Friday, April 15, 2005

Full Circle on Public Expenditure


14 April 2005

I am attending a day seminar in Edinburgh on the future of a public utility on Monday 18 April. It is about whether it should remain under public ownership or be privatised. Judging from the listed contributors it is fairly heavily biased in favour of remaining under public ownership. A rival seminar on the same utility in Edinburgh on 12 May will present the privatisation option. I wonder how many attendees at each seminar will have attended both?

The choice is interesting. Looking at it from a historical perspective we seem to have come full cycle. In the late18th century, Adam Smith made the case for government funded public works when no private capital could raise enough money from its own resources to erect and maintain roads, harbours and canals because likely profit streams would be uncertain and would probably not be realised, even though the works would be beneficial for commerce and growth.

When this situation was evident, government funded activities were appropriate, using national or local taxation to pay for them. Throughout the 19th and 20th centuries the state grew in size in all countries and took on wider and wider remits from political judgements about what a state should do in all kinds of activities well beyond those created by ‘market failure’. The tax base funded the expansion of the State.

Now the State accounts from 40 to 60 per cent of a country’s national product in Europe. In countries sensitive to the growing burden of taxation and borrowing, the scope for additional State expenditure is limited, politically. In short, the state cannot afford to raise the funds for new projects or commitments. One result has been the deterioration of maintenance and the replacement of public assets – a new twist on Galbraith’s charge of ‘private affluence, public squalor’ from the 1960s – because of the limitations of the tax base on corporate profits and personal incomes or consumer expenditures to support even minimal refurbishment and replacement programmes.

The Private Finance Initiative programme is a means by which the State funds the reconstruction of the public infrastructure and its expansion. Private capital is mobilised to supply State schools, hospitals, roads, bridges, water and sewage works, railways, air traffic control and public buildings of all kinds. These ‘concessions’ have contracts for 25-30 years, during which the privately funded and managed assets are paid a fee in return for agreed standards of performance. At the end of the contract the project reverts to public ownership. The State extends and replaced its infrastructure out of private funds, effectively paying for them by a method similar to a ‘mortgage’ as used by private citizens when buying their homes.

The objection that this is more expensive than the State raising the capital itself is spurious. It is always cheaper to buy a property for cash than paying for it by a mortgage – check how much your house will cost you to purchase over a 20 years mortgage, compared to paying cash for today’s asking price. The fact is that if you do not have the cash – true for most homebuyers and now too for States – then that option does not exist, either for you or the government.

States that try to borrow themselves out of insolvency (taxation receipts are insufficient to cover expenditures) end up with slower growth, higher unemployment and higher inflation than those that avoid this option. Examples of both proliferate in Western Europe.

That is why Adam Smith’s assertions in “Wealth of Nations” have come full circle. The obvious policy now would be to begin to dismantle over extended State activities, both in the funding and the managing of State provision infrastructures, institutions and welfare services and to replace them with privately funded and managed alternatives.


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