The idea that the government has a lower cost of capital continues to be raised in Australia (Quiggin, 2007). The Federal Government's Private Infrastructure Task Force (EPAC, 1995, p.37) considered this matter more than a decade ago, and:
...rejected the argument that the cost of government debt is necessarily cheaper than the private sector cost of capital (which would have implied that government should finance most infrastructure investment). The task force argued that government's lower cost of funds largely reflects the fact that taxpayers are providing an implicit guarantee for project risks under pubic ownership. Thus, it concluded that much of the difference in the private and public cost of capital is apparent rather than real.
This issue was further investigated by Australian state government treasuries during the latter half of the 1990s and more recently. For example,
Partnerships Victoria (July 2003, p.27) states explicitly that just because the government can issue bonds at the risk free rate, and corporate bonds are issued at higher rates of interest, this does not mean that the government's cost of capital is lower:
The reason government's cost of borrowing is low is that government can use its taxing powers to repay loans. Because of these taxing powers, lenders to government consider that it is unlikely to default, leading to lower interest rates on borrowings. However, when government decides whether to invest in a project, it should look at the riskiness of that project, and demand a return commensurate with the risk it is taking.
In the UK, in 1997 an entire issue of the Oxford Review of Economic Policy was devoted to the relative cost of capital issue in the context of public-sector investment. In their summary paper to that issue, Flemming and Mayer (1997 p.5) concluded that 'project risks depend on the project's design rather than on its financing - unless the latter affects the former', and that given the 'incentive and control advantages of the private sector' there is a 'strong presumption in favour of private sector investment'.
Claims that PPPs need to produce massive cost efficiencies in order to counteract the effect of the government sector's lower cost of capital continue to persist (Hodge, Quiggin, Pollitt). PPPs have, in fact, been shown to produce large cost efficiency (Mott MacDonald). However, as noted by Klein (1997, p.38), if the government's cost of capital was indeed significantly lower than that of the private sector, it would have some bizarre consequences, for example that:
• Governments should invest in projects and funds with high expected values, such as venture capital; or
• Private companies should benefit from free government credit guarantees on all their borrowings.
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.