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2004 Documento de Trabajo #176

Soft Budgets And Highway Franchising

First version: October, 2003This version: December, 2003  Latin American governments progressively substituted build–operate–and–transfer (BOT) contracts for government–provided highways during the nineties. Because under BOT a private franchise holder finances and operates the road in exchange for tolls, it is often claimed that BOT represents a privatization of highways. We argue that, as currently applied, the BOT model is an imperfect and incomplete privatization, because the franchise holders’ budget constraint has been soft, with losses being shifted to tax payers via minimum income guarantees and contract renegotiations. Soft budget constraints are inconsistent with the standard arguments in favor of BOT contracts and call into question their avowed advantages. Moreover, both renegotiations and minimum income guarantees allow governments to finance current expenditures with future tax receipts, sidestepping the normal budgetary process.  We propose various changes to the current model aimed at correcting its defects. First, franchises should be awarded through Present-Value-of-Revenue auctions rather than fixed-term franchises. Second, the agency in charge of monitoring contract compliance and regulating franchises should differ from the agency that plans and auctions projects. Third, franchises should be subject to hard budget constraints, so that both profits and losses are privatized. Key words: build-operate-and-transfer (BOT), concessions, cost-of-funds, franchising, government subsidies, present-value- of-revenue (PVR), regulation, renegotiation.

JEL classification: H21, L51, L91.

Eduardo Engel
Ronald Fischer
Alexander Galetovic

Keywords: build-operate-and-transfer (BOT), concessions, cost-of-funds, franchising, government subsidies, present-value-of-revenue (PVR), Regulation, renegotiation.