Monopolistic Capital Market or Public Private Partnerships

This week's Economist has a few articles on capital markets in the US. This one, "What's wrong with Wall Street", is the leader, and should be available to everyone. This one, "Down on the Street", is a special report, is longer, and requires a subscription. The articles discuss capital market efficiencies, and whether regulation is putting US capital markets at a disadvantage to London and other markets. I found the issues raised in context of the world's largest capital markets to mirror some thoughts I have about the very small capital market for funding Government of Canada (GoC) projects.

The GoC (or as the current prime minister would have it "Canada's New Government") spends about C$200B annually. Of that most is recurring expenditures, leaving about C$20B annually for new capital spending. Expenditures of over C$20M follow a formal approval process that includes the requirement for Treasury Board secretariat review, and depending on the value and other factors may require cabinet level approval, delegated to a committee of cabinet, the Treasury Board. This past June I participated in submissions to Treasury Board requesting just about C$170M in funding for various projects, funding that was approved by the Board. It was a rather depressing experience. Within the GoC bureaucracy it is an accepted fact that the GoC has, by definition, the lowest cost of capital, and therefore should fund all its own capital requirements. Put in another way, the GoC funds internal investments from its own captive, and monopolistic, capital market.

This is a classic error that many readers have likely already spotted. Within the procurement function we routinely review for "Total cost of ownership" (TCO). The TCO review I had our team look at for the cost of the capital investments for the submissions in June showed that, while the interest cost on the capital was the lower than that available from competitive capital markets, the pursuit costs and the opportunity costs seem to be substantially above those tolerated in competitive capital markets.

For an investment of C$170M the pursuit costs were approximately C$35M (which was also borne by the GoC), and it had taken the GoC approximately 5 years to work its way through to approval. The returns expected from the $170M are expected to be in the order of C$1B annually, of which the investment would enable the GoC to lock in $C200M immediately. I am not an expert on the workings of capital markets, but I suspect a competitive market would be able to fund projects with that profile at a substantially lower pursuit cost, and would have done so far more quickly, lowering the opportunity cost of the process as well.

The main arena that this debate is useful, is in the debate of whether "Public Private Partnerships" (PPPs) make sense for the governmental sector. Those opposed to PPPs will argue that the private sector cannot provide the same value as government self-performance as the government has a lower cost of capital and does not need to generate profit from its activities. I'll leave aside theoritical arguments for and against that view, and say that I am much more bullish on PPPs after closely observing how one government loads cost the private markets would not onto its own capital market.