August, 1999
Government Intertemporal Capital Management Decision Making
by David I. Meiselman1
I have spent some part of my professional career studying private sector capital and capital theory. Part of the motivation for the analysis that follows is to examine whether private sector capital analysis also has relevance to understanding public sector capital management decisions. For the private sector, although there are some unavoidable differences among economists about their judgements of relevant price, income and other elasticities, there is a high degree of consensus on the general nature of saving, investment and capital accumulation and maintenance functions that are central features of the traditional body of economic theory. This also includes the critical role of the rate of interest, the price of time, that permits discounting, capitalization, and intertemporal evaluation and choice.
I use elements of standard capital and price theory to examine some aspects of government intertemporal capital management decisions. There are important differences between private and public capital choices. We later make several assumptions to help focus on some of them. The analysis in this paper differs from the standard cost-benefit analysis or standard project evaluation of specific government proposals or activities. Cost-benefit and project evaluation analyses are typically normative, not positive. They try to answer the go, no go questions, or to rank alternative investment programs, not the positive question how governments do behave. Accordingly, we do not explicitly consider traditional cost-benefit analysis in this paper.
More than realized by the original contributors to the Socialist Calculation discussions of the 1930's, 1940's and earlier (Mises, Lerner, Lange, Hayek, etc.), the absence of a market for used government, capital made impossible a wide range of price discovery and efficiency enhancing choice. For example, if there is no explicit market value for a road or its services and no revenue from its use, how to decide its optimal maintenance for given costs of such repairs. If private repair costs change, there are standard tools to analyze its consequences. (What of changes in public repair costs, say, high pot hole repair costs?) Indeed, there is essentially no theory in the Socialist Calculation debate about what, in fact, governments actually do with respect to capital, because there is essentially little or no useful discussion of public capital management and maintenance. It was as if it was enough to point that the absence of a price system and private property was enough to conclude that governments could not manage capital with the efficiencies inherent in the private sector.
Neither Lerner nor Lange, proponents of thorough, centrally directed Socialism, have any mechanism for government investment in capital or for capital maintenance. Perhaps the deep depression of the 1930's, where capital may have appeared to be in excess of current demands, shifted focus from fundamental questions of how, in fact, governments do or should act.
For present purposes, I wish to avoid the usual Public Choice paradigm that emphasizes the interests of and constraints on politicians, government officials and voters in order to analyze some of the process of government capital decisions. I do so (1) by assuming that governments are ruled by benevolent bureaucrats. I also assume (2) that governments buy capital goods and other inputs in private markets but that governments never sell public capital assets. Government capital assets are essentially inalienable. (I am indebted to James Buchanan who first suggested the assumptions of bureaucratic benevolence and inalienability.) Thus, (3) there is essentially no market for real government capital assets, including used capital.
There are markets for some government liabilities such as tradeable public debts. There are effectively no markets for government assets such as land, aircraft carriers or post office buildings. Because there are no market prices for used government capital assets, there can be no serious calculation that depend on these prices, for example, decisions about optimal maintenance and repair, or buy versus lease decisions. Indeed, one of the surprising implications of this analysis is that governments inherently cannot make efficiency enhancing optimal maintenance and other capital management decisions.
There is another assumption (4) that because capital assets cannot be sold, no gains can be realized on "winners", assets whose market prices have markedly risen. Private owners often have incentives to sell or trade "winners". Governments have no such incentives, here assumed zero. Thus, winners cannot be used to offset losers. Also, (5) we assume no government adjustment to capital losses, either.
Consider briefly some of the standard elements of the analysis of the private market theory of capital and investment. Later, we will consider how the standard analysis generates optimal private maintenance. We continue with the same assumptions regarding government capital decisions (bureaucratic benevolence, no alienation of capital assets and no markets for government capital assets or their services).
Under certainty, the private capital input decision conforms to the usual input optimizing decisions, except that returns (possibly costs, too) are distributed over time. To make measurable values at present and different future times, all future values are discounted to their present values by the use of appropriate interest rates. The result is that the current net marginal cost of a capital good is driven to equality to the present discounted value of the capital good's future stream of net marginal revenue products, each element of which is the product of the capital's marginal physical product and its marginal revenue at alternative optimal outputs. Note also that there is an additional term, Sal, for salvage or scrap value, including resale. In some private decisions, salvage value may be an important consideration in the capital decision. Because of the non-alienability assumption, we also assume no government scrap, salvage or resale values.
In sum, for the certainty case for capital goods at point zero at the beginning of period 1 (now) we have
In turn, the NPV0 is the discounted sum of the stream of Marginal Revenue Products (MRP) over the life of the capital plus its final or later scrap or salvage value, Sal.