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The Risk Premium for Evaluating Public Projects

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  • Klein, Michael

Abstract

Governments face a lower apparent cost of capital than private firms. However, the low cost of borrowing by governments does not reflect superior capabilities to choose or manage projects. Instead, it reflects the fact that governments have recourse to taxpayers, who de facto provide a fairly open-ended credit insurance to the government. If taxpayers were remunerated for the risk they assume in the case of tax-financed projects, then ex ante there would be no capital cost advantage to government finance. The risk premium on government finance would, in principle, be no different from that of private investors. There is thus no justification on the basis of capital cost advantages for government funding or guaranteeing the provision of private goods or services. Privatization is, therefore, valuable, if it improves business efficiency when evaluated at the risk-adjusted private cost of capital. No more need be demonstrated in a value-for-money test. Copyright 1997 by Oxford University Press.

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Bibliographic Info

Article provided by Oxford University Press in its journal Oxford Review of Economic Policy.

Volume (Year): 13 (1997)
Issue (Month): 4 (Winter)
Pages: 29-42

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Handle: RePEc:oup:oxford:v:13:y:1997:i:4:p:29-42

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Cited by:
  1. Eduardo Engel & Ronald Fischer & Alexander Galetovic, 2007. "The Basic Public Finance of Public-Private Partnerships," Levine's Bibliography 843644000000000313, UCLA Department of Economics.
  2. Engel, Eduardo & Galetovic, Alexander, 2014. "Urban transport : can public-private partnerships work ?," Policy Research Working Paper Series 6873, The World Bank.
  3. Kenneth A. Small, 2009. "Private Provision of Highways: Economic Issues," Transport Reviews, Taylor & Francis Journals, vol. 30(1), pages 11-31, July.
  4. Marcel Boyer & Éric Gravel & Sandy Mokbel, 2013. "The Valuation of Public Projects: Risks, Cost of Financing and Cost of Capital Current," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 388, September.
  5. Nina Budina & Hana Polackova Brixi & Timothy Irwin, 2007. "Public-Private Partnerships in the New EU Member States," World Bank Publications, The World Bank, number 6743, October.
  6. Michael Spackman, 2011. "Government discounting controversies: changing prices, opportunity costs and systematic risk," Grantham Research Institute on Climate Change and the Environment Working Papers 67, Grantham Research Institute on Climate Change and the Environment.
  7. Frédéric Blanc-Brude & Hugh Goldsmith & Timo Välilä, 2009. "A Comparison of Construction Contract Prices for Traditionally Procured Roads and Public–Private Partnerships," Review of Industrial Organization, Springer, vol. 35(1), pages 19-40, September.

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