The limits of production efficiency analysis: New Institutional economics and PSP contracts

The provision of drinking water and sanitation is a key problem of sustainable development. In recent years private-sector participation (PSP) has been proposed as a major solution to solve efficiency problems and lack of investment in this sector. In this paper, we analyse PSP contracts from a new institutional economics [NIE) perspective. The NIE approach implies that contract settings with high transaction costs lead to increased risks of opportunistic behaviour for the contract parties. In application to the water and sanitation (WATSAN) sector, we show that long-term contracts-which seem superior from a mere efficiency viewpoint-tend to lead to inferior solutions regarding overall welfare effects. These findings are supported by empirical evidence from recent PSP experiences, especially from developing countries. As a solution, a stepwise approach leading from short-term to longer-term, more encompassing contracts might help to mitigate many of the identified transaction cost problems.