Evaluating Public Grants to Private Enterprise Where Information is Limited

This paper sets out a framework for evaluating public grants to private firms, where recommendation as to the social desirability of individual grant proposals must be made in the absence of information about alternative public expenditures and the optimality of the proposed output level. It is argued that a surplus of social benefits over social costs, as they are conventionally defined, is not sufficient to justify publicly subsidized production of a good in the private sector. It must also be the case that the recipient firm's production of the good will generate net external benefits at least as large as the proposed grant. The magnitude of the public grant can not be ignored on the grounds that it is merely an income transfer. In the case of publicly subsidized private production, the mechanism of public investment is a transfer of resources. Proper evaluation of a grant involves determining the extent to which this transfer will improve allocative efficiency as opposed to merely redistributing income.