A Pervasive Economic Fallacy in Assessing the Cost of Public Funds
32 Pages Posted: 3 Feb 2021 Last revised: 10 Mar 2021
Date Written: December 2, 2020
In the assessment of the cost of public funds, there is a pervasive economic fallacy, which is frequently repeated by officials in both the private and public sectors as well as in academia: since the cost of borrowing is higher for a private sector firm than it is for a public sector firm, the cost of carrying out an activity (investment, production, distribution, provision of goods and services) will necessarily be lower ceteris paribus in the public sector than in the private sector. The statement is erroneous because part of the government’s cost of borrowing is hidden from the casual observer of interest rates or yields. The all-inclusive borrowing cost, more generally the all-inclusive cost of capital, is the same for both the public and private sector. I discuss four specific real cases where the error is present, the first three more succinctly and the last more more extensively: the Quebec Generations Fund; the Québec CDPQ Infra REM project; the Infrastructure Ontario methodology to assess the riskiness of costs; the BC Hydro’s Site C hydroelectric megaproject. I discuss also a general fifth case, namely governement support programs for business (grants, loans, guarantees, subsidies, etc.). Those are often justified on the fallacious claim that the cost of financing is smaller for the government than for the private sector. I propose an auction process by which the true cost of business support programs could be made transparent. I conclude with an appeal for a more rigorous use and management of public funds. I expect that miscalculation, misinformation, mismanagement, and fallacious analysis will backfire, as always.
Keywords: Cost of Capital, Public Debt, Site C Project, Generations Fund, REM, Infrastructure Ontario
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