Government's credit-rating concerns and the evaluation of public projects

Abstract

We study how considerations regarding the credit rating of the government’s debt affect privatization policy. Credit-market discipline presses the government to put more weight on the monetary aspect of public projects, relative to their social benefits, as the anticipated income increases its creditors’ confidence in its ability to repay debt. Yet, several informational problems undermine this discipline, leading to a costly downgrading of the credit rating. Dynamic inconsistency occurs when the monetary to social-benefi tt radeoff is made only after the credit market has priced government’s debt (such as in the decision of the toll on a road): projects are operated with an excessive emphasis on social benefits. Adverse selection occurs when the government has private information regarding a prospective project’s characteristics (such as anticipated traffic). Project selection is tilted towards those with high social benefits and low monetary benefi ts. We study the possible roles for privatization to alleviate these informational problems, and evaluate the regimes with and without the option for privatization.