The Social Investment vs. Portfolio Management Decision

As shown in the table below, government has two problem situations and two decision points with respect to infrastructure projects.

This has lead to some confusion with respect to the choice of discount rate because it is not generally recognized that a rate suitable for one decision point is necessarily suitable for the other.

The first decision point, the investment decision, is whether government should fund construction of an infrastructure asset; and the second one, the procurement decision, is with respect to taking the risk of holding and operating an infrastructure asset, rather than having those functions taken on by the private sector. With respect to the procurement decision, the two options for the government to consider are traditional, public sector procurement, or a public private partnership.

The investment decision entails assessing whether society is better off foregoing current consumption and privately-funded, market-driven investment, to dedicate (re-allocate) these resources to the construction of public infrastructure. There is a considerable body of literature on this question, mainly in the area of cost/benefit analysis. Discussions of discount rates in this context usually focus on the cost/benefit decision government must make to evaluate whether or not it should fund an infrastructure project.

The costs included in this type of analysis are generally broader than the design, construction and operations costs an infrastructure builder and operator would face, and they would include such things as negative social and environmental impacts. The benefits are also typically broader than the financial returns associated with owning and operating an infrastructure asset. They would include, in a transportation project for example, the broader economic impacts of the project and sources of value such as would arise from there being less congestion, greater public health and safety, greater convenience or even an improved environment and positive social effects.

These would be considerations that are not necessarily reflected in the price individuals would pay to use infrastructure. As a result, the infrastructure owner would not typically pay all the costs and receive all the benefits from a project. In addition, some costs and benefits may include intergenerational impacts that society chooses to discount on a basis that does not reflect asset valuation or financial market considerations.

The procurement decision is an asset portfolio management decision: whether the infrastructure asset under consideration be in government's asset portfolio or a private partner's. The risk profile, considerations, and returns appropriate for an infrastructure funding decision are not the same as the ones government would use for this procurement decision. Accordingly, the discount rates government would use for making the two decisions would not necessarily be the same. The portfolio management decision would generally hinge on how the rate of return government would expect to receive from an investment in the infrastructure asset compares with the rate of return it would expect to earn on other assets having a similar risk profile.