Public and private sector discount rates in public–private partnerships

Abstract

Whether public sector projects should be discounted at a lower rate than private sector projects is highly contentious. This paper assesses the appropriate private and public sector discount rates in the context of public private partnerships. It shows that there are powerful arguments for using a higher rate to discount private projects than public sector projects and that failure to recognise this may lead to excessive reliance on public provision. However, the reason for the divergence is not related to the conventional incomplete market arguments in the literature. The results may have far broader implications for private sector involvement in public services. In the last 20 years there has been a major increase in the role of the private sector in the delivery of what were once considered public sector services. Outside transition economies, probably the single most significant change has been the international wave of privatisation of utilities. Such privatisations typically involve the complete transfer of ownership to the private sector with the role of the state being reduced to policing prices and conduct. More recently, however, there has been a rapid growth in more complex forms of private involvement. In many cases the public sector or its agencies remain the immediate final purchaser of the services but no longer own or operate the assets necessary for the provision of the service. Such arrangements tend to be referred to as public-private partnerships (PPP). In a typical PPP, the government signs a long-term contract with a private consortium to supply a service to the government and the private consortium designs, builds, owns and runs the physical assets required for the delivery of the service. This contrasts with traditional public sector provision where the government builds or purchases physical assets, retains ownership and uses public sector employees or a private contractor to deliver the required service. A PPP can be characterised as a situation where the government becomes a purchaser of services not physical assets.' This type of arrangement is now common in the case of roads, prisons, hospitals and schools both in the UK and elsewhere.2 The economic justification for PPPs is that they increase efficiency by aligning the incentives of the parties.3 As a result the government is able to provide the service at lower cost than would be possible with conventional public sector delivery. Indeed, the standard test criterion for a PPP project is that the cost to the