Study Case

OXFORD REVIEW OF ECONOMIC POLICY, VOL. 13, NO. 4

OXFORD REVIEW OF ECONOMIC POLICY, VOL. 13, NO. 4

INVESTMENT APPRAISAL IN THE PUBLIC SECTOR

R. A. BREALEY I. A. COOPER M. A. HABIB London Business School1

Recent developments, such as privatization and the private finance initiative, have raised the issue of which assets should be owned by the public sector and whether assets have different values in the public and private sectors. In order to answer these questions, we first note that the allocative considerations that usually motivate government intervention need not require the direct provision of services by the government using government-owned assets. We then argue that the government should own the assets used to provide the services where the private sector fears expropriation by the government, or where ownership confers on the private sector such power as to preclude efficient allocations. Finally, we argue that the discount rate for governments’ projects equals the expected return on comparable investments in the capital markets, The government should, however, discount pre-tax cash flows at the pre-tax discount rate, for it receives all tax revenues.

I. INTRODUCTION

Governments undertake a variety of activities. They are responsible for setting macroeconomic policy; they seek to promote equity by aiding the poor and the disadvantaged and they provide a variety of services, such as education, health, defence, infrastructure, and police and postal services. Many of these activities involve large investments. For example, the cost of the four-nation Eurofighter programme is expected to be of the order of £38 billion,

that of the proposed trans-European transportation network in the range of £53 billion. Recent developments such as privatization and the private finance initiative (PFI) in the United Kingdom have raised the issue of which assets should be owned by the public sector, whether assets have different values in the public and...