CAPITAL INVESTMENT PROGRAMMING
AND ITS FINANCIAL IMPLICATIONS
Budgeting and Financial Management
David C. Jones, C.P.F.A., F.C.C.A.(UK), and as:
Research Fellow & Visiting Instructor, President, Farsight Inc.
Center for Urbanization Studies, International Financial & Management
Graduate School of Design, Consultants
Harvard University, 4936, Andrea Avenue,
48, Quincy Street. CAMBRIDGE. Annandale,
Massachusetts Virginia. 22003. USA
Tel: 617-495-4964 Fax: 617-495-9347 Tel: 703-978-8564 Fax: 703-978-8014
E-mail: firstname.lastname@example.org E-mail: email@example.com
CAPITAL INVESTMENT PROGRAMMING AND ITS FINANCIAL IMPLICATIONS
BACKGROUND AND FINANCIAL FRAMEWORK
Capital Investment Programs are usually thought of as building things. This includes:
development of land; erection of buildings; installation of roads, bridges, pipes and other
infrastructure – above, on and under the ground; or, the supply of equipment for use on a semi-
Primary participants in these activities are mainly engineers. Thus, it is natural that they will be
concerned to build and install, as rapidly as possible, the infrastructure and other fixed assets
perceived to be urgently needed. They, after all, have the primary expertise for this task. A
principal limit on the pace and magnitude of their work is, clearly, financial resources. A capital
investment program, therefore, is an opportunity for prioritization of fixed asset implementation
activity and the related access to urgent and important funding sources. It will also show how the
vision and operational strategy of a community is reflected in the program for capital
Because of the very large Capital Investment Programs (CIP) to be financed, failure to consider
the availability of funding could give rise to an undue sense of urgency. That might engender a
disregard for the need to carefully examine each project component with due diligence. It is
important, of course, to ensure that the necessary funding will be available, in full and on time,
as and when needed for each project component. However, it is also important to ensure that:
(a) each project component, as well as its size and scope, is selected on the basis of a
rational prioritization, with reference to its financial and economic costs, measured
against its benefits or effectiveness – economic, financial, social and equity; and
(b) each project component represents the least economic cost of providing a sound
solution to the concern being addressed.
These should be addressed on the basis of life-cycle costs. These allow for the capital costs and
also the impact of these on recurrent finances, together with costs of operation, maintenance and
administration. Also to be considered are the costs of replacement or rehabilitation of equipment
that will not continuously serve with optimum efficiency, or even become unserviceable, during
the life-cycle of the principal project assets. Analyses will need to allow for expenditure in later
years to be discounted against earlier expenditures.
It is also important to take account of the extent and timing of revenue flows from the use of
various infrastructure items. Some components, such as water supply, will provide immediate
individual benefits and may well be connected with optimum promptness.
Others, such as sewerage, provide benefits that are only partially directed to individual
households. Some benefits accrue to the community as a whole. They are also more diverse and
less immediately obvious. It may be that there will be a greater reluctance by individual
households to connect to the system. Solid waste services also exhibit some of the same
Sometimes, financial revenues may still be collected, by levying charges whether there is a
direct household service or not. However, this may well be contentious, especially for sewerage.
For example, households that can ill-afford this may need modifications to internal plumbing.
Moreover, lack of connection will likely have technical shortcomings. Low flows will
potentially harm the sewer pipes, while a lack of connections will limit public health benefits to
the wider community.
Some infrastructure, such as roads and drainage, will likely provide benefits that are of a general
public nature, rather than to individuals. Road improvements1, moreover, are likely to improve
the efficiency of other public services that rely on transport, especially solid waste removal,
police, fire and ambulances. The operation and maintenance of roads and storm drainage,
together with necessary capital cost recovery, will need to be borne mainly from general taxes.
Thus, it is important to ensure that the necessary increases in general tax revenues are
engendered from: buoyant increases in the tax bases; politically acceptable and administratively
sustainable increases in the tax levies; or, reductions in other tax-borne expenditures. The last-
named would need to result either from efficiency improvements or curtailment of other
All of these matters are the concern of both technical and financial expertise. Moreover, they
have financial and economic effects beyond the scope of the individual projects. They impact
upon the entire financial framework of the local government unit, and way beyond it, to other
entities. Engineering specialists should, therefore, work closely with financial colleagues. This
will provide greater assurance that appropriate costs are budgeted and accounted for, in ways
that will be both credible for reporting and useful for effective action. Most importantly, these
are policy issues.
The above view of Capital Investment Programs has focused on the raising and spending of
cash, to provide the infrastructure and other assets. Some attention has also been given to the
provision of funds to operate and maintain these.
Certainly, cash-flow management is important, for a variety of reasons. However, other than by
blind coincidence, "cash-flow," is unlikely to be synonymous with "cost." Cost definition cannot
be meaningful unless based on economic principles. Therefore, it should relate as closely as
possible to the concept of resource consumption, rather than to the mere receipt and payment of
cash. It should also incorporate, where possible, recognition of the recovery of capital costs.
These need not be major or massive improvements. Sometimes, improved access to pedestrians and non-vehicular transport
can bring notable economic and social benefits, relating to access and egress at awkwardly located spaces.
Therefore, costs – in terms of resource use – of any business or public activity 2 should include
properly recognized and recorded expenditures on the following:
(a) operation of the activity - in terms of the production of goods and services;
(b) maintenance of all premises, plant and equipment in a satisfactory condition to
perform its operations in a safe and efficient manner for its entire working life;
(c) administration and management of the activities, together with the payment of
taxes, necessary to ensure that operations are efficiently effected; and,
(d) the rental cost (capital cost recovery factors) of fixed and working capital,
comprising, either (for property not owned) the market rent, or (for property
(i) consumption of capital, typically recognized as depreciation of premises,
plant and equipment;
(ii) adjustment of value, either in terms of changes in real values
(opportunity costs) of property or in recognition of the effects of changes
in monetary values (inflation and deflation); and,
(iii) return on investment, including interest on debt and an expected and
reasonable return on contributed (equity) capital, either by dividends to
owners or by retained earnings.
After covering all the above, which are resource costs, it would be prudent to expect that the
budgeted activity costs would also allow for an additional (albeit small) "surplus," over and
above the expected and reasonable costs of capital. This would allow for periodical fluctuations
in financial fortunes, more specifically: risk; uncertainty; new activity; and, longer-term
Return on Investment
Included as part of the "return on investment" is the provision for dividend and retained
earnings, typically accruing to the owners (shareholders) of an entity. These are items which,
according to "generally accepted accounting principles" are not treated as costs but as allocations
of "profit." The distinction arises because financial accounts reflect “property rights” rather than
economic principles. Thus, the interests of owners (shareholders) are reported as the earnings
(profits) after all claims have been met from outside of the entity, including those of lenders.
There is, however, common agreement among economists that what are considered to be
This concept is referred to elsewhere (e.g. in a set of training slides) as “OMAR’S CAR.” It reflects that the COSTS of any
business or activity are synonymous with those of a taxi-owner (called Omar). His costs must cover: Operation; Maintenance;
Administration & taxes; Rent (capital recovery) and Surplus. The Rent concept (CAR) covers: Consumption of capital
(depreciation); Adjustment of Value (revaluation); and Return on Investment (interest, dividend and retained earnings).
"normal" profits are no more than a part of the "opportunity cost of capital." Only extra-ordinary
earnings are typically regarded as true "profits." This is somewhat analogous to what is
described as "surplus" in the above set of distinctions3. Furthermore, the standard practices of
financial analysis deal explicitly with costs of capital, the return on total net assets, as the
weighted consolidation of the separate and specific returns to debt and equity financing4.
This has a parallel in the public sector. In some countries, notably in the USA and UK, it had in
the past typically been standard practice for state and local governments to finance up to and
including 100% of many items of capital expenditure by the borrowing. This usually had
amortization periods closely related to the working life of the fixed assets acquired.
However, even where all or part of these assets may have been financed from sources other than
debt5, the funds used for this purpose still have an opportunity cost. Indeed, the financing of
capital expenditure from general government revenues (local, state or central) will do one of two
things. Either it will add to the overall "deficit," which will have to be borrowed, with interest,
or it will eliminate some part of the overall "surplus," which will create a loss of interest on the
related monetary investment. Even if the deficit is covered by increased taxes, the taxpayers
(effectively the "shareholders" of the government) will (collectively) lose the equivalent in
interest on what would otherwise have been their own money6. They will also forego the use of
the principal sum.
The issue of cost definition has been fully stressed and explained because it forms the basis
against which all related aspects will need to be assessed. For example, it affects, or is affected
by: cost accounting systems; prices; allocation of overheads; budgetary management; fiscal
deficits; maintenance of assets; and, inter-governmental transfers. Costs of service cannot be
credibly stated, nor fully recovered, unless they include reference to all of these various factors.
Effective decisions on public service delivery, depend upon whether, and in what form, the costs
of these are determined. Furthermore, cost recognition, to be consistent, should relate to the
maintenance, use and consumption of resources and not to the manner in which these resources
are originally financed. Sometimes, subsidies are appropriate, for economic or social reasons.
However, unless costs are determined in an authentic fashion, there is no way to know whether,
or to what extent, the subsidies already exist (such as in the initial capitalization) or are
ultimately justified, as in transfers from other accounts, funds or governmental entities7.
Economists sometimes refer to this as “economic rent,” a concept introduced by the classical economist, Ricardo.
Equity includes "retained earnings." These are somewhat analogous to situations where borrowers retain compound interest,
in that they are expected to earn returns.
This includes grant financing, of the type used for the various capital programs supported by state or local governments.
This is not an argument against the financing of fixed assets from taxes - only an explanation of its consequences.
An example is the Washington Metro-rail transit system. In many presentations (of this and other urban transit systems),
“costs” are postulated only as operating costs, completely ignoring the impact of the costs of the use and deterioration of the
fixed capital assets. Then, when these become pervasive, it is necessary to “shop around” for capital funding from constituent
governments. An August 2004 press article, indeed, refers to “Urgency Drives New Metro Pitch for Funds.”
An example of the presentation and use of financial statements, incorporating full accounting for
resource use costs, is given in the annual financial statements of the City of Birmingham,
England8. As required by law, it follows the “Code of Practice on Local Authority
Accounting in Great Britain” and the “Statements of Standard Accounting Practice” (SSAP)
required by the Chartered Institute of Public Finance and Accountancy and other UK
professional accounting bodies. These include stipulations for full accounting of all fixed assets,
irrespective of the method of financing. It includes imputed rental, depreciation and interest
costs, where appropriate at current (replacement) values.
Central governments, of many other countries, are attempting to encourage and support activity
by the local government units. This includes activity that it favors or for which there is some
clear justification on national grounds. However, the prime responsibility is, increasingly, that of
the local government units.
A most important means of financial support by the central government of local government
units is the government grant. Among the many reasons for government grants are the
(a) transfer to local government units of a proportion of revenues collected in or
for their areas, but which can be collected more efficiently at national level
(e.g. income tax, sales tax, VAT and customs duty);
(b) support for services in which national government has an interest but which
may be better performed locally, with input from local people (e.g. primary
and secondary education, local roads and public health);
(c) equalization, to some degree, of the needs and resources among different
(d) provision for specific burdens upon individual areas not shared generally;
(e) encouragement of practices which are consistent with national social,
economic or financial policies (and discouragement of those which are not);
(f) enhancement of limited local resources to provide reasonable flexibility in
decision-making on the provision of services;
(g) major shifts in political, economic or social characteristics of a nation, group
of nations or region (e.g. the massive political changes resulting from the
liberalization policies in Eastern Europe).
There needs to be a great deal of common sense and political wisdom, as well as economic logic,
in the administration of a grant structure. For example, whatever may be argued for the needs of
These statements are available separately.
a particular area, it may also be one of the most important commercial centers, with a great deal
more economic potential than elsewhere. Thus, there might be a strong economic or equity-
based case for a net transfer of resources away from the area, in favor of much poorer areas9.
Grants may be given towards specific capital projects or to support recurrent operations. In
principle, capital grants have a distinct disadvantage. They will tend to support new capital
schemes, perhaps too soon, too large or even not justified at all, instead of encouraging the
continuance of a service using existing available equipment and infrastructure. This is very
serious in any country where capital resources, especially in foreign currency, are scarce and
Faced with a choice of spending its own resources on maintenance or getting a grant for new
capital investment, a local government unit may be strongly tempted to opt for a capital grant. A
more appropriate financial support for capital expenditure would be a loan, for the life of the
new asset, at market interest rates. Then, the local government would be faced with a more even-
handed financial choice. It would either continue to pay operation and maintenance costs for the
old (probably inefficient) asset or pay debt service (more strictly, capital charges) on the new
However, in practice, application of these principles may often be difficult, even inappropriate.
First, much local infrastructure is in a very poor state and in urgent need of replacement. Indeed,
there are some areas or communities that have been so disadvantaged that there is little or no
decent infrastructure to begin with10. Second, there is no reasonable supply of market-driven
medium-term or long-term capital. Even if there were, there is no satisfactory mechanism to
administer it. Third, many local government units lack credit-worthiness, at least until revenues
are greatly stabilized and enhanced. Finally, with the meager and uncertain financial resources
available to the central government, capital grants at least represent one-time payments for
which there is no continuing obligation beyond the duration of a particular program11.
For example, the Northern Virginia suburbs of Washington DC, USA, arguably comprise the Nation’s wealthiest area. It
makes good local politics (albeit, poor distributive economics) to complain of local tax revenues “sent elsewhere in the state.”
This is the situation in many formerly – and still currently – disadvantaged communities, emanating from socialist or other
centrally-planned economies, such as those in the former Soviet Empire. Central governments sometimes use capital grants as
“pump-priming” mechanisms, for installation of, or access to, infrastructure in areas where little or none had, hitherto,
This may not be exactly correct. Until local recurrent financial resources grow sufficiently robust to operate and maintain
the new infrastructure, there may be a case for declining annual interim central government support towards this expenditure.
Thus, capital grants offer the opportunity to assist with the initial installation, expansion,
reconstruction and rehabilitation of infrastructure. They can also be highly selective, giving
preference to areas of greatest need and with the poorest resources. Where used, they will almost
always represent a proportion of an approved capital cost, after careful examination and
appraisal of the project by central government officials, or those acting on their behalf (e.g. staff
of a "development fund" or "municipal bank").
Sometimes, as an alternative, projects will qualify if they meet pre-determined conditions that
apply to all similar and relevant circumstances. This suggests that the central government
ministry responsible for local government should try to develop an improved capability for
project appraisal. This could provide significant assistance to local government units in planning
their development, even without grant support.
However capital expenditure is financed or supported, there will usually be some need for
continuing support of recurrent operations. Thus, methods must be found to provide this support.
To some degree, at least, this may also need to be supplied by central or state government grants.
Usually, there is a system which combines a local government’s own revenue sources with
recurrent grants from state or central governments.
Some of the methods to be considered for the administration of a recurrent grant system are set
out below. However, it must be realized that, at present, many would need to rely upon statistical
information that is simply not available or reliable. The ministry of “local government” or of
“finance” should, therefore, attempt to build a data-base for this and many other purposes.
Possible assessment and distribution methods for recurrent grants are:
(a) budget review – central government reviews each local budget in turn, assesses its
credibility and provides a grant to cover all or some of any expected recurrent deficit;
(b) policy support – central government undertakes to reimburse local government units
for the costs of nationally mandated policies, such as nation-wide salary increases;
(c) reimbursement – central government effectively pays for the costs of delegated
services, properly the primary responsibility of the central government;
(d) revenue compensation – central government covers losses resulting from curtailment
of local revenues as a result of national policy (e.g. abolition of a local tax based on
incomes or the imposition of rent controls affecting property tax valuations);
(e) percentage – central government provides a percentage of the cost of local services,
with percentages, typically, varying from service to service;
(f) population – central government provides a lump sum per head of population, which
could vary among age-groups to take account, for example, of the special needs of
children and the elderly, with respect to education, health and welfare;
(g) unit – central government provides a lump sum per unit of service or potential service
(eg. per mile of road, per patient at clinics, per refuse vehicle);
(h) revenue potential – central government compensates for potential loss of revenue, for
example, based on property tax values or assessed incomes for graduated tax, relative
to total population and national average tax potentials;
(i) revenue sharing – government designates all or part of nationally-collected revenues
(eg. vehicle licences) to be shared among local government units; and
(j) formula – a variety of factors is taken into account to provide a grant structure which
meets multiple objectives.
All of these procedures are appropriate for most sets of circumstances, although only some of
them may be chosen for practical use.
STRATEGIC PLANNING FOR CAPITAL INVESTMENT
When looking at a strategy for a Capital Investment Program, it might be well to remember
some words used by John Muir, ecologist and environmentalist:
“When we try to focus on one thing by itself, we
find it hooked to everything else in the universe.”
A local government unit, establishing a capital investment program, can hardly be so profound.
However, it can surely do better than just to prepare a list of projects that then need to be,
somehow, financed. In a local or regional community, failure to visualize linkages, among the
various concerns, constraints and opportunities inherent in any community can lead to very
serious shortcomings. This is especially the case with capital investment programs, because of
the large expenditures, the significant consumption of space and time and the specialist and often
single-purpose nature of the assets installed.
Even in the physical sense, there are many, many, linkages. New buildings need new
investments in roads, footpaths, surface drainage, water supply, sewerage, electricity supply, and
telephone services. All of these infrastructures, if already at capacity use, will need to be either
developed or expanded. If not, they will be overloaded, operating with increasing inefficiency.
For example, the much-heralded “Big Dig,” for a $15 billion massive road improvement in
Boston, USA, required huge expenditures for construction, realignment and compensation for
objects and activities that had nothing to do, directly, with the actual road improvements. They
were, however, impacted by the construction, realignment and tunneling for this.
If social concerns are added, one must also recognize that buildings will almost always have
occupants. Thus, there will be a need for shops, offices, schools, theatres, parks and many other
developments to house or supply the goods and services needed by these people or their families.
Also, if there is to be reasonable communication among residents, public or private transport
systems will be needed.
It might be argued that almost everything in a community is concerned with transportation, in
one form or another. Indeed, one way of perceiving a community is as a giant transportation
system: for people, goods, services, information and waste products. At least two other concerns
will influence the development of a capital investment program within a community. Firstly,
there is the history, tradition and heritage of the community. No community on earth just sprang
up, in the middle of the night, so to say. Every community is coming from somewhere. It has
history, traditions, heritage, habits and prejudices. Many of these are reflected in the buildings
and other structures, some very beautiful, some quite ugly. By consensus among residents and
with pressures and influences from outside of the community, some of these structures will be
preserved; some will be destroyed or significantly altered. Change is inevitable and continuous.
Change is the motivator for the other concern. That is the need for vision. Someone, or a small
group of people, must have an idea about where the community is going. What will it become?
How will its residents behave? What might have to be done to influence, sustain or curtail this
behavior? How intrusive, coercive, supportive, permissive, benevolent, helpful, officious or
charitable should be the collective governance system? How reliant upon the free-market or how
tolerant or corrective of market failure should it be?
Reaching consensus, even on a single issue, is difficult. Reaching consensus on a whole range of
community issues often seems nearly impossible. The mechanisms for doing this, even at local
level, are by their nature clumsy and inefficient. Full and free citizen participation must be
matched with constitutional rights, legal requirements and effective government. Individual
concerns must be tempered by sensible and efficient governance, planning, management and
All of these concerns form a background to strategic planning, as a precursor to the
establishment and timing of a capital investment program. A major constraint will be that of
finance. Indeed, as explained later in this document, if a capital project cannot be financed, it
cannot be implemented. However, from a strategic perspective, one must examine not only
whether an individual project can be financed but also whether all of the financial implications
of its implementation can be efficiently coped with.
For example, if there is enough funding for a water supply extension, will there also be enough
to deal with the inevitable increase in sewage disposal requirements? If so, will the potential
adverse impacts on the environment be overcome. Finally, if sewerage is to be installed, it might
require substantial and costly modifications to the internal plumbing of residences and other
buildings. Unless this is affordable to the owners, the sewerage service will not be able to
operate properly. Consequently, some understanding of the ability and willingness to pay, even
for the private parts of the service, is necessary.
Strategic Planning for Activity
The management of a local government unit, or of almost anything else, will need to deal daily
with predicaments. These arise from the local government’s formal or informal mandate (long-
term) its policies (medium-term) or its (short-term) provocations. Each will overlap and impact
on the others. Each will create predicaments, which will need to be addressed in some way by
There are, perhaps three main reactions that can take place. Firstly, the managers may decide
that they have no concern to deal with. This may be because it is beyond their mandate or
contrary to their policy to become involved. Indeed, the predicament might be quite a serious
one. However, it may not be one with which the local government unit is willing or able to
become involved. Consequently, as an institution, it can be at peace. There is nothing for it to
Secondly, the managers may decide that the provocation is the responsibility of the local
government unit to deal with, as a concern. It comes under its mandate and is addressed by its
policy. It may decide, however, for a variety of reasons, that it is either unable, unwilling or
both, to address it as a concern, at this particular time. It therefore remains a problem and the
people involved or affected by it will continue to suffer.
Finally, the local government’s management may decide that the provocation creates a
predicament that the local government will address, at this time. It comes under its mandate, it
can be dealt with under its policy and is accepted as a concern. Therefore, it must follow that
there will be activity. Under the principles of activity-based management, incorporating activity-
based budgeting and costing, the only phenomenon that operators and managers can be held
accountable is activity. For example, it might be very interesting to know: what the mayor of a
city thinks about a new water supply system; what a public works director feels about the road
maintenance program; or, what a chief financial officer knows about accounting. However, what
they will be held accountable for is what they do about these concerns. In other words, they are
accountable for their activity: signing a contract for a water supply system; repairing potholes
and other road damage; or, publishing a set of financial statements.
Under the concepts of activity-based management, only activity can be budgeted, costed or held
accountable for. Thoughts, ideas and concepts, however profound, do not find directly find
places in the financial interpretations of activity.
Activity begins with a purpose. If an activity has no purpose, it is relatively meaningless.
Usually, money spent on it cannot be justified. The purpose should be carefully defined, both in
tactical and strategic terms. From a tactical perspective, the purpose should indicate clearly and
directly how the particular activity is expected to achieve it. From a strategic perspective, the
purpose should indicate what it is that the activity, together with its tactical purpose, is expected
to contribute to the wider vision, goal or perspective. In some respects, this is similar to the
distinctions drawn between outputs and outcomes.
Outputs achieve tactical purposes. Outcomes achieve strategic purposes. It is, typically, the
outcomes that relate to the visions of those with the wider views on policies. For example, for
the London Docklands Development to have succeeded, as it has done substantially to date, it is
doubtful whether this could have been achieved just by any number of tactical activities,
however well-coordinated. Its managers were faced with a ramshackle and moribund collection
of derelict buildings, rusting ship-hulks, shabby storage sheds and polluted sites.
Only a strategic vision of future possibilities could have served to create the resurrection and
transformation of this. Therefore, it was sometimes said that one of the first managers of the
project had: “Both feet firmly planted in mid-air!” This encapsulates what is often meant by –
and needed – as vision.
Purposes, Outputs and Outcomes
When purposes have been established, resources must be assembled. These must be organized to
work efficiently. Assessments need to be made about the time-span of the activities and also
their spatial coverage. With capital development projects, rather than programs of operational
activities, one is often talking about long time spans, with fairly narrow spatial coverage. The
latter is often confined to a single site or project area. However, the strategic implications, as
well as the operational impacts, could cover much wider spatial dimensions. They could be
perceived of in shorter-term time packages, perhaps linked to much longer strategic time-frames.
For example, a project to deliver additional electricity will confine its construction activity to the
project site and to any new transmission facilities. It may well, however, be implemented over a
five to ten year time frame.
When completed, the operation and maintenance of the project will not be so isolated. Instead, it
will be integrated within the entire system of electricity delivery. Concurrently, the supply of
electricity will be perceived of in yearly or other relatively short-term time packages.
Strategically, however, planning will need to be looking far ahead of the present, to identify new
sites, new fuels, environmental concerns, growth of new areas and many other considerations.
This will need to link up to predictions about the movements and demography of people, as well
as about the operations of a variety of related activities.
Design and implementation of a capital project will need to take account of its ultimate
operations. Different modes of operation will apply in different circumstances, especially with
respect to the prices and availability of (say): trained workers; raw materials; transport facilities;
and, maintenance facilities. Much of this will be directed towards economic efficiency. This,
again, needs to be both tactical and strategic in outlook.
With respect to efficiency of operations, it will be necessary to examine the motivations and
incentives of those involved, whether inside or outside of the primary activity. There are many
stakeholders and all will expect to be considered. Finally, there is a need to keep abreast of
evolving technologies. In modern times, some technological changes are unfolding with breath-
taking speed. It is very hard to keep up with this phenomenon.
Tactical Planning for Activity
In the language of Capital Investment Programs, an activity is often referred to as a project. As
already indicated, it is typically bounded by time, space and tactical purpose. It is, however, the
unit of activity which can be implemented, budgeted and costed, to deal with a specific
predicament or concern. Predicaments engender responses. These will often begin with feelings,
then thoughts and ideas. Eventually, however, a response to a predicament must be in the form
of activity. The first activities will likely be plans, programs and budgets. Then there may be
intellectual and physical work on project implementation.
Unfortunately, project implementation will hardly ever run smoothly. The activities, however
well-planned or well-executed, are virtually certain to encounter obstacles. These may be
political, technical, financial or of many other kinds. They will all need to be mitigated or
resolved, so that the activity can continue and the purpose achieved. This can absorb, sometimes,
a great deal of time, energy, money ad frustration. They may be as often administrative as
physical. Hidden blockages may appear under the ground or in the office! Explosions may occur
when blasting out rocks or blasting out people. All must be resolved and the funds to do this
should have been allowed for.
Activities, therefore, have many implications involving decisions. Each of these will have
financial and operational implications. Sometimes, major tactics and even entire strategies will
need to be revised. This will usually have even larger financial and operational implications.
Each new situation, moreover, will become a new predicament. Each will have its own new set
of tactical, strategic and other concerns, until the project is again brought into equilibrium or is
FINANCING OF PUBLIC SECTOR INFRASTRUCTURE
Overall Financial Requirements
00000000From the overall perspective of various entities dealing with public utilities and
infrastructure, it is clear that in many situations, world wide, future demands on public financial
resources will be formidable. This will apply to the funding of ongoing public services as well as to
For example, in many situations, road-space, drainage and sewerage systems are totally inadequate
to deal with even the current needs of residents. Underground piping is also old and worn. The
development of new residential and commercial areas typically demands large inputs of primary
infrastructure. Where cities are, as is common, located astride rivers, there is also need for
substantial upgrading of river crossing facilities. Often, sites formerly used for other purposes,
especially industrial ones, will need to be cleared and then made environmentally safe.
Where underground rapid-rail systems are planned or under construction, capital-financing
requirements will be huge. Moreover, subsequent operation and maintenance will likely require
significant annual subsidies. Bus, streetcar, gas, electricity and water supply services often operate
under policies dominated by public welfare considerations. Thus, prices are inadequate to cover
operation, maintenance and capital-cost recovery. As a result, current budgets of municipal
governments must often provide for heavy annual subsidies of these, too.
Basic Capital Financing Principles
The search for alternative financing of public services and infrastructure should clearly explore
possible new approaches. In particular, there may be considerable potential to use leasing, sale or
grant of concessions for publicly owned land, in exchange for private sector financing of public
infrastructure. Indeed, it is likely that some attractive packages can be arranged, with both local and
foreign investors. It should, however, be cautioned that the search for innovative financing options
should not overshadow the need to apply some well-known and commonly used principles. These,
valid in most situations in the world, must be the inevitable fallback positions, if more creative
options are not available. These basic principles may be summarized as follows:
a. long-term borrowing should be confined to the financing of investment in land,
buildings, permanent works and equipment, intended to provide a future flow of
benefit to the community;
b. borrowing periods should be related, as closely as possible, to the working lives of
the assets to be financed and to their ability to efficiently deliver the future benefit
It is often just as financially imprudent to finance long-life assets from short-term loans as to borrow for too long a period. It
creates additional burdens on current finances, not justified by the longer utilization of the assets, but inevitable unless the loans
can be rolled over or refinanced. This may preempt more important and urgent recurrent expenditures. Because short-term
financing is often more readily available than that for longer terms, it creates a great temptation for municipal governments to rely
upon it too heavily.
c. long-term loans should be fully repaid, together with all interest, within the working
lives of the assets financed; and,
d. all expenditures relating to the current delivery of public services, including
operation, maintenance and debt service on fixed assets should be met, on an annual
basis, from stable and growing sources of local revenue, from either taxes or user
0It follows that municipal governments and public utilities must continuously operate within the
framework of a balanced recurrent budget. Furthermore, the various revenues used to bring the
recurrent budgets into balance must exclude revenues from sales of land and other public assets.
They must also exclude other one-time financial inflows, such as capital grants and donations,
public utility consumer contributions and receipts from the disposal of public enterprises to
commercial interests. These funds flows are of a "windfall" nature. They should, thus, be reserved
for capital expenditures13.
Public Sector Institutions
Based on institutional performance in many places, it is possible to postulate a number of options
for service delivery entities, within the jurisdiction of a municipal government. The distinctions
among them largely relate to the extent to which the services provided will be (wholly or partly)
directly revenue seeking or tax-borne.
The options often postulate some form of corporate structure, to some degree separate from the
overall administration of the municipal government. This has one important advantage. It allows the
setting, by the national or municipal government, of a specific set of concerns to be addressed by
each individual entity. Against these, it can be held accountable for both financial stewardship and
operational performance. The formulation of a corporate structure for each set of objectives offers
the opportunity that the activity of each autonomous entity will be substantially immune from the
likely changing political agendas of the core governance function.
It is important to note, however, that the establishment of a corporate structure for wholly or
partially autonomous operations is not necessarily consistent with the concept of the private "joint
stock company." This is frequently referred to in discussions about the restructuring of state owned
enterprises. Instead, a circular set of discontinuities can be perceived. They concern: financial
markets; ownership; control and management; and, institutional structure. First, capitalization from
financial markets does not necessarily provide for effective ownership. Such capitalization may
come from bonds (lending), rather than stocks (ownership). Furthermore, the issue of different
classes of stock may result in the trade-off of decision-making power for security, as in the case of
so-called "preference shares." Finally, holdings by minority stockholders may endow them with
only nominal (legal) ownership, with no effective control or management. Thus, in the "Western"
system, if there is really no intention to give effective ownership to investors, as in the case of
publicly owned utility corporations, virtually all capitalization is from bond issues.
By contrast, the United Kingdom central government credited the proceeds of its privatization activities to its recurrent budget.
This practice was severely criticized by many public sector financial specialists.
Second, legal ownership, through stockholding, does not necessarily, imply effective control or
management14. Apart from the potential ineffectiveness of minority stockholders, it is virtually
impossible for the stockholders, as a group, to manage the day-to-day affairs of the corporation.
This function must be delegated to a board, which may, in turn, be dominated by the chief
executive and managers. Neither the board nor the managers necessarily have identical agendas to
those of the (stockholder) owners15.
For example, the principal goal of the stockholders may be that of profit, whereas the personal
goals of the chief executive – especially if not a substantial stockholder – may concern benefits,
power, control and "perks." Furthermore, where the public interest is present, the pure profit-
seeking motive of the stockholders may be significantly over-ridden by regulation, of either
operations or prices. This is particularly true when dealing with activities that are considered as
Third, autonomous control or management need not necessarily imply the use of a corporate
structure – and certainly not in the "joint-stock" form. In the public sector, there are many other
forms of delegation to individual entities. These may range from the establishment of quasi-
independent government departments or operational units (such as schools, hospitals or colleges) to
wholly owned government corporations, with no private stockholdings and no intention to create
them. In the UK, for example, some of these have been collectively designated as: “quasi-
autonomous national government organizations” (QUANGOs); “quasi-autonomous local
government organizations” (QUALGOs); and “arms-length management organizations” (ALMOs).
Finally, a financially autonomous corporate structure may not necessarily imply the use of capital-
market financing. It is quite common for public assets, within publicly-owned autonomous
corporations, to be wholly financed from direct government loans or grants. Thus, the "equity
interest" of the government is often merely a formal, legal, artifact, as with London Docklands
In summary, therefore, the establishment of financially autonomous entities, for the delivery of
public services, offers a range of options which might be substantially different from what is
commonly now known as "privatization." Some might involve corporate structures, some not.
Policies of institutional restructuring should be evaluated not only with regard to a set of given
objectives but also in terms of how those objectives might be achieved in alternative ways. It is
appropriate, therefore, not to regard "privatization" as a panacea, because it most certainly is not.
Instead, it should be regarded as one of the tools, albeit it an important and powerful one, for
fulfilling the political and operational objectives of a local, state or national government.
There is a great deal of literature on the economics of the “principal-agent” situation.
This has been dramatically illustrated by the disgraceful (and illegal) behavior of some US companies delivering “public
utility” services (electricity, telephones, gas and solid waste management). Among the most notorious have been Enron,
WorldCom and Waste Management Inc. The related demise of the accounting firm, Arthur Andersen is well-known to all!
Contracting-Out of Public Services16
There is an alternative to the delivery of all services by the employment of direct labor by public
sector institutions. Many activities offer opportunities for contracting, by open competition, for
such services to be provided by enterprises outside of the direct control of a public entity. This
could apply to both core governance activities, as well as those provided by autonomous
The normal "Western" practice would be to allow the public sector "direct service" units to
participate in the tendering, after being formed into quasi-independent "direct service
organizations." An essential feature of such re-structured units is the establishment of cost-
accounting systems that are consistent with those of outside contracting entities, to ensure fair
competition. This arrangement often leads to the "internal" entities actually winning and performing
the contracts but with the added advantage of doing this under competitive conditions 17. For such a
system to work consistently, it must result in improved productivity in service delivery – in the
sense of more service for lower unit cost. Thus, opportunities must be present for the public sector
to save on costs – otherwise there would be no incentive to "contract out." It is, also, necessary for
the commercial enterprise to earn profits – otherwise, there would be no incentive to tender.
Often, the savings and profits come about as a result of improvements in labor productivity.
Whether or not this is always shared by workers, in terms of improved benefits, is often one of the
more contentious issues. There is no shortage of examples of "contracting-out" where major
"savings" to the contractor have been as a result of paying lower wages, with very few “fringe”
benefits, to less-skilled staff, delivering a lower standard of service to the public.
It is usually appropriate for "contracting out" to be approached gradually. Furthermore, it is often
most useful to divide work in such a way that it can be delivered by several commercial enterprises,
in competition with one another. If this is not done, there is a greater potential for a single
commercial contractor to develop monopoly power of its own. This, it can do by gradually
developing an incumbency position, especially by preempting the public sector's ownership of
For example, if the garbage-collection service were to be fully "contracted-out" by (say) a
municipal government to a single – or very few – commercial enterprises, these would, after a short
time, own all the essential vehicles, plant and disposal sites, leaving the enterprises with a
significant tendering advantage18. This would inhibit competition, on equal terms, by other
competent contractors. It would also inhibit the return of the service to a restructured and more
efficient local government unit. A very well-known technique is possible, where a quasi-monopolist
bids for individual small packages of work. This is loss-leading: under-pricing the initial bid – to
gain a foothold – by using financial support from the bidder’s other operations
There are other factors. The importance to a commercial enterprise of consistently winning the
Conditions normally acceptable for efficient contracting-out of services are listed in Annex 2.
Much is currently written about the merits of competition. This is not a panacea either, because under certain conditions, it
may well create unacceptable quality for the lower prices. There may also be increased “economic externalities.”
Indeed, this has already occurred. For example, Waste Management Inc. has gained a significant foothold in the industry,
which it then chose to abuse, in collusion with its auditors (Arthur Andersen), by presenting falsified financial statements.
In summary, therefore, public entities should exploit opportunities for alternative methods in the
delivery of services and the performance of public activities. They should do so, however, not as
seeking a panacea but with a prudent balancing of productivity improvements against risks,
safeguards and administrative costs.
Public Borrowing - Control and Allocation
Whatever other financing methods are used, the financial resource requirements for public utilities
and infrastructure will require significant borrowing. This will demand that attention be given, at
the highest level of any municipal or other public sector entity, to suitable systems of control and
regulation of borrowing, throughout the entire financial management domain under its control.
Prudent financial management predicates that all public sector borrowing, for whatever purpose and
by whatever subsidiary public entity, be brought firmly under the control of the central financial
management function of the entity. Thus, the "Director of Finance" will need to take a leading role
in advising on the allocation of loan resources and on providing guarantees of loans raised by or for
the various entities. Moreover, it is a fundamental principle of democracy that only an elected
council or board21 may approve, by resolution, the raising of loans by a local government entity.
This is of crucial importance when the borrowing is for services that will be wholly or mainly
financed from general revenues, including taxes. It applies whether these revenues are used to
finance the direct governmental functions of the municipality or – absent any ability or willingness
to cover costs from charges – as increases in public utility subsidies. This could be especially
burdensome, for example, for new rapid-rail transportation systems.
Pending the establishment of efficient and effective financial markets, it may well be necessary for
central governments to establish or adapt a centralized financing entity, through which to channel
all or most of its public borrowing. For example, there might be the establishment of (say) a "Public
Works Investment Corporation."
This could well be designed to function as a "Consolidated Loans Fund," or "Capital Fund."
Alternatively, it could manage such a fund, in addition to other activities and obligations. Such a
fund would raise all public debt for the governmental, utility and infrastructure functions of the
local governments, on whatever terms and conditions were available in the market place. It would
then re-package this debt, so as to lend to the various municipalities or operational entities. This
would be in exchange for obligations to service the principal and interest obligations, from either
operational revenues or budgetary allocations. For a particular entity, this obligation would need to
be undertaken in close consultation with the Director of Finance, to ensure that long-term charges
on general revenues be given priority over new expenditures, especially new capital expenditures.
Sadly, in the UK for example, much public expenditure is now controlled by organizations such as the QUALGOs and
QUANGOs, whose boards have NOT been elected. Often, they have followed the traditional British practice of being
appointed from among what are sometimes termed “the great and the good’ of British society. Thus, among managements and
boards of directors, knighthoods and peerages abound!
There are now many situations where nations and communities are emerging from "planned" to
"market" economies. For them, an important feature in re-structuring the debt-management
function of the municipalities or public utilities will be a shift of emphasis from an "allocative"
approach to a "contractual" one. Lenders, in the public market place, must be assured that their debt
service entitlements will be met in full and on time. Public service entities, in turn, must be aware
that they will be held ruthlessly accountable, from their annual budgets, for the full allocation of
debt service obligations, either directly or through a "Consolidated Loans Fund." Indeed, such a
debt-management approach will require that all parties view their debt obligations as virtually "not
To facilitate the allocation of borrowing and other capital-financing resources against priority
projects, it would be necessary to establish a centralized project appraisal capability. This could
well be formed as part of (or as an adjunct to) the "Public Works Investment Corporation." It will
need to use criteria which will be established in consultation with (or prescribed by) the national
Ministry of Finance. Indeed, even though the borrowing and appraisal activities may be carried out
within the Investment Corporation, it will be important for the Ministry of Finance to exercise a
meaningful oversight and audit function. This accords with its overall responsibility for the
allocation of public funds, through the budgetary process. It also allows the Ministry of Finance to
fulfill its role as a macro-economic manager of the nation’s resources.
Although the appraisal of capital projects will require guidance, direction and monitoring from the
center, the primary responsibility should gradually be delegated to the entities most directly
responsible. The process will then form part of the overall planning, programming and budgeting
capability, which each service-delivery unit should develop for itself.
Public Borrowing – Foreign Exchange Requirements
In many countries, some of the capital financing requirements will need to be raised in foreign
currency. These will likely be for the importation of foreign goods and services. However, if a
community's domestic resources are inadequate to meet its infrastructure needs, it may be that part
of its future borrowing – or its equity financing – even for locally procured goods and services, will
come from foreign sources.
In either case, a community's contractual obligations, with respect to its debt service, will extend to
the foreign exchange requirements. In particular, if the value of the local currency deteriorates
against the foreign currency of any loan, more local currency will be required to finance the debt
service. Public sector activities will likely make significant indirect contributions to the earning of
foreign exchange. For example, infrastructure improvements will facilitate both foreign trade and
However, in practice, these activities will not generate foreign exchange directly. Thus, it will be
necessary for the debt servicing entities to have access to foreign exchange earnings of the
commercial sector. This will either be by contracts with commercial enterprises or – more likely –
through the national banking system.
Public Borrowing – Financial Markets
To ensure the most economical raising and use of public funds for infrastructure development, it
will be necessary for financial markets to develop and sustain a significant capacity for the raising
of funds. A large proportion of this funding will likely be in the form of bonds, rather than equity,
consistent with the likely wish of many public sector entities to retain effective ownership in the
hands of government.
A most important feature to develop in the financial market, for both public sector and commercial
financing, is that of trust. Investors must develop confidence that borrowing entities have the
competence, sincerity and reliability to service their debts. This means that the financial market
place must be provided with reliable information, which can be so assessed by independent bodies.
These will comprise the regulators of the financial markets, as well as those with a fiduciary duty to
the investing public, such as auditors, underwriters, issuing houses and rating agencies. Such
bodies, where not already existing in adequate form, will need to be established, upgraded or
As already indicated, the sums needed to finance the services and infrastructure of many
communities are formidable. Thus, the development of the quality of the administrative
management of the financial market place will need to be matched by an adequate expansion and
sustainability of its capacity to raise the required sums of capital.
Investment Financing – The Competitive Environment
Competition for investment capital will largely be based on perceived risk and return. For public
sector bond issues, this will depend upon the interest rate, combined with the reliability and quality
of the expected revenue earnings. These, in turn, will be based on either the expected operational
and financial performance of the borrowing entity or the underlying strength of the local
(municipal) taxing structure. Thus, sound pricing and taxing systems will be essential, in the
promotion of bonds and other capital financing instruments. Also, there will be competition for
funds from commercial activities. This may be significantly oriented towards equities. Moreover,
for potential private investors in emerging economies, it might well be that their interests will lie
more towards the opportunity for making fast profits than for longer-term goals. This situation may
be reinforced by the fact that, under currently sustained social safety nets, investors will perceive
that their basic long-term needs are provided for22. Discretionary funds may therefore be more
willingly channeled into "glamour" security issues, albeit for more fickle purposes than for
development of infrastructure. The latter, by contrast, may be considered, in the short term, dull and
uninteresting as backing for security issues. Also, the commercial market place will not always
provide more economically efficient alternatives to public sector activity 23. It is, unfortunately,
highly speculative. The combination of empty offices and deteriorating public infrastructure in
(say) the U.K. and U.S.A. is a current testimony to this, especially when there is so much consumer
This has a parallel in the U.S.A. There, it is claimed, federal insurance of the funds of depositors of "savings and loan
associations" permitted a degree of public indifference towards reckless use of such funds by their unscrupulous or incompetent
A significant market failure in this respect is that quicker private profits may often bring much higher investment returns
than the more slow and ponderous – but eventually more enduring – public infrastructure improvements.
spending on trivial distraction, entertainment and amusement
It may well be important, therefore, for national and local governments to embark upon programs
of public education, to encourage potential investors to channel funds towards public utilities and
infrastructure. The costs of such a campaign might well be offset by the refinement of interest rates
for public borrowing and the greater availability of funding. Both will bring net economic benefits.
It is equally important to note that, in a market-friendly environment, the allocation of investment
resources will be through investor perceptions of risk and return. Failure to recognize this, resulting
in a return to a process of political allocation, will result in long-term economic inefficiency and a
significant reversal of any economic reform principles.
Competition for funds will not be only among opportunities for investment. As nations and
communities move further towards a commercial environment, investment demands will compete
against consumption opportunities, for both commercial and publicly provided goods and services.
This may be all the more pervasive as an emancipated public seeks for immediate satisfactions, in
the form of increased enjoyment and reduced suffering – of both inconvenience and privation.
These attitudes, combined with the availability of savings, will determine how much funding is
available for the different claims of public, commercial and private sectors.
An important aspect of resource mobilization, as well as mitigating demands on general public
revenues, will be through the use, where possible and appropriate, of economic efficiency prices,
such as for public utility services. An essential part of any public information system will be to
encourage the economic signals to be given by prices. In other words, a most effective way to get
the attention of the public will be to charge full prices for services. The only significant opportunity
for coercion, in these circumstances, is that common in all market or controlled economies –
adjustment in the level of taxes. Local taxes will need to be set high enough to cover all recurrent
public expenditures, including the service of debt. Chosen levels, of taxes and charges, will have
political and economic limits on the public capacity to bear them. This will also affect the level of
Public Sector Financial Management
The economic reforms undertaken in many countries, especially those of Eastern Europe, will
likely lead to:
a. a tightening of the allocative process;
b. a need for fuller public information to support investment financing;
c. increased importance of financial reporting, accountability and control; and,
d. greater participation by citizens in the conduct of public affairs.
Planning, Programming and Budgeting
Governmental and operational entities should be encouraged in the use of appropriate procedures
for planning, programming and budgeting of their activities, within the framework of an overall
performance budgeting approach. Arrangements are also required for both tactical and strategic
cash management, including the overall management of debt.
It is important, for these procedures to reflect the predicted economic, physical, spatial, commercial,
fiscal, population and social changes, especially significant growth or decline. Attention must also
be paid to financial commitments that a municipal government - or any of its entities - will be
"locked into" over significant time-periods. This would include debt-service and unavoidable
Public Utility Pricing and Subsidy
Some public utilities operate as natural monopolies, at least in the short term. To optimize the
economic efficiency of their operations, and limiting demands upon scarce general revenues, all
such entities, wherever possible, should be encouraged to charge economic efficiency prices. These
should be consistent with full-cost recovery of economic resources and coverage of all financial
requirements. Thus, in principle, public utility companies should set charges which are intended to
cover operation, maintenance, depreciation (at current values) and a real return on assets, valued in
current prices. The entities should also be required to generate funds from operations to cover debt
service and to contribute towards expansion of facilities and plant.
Where claims are made for subsidy, on grounds of economics, welfare or financial hardship, these
should be carefully evaluated. They should, however, be allowed only where fully justified and can
be implemented in an efficient manner. In general, the overall subsidy of service delivery systems is
vastly more inefficient than the individual subsidy of deserving consumers. Where used, it is often
because the individual consumers cannot readily be identified, evaluated and compensated.
Moreover, the service characteristics should be conducive to a reasonable assurance that targeted
consumers are most likely to benefit. Sometimes, because of administrative costs, the perfect is the
enemy of the good. The principal justification for subsidies to entities lies in cases where there are
high transaction costs, uncertainties or resentments in directing them to individuals. This may
apply, for example, in the administration of "means tests."
This concern applies to both economic efficiency and equity considerations. If care is not taken, a
poorly directed subsidy may merely mean that the more profligate (and likely better off) consumers
will (at standard unit prices) receive the highest cash subsidies.
The situation is different where the direct recipient of the service is not assessed as the sole, or
principal, beneficiary. This is an argument sometimes applied, for example, to rapid rail systems,
with respect to the diversion of road congestion, accident risk and air pollution. It is, however, even
in this case, still very contentious. Moreover, even when there is broad agreement on the economic
principles, there can often be serious disagreement about the extent and amounts of subsidies.
To the extent that either publicly owned or commercial enterprises are in a position to charge
monopoly prices, there should be provision for the regulation of such prices by independent
national or local government agencies. These should have the power to over-ride both the political
agendas of government and also the pure profit-seeking agendas of the enterprises, after holding
public hearings on all applications for price adjustments. However, many witnesses seeking to be
heard at such public hearings are less likely to be in favor of socio-economic-efficiency pricing than
in imposing their private agendas, or those of their interest groups. Thus, it may well be found that
the role of an independent regulator must be to ensure that prices are set at levels which are high
enough to fully cover costs, as well as to ensure that legitimate equity considerations are dealt with
A major asset, available to many developing cities, is the ownership, control or management of
substantial public land. This can be exploited in a variety of ways, for the purpose of financing
infrastructure. Increasingly, such land will be subject to activity based on commercial valuations.
Sometimes, much of the land required for infrastructure development may already be in public
hands. This results in significant potential savings, or financing opportunities, over situations found
elsewhere, with the majority of required land in private ownership. The more that public land
increases in value25, the more savings accrue to the public sector, in terms of the opportunity costs
(or benefits) of its acquisition or disposal. In addition, there are notable savings in the transaction
costs of land acquisitions, especially where this might otherwise involve compulsory purchase. For
direct funding purposes, receipts from the sales of public land, not required for municipal purposes,
can be used for related infrastructure costs. As alternatives to receiving all sales revenues in cash,
contracts can be made with developers to provide a part of the sales price in the form of
Prime development land is sometimes located in the vicinity of significant public infrastructure,
such as a river bridge or a metro station. In such a case, it becomes possible for a developer to
accept a parcel of land, at no cash cost, in exchange for the construction of the entire public
infrastructure. The rest of the land can then be used for commercial facilities, for the developer's
own benefit. Where such exchanges take place, it will be important for them to be properly
evaluated and accounted for. As indicated, such one-time sales or exchanges should not be regarded
as recurrent revenues. Cash proceeds not immediately used for development should be reserved for
future capital expenditures.
A feature of the final disposal of land – whether in exchange for infrastructure or not – is that it
represents the disposal of claims to future revenues from this land, with the exception of property
taxes26. It will kill the goose that lays the golden eggs! Thus, the prudence of land disposal – and of
its extent and timing – will be influenced by the financial needs of the local government and its
entities. This is another reason for careful matching of budgetary requirements to overall
This is particularly important where such public land is derived from abandoned or curtailed activities. Examples occur where
land occupied by railway yards, shipping or military interests is no longer needed for its earlier purpose. Often, it has become
derelict and unattractive, as well as having no public facilities and infrastructure suitable for new development. Thus, its initial
value is very low.
Even these may be curtailed or postponed if the land is part of an "enterprise zone." Property taxes may then not be collected for
several years into the future, to encourage developers to risk new activities on the land.
An important point is that as future real land values increase, rents – in real terms – can be adjusted
to allow for this. Sale prices, by contrast, are fixed on a "once for all" basis. In the absence of a fully
developed land-price information system, it might well be found that early disposal of land is – in
real terms – under-priced. This would represent a partial gift to the purchaser, who is, effectively,
purchasing the present value of all future real land rents.
Where land is not disposed of by final sale, it will, of course, continue to yield rents to its public
sector landlord. These, along with other revenues, will be available to the general (recurrent)
revenue pool to finance debt service. Where the local government (or a development authority) has
the power to grant planning (zoning) permission over privately-owned or rented land, this might be
accompanied by a requirement that the owner (user) provide some degree of public facilities, in
exchange for the valuable (monopoly) development right27.
This cannot, however, be pressed too far. First, an excessive demand, causing a potential loss to the
developer, will cause a backing away from the whole enterprise. Second, the local government or
development authority may sell land, with planning permission already included in the price. To
avoid disputes, it is important for the seller and the purchaser to be certain whether or not this is the
In some cases, a municipality (or one of its entities) will own land rights in connection with the
operation of public facilities. An example would be the air rights over a "metro" or mainline station
entrance. These rights can, of course, be leased to developers to help cover the costs (or related debt
service) on the principal facilities. The extent of this will be facilitated or curtailed, for example, by
regulations regarding building height. Finally, when land is in the hands of commercial enterprises
or is privately owned, it can be subject to property tax, either on the land alone or also on
Even land owned by public sector entities should be subject to tax. This is not, usually, to bring in
additional revenue, although the setting of public utility prices, to cover such taxes, will do just that.
What the taxing of public facilities does achieve, however, is to militate against distortions within
the allocative process of the public sector. In particular, it will prevent hidden subsidies to (say)
public utility enterprises that own substantial real property. In addition, taxation of public facilities
will indicate the extent to which revenue is being foregone, by retaining them within the public
Increasingly, it will become necessary to provide in the accounts of public entities for potential
costs to remedy current environmental degradation. This may arise from technologically inefficient
operation of current service delivery. For example, if a sewage treatment works is operating without
This is known, in the U.S.A., as an "exaction." Sometimes, state or local law forbids this. In such case, developers typically
make offers to provide public facilities, then known as a "proffer." In Britain, authorities have had, until recently, very limited
scope to secure developer contributions for infrastructure. The "Planning and Compensation Act 1991" changed that position
dramatically. Developers can now be made to bear the costs of infrastructure and community facilities, as a condition of being
granted planning permission.
producing adequate effluent quality or disposal of sludge, this may create costs to be incurred in the
To the extent that these are only delayed – but eventually inevitable – they resemble future "debt
service" on current "borrowing." Another example would be future closing costs of currently
operating garbage disposal sites. In this particular case, it is ecological, rather than financial,
borrowing. However, the future resource demands, from either charges or taxes, will be virtually
identical. Tightening of environmental standards will – as a direct outcome – increase the costs of
such ecological borrowing.
The means to achieve economic development and reform do not necessarily, or principally, lie in
the restructuring of institutions. Furthermore, many of the activities to be undertaken by the
municipal governments or development authorities will have to be coordinated with many
departments, agencies, bureaus and commissions of a central or state government. Indeed, policies
of institutional reform and restructuring, including privatization, should be evaluated not only with
regard to a set of given objectives but also in terms of how those objectives might be achieved in
For example, the conversion of (say) a municipal water company from a publicly owned
corporation to a commercially owned one may be less important than a rationalization of its pricing
structure. If the latter can be achieved under public ownership, institutional change might not be
necessary, appropriate or desirable. However, the public authorities should not use this further
opportunity for reflection as merely a means to validate current practices or excuse itself from the
need to take effective actions. A great deal of institutional, administrative, financial and operational
reform must often be undertaken. In addressing overall goals of reform, as contrasted with specific
activities or reorganizations, the following should rank as among the most important:
a. mobilization of resources for both recurrent and capital expenditures;
b. identification, exploitation and implementation of alternative methods of
c. improvement and consolidation of debt management;
d. overall management and administrative efficiency;
e. economy, efficiency and effectiveness in the delivery of public services;
f. where appropriate and feasible, recoveries of full costs of service from direct users,
by economic efficiency pricing;
g. introduction and use of appropriate technology;
h. use of "market-friendly" approaches in the procurement of the factors of production,
in the form of goods and services;
i. limitation of otherwise unconstrained demands upon the general revenues of the
public budgets; and,
j. maximization of the operational autonomy of entities, consistent with optimal
accountability for both stewardship of resources and performance of activities.
0 Finally, as much of the activity under the control of public entities is clearly concerned with
government and public service delivery, it is essential that their activities be (and be seen to be)
consistent with the prevailing political agenda.
FINANCIAL, ECONOMIC AND SOCIAL IMPACTS ON LOCAL COMMUNITIES
Community Balance Of Payments (1)
Within the overall national and international economy, a local community must either sustain itself
from its own production and exchange of satisfactions or else be supported by transfers from
elsewhere, usually governmental. If neither of these occur to a sufficient extent, the community's
economic and social structure will deteriorate. This will often leave in its wake a declining physical
infrastructure and derelict buildings, together with a discouraged and increasingly disadvantaged
The oft-perceived, though commonly simplistic, remedy is the creation of more job opportunities
for the local populace. This can be sustained, however, only by the maintenance of a substantial
balance between financial flows of funds into and out of the local community. This concept is
more intuitive than statistical, because economic data gathering does not normally encompass a
detailed analysis of this type, by individual communities. It is made more difficult, indeed virtually
impossible, by the concern of making distinctions as to what constitutes a community 29. However,
for each development decision or strategy, it should be possible to assess (or at least to intelligently
speculate) some of the local "balance of payments" effects. Even an educated guess as to the likely
direction of net incremental funds flows will be of decision-making value. This can be done only if
all the principal flows are examined. They can then be used, refined or discarded, depending on
their reliability and the concerns to be addressed.
Commercial activity will bring inflows of funds to a community (from community non-residents)
as a result of:
(a) external work locations;
(b) remitted earnings from outside the community;
(a) tourism within the community by non-residents;
(b) local taxes; and,
(c) investment earnings by community residents (including rents) from financial markets
and assets elsewhere.
For a detailed explanation of these effects – and the need for commercially viable remedies – see "The Competitive Advantage
of the Inner City” (11/1/94) by Professor Michael E. Porter of the Harvard Business School.
It is important not to be misled into a perception that the funds are flowing though a particular official entity, such as the local
government unit or a particular bank. They are not. The balance of payments is an assessment of the net flow of funds - if it could
be measured – for all community transactions with the outside economy, arising separately and independently in the normal course
of personal, commercial, and governmental activity. These will include (but not wholly comprise) payments to and by banks and
governments. Even transfers between different branches of the same government entity or commercial enterprise are included.
The same kind of commercial activity will also bring about outflows of funds (to community non-
residents) as a result of:
(a) purchases of goods;
(b) services by non-residents (including outside residents commuting to local businesses);
(c) remitted earnings by non-residents from local businesses;
(d) external tourism by local residents; and,
(e) investment earnings (including property rents) by non-residents in local financial
markets or on local assets.
Other outward funds-flows will likely arise from local taxes payable by residents to other than the
local government (e.g. state and national taxes) and by welfare and subsidy payments out of the
community. For working communities, whose retirees move elsewhere, there may well be net
payments for pensions, to non-residents formerly working locally. Were all these transactions offset
(in practice they are – it is just difficult or impossible to measure them!) an assessment could be
made of the net current balance of the community. This would be the net amount owed, relative to
the local community as a whole, by or to the rest of the economy30.
Community Balance Of Payments (2)
The first stage of any assessment of a community balance of payments will only show the net
current balance. This is the result of the day-to-day transactions among business, household,
government and utility entities. As the net balance relates, by definition, to claims against future
satisfactions (goods and services) it must be held in some form until these future satisfactions are
procured and paid for.
The second stage of the community balance of payments, therefore, deals with capital transactions.
These are not of a day-to-day nature. Instead, they result in some form of longer-term saving,
investment, financing or borrowing.
A dramatization of this concept might help. Suppose all transactions to be in cash. Further suppose every member of a local
community to have settled their accounts with one another and then brought to the "community hall" all their remaining invoices or
money earned from transactions with those outside their own community. Using the available money to pay the invoices, all now
owed to outside parties, what remains would be a smaller quantity of either invoices or money. If money, it would be the local
"balance of payments" surplus, on current account. If invoices, it would be the current deficit. The money would represent an
increased claim on the rest of the nation or the world for its future goods and services. Invoices would be a claim by the rest of
nation or the world on future goods and services of the local community. (The local community might well be in a muddle about
whose money had paid which invoices. This, however, would not be a balance of payments concern. It would be one to be resolved
entirely locally. Indeed, official national balance of payments statements usually include large components for "errors and
If the community accumulates a current surplus, this will facilitate the participation of its residents
(a) purchases of property from non-residents31;
(b) repayment of loans, earlier granted by non-residents, or non-resident financial
(c) withdrawal of capital from local businesses by non-residents, perhaps (though not
necessarily) being replaced by local capital32; and,
(d) capital investments or loans by local residents and businesses or capital grants by local
governments, all to non-residents or non-resident entities.
If the community accumulates a current deficit, this will need to be covered by the participation of
non-residents in the making of capital payments to resident households, businesses, governments or
public utilities, for:
(a) property purchases from residents33;
(b) repayment of loans earlier made by resident financial institutions;
(c) infusion of capital into local businesses, perhaps (though not necessarily) replacing local
(d) local capital investments or loans by non-residents, or locally-used capital grants, by
outside (e.g. national or state) governments.
Community Economic Results
A balance of payments for a local community deals only with flows of funds. It does not
directly address the economic activity to which the funds relate. Thus, it is possible for a local
community to derive a great deal of funding from outside, yet indulge in little or no economic
For balance of payments purposes, it is irrelevant whether the property is located within or outside the local community. Its
purchase will absorb local cash, equal to its price. What is important is that the vendor be a non-local-community resident.
Local capitalization of local business is not a balance of payments activity. Thus, to the extent that external business capital is
not replaced by local capital, the affected businesses will be de-capitalized. If they are over-capitalized already, this could be an
advantage. If not, activities might have to be curtailed.
For “balance of payments” purposes, it is irrelevant whether property is located within or outside the local community. Its
purchase will provide locals with cash, equal to its price. What is important is that the purchaser be a non-local-community
resident. An analogy is that the US accumulated current balance of payments deficit is supported, to some extent, by holdings of
US property by foreigners. However, a US balance of payments deficit could be (partially) covered by the sale of London (physical
or financial) property by a US resident to a German resident.
Local de-capitalization of local business is not a balance of payments activity. To the extent that external capital does replace
local capital, the affected businesses will be further capitalized. If they are under-capitalized already, this could be advantageous. If
not, activities might be expanded. This would be an advantage only if there is potential increased demand for the local product.