THE TRUTH ABOUT PRIVATISATION: BLOG # 11

One of the difficulties of debunking myths about privatisation is that some people do not get basic factual or economic points even when they are clearly explained.

Thus in a recent letter to the Dominion Post, investment analyst Garth Ireland wrote:

Labour leader Phil Goff says that, under Labour, there will be no asset sales (May 2). He says: “It is economic madness. The power companies return $700 million in dividends every year – that is lost forever”. But is it?

Surely the sale price received today is equivalent to the future expected dividends? Nothing is lost. Dividends of $700m a year at a rate of return of, say, 10 per cent are equivalent to $7 billion today.

Mr Goff claims that the dividends “pay for 10,300 teachers, 12,600 new police officers or 33,000 hip replacements”. He can still spend the $7b sale proceeds or the $700m each year forever. They are equivalent.

This drew the following comment on the Dominion Post website:

“Surely the sale price received today is equivalent to the future expected dividends?” I think you sir may in fact not get it. “The future expected dividend” is infinite. Inflation happens, and so does increasing dividend.

If we sell it for 7 billion, that is ALL we ever get and it will end up like kiwi rail, run down by the owners to maximise profit. The 7 Billion will become worth less and less. And we will become asset poor.

If we keep it, the value will increase, dividends will increase as electricity becomes our primary fuel source (Oil crisis), and because we (the NZ government, and by default the NZ people) will invest in it, it will not become run down.

Would you sell your kidney for short term profit? I think you would. Think long term, thinking short term led to the current problems.

The future expected dividend may indeed be infinite (if the SOE performs well). But what Garth Ireland was pointing out is that to compare the value of the asset to the Crown if it remained in public ownership with the value to the Crown of a sale, you have to discount the future (infinite) dividend stream to express it in net present value terms. People value a dollar today more than they value a dollar in 100 years’ time.

On that basis, the Crown’s financial position is no worse as a result of the sale. In fact Garth Ireland could have made a stronger point: because the new private owners of the business are likely, on average, to operate it more efficiently, the Crown is likely to be better off financially (relative to keeping the asset) because in a competitive sale process it will capture some of the likely efficiency gains.

90-DAY LAW DOES NOT FAVOUR EMPLOYERS

On 5 April employment lawyer Peter Cullen had an article in the Dominion Post on the employment law changes that came into effect on 1 April.

These included the extension of the 90-day trial period for new employees to all firms.

The article concluded: “The changes generally represent a shift of power to employers.”

In fact they represent no such thing.  The comment reflects the old ‘imbalance in bargaining power’ idea with its Marxist origins.

It’s not hard to see the fallacy.

Start with a world without any statutory provisions about so-called ‘unfair’ dismissals.  Then bring in such a rule.  What will happen?

Clearly something will change, because employers now face the risks and costs of being found to have unjustifiably dismissed an employee.  In the first instance the costs will fall on them.  But clearly they will have to shift them – in competitive markets they have no alternative if they are to maintain normal profits.  The costs will be shifted primarily to employees (or possibly consumers through higher prices).  In other words, employees will largely bear the ultimate costs of the provision through wages (or other benefits) that will be lower than otherwise, or unemployment will rise if the costs are not passed on.

This is just basic economics.  It is explained more fully in this study by US labour academic Charles Baird, ‘The Employment Contracts Act and Unjustifiable Dismissal: The economics of an unjust employment tax’, published by the Business Roundtable.

Baird estimates that, extrapolating from US data, the imposition of unjustifiable dismissal restrictions (which did not apply to around half the workforce prior to the ECA) worsened income inequality, lowered real wages by over 7 percent, and reduced employment by 1.5-3%.

Given these results, it is no surprise that where employees have the option of bargaining voluntarily for unfair dismissal procedures in contracts, few opt to take it up.

As in other markets, bargaining power varies at times in the labour market depending on whether labour is in short or plentiful supply.  That helps labour markets to clear.  But employers have no systematic bargaining power, and recent law changes have done nothing to increase it.

MORE ON ECONOMIC JOURNALISM

Brian Fallow isn’t the only journalist given to economic howlers (see the last point in my blog of 28 January).

Here is Tracy Watkins in the Dominion Post the next day making the same mistake:

There are no guarantees, meanwhile, that their sale won’t ultimately exacerbate New Zealand’s foreign debt position, given the possibility of shares ultimately being traded into foreign hands.

And here is Simon Collins in the Herald of 29 January:

Partial foreign ownership of our economy will increase” because “New Zealanders will be free to sell at least some of their shares to foreigners.

To spell out the point I made in my 28 January blog, here are the answers to Questions 4 and 5 of this report by Phil Barry:

4 Hasn’t privatisation led to more foreign control over New Zealand?

No. First, privatisation does not lead to a change in net claims by foreigners over New Zealanders. Rather, privatisation changes the mix of foreign liabilities, with the proceeds of any investment by foreigners being used effectively to repay foreign debt. Secondly, regardless of whom the shares are sold to, the assets stay in New Zealand, as do the jobs and the government’s sovereign powers to tax and regulate. Further, there are very good reasons for allowing foreigners to participate in the sale process. The number of (potential) bidders is increased, thus increasing the likely sale proceeds for the taxpayer. In addition, foreign ownership facilitates the transfer of international industry-specific expertise to the domestic firm. This transfer will in turn also increase the expected revenue raised from the sale (in a widely marketed sale, the purchase price will reflect fully the discounted expected cash flows)50 and the expected efficiency of the firm. Potential ownership by foreign companies also broadens the pool from which managers can be selected. Listing the firm in foreign share markets may also offer some advantages through increased monitoring, potentially extended information disclosure requirements and a ‘deeper’ market for the shares.  Finally, it is not the case that all the Crown assets have been sold to foreigners. Analysis of the residency of the buyers of assets (refer Annex 4) shows that around two-thirds of the assets (by number and value) were sold to combinations of foreign and domestic owners and around one-third to predominantly (that is, over 75 percent foreign-owned) or solely foreign-owned concerns. 50 As long as property rights are expected to be secure: refer to Maskin (1992).

5 Hasn’t New Zealand lost out from the huge sums of money sent overseas in dividends by the former SOEs? Hasn’t privatisation been a significant factor behind New Zealand’s large current account deficit?

Some observers point to the dividends being paid to foreign owners by former SOEs  as ‘proof’ that privatisation has increased New Zealand’s current account deficit. But privatisation is not to blame for the deficit.

With a floating exchange rate, when a foreigner buys NZ$1 of New Zealand assets, they must exchange it for a NZ$1 claim on foreign assets. The net claims on New Zealand from the rest of the world are unchanged. It is only if subsequent returns on the New Zealand or foreign assets are different from those expected at the time of the sale that there will be a (positive or negative) effect on the current account. Returns on individual investments by foreigners in New Zealand and by New Zealanders offshore will, in some cases, have exceeded average market returns and in other cases they will have been below average market returns.

But, as noted in response to question 2 above, there is no reason to expect that the returns on investments in privatised assets in New Zealand will have systematically been above average market returns.  As noted in response to question 4 above, privatisation did not increase (or decrease)  the country’s net foreign liabilities. If the assets had not been privatised, it is true that there would be less dividends going offshore, but there would also be more interest payments going offshore as New Zealand’s overseas debt would be commensurably higher. The overall effect on the current account would be very similar.

I can see that demythologising privatisation myths among journalists (and many members of the public) may be a lengthy process.  I might start a special blog on it.