4.8. Compensation to project sponsor/developer

Forms of compensation to private sector

There are five main ways to compensate a private investor of a PPP project:

  • Direct charging of users
  • Indirect charging of (third party) beneficiaries
  • Cross-subsidization between project components
  • Payment by the Government (periodic fixed amount or according to use of the facility, product or service)
  • Grants and subsidies (already discussed in a separate section)

Direct charging of users by the private investor is most common for economic infrastructures such as power, telecommunication, water, and transport, particularly for port, airport and railway projects. In case of road projects however, compensation may be made either through direct charging of users or payment by the government. Direct charging of road users may not always be possible because of social and political reasons. In such a situation, the government pays the operator on behalf of the road users.

Payment from indirect beneficiaries

Systems for collecting payment from the indirect beneficiaries of transport projects can constitute a major source of funding. Such systems, which include a capital gains tax in the form of certain land-related taxes and fees imposed on property owners and developers, are used, for example, in China; Hong Kong, China; and Japan as well as in the United States of America to capture a part of the development gains generated by new transport projects. However, in most countries such payment systems either do not exist or have very limited applications. Japan and the Republic of Korea have used the land readjustment tool for the financing of urban infrastructure projects.

IDevice Icon Land readjustment
Land readjustment is a comprehensive technique for urban area development that provides network infrastructure and other utility facilities and amenities in an integrated manner together with serviced building plots. This approach is also known as land pooling or reconstitution of plots. It may be undertaken by a group of landowners or by a public authority. In this method all the parcels of land in an area are readjusted in a way that each land owner gives up an amount of land in proportion to the benefits received from the infrastructure which is determined on the basis of the size and location of each site. The provision of public facilities enhances the land value and a sound urban area is created. The land contributed by the landowners is used to provide community facilities and amenities and can also be sold or leased out to meet the project costs including those for the infrastructure.

Cross-subsidization in PPPs

PPPs can be designed based on cross-subsidization between project components, when excess revenues generated from one component can be used to compensate the shortfall in another component in order to make the whole project commercially self-sustainable. The rail-property development model used in Hong Kong, China is a good example of such an arrangement. In this model, part of the profit made from real estate development on lands at or close to station areas, and along the right-of-way of rail transit routes is used to partly finance the rail system. A differential pricing policy with the objective of cross-subsidization may be adopted in an urban utility service project. For example, the industrial and commercial users of a water and sanitation project in Tirupur, South India pay a higher price for water to subsidise the residential users who are charged much lower than the actual cost of water.

Government buys the service on behalf of the beneficiaries

The government can make payments of periodic fixed amount or according to use of the facility, product or service at a predetermined agreed price. This type of arrangement is common for social infrastructures such as school, hospital and other public buildings. Shadow tolling of roads is another example. Shadow tolls are payments made by government to the private sector operator of a road, at least in part, based on the number of vehicles using the road. Shadow tolling is practiced in the U.K. However, instead of shadow pricing, the government may also make payments of periodic fixed amount, as the National Highway Authority (NHAI) in India pays for their PPP projects implemented under the "annuity model".

Why grants may be considered

Grants and subsidies by the government, if available, can be used to finance in part. Such grants and subsidies can be justified on the following grounds:

  • To meet public service obligations (PSOs)
  • To achieve social objectives (for example, to ensure no body is priced out in a water project)
  • To rectify market imperfections (that create externalities)
  • To make economically viable and socially desirable projects commercially viable

The size of government support should depend on what extent a particular project may qualify for such grants and subsidies considering such grounds.

Copyright © 2008 by Transport Policy and Development Section, United Nations Economic and Social Commission for Asia and the Pacific (ESCAP).