed at the reduction of expenditures from the federal budget in order to redirect them to other programs (Nun ˜ez-Luna, 2005). 38 Competition and Regulation in Network Industries 22(1) The program of highway concessions undertaken by President Carlos Salinas’s administration (1986–1992) was a bad experience. Given the need for considerable investments to broaden the federal roads network and guarantee its maintenance and efficient operation, it was decided to grant the private sector 52 freeways with a validity of up to 50 years. In 1997, in the face of financial problems for the operating companies, the federal government had to bail out 23 out of 52 granted freeways, assuming a debt of $57.7 thousand million pesos (US $3.11 billion) (CEFP, 2007). At the end of 1997, the total cost for the rescuing of roads went up to $58.1 thousand million pesos (US $3.14 billion). At the end of 2006, the cost reached $178.3 thousand million pesos (US $9.62 billion). 2 Provision of services project model (PPS) Once the lessons of the roads rescue was learnt, in the first decade of the 21st century there was a search for schemes to attract private participation under a different design that would allow the flow of financial resources for project construction. This is how provision of services projects, better known as PPS (for its Spanish acronym), emerged on a federal level, emulating the British Private Financing Initiative model (SHCP, 2011b). In a typical case of the PPS model, the providing investor takes over the design, financing, construction, operation, and maintenance of assets and services. By and large, the public sector can propose any project whose services, levels of quality, and long-term risks can be defined. However, in order to develop a PPS project, it must be demonstrated, through cost and benefit analysis, that its net social value will be positive compared to a traditional public investment reference project. PPS projects presented several design-related problems. A fact to single out is the continuous lack of systemic coordination between agencies involved. This implied either the risk of losing synergies between projects, or the selection criteria not being homogeneously applied. An additional problem was that the multiyear framework was not guaranteed, raising the uncertainty risk for private investors in terms of long-term infrastructure development. Summing up, the PPS model presented a legal puzzle, low coordination, and inability to finance long-term projects. This was the context for the appearance of a new model: PPP projects. Public-private association model (PPP) Public-Private Partnerships in Mexico were envisioned as a more comprehensive framework to improve the amount and quality of investment (SHCP, 2011a). They were conceived as contracts between public and private sectors to plan, construct, operate, and maintain long-term public infrastructure works, as well as the provision of services related to these projects. After a long learning process, in November 2009 the Federal Executive sent the Senate an initiative for a Federal Act on PPPs (LAPP). Before this initiative, the functioning of PPPs was more in the modality of a PPS project and subject to federal entities or states own legislation. As a matter of fact, Nayarit was the first state to rely on a PPP Law in 2006. There was insufficient transparency, especially regarding the adjudication procedures. Given the large scale of highway and water infrastructure projects and the fact that several of them involved the participation of more than one state, more uniform legal certainty and 2. As for privatization process experience, one can read: Chong and Lopez-Silanes (2005), Estache (2008), Estache and Trujillo (2008) and Kay (2002). Fuentes et al. 39 security became a must. In this new rationale, risk analysis had a more profound consideration and so did the determination of the best financial options (traditional public sources or PPPs). In January 2012, a specific regulatory framework was issued for the development of Public Private Association projects (APP for its Spanish acronym), a Mexican version of the British PPP model, as mentioned before. The PPP Law that emerged (LAPP in Spanish) intended to regulate the process of structuring and approving projects, as well as securing the guarantee and transparency of payments under only one system. The LAPP was published in the Official Gazette (Diario Oficial de la Federaci´on, DOF) on January 12th 2012. The regulatory body of the LAPP was published in the DOF on November 5th, 2012. The law defined mechanisms to solve disputes and the early termination of contracts, bringing legal certainty to the actors involved and minimizing the occurrence of risks. The modified law empowered the Secretary of Finance (SHCP) over federal dependencies and states in the process of the structuring and preparation of projects. This means that for any project that federal dependencies or states want to develop, they must first apply for the project’s enrollment to the SHCP as a Public Investment Project (PPI for its initials in Spanish) and justify its cost effectiveness. After that, there are legal steps to guarantee the execution of multi-year projects. The Public Expenditure, Financing, and De-Incorporation Inter-Ministerial Commission has to give authorization for the projects to be prioritized and authorized so they can be incorporated into the Public Budget of the Federation in the section that guarantees the multi-year quality of projects. Once the PPP projects are approved, they are submitted to the bidding process under the strict responsibility of the federal agency or state entity. After awarding the projects, the SHCP has the obligation to integrate a registry of the approved projects under the PPP scheme. 3 The works conducted by Sada and Sada (2014) and Lozano et al. (2017) show transparency, information access and accountability weaknesses; however, the current evolution of the legal framework has contributed to improving these aspects and entails greater advantages in relation to previous financing models. In this context, SOFT (2016) expounds the potentialities of the model for the legislative work in the Chamber of Deputies in comparison to the financial restrictions and voids as belonged to former models. For instance, there is an obligation to register the projects, which means that local governments cannot compromise public funds without making it visible. In addition, it is required to publish the figures of costs and additional revenues linked to the PPP projects. Likewise, it is necessary to determine deductions (recoups) due to a bad performance of the private entities involved in the project. This effort requires the establishment of a surveillance system along with a PPP supervisor, whose main responsibility is to collect ‘‘tickets’’ (evidence) of bad performances, thus minimizing a potential collusion among private parties and reducing the risk of the misuse of public funds. As for the states’ involvement to formalize PPP model, Reyes-Tagle (2018) show that 27 of the 32 states have their own local PPP framework, many of which have different definitions or scopes. Since the implementation of the PPP Law in 2012, many Mexican states have harmonized their local laws and regulations to be in line with the federal law. Nevertheless, this does not ensure, as it will be seen later, a real participation of states. 3. In relation to PPP implementation, one can consult: Akitoby et al. (2007), Guasch (2004, 2016), Li et al. (2005). Regarding the factors linked to a successful PPP application: Osei-Kyei and Chan (2015), Zhang (2005), Roehrich et al. (2014). As for the experience in the use of PPP: Emek (2016), Flores (2017) Gonzalez Guerra (2014), Thomas et al. (2012). 40 Competition and Regulation in Network Industries 22(1) Regarding subnational participation in the total number of projects developed in Mexico in the period 2005–2011, the so-called PPS projects, Figure 1 shows 20 projects in different areas (15 federal and 5 belonging to states). As for the period 2012–2019, one can see in Figure 2 that there were 25 PPP projects in total (25 federal and 0 belonging to states). Despite an increase in the total number of projects during this period, there was a dramatic reduction in state participation (down from 25%to 0%). It is important to note that the projects included in this analysis referred to those that were executed. The cases of those that were proposed without being implemented are not considered. Methodology: Measuring the capacity of state governments in Mexico to implement PPP schemes As it was described in the previous section, the number of PPP projects carried out during 2012– 2019 is zero. In view of this, it is meaningful to analyze whether states fulfill or not the required conditions to develop this kind of projects. Therefore, it is necessary to count on a thorough and robust methodology that provides us with the answer. An important contribution of this article is the unprecedented exercise of analyzing PPPs at the subnational level in Mexico. Following the methodology of the OECD on regulatory governance 3 0 2 0000 3 1 7 3 100 0 2 4 6 8 Health Ports Security Airports Educaon Communicaons Transportaon State Federal Figure 1. PPS projects-states vs. federation (2005-2011). Source: Own elaboration based upon federal budget. 0000000 8 23 001 11 0 5 10 15 Health Ports Security Airports Educaon Communicaons Transportaon State Federal Figure 2. PPP projects-states vs federation (2012-2019). Source: Own elaboration based upon federal budget. Fuentes et al. 41 and policy for country level (Arndt et al., 2015), a framework of analysis was constructed through the use of 12 criteria grouped into three blocks (Table 1). The first block includes an analysis of the elements that are related to the design of a straightforward promotion policy for the PPP schemes, such as: (1) the existence of a clear communication strategy to different groups, aimed at promoting the use of the PPP scheme in the state; (2) a clear leadership commitment at the toplevelofthesubnationalentityonbehalfof the governor; (3) the existence of a robust and solid mandate included in the state public management strategic documents in order to foster the use of PPP schemes as an alternative to developing investment projects. The second block comprises a set of factors, so-called institutional elements, which consist of: (1) the existence of a well-designed legal framework to control the implementation of PPP schemes, such as the PPP State Act; (2) the issuing of the regulation on the State Act which must define the scope of actions and limitations that either the state ministries or municipalities face to develop PPP projects or, in its absence, the existence of administrative guidelines. In this section, the existence of any specialized areas within the state governments which oversee and promote the Table 1. Criteria for a successful regulatory PPP framework at the state level in Mexico. Block Criterion Criterion Definition Policies Communication Identifies the existence of a speech or announcement where the governor instructs to prepare projects under the PPP scheme. Leadership Identifies the existence of a clear message from the governor or state high level officials instructing public servers on the implementation of PPP projects. Clear Command Identifies the existence of some government plan or strategy that includes structuring APP/PPP investment projects. Institutions PPP State Law Identifies whether there is a specific law in matters of PublicPrivate Associations. Set of Rules Identifies whether the law has a specific set of rules. Guidelines Identifies the existence of some secondary instrument to regulate projects under the PPP scheme. Specialized Area Identifies whether there is an area inside the government in charge of structuring, preparation and bidding for PPP projects. Tools Training Identifies whether there is a specific program to train public officials in matters of Public-Private Associations. Project Management Identifies the existence of an area responsible for execution and follow up of PPP projects. Project Registry Identifies the existence in the government of some registry with all the information related to the projects in order to make it public and transparent for consultation by businessmen and citizens. Clear Evaluation Process Identifies whether there is an evaluation process for projects that is private and contains clear technical profitability and legal criteria to determine the viability of a PPP. Clear Approval Process Identifies whether there is an explicit and clear process with each of the steps that dependencies and para-state entities must follow to authorize a PPP project. Source:Own elaboration based upon the methodology of Arndt et al. (2015). 42 Competition and Regulation in Network Industries 22(1) execution of PPP schemes were identified, including control of the project endorsement and its corresponding follow-up. Finally, the third block is focused on determining the existence of tools to promote the use of the PPP model. In particular, it analyzed: (1) the presence of permanent training programs to build capacities as to the projects’ preparation and endorsement, as well as the conduction of procurement activities; (2) the development of a formal and official data bank on the projects, along with relevant documents that justify their implementation, whose main purpose is to prioritize the development of certain projects, as well as creating suitable conditions for citizenry and firms to have access to relevant public information on PPP schemes; (3) the establishment of clear and transparent processes regarding the evaluation of projects (for those states ministries involved and potential private sector petitioners), and the development of a straightforward endorsement process with a clear and transparent methodology to create certainty before municipality treasury offices and local legislatures; and, finally, (4) the existing capacity of states to manage procurement and follow-up processes on PPP schemes, as well as dealing with contingent liabilities. Through a careful analysis of the states’ PPP legal frameworks, along with interviews with key actors, this article evaluates if they have in place the required policies, institutions and tools to encourage the development of PPP projects on a subnational level. Public-private partnerships at a subnational (state) level Table 2 shows the state level criteria fulfillment established in Table 3 (number of criteria covered / 12) * 100. The results for the 32 states show that, even if Mexico occupies the sixth place internationally to potentially develop PPP projects, at a sub-national level the making of PPP Table 2. State level fulfillment of criteria for a successful PPP in Mexico (percentage of fulfillment). Ranking of Criteria Fulfillment (in percentage) Ranking State Percentage Ranking State Percentage 1 Baja California 91.7 6 Michoacan 50.0 2 Tabasco 83.3 6 Colima 50.0 2 Nuevo Leon 83.3 6 Guerrero 50.0 3 Queretaro 75.0 7 Estado de Mexico 33.3 3 Baja California Sur 75.00 8 Yucatan 25.0 4 Chiapas 66.7 9 Aguascalientes 16.7 4 Morelos 66.7 9 Chihuahua 16.7 4 Sinaloa 66.7 9 Jalisco 16.7 4 Veracruz 66.7 9 Zacatecas 16.7 5 Campeche 58.3 10 Mexico City 8.3 5 Hidalgo 58.3 10 Guanajuato 8.3 5 Oaxaca 58.3 10 Tlaxcala 8.3 5 San Luis Potosi 58.3 11 Coahuila 0.0 5 Sonora 58.3 11 Durango 0.0 6 Tamaulipas 50.0 11 Puebla 0.0 6 Nayarit 50.0 11 Quintana Roo 0.0 Source: Own elaboration based upon the methodology of Arndt et al. (2015) and the state legislation analysis of PPPs. Fuentes et al. 43 Flores, S. A. (2017). La ecuaci´on entre APP, infraestructura h´ıdrica y derecho humano al agua. Revista Agua y Saneamiento, July–August, pp. 41–50 Frank, J., & Mart´ınez V´azquez, J. (2015). In J. Frank & J. 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