The role of public funds

I was reminded the other day of a piece of work I looked at several years ago when Governments were first intervening to make broadband widely available which considered the role of public funds in general in commercial projects.

The general rule of thumb in Europe, and in most modern economies, is that public money should only be used where there is evidence of market failure, and even then the funds should only be made available in a manner that minimises the market distortion in an otherwise free market.

Degree of State Aid

Having a robust state aid mechanism not only attempts to underpin an essentially free market and ensure public funds are only used where they are needed, but they also help to provide assurance to other trading countries that they won’t face unfair, state-sponsored competition.

The role of Public Funds
The role of Public Funds

The image above is a very simplified attempt to show the degrees of intervention, balancing some measure of commercial return from the private sector with an arguably more abstract measure of social or economic return for the state.

Setting aside the role of critical national infrastructure, which may be commercial viable but the social or economic value is so high it’s considered too risky to be left solely in private hands, the layers above consider the typical types of intervention the state might make.

At its simplest, simply promoting the sector may be enough to encourage economic activity in markets that need a boost rather than more structural help. In markets that need stronger assistance, providing some form of investment underwriting (loan guarantees, for example) may encourage investors to take the plunge, assuring investors that if things are as bad as they fear the state will offset at least some of their losses.

If that doesn’t work, the state could consider co-investing – Government’s are naturally more patient investors so this may provide the assurances other investors need. This is less common in the UK but has been used effectively in many parts of the world. Norway famously invests state revenue from oil and gas, while many countries have semi-commercial infrastructure funds.

If the medicine still isn’t strong enough then grants may be necessary. In essence, a grant is a co-investment where the Government writes down the principle and forgoes any expectation of a return from the outset, and is therefore considered one of the most distorting type of public intervention short of nationalisation. For this reason, competition authorities like the European Commission are likely to need substantial evidence that other interventions are insufficient before approving grant aid programmes.

And if all else fails, and the social or economic need is sufficiently high, then it may be necessary to nationalise the industry – something most modern market economies seek to minimise but state aid rules support where the market is sufficiently critical and the risk of market failure is so high.

Not all aid is distorting

State aid schemes are created to Government’s excessively distorting markets but having rules for every single time a state needs to intervene becomes burdensome and frankly pointless. Not all aid is sufficiently distorting that it needs special consideration, so sophisticated state aid frameworks tend to have categories of blanket exemptions – areas of intervention that are either considered universally necessary or are unlikely to negatively distort the overall workings of a market.

For example, most economies have a carve out for agriculture, and for aid that is so small (often referred to as de minimis) that it makes little difference to the market. In Europe there are also exemptions for small and medium enterprises providing the public investments is below a certain level, for example 20% of the costs of a small business.

Why here?

I’ve written about state aid on this site periodically as it’s become a significant part of the UK broadband market transition to superfast speeds and now to full fibre. Any operator looking to invest in the UK needs to have a clear understanding of how aid works, and to gauge whether it’s necessary in their market niche, a defensive play to establish a stronger foothold on their nice, or a more strategic investment opportunity.

Over at Xpedium we have been working with a number of clients on understanding the role of public funds in their investment plans.

About the Author

Adrian Wooster

Adrian Wooster is a broadband strategist with over 25 year' experience currently focusing on the transition from copper to full fibre networks.

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