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Patient and impatient capital: time horizons as market boundaries

Offer A.

Since the 1980s privatisation and outsourcing have been promoted on the grounds of efficiency and fiscal convenience. The paper argues that private enterprise does and should provide for society’s future needs, but it is circumscribed in what it can and should do.

Despite the promotion of market mechanisms, the public sector has not contracted in recent years. Public spending typically remains between 40% and 50% of GDP in most advanced countries. The level appears to be trendless and counter cyclical and endures despite austerity policies. Such persistence suggests that something more powerful than ideology may be at work, and that the public-private boundary is an expression of economic fundamentals. The paper aims to identify what these may be.

The appropriate choice between business and public enterprise is determined by the interaction between a financial time horizon and a project time horizon: the prevailing interest rate defines a credit time horizon, while payback appraisals define a unique break-even point for the private sector. The paper suggests that any project which has a break-even longer than the payback period cannot be funded by business alone. The payback method is used here as a diagnostic, and is not recommended for project appraisal.

Public-private partnerships were intended to overcome credit time boundaries, but their implementation has given rise to inefficiencies and corruption. Long term projects such as infrastructure development involve an array of uncertainties concerning the time-scale, budget and benefits. Attempts to control these by means of rigid financial contracts invariably lead to inferior outcomes. Uncertainties cannot be dissipated by mere contract.

In the UK, Private Finance Initiatives (PFIs) were a response to the financial sector’s quest for yield after 1980. The form was sustained because of the ‘magical thinking’ of politicians, but it has failed. The desire to lock down terms may be advantageous for financiers but is likely to undermine overall project quality, and very often the promised savings and risk transfers failed to materialise. Consequently, the number of PFI projects declined, although the financial liabilities continue far into the future.

Another method of transcending credit boundaries is through a ‘franchise’, defined as a revenue flow with pricing power, of long duration and low variance, with some protection from competition provided by social and government agencies. It runs counter to the neoclassical premise that business superiority arises from competition, relying instead on some form of state-backed protection. Franchises allow longer credit break-evens and provides social leverage for imposing corporate compliance with the public good but do not eliminate inefficiencies or corruption.

The author argues that franchising or any other form of public-private partnership requires integrity to be efficient, and that integrity is not ‘naturally abundant’. Public management therefore needs to be governed more strongly by intrinsic normative motivation, or ‘ethical capital’.

For long term projects, local knowledge and market choice, as advocated by the economist Friedrick Hayek are not sufficient. The drive by public authorities to promote market mechanisms has created perverse incentives. The task of social planning is to manage uncertainty, but it is private finance which needs certainty most. Private enterprise works best in the short term, public management is required for long term projects.

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