Saturday, March 12, 2011

Roger Kerr: Privatisation Myths Need To Be Busted

There are an extraordinary number of myths about privatisation, more than can be busted in a single article. Some are perpetuated by supporters of the policy, not just opponents.
Myth#1 In a supportive article in the Dominion Post of February 23, Terry McLaughlin, chief executive of the New Zealand Institute of Chartered Accountants, wrote, “privately owned businesses consistently outperform publicly owned businesses.”

This is clearly not the case: some private firms fail and some publicly owned ones perform well, at least for a time. The correct statement, supported by much economic research, is that, on average and over time, privately owned businesses outperform publicly owned ones.

This is the necessary and sufficient finding for policy purposes. As the Nobel laureate George Stigler wrote, “we must base policy not upon signal triumphs or scandalous failures but upon the regular, average performance of policy.”

Myth #2 Privatisation is ideological. To the contrary, it is pragmatic: it (generally) works. When the Thatcher government embarked on privatisation in the 1980s, some regarded it as a leap of faith. It was not a popular policy to advance but was supported when the benefits became clear.

As a British minister said, “facts overtook the debate.”

The genuinely ideological argument is the reverse: the Marxist attachment to “public ownership of the means of production, distribution and exchange.”

Myth #3 Privatisation is needed to reduce debt. This is a secondary argument: privatisation is really just a transfer of ownership. The policy is desirable regardless of New Zealand’s (public or private) debt position. I’d be happy to see the government simply give away shares in state-owned enterprises to their true (but disenfranchised) owners, taxpayers.

Myth #4 The government should own SOEs because it has a lower cost of (debt) capital. This is one of the oldest of economic fallacies, recycled recently by British academic David Wood on a visit to New Zealand sponsored by the PSA. If it were true, the government should take over most businesses in the economy! But it isn’t – the economic risk and cost of a project and hence its cost of capital, is unaffected by the source of funds. Government borrowing is (largely) risk-free only because the government can force taxpayers to fund losses.

Myth#5 SOEs were sold too cheaply. In fact almost all privatisations in New Zealand were conducted through an open and competitive sales process with anyone in the world able to bid. The price obtained was therefore the best available. The price paid for Telecom ($4,250 million in 1990) was widely seen as high and a positive surprise to the market.

Fletcher Challenge clearly paid too much in retrospect for the Forestry Corporation but hindsight is an irrelevant standard from an investment perspective.

Myth #6 Privatisation leads to more foreign control over New Zealand. Not so: it may lead to a level of foreign control of the privatised company (which is inevitable and desirable for large listed companies: domestic institutions must have diversified portfolios) but not to more overall foreign ownership of New Zealand assets. When a foreigner buys New Zealand assets they must exchange them for an equivalent New Zealand claim on foreign assets. The net claims on New Zealand from the rest of the world are unchanged.

Ironically, many of the people who regard the privatisation of Tranz Rail as a failure also wrongly make this complaint. But in the case of Tranz Rail overseas investors did not achieve returns that covered their cost of capital – the likely result was a reduction in net claims on New Zealand.

Myth #7 The government loses financially from privatisation because it forgoes dividends. This is nonsense: the sale price reflects all future expected dividends paid up front. In addition, the government will capture in the sale price some of the likely efficiency gains resulting from privatisation.

Myth #8 Air New Zealand is a good model for the government’s partial privatisation approach. Air New Zealand is innovative and it is performing well operationally. However, it has not been meeting its cost of capital (by perhaps as much as half in the last financial year), meaning that potential national income has been sacrificed (New Zealanders are poorer than otherwise). Treasury numbers indicate Air New Zealand’s value (market capitalisation) more than halved between 2007 and 2010. A private firm that fails to meet its cost of capital (like Fletcher Challenge in the 1990s) ultimately has to cut costs, end loss-making activities or restructure, but there are weaker pressures on Air New Zealand.

How has this litany of myths been allowed to persist?

Arguably, because politicians (and others) failed to explain and defend privatisation. It is a classic example of the Big Lie – repeat the same thing over and over again and people will believe it.

The government will need to do better if it is to sustain its case for partial privatisation.

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