The idea that PPPs need to achieve massive cost savings to overcome the disadvantage of having a higher cost of capital than government funded projects continues to be raised in Australia. This matter was widely debated in the 1990s, when the Federal Government's Private Infrastructure Taskforce (EPAC, 1995, p. 37) concluded that 'much of the difference in the private and public cost of capital is apparent rather than real'.
While governments can borrow at the risk free rate of interest, this is due to the fact that governments have taxing powers, and as a result investors consider that the likelihood of default is minimal. Fundamentally, government ownership of business assets does not eliminate business (or project) risk, which does not change depending on ownership and financing. The taxpayers who underwrite the risk of a government-financed project do not receive a reward in the way that private investors receive a higher expected return when bearing greater risk. It is a net cost to them that must be added back to the government borrowing rate.
The cost of capital for a project is the weighted cost of debt and equity applied to the project. The cost and proportions of debt and equity in a PPP reflect a market assessment of the risks and rewards of the project in question. The cost of debt in a government bond financed project is known, but the public sector does not have a cost of equity, and the government bond rate has nothing to do with the project's cost of capital. In Australia the price of government bonds is set without regard to the projects that are to be financed.
Put simply, the taxpayers ultimately and always bear the costs of cost over-runs and other project risks that cannot be assumed away by the fact of Traditional government procurement methods and operation. The notion that Traditional government procurement creates a 'risk free' project is deeply flawed.