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# **11.1.2. "Government funding is cheaper, but private management is better"**

When governments are not credit-rationed, they tend to be able to raise funds at lower rates than private firms. To still advocate private projects in this situation one would need to assume that the government's funding advantage is more than offset by the private sector's management efficiency.

An example of this argument can be found in the World Bank's _World Development Report_ 1994:5 "In infrastructure projects, the cheaper credit available to governments needs to be weighed against possible inefficiencies in channeling funds through government." The report cites an example where a 3 percentage interest rate advantage of government funding would need to be offset by cost savings of more than 20 percent for private ownership to be advantageous.

There are a number of cases where efficiency gains of 20 or more percent have, indeed, been achieved by transferring management to the private sector.6 But efficiency gains vary widely. They may amount to only a few percent and in some important cases it is not clear whether private is really more effective than public management, particularly when private enterprise is subject to monopoly regulation. For example, the most thorough study of the relative efficiency of private versus public sector power utilities in the United States suggests that - controlling for differences in cost of capital, tax treatment and other factors - public utilities are more efficient than investorowned ones (Kwoka 1996). Should the United States, therefore, nationalize all power utilities? If we believe in the basic arguments about the cost of government borrowing, the case would seem strong, because public sector utilities deliver slightly cheaper service even when one does not add in the borrowing cost advantage.

If one believes that a tradeoff between low-cost government finance and greater private sector efficiency exists, then one needs to be careful with privatization unless it is reasonably clear that private management will yield sufficient benefits to offset the lower cost of sovereign funds. By the same token private management is then justified to clamor for government financial support up to the point where its own incentives to perform efficiently are undermined.

This line of arguments also lies behind calls for government or multilateral financial participation in private projects. Such calls are, for example, made by the Institute for International Finance,<sup>7</sup> which suggests World Bank lending to the private sector. As is well known a number of infrastructure projects benefit from some type of government financial participation (beyond guarantees for policy failures), for example, Hungary's M5 motorway project.

5World Bank 1994, box 5.1, p. 91.

6See for example Camaghan and Bracewell-Milnes (1993) and Domberger, Meadowcroft, and Thompson (1994).

7Institute of International Finance (1995), p.<sup>6</sup> . The IIF suggested World Bank lending to the private sector without a host government counterguarantee. Private companies would thus benefit from the low cost funds the World Bank can raise due to its backing by the best credit risks of the world i.e. the major governments of this world.