1. “The problem with practitioners and researchers is that practitioners
practice but don’t read, and researchers read but don’t practice” (John
Briscoe, former head of the central Urban and Water unit of the World
Bank, 2014)
The Institutional Analysis of PPP Infrastructure
Incentives: How they Function
By Neil Boyle
December 2015
Ongoing since 2007
The incentives of PPP infrastructure projects start within the transaction— in the economic
exchange that occurs beween buyers and suppliers. The expected performance of the parties
generally serves to trigger motivation. Motivation for these incentives come from three sources
that are called transaction attributes: asset specificity—the special term economists use to describe
the level of specialization (k, from zero/negligible to high) that is exchanged between buyers and
suppliers of a transaction; uncertainty (from zero/negligible to high) another transaction attrubute
with a unique adaptive need for additional information (the ambiguity associated with makiing a
choice), a cost that is associated with the absence of information; and frequency—a third
transaction attribute that refers to the number of times the transaction is repeated and the reputation
effects that emerge as a result especially when communication among parties is facilitated as in a
cooperative or suppliers association (from negligible to high). Among the three, asset specificity
is the central attribute for discussing incentives.
Specialization is needed to solve the problem of complex production. Complex production is
another term economist use to describe transactions that involve incomplete contract, specialized
assets, uncertainty, and together a bilateral dependency sets in between the buyer and the supplier.
Most infrastructure investments by definition involve complex production due to the specialized
assets that are within the exchange process. A specialized exchange asset is what gives value to
the transaction that attracts corruption in one form or another. This may not include collusion
among bidders at the bidding stage of a project because collusion can be for any reason, while for
the specialized version of corruption there is a specific value that can be identified.
Curiously enough, Adam Smith was the first person to grapple with the role specialization played
in the organization of production. His study of the economic organization of 18th
century
Scotland’s pin industry led to solving the dismal production of a few number of pins per day to
several thousands per day by virtue of understanding the way the industry was organized. By
understanding the industry, he managed to observe its market price variation. Smith accomplished
this by discovering the relationships between and among the institutional concepts of the division
of labor, specialization, economies of scale, assembly line production, and self-interest rather than
individual fiat by monarch rule. On this last point, Smith found that individuals acted on the basis
of intrinsic self-motivation rather than on what the reigning monarch said was to be produced.
Asset specificity, however, is a double edged sword—the higher the specialization the more

2. nuanced are the incentives, and the more nuanced the incentives—the more opportunism sets-into
the transaction that tends to disrupt trouble-free operations.
As a result, this form of reciprocal relations between asset specificity and opportunism creates a
need for cooperation from the counterparty. Otherwise, in the presence of opportunities for private
gain, the guileful self-interest of the counterparty is activated. Because guile is a universal human
behavior, this works for both the buyer and supplier; guile is a threat to both parties and hence to
the success of the transaction.
These special purpose transactions are almost always governed by hybrid (aka long-term contract)
at mid=levels, of asset specificity, and at very high levels of asset specificity, hierarchy (aka the
firm) governance structures. General purpose (generic) transactions are governed by market
governance structures, the third of a generic (underlined) set of governance strucetures (i.e.,
markets. Hybrids, and hierarchies) Market intermediation excludes guile from taking root for two
reasons. The intense incentives of the market override most mediation hurdles, and thick markets
provide ample and ready exit strategies for trading with others. The supplier’s incentive would
have been to find the best competitive price for the good or service among the thick market of
numerous traders. Moreover, if generic assets were used, the value of continuing with the
transaction once the bill is paid diminishes to zero because general purpose assets do not need to
be continued—construction, equipment installation, commissioning, and operating the asset are
typically excluded from market trading. Once nuts and bolts are fastened and the bill is paid, the
technology operates on its own; this is generally quick, if not instantaneous in spot markets.
Maintenance of generic assets through some form of warranty may be needed.
In both specialized and generic governance cases, the business purpose of both parties is to jointly
increase the net present value of the transaction so that the project company benefits financially,
and hence in the case of PPPs, both partners gain according to pre-agreed shares, that is, there are
no bargaining costs.
But there are two additional reasons why incentives are unique in PPP infrastructure projects. The
first is PPP infrastructure assets have negligible productive value outside of the transaction for
which they were intended; they are non-redeployable durable assets. In financial terms, they are
sunk costs. For the supplier, the asset must complete its work in its intended transaction or it is
likely to be scrap, and in the event the project is terminated, its value would be near salvage levels.
The implication is in a pragmatic sense infinite continuity. The second reason is PPP assets are
unprotected from the guile of the counterparty so both parties require the cooperation of the
counterparty to protect its asset. This means the two parties to the contract are bilaterally
dependent and autonomous at the same time; they are dependent and independent simultaneously.
Autonomous bilaterally dependent incentives have profound implications on PPP infrastructure
systems where user charges are involved. They are likely to antagonize the indigenous culture of
consumer’s self-interest of affordability and equilibration of differences that are associated with
high bargaining costs.
When contract incentive structures are characterized by autonomous bilateral trading and
incomplete contract, disruptions will almost certainly occur and measures must be taken to
mitigate them promptly. Delay in the form of increased search costs (e.g., estimating the

3. probability of every contingency) through “blackboard economics” (as mentioned by a conferee
at the Ronald Coase Institute conference, Washington, DC, 2015), insertion of superior
institutional measures or arrangements should be initiated promptly without delay. These measures
are called “provisioning of contracts”, clauses that serve to reassign property rights of
organizational business rules of counterparty bureaucratic structures, among other things, are thus
obtained.
An important distinction should be made here. The difficulty lies in the relationship and not in the
individuals, per se. Autonomous individuals can handle most disruptions (by definition).
However, in the autonomous bilateral interaction, and in the absence of a sequential decision-
making apparatus, parties do not know or cannot rely on what the other is doing because
information flow is erratic, especially when the stakes are not trivial. This is the main characteristic
of a complex contract.
We also learned from organization theorist/economist Herbert Simon (1963) and Oliver
Williamson (1985) that promises were never self-enforcing, but because we glossed over this fact,
it was easy to continue doing so rather than to find a solution to the problem such as “credible
commitment”. (Credible commitment will be explained subsequently.) Instead, we tended to rely
on “efficient risk bearing” to mitigate any risk we identified, which was convenient to do under
the circumstances. However, efficient risk bearing is problematic; it succumbs to the guile of self-
interest.
Within all of the above, the twin assumptions of human behavior of bounded rationality (limited
cognitive capacity) and opportunism (guileful self-interest) of agents who design and manage
transactions are constant contextual conditions, the effects of which always require safeguarding
the agreement in project design, implementation, and enforcement. Similarly, politics must be
taken into account in ex-ante contract design and ex-post implementation because property rights
are defined through democratic politics. One implication of this is that while changing property
rights is well known among organizational theorists, another change process may be through the
machinery of politics.
Production opportunities that interact with the transaction’s asset specificity and uncertainty create
incentive structures. For example, production price is a common incentive setter. Production
quantity and related contingencies are also incentive setters. A cost plus contract sets up different
incentives than say a lump sum contract. The former gives budgetary discretion to the winning
bidder, while the latter limits the winning bidder to execution within a specified budget. The
former is used in technologically complex projects where advanced technological engineering
studies are incomplete and on-going. The combination of price and contingency is akin to reducing
the certainty of the established price. The latter raises the question of contract agents’ staying-on-
the contract curve (i.e., sticking to the agreement). Other combinations of production opportunities
and the attributes of transactions can also create incentive structures. For example, the market
buy-price for a farmer’s crop sets-up different incentive structures than an administratively-set
buy-price for the same crop.