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​Getting risk-sharing models right

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Local Industrial Strategies give the Government the opportunity to re-think and potentially step up partnerships between local government and the private sector.

In the UK, local firms and educational institutions already help drive local economic policy through Local Enterprise Partnerships (“LEPs”). In our recent report on Local Industrial Strategies, we ask areas to think more broadly about how partnerships with the private sector can help share risk.

Risk-sharing between public and private actors has taken a variety of forms in the past and has had a mixed track record. Public-private partnerships (PPPs) in the UK and the USA have been widely deployed to deliver hospitals, schools and defence systems. In recent decades, cities and local authorities throughout the UK have also rolled out projects alongside private actors with varying degrees of success, including broadband projects and City funds.

These models are hard to get right. Questions on which risks and project sizes are more appropriately shared between partners remain.

The UK government-backed Catapult Centres are an interesting example. Catapult Centres are companies limited by guarantee (CLG), which offer support, advice and technical know-how to businesses to help them bridge the gap between early-stage innovation and full-scale commercial production. These Centres get their funds from a mix of competitively earned commercial funding and core public investment. A recent report suggests that whilst manufacturing and biotech catapults had a positive economic impact, the success of the Catapults in other sectors is mixed. Even with very similar projects, risk is hard to predict, and one-size risk-sharing models do not fit all.

So, what should policymakers keep in mind when considering these models?

Risk-sharing models can be attractive for multiple reasons:

  • Commercial viability: Partnering with the private sector can relax financial constraints and provide a sense check on commercial viability for projects that involve large fixed and overhead costs, especially infrastructure projects.
  • Improve design and delivery: in specific policy areas, the evidence is clear that getting employers on board as designers, but also possibly as co-funders, is key for successful implementation. This is particularly true for skills, such as employment training programs, or public provision projects, such as broadband.
  • Ability to scale up: as Meg Kaufman highlighted, a widespread limitation in evaluating the impact of local policies is the lack of scale. If we want policies piloted, tested and refined, seeking match private sector funding is one way to run bigger projects.
  • Eliciting information: Dani Rodrik argues that industrial policy is as much about eliciting information from the private sector on significant externalities and their remedies as it is about implementing appropriate policies. He views information elicitation as the most important element of the industrial strategy design process so much so that it ‘overshadows all other elements of policy design’.

Risk-sharing investments do not come without challenges:

  • Transaction costs incurred in co-investment models tend to be higher throughout the project life-cycle. In the case of the London Underground – an admittedly complex program – negotiations of the PPPs took longer than expected and were costly.
  • Capture: co-funding designs might facilitate ‘capture’ by local vested interests. Recent evidence from the UK suggests that local government agencies structure subsidies to favour pre-existing employment in locally agglomerated industries to a higher degree than grants structured by central government agencies. Rent seeking doesn’t mean private actors need to be kept at arm’s length, but relationships must be managed in transparent and accountable ways. This type of ongoing relationship coined “embedded autonomy” is especially relevant for LEPs, where large employers are often represented on the boards, potentially giving them leverage over spending decisions.
  • Data safety: co-investing with private actors might require time-consuming data safety and privacy safeguards, especially with GDPR.

In short, sharing risks with the private sector is likely to be important for some elements of LIS. But if public partners use LIS to test risk-sharing models with private partners, these need to be embedded in transparent and accountable decision-making processes, designed with an eye for optimal risk-sharing contracts, and used as an instrument for market information elicitation.