Government-issued debt is cheaper than the private sector's, making private financing and development a bad deal for taxpayers.
This is perhaps the major objection to PPPs. This line of argument contains some truth, but it also overlooks several important points.
Difference between cost of capital and cost of debt. First, the argument assumes that the cost of capital and the cost of debt are one and the same. However, a government's risk-adjusted average cost of capital typically exceeds its cost of debt because the public sector takes on project-specific risks such as cost overruns and delays that need to be factored into the cost of capital for each project it undertakes. Moreover, even though the private sector takes on some of the risks of construction, time overruns, and project performance, it can better control its capital costs by making efficient use of resources. The comparison should therefore be between the public sector's cost of capital (to which a risk premium must be added) and the private sector's cost of capital (which amounts to the weighted average of its cost of debt and equity), not between the two sectors' different costs of borrowing (see figure 8).66 Moreover, the benefits achieved in terms of superior service delivery alone are often worth the extra costs to the government.
Gap Narrowing. Second, as the private infrastructure market has grown and financing mechanisms have become more sophisticated, the gap between the public and the private sector's cost of debt has narrowed. For example, with the maturing of the private finance market in the United Kingdom, the financing costs difference between the private cost of capital and public borrowing is now in the range of only 1-3 percentage points. The additional cost to the public sector should not be significant enough to risk losing the value for money of the project, provided the private sector can deliver savings in other aspects of the project.
Creative Financing Models. Last, a variety of financing approaches enables governments to combine their ability to obtain lower interest rates with the benefits of private financing and development. In the United Kingdom, the Treasury launched a program called Credit Guarantee Finance (CGF) to reduce the costs of borrowing to finance PFI (Private Finance Initiative) schemes.68 Under the credit guarantee program, the government provides funds to the PFI project through cash advances governed under the terms of a loan agreement. The private firm repays these loans to the government after completing the project. The government receives an unconditional repayment guarantee from the private financier for providing this loan facility in return for a fee.69
In the United States, the Department of Transportation has allocated $15 billion in tax-exempt private activity bonds for qualifying PPP highway and intermodal freight facilities. This approach lowers the private sector's cost of capital significantly, enhancing the investment prospects.