Should international trading in emission permits be encouraged?

Introduction

Many evidences show that climate change is real. The National Academy of Sciences reports 'with a high level of confidence that global mean surface temperature was higher during the last few decades of the 20th century than during any comparable period during the preceding four centuries' (2006, p. 3). Although the economic impacts of climate change are hard to predict, there are serious prediction in non-market impacts such as the additional 165,000 to 250,000 children could die (Stern 2007, p. 63).

The serious mitigation actions must be taken at global level as soon as possible. The delay inaction will just cost the world economy i.e. US$5.7 trillion per year (Bosetti et al. 2009, p. 304). Since the GHG concentration is caused directly by human activities (Australian Academy of Science 2010, p. 4), the key thing in mitigation is to change people's behaviour. In domestic level, there are three public policy options which currently practiced and/or considered; they are: carbon tax, cap and trade, and the combination of both (the hybrid). The former sets the carbon price; the second fixed the emission quantity; while the latter start by settling the emission quantity but also allowing additional permits to control the carbon price. Although there are huge debates on comparing the three (see, for example, McKibbin & Wilcoxen 2007, pp. 187-190; Hansen 2009, p. 2; Stiglitz 2007; Garnaut 2008a, p. 311; Pizer 2002), the basic principle of the three approaches is the same; that is to put a price into carbon. Carbon price is important because price has rationing and allocating function of the scarce resources (Frank et al. 2009, p. 233). Theoretically, the price must be set at the level so that the cost of the emission equal to the present value of the social damage it causes (IMF 2008, p. 9). The three carbon pricing approaches are central to carbon market.

The current international emission permit trading practices are operated under carbon market mechanisms. There are three carbon market mechanisms under the 1997 Kyoto protocol; they are: carbon trading, clean development mechanism (CDM), and joint implementation (JI) (Gerrard et al. 2007, p. 1). Both carbon trading and JI involve international permit trading, the difference is that the latter is project based, whereas the former is purely a permit trading. Meanwhile, CDM is only about offset either it is project or program based. Permit trading can be conducted only between actors in countries with cap, whereas countries without caps can provide offsets to countries with caps.

This paper will focus on international trading in emissions permits (IPT). It will first elaborate the pros and cons of IPT and will argue that IPT should be conducted gradually after the improvement of the capacity of the developing countries and the global market regulatory body.

Pros

IPT could reduce the global mitigation costs which reflected by the lower permit price or lower carbon price. That could happen because of the marginal abatement costs differ across countries (McKibbin et al. 2004, p. 25; Nordhaus 2008, p. 13), which developing countries have lower marginal abatement costs (Weyant & Hill 1999, p. xxxv; Howes 2009, p.10). When there is global trading, the abatement cost will be equalized into a global price which will be between the developed countries' marginal abatement cost and the developing countries' marginal abatement cost. That will result in a lower global abatement costs to achieve the same emission reductions. And the reduction will be more when there are more big players cap their emissions and participate in the permit trading (Aldy & Stavins 2007, p. 12).

IPT could increase the possibility to achieve the higher target of stabilization level through more participation. Another effect of the different marginal abatement costs in IPT is the attraction to more countries to join the global efforts on climate change mitigation. IPT could attract net-sellers countries through profit-making motives, whereas net-purchaser countries could be tempted to join because of their domestic political interests (Keohane & Raustiala 2008, p. 6). As more countries participate and more ambitious target they can make due to the lower abatement costs (Garnaut 2008b, p. 6), the more global abatements can be expected. In contrast, incomplete participation could reduce the effectiveness, and increase the cost of mitigation (Howes 2009, p. 13). If we just rely only to Annex B of the Kyoto protocol, the GHG concentration in atmosphere will exceed 550 ppm—or leads to more than 3⁰C warming—by the end of this century (Wigley 1998, p. 2288).

IPT is an instrument that can help the creation of global economic convergence as an impact of the emissions convergence in per capita basis. Although developed countries are unlikely to support, developing countries—especially India—have been in the position to argue that equity requires setting quantitative targets at equal amounts per capita (Frankel 2007, p. 40). Indeed, distributing permits based on equal right to emit is the only principle that has some ethical basis (Stiglitz 2007). The best way to achieve equal emission per capita is through 'convergence and construction' approach (Garnaut 2008a, p. xxiv). There are two main steps as reflected in the name of the approach: set-up the stabilization level as the global target, for example 450 ppmv (contraction); share the emission limit among all countries so that per-capita emissions converge by specific date (convergence). There are two key elements to be negotiated and agreed upon: the target atmospheric concentration of GHG and the date (HÖhne et al. 2006, p. 47). This approach will lead to the transfer of resources to the least developed countries through IPT. Without IPT the costs of mitigation in developed countries will be higher and there will be no resources transfer to the developing countries. The resources transfer, which can be in the form of finance or technology or others, could help developing countries to catch up the developed countries which could result in the economic convergence. Interestingly, the sources of financing for developments support in developing countries can be mainly from private sectors in developed countries rather than from public sectors as that in the development aid.

IPT will self-enforce the low-emission development. Once the IPT is there and the caps are set, every participant countries will have strong incentives to work hard to lowering their emission intensity (of GDP) because it is the only way to optimize benefit from the trading. The more they can maintain or increase their outputs but lowering emission at the same time, the more they can sell their permits to other countries or just hold the excess permits for the future developments. It is even possible for them who highly efficient in GHG emissions to use their excess permits as an asset in international political bargaining since permits will be highly valuable. Carbon price can attract investments in low-carbon developments such as investment in green energy. Since IPT increases carbon price in developing countries, it would attract more investments in developing countries in low-carbon development economic activities. The promotion of low-emission development can be more explicit in the case of 'joint implementation' where permit trading is conducted through carbon offset projects. The EU ETS claims the promotion of low-carbon development as one of its successes (Carbon Finance 2010, p. 7).

Domestic trading scheme in developing countries is hardly to be established without IPT. That is because variation of the marginal abatement costs among actors is less in domestic market compared to the global market. This is particularly difficult in developing countries where we can expect to find more sellers than buyers. For example, 180,000 tonnes of voluntary credits in the first auction in Latin America (Brazil) was end up without a single bid (Reuters 2010).

Cons

IPT might reduce future development possibilities of developing countries and might lead to the emission per capita divergence. If one country sells emission permits to another country, the seller country basically transfer its future development possibilities. When every country adopts a cap and the cap is fixed, the cap reflects the future development possibilities. If the cap is equal to current level of emission of one country, the country would be allowed to produce more economic output only if the emission intensity of output of that country is reduced. Reducing emission intensity, however, is not easy. It does not only require investments in new technology, but also need better public governance. For example, reducing emission intensity in forests activities require better forest management, whereas better forest management needs better public governance (Mayers et al. 2006, p. 101). It also depends on the quality of the global trading governance. If the global trading governance is weak, one poor country might sell its permit just because they need revenue (or because the corrupt leaders need quick cash for their political interests), not because the country has reduced its emission intensity. It is just similar to the case where a poor farmer sold his farm land to a mining company just because he wanted to have a motorcycle. At the end, the emission per capita will diverge, not converge. In this case, although the emission reduction might be well-proven, it does not meet ethical standard.

Without a credible government of countries involved in the trade, the IPT might increase the level of GHG and weaken the credibility of the high integrity domestic market scheme. IPT cannot avoid the involvement of government even though the trade might be between private firms. That is because the legal basis of IPT is international agreement which supposed to be made by governments. National government capabilities are needed at least for two important functions: the monitoring, reporting, and verification (MRV) system and the market regulation. IPT requires reliable MRV which not easy to build internationally. The lesson from the successful acid rain program (ARP) in the U.S. points out that the MRV is central to develop the accuracy and maintaining emission data which lead to the development of public confidence in the program, and has resulted in a high compliance rate (Schakenbach et al. 2006, p. 1576). A weak MRV system could end up raising the level of global emissions if the monitoring in the seller's country is ineffective because the emission of the buyer would rise while the seller's emission would remain unchanged (Nordhaus 2008, p. 160). The market regulator function is important to maintain the trust, not only the trust of the sellers and buyers, but also the tax payers in the participating countries. This is particularly relevant in developed countries where their political concern values the integrity of the mitigation measures (Grubb 2003, p. 166). An international trading system implies that governments in all participating countries would perform the functions with similar competence (Victor 2007, p. 143). However, the quality of governments around the world is vary which many of them, particularly in developing countries, are still associated with high corruption. One trading scheme with high integrity might be poisoned by other trading scheme in different countries with low integrity.

IPT might make developing countries (sellers) worse-off. The IPT might lead to the increase of production cost of output which could result in the increased cost consumptions and create reduced real wages. The effects would continue to the reduced labour supplies and would end up with reduced tax revenues. These effects chain called 'tax interaction effect' (Goulder et al. 1998, cited in Babiker et al. 2002, p. 4). Theoretically, the effects can be overcome by cutting other distorting taxes, such as social security taxes and corporate income taxes (Parry 1997, p.1). That could happen if the incomes gained from emission trading exceed the efficiency costs from the tax interaction effect (Babiker et al. 2002, p. 5). That means the benefits of IPT for developing countries depend a lot on the level of the carbon price in the global market.

IPT might harm marginal communities. For example, the high value of carbon could adversely affect indigenous people and local communities when government move them to other place in order to reduce emission from deforestation and forest degradation (Macintosh 2010, p. 2).

IPT might bring 'resource curse' through corruption practices and low productivity. IPT must involve cap which imply the permit limitation and the high value of the permits. That creates scarcity of permits and would invite corruption practices (Cooper 2007: 106). Cap and trade is a rent-creating program which, in the case of weak governments, could easily lead to corrupt practices and low productivity (Nordhaus 2008, p. 159).

Price volatility cannot be avoided totally because of the nature of the permit trading and also because of its link with the stability of global economy and politics. Price volatile caused by the complete inelasticity of the supply of permits along with the highly inelastic demand for permits in the short run (Nordhaus 2008, p. 153). The stability of politic and economic influences the stability of supply and demand which affect the carbon price (Carbon Finance 2010, p. 7). In addition, since EU ETS began in 2005, it is observed that the stability of carbon price correlates with the stability of energy price since there is high correlation between the two (Harvey 2009).

The price volatile phenomenon reflects the inability of any national government, particularly government from small countries, to control global carbon price. This is very important because, as discussed earlier, price is matter. Without sufficient price, developing countries can be worse-off and therefore reduce their incentive to participate.

The success of IPT depends on the quality of the caps, whereas set-up the right caps is difficult. Since IPT requires binding caps, the plan of make a trading might increase the value of the permit during the negotiation time which will make the permit distribution among countries become difficult and sensitive. Giving more permits than required to one country (i.e. hot air) will attract participation of the country but at the same time will harm the participation of all other countries (Barret & Stavins 2003, p. 360). This can lead to a failed negotiation. The errors in allocating caps—e.g. because of the mistake of baseline making such as the 'hot air' phenomenon—could discourage the abatement and even increase the cost of the abatement (CCAP 2007, p. 5; Gilbertson & Reyes 2009, p. 9). The errors in allocating caps could also discourage wide participation especially when it leads to the reduction of commitment of big player countries which might caused by the perception of unfairly treated. The exit of one country could magnify the pressures for others to exit (Victor 2007, p. 142).

My proposal

Considering the pros and the cons, I propose to implement the IPT gradually. That is because the success of IPT requires credible nation state institutions and credible international climate institution. The former is crucial for developing countries, whereas the latter is the main challenge in global level. Institutional development in national and global level is a must to reduce the potential of negative impacts, as well as to optimize the potential benefit, from the IPT.

Although the IPT should not be set-up until we have credible institutions, the emission caps must be agreed soon. We can use the pledges that have been agreed in Copenhagen. As being agreed in previous negotiations, arrangement of the IPT must be based on the 'common but differentiated responsibilities and respected capabilities' principle. It implies that, unlike for developed countries, the caps of developing countries are not immediately binding.

I would copy the way the successful Montreal Protocol did on dealing with emission limit. That is that all countries must have emission limits which immediately binding the developed countries but allowing grace period to developing countries (Barrett & Stavins 2003, p. 361). We can just adopt the pledges made in Copenhagen which—after compared across different metrics—imply significant efforts and considered to be more equal among developed and developing countries; for example the emission per capita differences are smaller (Jotzo 2010, p. 21). In addition, the Copenhagen pledges (if we can get it) brings a solid foundation to bring the emission down to the 450 trajectories which make the 2⁰C target possible to achieve. It is important to note that Copenhagen pledges made in bottom-up nature which allow us to expect a stronger commitment because the promises were made without pressure and were according to individual country's interest. The equal per capita emission must be part of the targets by using the 'convergence and contraction' approach. The converged date must be set by considering the sufficient adjustment time and accepted by developed and developing countries, say, 2050, as suggested by Garnaut (2008a, p. 207).

The gradual implementation of IPT involves three stages: (a) capacity development; (b) IPT implementation that combined with the project based, caps bind developed countries only, but monitored, reported, and verified in developing countries as well (almost similar to the Kyoto), and (c) full IPT implementation which all caps are binding.

The capacity development activities must focus on two targets: (a) developing countries, (b) global regulatory body. The objective of capacity development of developing countries should cover the following issues: low-carbon development; good governance, MRV system, domestic market regulation; market policy making capability e.g. to avoid the tax interaction effect. The global regulatory body capacity development must address the following issues: prioritizing domestic abatement as opposed to trading and offset; market regulation e.g. to avoid human right violation; monitoring and leadership communication to ensure the achievement mitigation target and per-capita basis target; monitor to minimize the price volatility. The costs of capacity building must be paid by developed countries as part, or addition to, development aid. In order to be successful, some lessons from development aid effectiveness can be considered; for example, the three aid effectiveness determinants: the quality of the government of recipient country, the quality of the aid donor, and the way in which aid business is organized (Howes 2011).

The low-carbon development must in line with the nationally appropriate mitigation actions (NAMA). NAMA will likely balance the mitigation and development objective of developing countries. The priority of developing countries is more to bring prosperity to the most of their people, not so much about environmental concern. Therefore government of developing countries are unlikely to cap the economy soon. However, prosperity can be developed under sustainable development approach which includes some elements that support climate mitigation. For example, the policy of government of India called 'perform achieved and trade (PAT)' with the main intention is energy saving, but is contributing to climate change mitigation by reducing or avoiding GHG emissions (Uphadyaya 2010, p. 564). The focus of developing countries in their NAMAs should be on low carbon development strategy which means that they alleviate poverty through low carbon intensity activities.

In the second and third stage, buying permit from other countries is allowed only if the domestic price is too high and could harm domestic economy seriously. In the second stage in particular, selling permit from developing countries must be meet some criteria; for example, the permits to be sold are only that as result from the increased emission efficiency.

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Challenges in Indonesia Infrastructure Development

Introduction

Despite the mixed research findings about relationship between infrastructure and economic growth, the majority concludes that there is a positive and significant link between the two particularly in developing countries (Straub 2008, p. 33). In Indonesia, according to some facts, infrastructure affects economic growth through the level of private sector investment and their business development. Japanese companies operating in Indonesia rank the underdeveloped infrastructure as the main problem in investment in manufacturing and non-manufacturing industries (JETRO 2009, p. 27). This supports the perception of more than 12,000 businesses spread out in about half of Indonesia's districts which confirms that the low quality of infrastructure become the primary constraint of business development (KPPOD & TAF 2008, p. 2). As a result, Indonesia's economic growth during the period of 1990 to 2007 was below the average of developing Asia, and certainly below China and India (Garnaut et al. 2009, p. 90). Economic growth is very important for Indonesia because it is the main driver of human development in the country (UNDP 2010, p. 56).

The five year development plan 2010-2014 states an ambitious infrastructure development plan throughout the country. That requires investments as high as IDR1,429 trillion which is equivalent to nearly one and a half times of the government's annual expenditure (Alisjahbana 2010, p. 5).

Key Issue

The key issue for the national government is the lack of infrastructure funding in Indonesia. The public authorities are faced with the dilemma: either to fully finance the infrastructure facilities—by borrowing more—in order to secure its control, or to attract private financing in order to accelerate infrastructure development.

Indonesia's infrastructure relatively legs behind in terms of quality and quantity in the region. Among the ASEAN five, Indonesia's infrastructure quality is just better than the Philippines but far below Singapore, Malaysia, and Thailand (Schwab 2010, pp. 18-19). However, in terms of quantity, the length of Indonesia's roads per arable land area in 2003 was even below the Philippines as well as other Asian countries such as Lao PDR, Mongolia, and Vietnam (World Bank 2005, p. 15).

There is a great imbalance between the increase of vehicle number and the expansion of road. At national level, the increase of paved road during 1998-2005 was 28 per cent, whereas the rise of motor vehicle number at the same period was 80 per cent (World Bank 2007, p. 77). The situation is even worse in Jakarta. The growth rate of Jakarta roads is 0.9 per cent a year, whereas vehicle growth rate is nine per cent per year. Unless something is done, this would lead to total gridlock in Jakarta by 2014 (Cochrane 2009).

The poor infrastructure facilities are mainly a result of underinvestment in infrastructure particularly after the 1997/1998 Asian financial crisis (AFC). Investment in infrastructure in Indonesia, both private and public including from the state owned enterprises, fell from 5-6 per cent of gross domestic product (GDP) before 1997 to 1-2 per cent of GDP in 2000, and was stable at 3.4 per cent of GDP in 2007 (World Bank 2007, p. 74). The private sector investment in infrastructure has declined sharply before and after the AFC, from 30-40 per cent to less than a quarter of government spending on infrastructure (World Bank 2007, p. 74). The latest figure shows a small increase in the government budget allocation. In 2010, infrastructure budget allocation was close to two per cent of GDP. That is still below the pre-AFC level (as average of the period 1994 to 1997) which was 2.4 per cent of GDP (World Bank 2007, p. 80).

Solution options

Indonesia’s public sector performance is poor relative to private sector counterparts (Arif & Viverita 2004: 22). Therefore, the question is no longer whether private sector should be involved in infrastructure development, but rather which form of private participation suitable in the Indonesian context. This paper is going to outline two possible options.

Option-1: Full state financing

The Indonesian government has fair credibility to borrow money either from domestic financial institutions, foreign countries, or multilateral agencies. Indonesia's sovereign credit rating has been improved over time. The Standard & Poor’s rates Indonesia's sovereign credit for local and foreign currency at ‘BB+/positive’ (Standard & Poor’s 2011), while Moody’s just upgraded the Indonesian government’s foreign and local currency bond rating to 'Ba1' (Moody’s 2011). Improved ratings mean a lower country risk premium and thus reduced costs of financing (Wie & Negara 2010, p. 294). The Indonesian government need not to be concerned about borrowing money because its debt to GDP ratio is 27 per cent at the end of 2010, which is less than the average of G20 countries both for the advanced and the emerging economies (Departemen Keuangan 2010, p. 30). By borrowing money, government will declare the debts clearly in its financial statement as opposed to financing partnership which tempts undervaluing the liabilities by not recording them in the balance sheet (Webb & Pulle 2002, p. ii).

Indonesian government must have strong control over the making and the operation of the infrastructure facilities to secure public value[1]. With the full state financing option, government has better power to control the contractors. It will also mean government has full ownership of the facility which provides it the right to use, to change the form and substance, and to appropriate returns from the facilities (Furubotn & Pejovich 1972, p. 1140).

The state full ownership model is also in line with the traditional democratic structure. If the users (which are also citizens at the same time) want to complain about public infrastructure facilities, they can do so through the existing democracy structure—such as the Ombudsman Commission, the Administration Court, or to their representative in the parliament—in addition to the direct complaint to the facility operator. Those institutions can pressure government who own and control the facility directly. That would lead to a more pressure to government to impose citizens' aspirations to its contractors under a principal-agent relation (Teisman & Klijn 2002, p. 199).

There are several options of mode of delivery of public-private cooperation under the full-state-financing approach. The range starts from construction manager at fee (CM-at fee) to the Design-Build-Operate-Maintain (DBOM) (Pakkala 2002, pp. 10-12). The more works are bundled in the contract the more complexity of the contract and therefore the more difficult for the government—as the principal—to control the contractor (Seddon 2004, p. 23). That is because the contract will not be specific enough in determining the result and conditions due to the bounded rationality which lead to the increase of opportunism (Williamson 1985, p. xiii).

In order to have a strong control over the contract implementation, government must go for the segmented mode of delivery by preparing contract per each work segment and limit the contract period to a relatively short term. That would allow more certainty in predicting the future and therefore reduce the bounded rationality effects. That allows the government to specify results in the contract in order to monitor and control its contractors (Donahue 1989, p. 86). The sharp description on results would simplify the dispute resolution mechanism so that both parties can just rely on court (Williamson 1985, p. 32).

Although government has strong control over the contract implementation in option-1, there is no guarantee it can secure public value. Government will rely on courts in dispute resolution which is often costly and ineffectual (Klein et al. 1978, p. 71). The simple contract may not be helpful because of the bad credibility of Indonesia's justice system (MacIntyre 2003, p. 3). Government is more likely to lose in court because of two reasons: (a) government is strongly requested to behave impeccably (Seddon 2004, p. 14), (b) public officials have less incentive to win the disputes because their private interest will not be much affected.

Option-2: Private Financing Initiative (PFI)

Considering the limitation of fiscal capacity, instead of borrowing more, Indonesian government must go for PFI. Indonesia's public spending is only 17.7 per cent of GDP (Departemen Keuangan n.d, pp. 1-12). Indonesia's tax revenue is among the lowest Asia's non-OECD countries (IMF 2008, p. 11).

Despite some constraints in private sector investment (Kalinova 2010, p. 18; Prasetowo et al 2010, p. 1), various indicators reveal some opportunities. Together with key Asian countries, Indonesia has been constantly registering a more than 30 per cent saving since mid-1980s (Jha et al. 2009, p. 11). The average annual growth of market capitalization in Indonesia's Stock Exchange after the 1997 Asian Crisis is close to 25 per cent (ISE 2010, p. 2). Indonesia gained 10 places in the Global Competitiveness Index rank of 2010-2011 compared to the 2009-2010 rank (Schwab 2010, p. 29). Moreover, high demand to the pay-facilities can be expected due to the improvement of Indonesian prosperity (Euromonitor 2010; Ahniar 2011).

PFI is one among many forms of public-private partnership. In this case the firms should finance all the construction, operation, and maintenance costs in return for payment from the users and—when eligible—from government subsidy. Government must independently do the design and the plan which represent public interests such as user safety and environment standard. The plan must be made by contractor through a design competition. The plan that represent the public interests the most with the least costs requirement for construction and maintenance should be the winner, to be paid by government. Once the plan is ready, government must put it into a transparent tendering process. The private firm who bids with the lowest user charge rate and lowest guaranteed net sales[2] (for the same design of facility) is the most efficient firm therefore should be the winner. The contract between government and the private firm bundles all the building, operation, and maintenance works which will last for 30 to 35 years of the operation before transferring the ownership to government (BOOT).

This partnership approach will allocate the risks efficiently; that is 'to the party that is best able to manage them' (EIU 1999, p. 2). There are three kinds of risk in public private partnership, being construction risk, availability risk, and demand risk (Blöndal 2005, p. 22). The first two risks should be transferred to the partner because private firms are the best in handling them (U.S. Department of Transportation 2007, p. 21). The government must share the demand risk by paying the gap between the actual and the guaranteed net sales when the former is lower than the latter (the subsidy)[3]. In order to attract investments, it is also important for the government to share the pre-construction risk by handling the land acquisition works. At the moment, Indonesia is considered to be high risk in pre-construction which is mainly caused by land acquisition issues (Khan 2009, p. 13; Pisu 2010, p. 5). The public sector can take most of the pre-construction risk because the solution depends more on the political context (Wie & Negara 2010, p. 291).

The level of control of government over the partner under the PFI is not as strong as in option-1. Therefore, there is a potential for the private interests to undermine the public interests (Hodge & Grave 2010, p. s16; Hellowell & Pollock 2010, p. p. s26). One obvious source of the threat is the difficulty to specify results and conditions in a long term contract (Hodge & Greve 2007, p. 549). Partnership needs more flexibility in its contract governance to identify unforseen risks in a sensible way (Seddon 2004, p. 23). It requires private ordering rather than legal centralism (Williamson 1985, p. 31; Birnhack 2004, p. 2). However, the public sector has limitations in doing private ordering due to its unique accountability system compared to private organizations.

Nevertheless, although the power to control the private partner is lower, a long term PFI partnership has the potential to satisfy public value with a lower transaction cost. Partnership is a collaboration process of cross boundary partners where risks and resources are efficiently shared in mutual trust for collective benefit (O'Flynn 2009, p. 115). In collaboration process, instead of using power to control, government must negotiate and persuade its partner (Pollitt 2003, p. 47). Many infrastructure facilities—such as road and water infrastructure—have asset specificity in terms of location and physical; that is the asset that the benefit can be realized only if the partnership is maintained (Williamson 1979, p. 240). Specific asset enhances trust and cooperative behaviours among partner (Lui et al. 2009, p. 1218). The long term reliance and cooperative behaviours—such as exchange information—are examples of relational norms which reduce transaction costs (Artz & Brush 2000, p. 356). The partnership strengthens contractual relationship through interest alignment (Domberger et al. 1997, p. 777). Therefore, in partnership, private firm executive has interest to satisfy the concern of the public sector manager: that is to create public value (Moore 1994, p. 296)

Proposal

By applying two criteria: a) allocative efficiency, and b) value for money, option-2 is chosen to overcome the infrastructure backwardness in Indonesia.

Option-1 puts the entire financial burden to the government. That could accelerate the infrastructure development—as outlined in the five year development plan 2010-2014—only by sacrificing other government programs including the basic services for human development (such as health and education) or by significantly increasing government debts. Both consequences should not happen in current circumstances. Indonesia's human development index (HDI) rank in 2010 is still below 100 and is the lowest of the ASEAN Five countries (UNDP 2010, p. 145). Government debt is highly sensitive in Indonesian politics. This is particularly for foreign debt which embodies sovereignty issue as a result from the Asian crisis experiences when IMF dictated the bad recipe causing the country into a deeper crisis (Radelet & Sachs 1999, p. 14). In contrast, option-2 would allow the government to accelerate infrastructure development neither by disturbing financial support to other important programs nor by putting pressure on the public finance cash flow. That means option-2 not only allocates the risks better but also allocates the resources more efficient than option-1.

In option-1 tax payer money is more likely to be spent for less value either for citizens or clients. That is because in option-1 public funds are used to pay for construction and operation which involves huge risks before the users can really get benefit from the facilities. In contrast, in option-2 government only pays for value: that is to pay the top-up of the rate paid by the clients who gain benefit from the infrastructure facilities. One may argue that option-2 will just satisfy the client/user (private value) but not the citizens (public value). The argument is not convincing because of two reasons: (a) citizens who need but cannot access the facility still enjoy a better access to the ordinary facility—such as public roads (not the toll road)—because less users can be expected, whereas citizens who do not need the facility still enjoy the better economic development as the impact of better infrastructure; (b) Public value concerns such as externalities, public safety and transparency—as commonly argued by scholars (Flinders 2005, p. 232; Hodge & Greve 2007, p. 551; Erridge 2003, p. 94)—still possible to be achieved in option-2 because the private firms have a long term interest for their current and future investments. Therefore, they will have incentive to build good image and therefore to align their interest into public interest.

In short, option-2 allocates public resource and risks efficiently and provides better value against public money both for users and citizens. Therefore option-2 is recommended.

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[1] Despite the need to distinguish ‘public value’ and ‘public interest’ (Alford & O’Flynn 2009, p. 176), for the purpose of this paper the two phrases will be used interchangeably.

[2] That is the annual net sales that guaranteed by the firm. That means the private firm cannot claim subsidy when the actual net sales are equal or exceed the guaranteed level. Government must have power to determine the user charge rate in order to achieve certain level of citizen access over the facilities.

[3] The rate charged to the users is fixed, but the rate paid to the partner depends on the actual demand which affect to the net sales. If the net sales less than the guaranteed level, government will pay the gap which basically the top-up of the rate paid by the actual users. This kind of flexibility is required in such a long term contract (Crocker & Masten 1991, p. 96)