In recent years a number of public authorities in Scotland have procured privately financed infrastructure projects using the “non-profit distributing” or “NPD” model. The NPD model was developed and introduced as an alternative to, and has since superseded, the traditional private finance initiative or “PFI” model in Scotland. It has been used in the education (schools) and health sectors and is currently being rolled-out in the transport sector. The model has been fine-tuned since it was first introduced.
You have been approached by National Audit Office, through their Assistant Director of Infrastructure investment, to write a report, with examples from your own experience or literature, which should include the following:
1) The basic principles that underpin the NPD model (as it will be applied in future privately financed infrastructure projects) and differentiate it from the traditional PFI model.
2) An exploration of the critical success/failure factors (reasons for success/failure) for NPD projects in the Scottish construction industry
3) What are the contributions to knowledge of your findings in part 1, 2 and 3?
An overview of the Non-Profit Distribution Model
In any country, the government or the regulatory authorities have the responsibility to maintain a high welfare for the residents of the country as a whole and to increase the economic growth as well as development of the same with time. To facilitate the increase in the overall welfare of the residents of a country, it is important for the government to assure that there are proper infrastructural framework in the country, which in turn helps in facilitating the overall development of the country in the long run. These infrastructural aspects involve the efficient production and dissemination of health and education services, transports, monetary welfare and employment generational activities. Most of these aspects fall under the domain of public good and are thus non-rival and non-excludable in nature (Auerbach et al. 2013).
However, to build adequate and efficient infrastructure in a country, huge amount of capital resources are required, which are not always possible for the government to gather alone. In these cases, more specifically in the contemporary periods, with economic development being one of the primary issues of concern, the government often collaborated with the private investors for this purpose (Bodie, Kane and Marcus 2014). There exist different forms of private public co-operations, negotiations and partnerships in the economy, which are used by the governing authority of the country for facilitating fund allocation and investment. Of these the most widely used one is the Private Finance Initiative Model. Under this Model, for infrastructural development, both the sectors enter into partnership for the purpose of procurement of funds (Iossa and Martimort 2015).
Taking this into context, the report tries to analyze the Non-Profit Distribution Model of fund procurement for public infrastructural developments and tries to compare the positive as well as the negative implications of the same vis-à-vis that of the Private Finance Initiative Model, which has traditionally existed in this aspect (Bidgood 2012). To compare the same and to highlight its problems and prospects the report takes into account the economy and infrastructural funding policies of Scotland.v
The Non-Profit Distribution Model has been developed by the governing authorities of Scotland, in the contemporary period in order to procure funds from the private sectors more efficiently. These funds are in turn are expected to be used for the development of the infrastructural and other public sector activities for the increase in the welfare of the residents of the country in the long run (Asenova 2013). This particular form of fund procurement policy, since its implementation, has gained considerable amount of popularity with regards to its uniqueness and potential profitability and has even surpassed the popularity of the traditionally popular PFI Model, which was the dominant system prior to the implementation of the NPD Model. In the sectors like health and education, which are the primary public welfare commodities and services, the government of the country has started implementing the same. it also has future plans of rolling out the same Model for fund collecting for the development of the transport infrastructures in the country (Hwang and Choi 2017).
NPD Model: Core Underpinning Principles
Like any Policy or Strategic Framework, the NPD Model is also made on the basis of several underpinning principles. These principles have the common objective of efficient and optimum procurement of funds from private sector sources for the purpose of investment in the infrastructural and other public goods production, which if appropriately distributed, are expected to increase the welfare of the society as a whole. The primary core principles of the NPD Model are as follows:
a) The funds are collected from the private sector with the principle of distribution of the returns or benefits of such investment being not similar to dividends, which are equity-based. That is, in the NPD Model of fund procurement, the investors do not bear the risk-return aspects of their investments and they get the amount as their investment returns, which are pre-decided and are not similar to the traditional models of investment procurement like PFI. Thus, under this principle, the subordinated-debt framework replaces the traditional equity-based framework (Inderst 2017).
b) One of the primary underpinning principles of this model is the principle of more inclusive and integrated environment comprising of more enthusiastic involvement of the private stakeholders as it includes their involvement in the infrastructural development of the society as a whole (Wang 2014).
c) The investment returns under the NPD Model of fund procurement, made by the private sectors, are limited to an upper ceiling. Thus, under this framework, the private investors investing in the public sector undertakings receive a pre-decided amount which cannot be increased after a certain limit, even if the returns from the investments surpass expectations (Asenova and Beck 2015).
The NPD Model, which has been established and rolled out by the government of Scotland, has taken the place of the traditionally existing Private Finance Initiative Model, to a considerable extent. The newly developed NPD Model varies in different aspects from the PFI Model, the primary reason behind these fundamental differences between the two models being the fact that the former developed from the shortcomings of the latter model (Hwang and Choi 2017).
The primary difference between the traditionally existing PFI Model and the newly established NPD Model is in the structure of return, which the private sector investors receive from their investment in the public sector projects. In the PFI Model, the private investors have the provision of deriving equity based returns from their investment and are also subjected to the risks of getting financially vulnerable to the success and failures of the projects in which they invest (Maltby 2013). However, this equity return aspect is absent in the NPD Model, as the investors under this model, are not a part of the risk and return system and there exists an upper capping on their earnings from their investments.
The PFI and the NPD Models: Differences and Comparisons
This in turn means that in the PFI Model, as the investors are also the risk bearers so in case of surplus generations from their investments on the public sector projects, the surplus is accrued to the investors only. This in turn, only increases their individual welfare and does not contribute anything significant for the overall welfare of the society as a whole. However, in the NPD Model of procurement of fund, there lies huge difference in the aspect of distribution of the returns from the investment on the infrastructural and other public sector projects (Cruz and da Cruz 2017). In this model, the investors getting back only a pre-decided amount of return from their investment, when surplus is generated in any of such projects, the surplus is not accrued to the private sector investors as there exists an upper limit to their earnings from the investments made by them in this aspect. The surplus generated, instead, is reinvested back to the community or the society as a whole, mostly in the form of welfare charities (Pautz and Bailey 2012). The surplus amounts are used to develop the lagging aspects of the society as a whole, thereby contributing to the increase in their welfare. Thus, it can be asserted that the NPD Model of procurement of fund has a component of societal welfare and community development in its framework, which is absent in its traditional counterpart, that is the PFI Model.
The implementation and rolling of the NPD Model, in the infrastructural domain of Scotland, is in the hands of the independent regulatory body, the Scottish Future Trust. The primary role of this trust is to obtain private sector finance for the purpose of investment in the infrastructural and other welfare projects taken up by the public sector. The main feature of the NPD Model being limiting the earnings of the private investors from their investments in the public sector projects, the Model has shown considerable success in the aspect of collection of fund, specifically in the construction industry of Scotland. After the rolling out of this model, the sector experienced a huge inflow of private investments and till date around 8000 additional jobs have also been created in the country.
In the past years, the procedure of fund procurement in the construction sector of the country, like many other sectors, was mainly based on the PFI Model. However, with time and increase in the complications of investment structures, the limitations of the PFI Model were seen, which became even more prominent post the Global Financial Crisis, which shook almost all the leading economies of the world. The effects of the same on the construction sector of the country were seen in the form of unequal allocation of returns with bias towards the large investors, lack of clarity and distorted developments in the construction industry. This left many small and medium investors skeptic as only the big ones were benefitting, thereby leading to a huge retraction of investment from this sector of the country.
This led to the creation of the NPD Model, which had this unique aspect of redistribution of the generated surplus for the betterment of the community aspects. The model proved to be highly successful in combating the Financial Crisis and bringing back investments in this sector, which can be attributed to several causal factors, which are discussed in the following sections.
The NPD Model has a unique system of upper capping the returns for the private sector investors from whom the funds are originally collected. But that does not deprive the investors from the privilege of earning profit and in fact shields them from the uncertainties of their investments in the public sectors. The investors have the facility to earn the pre-decided amounts from their investments. On the other hand, under this model, the surplus, if generated, is reinvested back to the development of the community as a whole, in some pre-designated sectors, which are found to be lagging, back (McKibbin 2016).
The inequality of distribution of the returns and the bias towards the big investors, which are present in the PFI Model are found to be absent in this model. The buffering of the small and medium investors from the risks of their investment have also contributed in increasing their enthusiasm in investing in these projects.
Though the capping system of returns from the investment apparently is expected to decrease the opportunity of the investors, however, proved to be beneficial, especially for the construction sector of the country. Though the expectations of returns from investment under the NPD Model is found to be much less than that of the same in the PFI Model (the expectations being set at 14% usually), results in lower bidding on part of the investors (Villalba-Romero and Liyanage 2016).
One of the most positive aspects of the NPD Model is the redistribution of the surplus generated from the investments in the infrastructural and other public sector projects. This model, having both economic as well as political motivation in its implementation, has considerable presence of public sector component in the partnership of the public and private sector, unlike that of the PFI Model. The greater presence of the public sector reduces the level of autocracy of the private players, especially the big and influential investors as in the PFI Model fewer restrictions were imposed on them. This in turn, decreases the lack of equity in distribution of returns in the NPD Model (Akintoye and Main 2012). The accruing of huge surplus to the big investors are also absent in this model and the allocation of surplus to the societal welfare aspects contribute towards the increase the overall wellbeing instead of making the rich richer.
The positive aspects of the NPD Model being noticeably effective, the construction sector of the country has been seen to be benefitted to impressive extent from the implementation of the NPD Model, which has also laid ways for the government to roll out the same model in other sectors too. However, the model is now entirely devoid of flaws or shortcomings and there are still many investors in the country, who prefer the PFI Model over that of the NPD Model of fund procurement (Whitfield 2016). The primary factors, which contribute to the limitations of the NPD Model, are discussed in the following section:
The primary factors having the negative effects in the NPD Model are as follows:
The model of NPD framework has the unique characteristics of redistribution of the surplus generated from the investments to the other community aspects. This implies that there is significant presence of the public sector control over the investment and especially on the allocation of the surplus generated. For this purpose, there is the presence of Special Purpose Vehicle in the country, which is bestowed with the responsibility of allocation of the private investment in the public sector projects. However, though the decision making power is bestowed primarily with the SPV in the public sector, however, the risks of investments are borne by the private sector investors, who lacks the decision making power (Morris). This in turn, creates a lack of incentives of the private sector investors to invest on these aspects as they feel vulnerable to the negative implications of the decision makers who are not the direct fund providers of the projects.
The presence of the upper capping on the returns from the investments by the private sector investors in the public sector undertakings, clubbed with the mechanism of distribution of the generated surplus among the community and society welfare upgrading projects also create huge discouragement among the private investors. This is especially true for big investors, who find it more profitable to invest elsewhere, especially in other countries where the PFI model is still in existence (Roy, Eiser and Lisenkova 2016). This leads to considerable drain of investment outside the country. The empirical evidences, in fact support this,, which shows that many big investors in the construction sector of the country have relocated their investment to other sectors or outside the country, after the substitution of the PFI Model by the NPD Model in the country.
From the above discussion, it can be concluded that there are still many scopes of improvement in the framework of the NPD Model, in order to make it wholesome and efficient for the purpose of procurement and allocation of the funds. The corrective measures, which can be taken for the concerned purpose, are as follows:
a) The incentive mechanism of the NPD Model has to be changed significantly in order to attract the big investors back in the sector and to stop the drain of investment to other sectors or to other countries.
b) The decision making power should not be only in the hands of the public sector regulating body but also has to be partially with the private investors as well, which will in fact increase their enthusiasm (Gregson, Mann and Harrison 2013).
c) Though the refinancing mechanism is not advocated, however, this is a requirement in the investment scenario and thus efficient capital framework has to be made in order to implement the same.
From the above discussion, it can be asserted that the NPD Model, which have been newly implemented by the government of Scotland, has shown immense prospects and potential in the implications. The program has shown the ability to substitute the PFI Model fully. However, there still are scopes for development of the NPD framework so as to make the Model more efficient as well as beneficial for the society as well as for the investors and their overall welfare.
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