THE TRUTH ABOUT PRIVATISATION: BLOG # 8

Here is a presentation on partial privatisation given by economist Phil Barry to a well-attended meeting of the Law and Economics Association of New Zealand in Wellington on 21 March 2011.

Some interesting points include:

• 2009 was a record year for privatisation globally
• the international trend has been away from public floats and towards trade sales
• the under-pricing of government floats has been much less in New Zealand than the global average
• research indicates that the average gains from privatisation are large: 20% improvements in efficiency are reported, for example
• most studies also find significant performance gains from partial privatisation
• allowing foreign ownership increases the gains
• the internal rate of return for the Crown’s investment in Air New Zealand has been just 4.1% p.a. to March 2011.

Phil Barry concludes that the government’s plans for partial privatisation are a step in the right direction.

PPPs: DO THEY WORK?

Here is an excellent, balanced article on public-private partnerships by economic consultant, Phil Barry of Taylor Duignan Barry Ltd.

He is the author of the report The Changing Balance Between The Public And Private Sectors commissioned by the Business Roundtable.

The article notes that:

More than 90 countries are now using PPPs in areas as diverse as designing and building roads and schools, constructing and running prisons, and designing, building and operating water and wastewater treatment facilities.  Amongst the most active countries using PPPs have been the United Kingdom, Australia and Canada, countries we have much in common with.

But do PPPs work?  Here is Phil Barry’s assessment:

The formal studies that have been undertaken generally provide a qualified “yes” to that question. I say qualified because the PPPs don’t always work. And even when they do work, the PPPs are by no means perfect.

A study by the UK National Audit Office (refer the table below) provided one of the most comprehensive independent evaluations of PPPs. That study found PPPs had their flaws: of the 37 PPP projects evaluated, 9 of the projects (24%) were late and the projects incurred cost-overruns, on average, of 22%. But the experience in the public sector was a lot worse: 70% of the projects were delivered late and the cost overruns averaged 73%.

A comparison of PPPs and conventional public sector performance
	PPP performance	Public sector performance
Cost overruns	22%	73%
Delay in project delivery	24%	70%

Source: UK National Audit Office

Some people think PPPs have failed because private investors have gone belly up.  But this is just a normal business risk that they should bear.  As the article notes:

There have been some high-profile collapses of companies involved in PPPs in Australia in recent years. For example, the consortium behind the Cross-City Tunnel underneath central Sydney went bankrupt, largely because of its over-optimistic projections of traffic volumes. Much the same happened with the Brisbane and Sydney airport rail links.  Does that mean the PPPs failed? There was no loss of service – the tunnel and rail links remained open – and the taxpayer didn’t lose out. Those who lost their money were the private investors who took the risk. Another road PPP, Melbourne’s Citylink freeway, has been highly successful, and when there were problems with one of the tunnels the entire rectification cost was borne by private parties with no call on taxpayers.

Phil Barry debunks the old canard that PPPs are not appropriate because the government can finance the project more cheaply:

Certainly the government can almost always borrow more cheaply than the private sector. But that doesn’t mean the government should necessarily finance a project. If that logic was correct, the government would end up funding all the riskiest activities in the economy. Why not have the government fund property development or own football teams if all that mattered was access to cheap finance?  Higher private sector rates allow for risk, but the true cost of government borrowing is higher than it appears – the risk element is often only recognised when taxpayers end up bailing out unsuccessful projects.

The article notes the relevance of PPPs to the social sector.  A case in point is the recommendation of the recent Welfare Working Group that much of the job placement role of Work and Income New Zealand should be outsourced to the private (voluntary and for-profit) sector.

It concludes with a comment on the relevance of PPPs to the Christchurch earthquake recovery effort.  They are an obvious source of capital for replacement infrastructure.

THE TRUTH ABOUT PRIVATISATION: BLOG # 5

In foreshadowing partial privatisation of some SOEs and Air New Zealand, the government is placing emphasis on the case for reducing debt.  There was a similar emphasis in the privatisations of the late 1980s.

This case is valid but it is a secondary argument.  The main argument is about economic efficiency: that on average and over time, privately owned enterprises out-perform publicly owned ones (and hence contribute more to national income).

For some years the most commonly cited meta-study in support of this view was a 2001 Journal of Economic Literature (JEL) article by Megginson and Netter.  The JEL is the leading economic journal for survey articles of this kind.  As summarised by Phil Barry in his report for the Business Roundtable, the paper found that:

1. of the ten studies examining the relative efficiency of private and public enterprises operating in the same industry, eight studies found the private sector firms performed better, while two found no significant difference between the privately and publicly owned firms. None of the studies found the public sector was more efficient;
2. of the 22 studies that examined the effects of privatisation in developed countries, all but one found privatisation was associated with improvements in the operating and financial performance of the divested firms; and
3. of the 16 different studies of the effects of privatisation in transition economies, the studies documented “consistent and significant” evidence that private ownership was associated with better firm-level performance than was the case with continued state ownership. Further, foreign ownership was associated with greater performance improvement than for firms where ownership was limited to domestic investors.

Phil Barry also cited OECD and World Bank surveys that reached similar conclusions.

One would not expect all studies of privatisation to find that private ownership is superior:  SOEs can perform well for periods of time.  Some individual case studies have found public sector superiority.  The key point is the “on average and over time” finding.  Governments should not gamble against known odds with taxpayers’ money.

Since the three studies mentioned above, the only comprehensive survey article I’m aware of is this paper by Saul Estrin et al, published by the World Bank and also in the JEL in September 2009.

The Estrin et al survey examines the effects of privatisation in post-communist economies and in China. Their findings parallel those of the three earlier surveys noted above. In particular Estrin et al find:

• ownership matters but it is not the only thing that matters;
• on average and over time privatisation leads to improved firm performance and improved economic performance (the CIS seems to be an exception to the latter); and
• allowing foreign ownership significantly increases the positive effects of privatisation.

Thus the government would appear to be on firm ground in citing the empirical evidence in support of full privatisation.  The evidence on partial privatisation may well be more mixed.

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.

ECONOMIC JOURNALISM GETS A FAIL MARK

Some of what passes for economic journalism in New Zealand is not impressive.

A case in point is this article in yesterday’s New Zealand Herald by Brian Fallow. Headlined ‘Ideology and tribalism behind questionable policy’, it poured cold water on the government’s partial privatisation announcement.

‘Ideology’?  Around the world governments of all political persuasions have been getting out of running commercial businesses for over 25 years.  Labor governments at federal and state levels in Australia, for example, have been to the fore. The only ‘ideological’ underpinning of policies in the world today seems to be the socialist attachment to ‘public ownership of the means of production, distribution and exchange’ in a few countries like Cuba – although even Cuba is changing – and North Korea, and in the policies of the last New Zealand government.

“There isn’t all that much family silver left in the cabinet.” Well, just a mere $18 billion, according to the December Investment statement, all or most of which belongs in the private sector. ‘Family silver’: is this economic analysis or politicised rhetoric?

“It does nothing to deal with the … perilously high reliance on foreign capital and credit.” This is a reference to New Zealand’s large current account deficits and increases in external liabilities under the last Labour government. These were due in part to a loss of international competitiveness as the government turned its back on efficiency-improving reforms such as privatisation.

Then the inevitable foreign ownership bogey: “once sold, it would be difficult … to prevent the new owners from selling them to foreign investors”.  No explanation is given as to why foreign investment would be a bad thing. A large part of the shareholding of companies like Telecom is inevitably and desirably in foreign hands: it would be unwise for New Zealand institutions to hold large parcels in their portfolios.

Then a real howler: “To the extent that these shares end up in foreign hands, they would increase the country’s net foreign liabilities …”  But a foreigner buying shares has to purchase them in New Zealand dollars, and the seller than acquires the same amount of foreign currency assets. The country’s net liability position is unchanged.

Fortunately, the Herald did better in an editorial the same day which supported the privatisation initiative.

Myths about privatisation abound, even though they have been debunked many times. For a rebuttal of some of them, see this report by Phil Barry.

PRIVATISATION DEBATE SHOULD BE RIGOROUS

It’s hardly a state secret that the government is considering some rearrangement of its portfolio of assets if it is re-elected this year.  Its Investment Statement reporting current asset holdings issued in December provides useful information on available choices.

There is much to consider on the why, how and when assets should be transferred from the public to the private sector.  This 2002 study by Phil Barry was commissioned by the Business Roundtable as a contribution to the debate.   It dealt with many of the myths concerning past privatisations.  (I discussed some in my blog of 9 December 2010.)

Another contribution was this article by commercial law academics Susan Watson and Chye-Ching Huang published in the New Zealand Herald of 15 January.  It made the case for partial privatisation, in line with the government’s assumed intentions.  However, it was not the sort of rigorous analysis that might be expected of academics.

Nowhere did it consider, for example, whether full privatisation would be superior to partial privatisation.  Academic studies clearly favour the former over the latter for commercial enterprises.

Nor did it expose the pitfalls of partial privatisations.  These involve continuing (majority or minority) government stakes in enterprises and the risk that political incentives will dominate commercial incentives (and limit the contribution of entities to wealth creation).  Conflicts between the government’s roles as owner and regulator are not resolved with partial privatisation.

We have seen partially privatised companies remain political playthings, a prime example being the former Auckland Regional Council’s nationalisation of Ports of Auckland.  Earlier experience with the partial privatisation of the Bank of New Zealand was also unhappy.

Watson and Huang note that the New Zealand sharemarket would benefit from partial listings, as did the Capital Market Development Taskforce.  But, other things equal, it would obviously benefit more from full privatisation.  Moreover, partial privatisation of the small entities they give as examples – Quotable Value, Learning Media and Asure New Zealand – would hardly be worth the candle.  Game-changing policy must involve major SOEs such as those in the electricity sector.

The article cites Air New Zealand as a model of partial privatisation but unaccountably fails to note that the company’s share price performance since the government resumed majority ownership has been poor.

They also commend the Singaporean Temasek holding company model.  This is also dubious.  The performance of the underlying businesses is not sharply reflected in such a model.

The authors mention the possibility of restricting privatised company shares to New Zealand nationals, and rightly note that this would depress the share price.  The arguments for such restrictions could only be political.  The idea that foreign ownership is a cost of privatisation is misplaced.  The level of foreign ownership in the economy is determined by the cumulative current account deficit or surplus in the balance of payments, not by which assets are for sale.  If foreign ownership of some assets is blocked, foreign stakes in other assets will be higher.  If this is an issue, a better approach would arguably be to simply give SOE shares to their true owners, New Zealand taxpayers.

The value of partial privatisation should not be over-stated (which is probably why the 2025 Taskforce recommended full sales for competitive enterprises).  Phil Barry concludes as follows:

… partial privatisation has significant disadvantages compared with full privatisation. Ownership of partially privatised companies is often widely held (outside the government’s stake) and control is not readily contestable; private investors have limited incentive to monitor the company, relying instead on the ‘deep pockets’ of the government to bail out the company if it gets into difficulty; and the company remains open to political interference. Further, governments, as owners, may be unable to agree for long as to why they own the company, thus making it difficult for the company to develop and implement a strategic direction.

The empirical evidence supports the view that partial privatisation is not a desirable long-run state. Most studies indicate that there is no lasting difference between the performance of fully state-owned and partially state-owned enterprises: that is, that full private control is necessary to achieve sustained performance gains. But as a stepping stone towards full privatisation, partial privatisation has merits.

A better article would have reflected these nuances.