The Risk Premium for Evaluating Public Projects
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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