Gemmell on state assets sales

By Paul Walker 03/02/2013 13


In the past I have written on privatisation in general and the partial sales of state owned assets in particular. See also here. Norman Gemmell, has also been writing on asset sales, but in his case its in the New Zealand Herald. He says,

First, what might “selling off the nation’s silverware” mean? This phrase seems designed to convey the notion that, like inherited family heirlooms, state assets will be lost to the nation forever if sold to the highest bidder.

So, what heirlooms might the sale of electricity companies involve?

Well, it could be, for example, that the singular pursuit of profit in this industry destroys some of the valuable natural assets that we prize – such as scenic beauty and pollution-free rivers. Sometimes, once damaged, these things are hard to recover and government ownership might better protect against this.

The problem with this argument is that even if we accept the need to protect our natural heritage, why should it be best to give government ministers and their bureaucrat advisers the right to decide the best balance between profit and protection? Politicians are subject to all sorts of covert lobbying over their decision-making, while public servants generally have pretty limited experience either of running commercial organisations or of environmental protection in practice.

Even trade union leaders in the industry would probably do a better job than government ministers. At least those leaders have more day-to-day experience of the relevant issues. But the wider point is that, as most countries’ governments now recognise, the burden of proof for state ownership and control of commercial activity should be based on demonstrating why the private sector cannot be trusted. This is quite the opposite of the “family silverware” argument that generally presumes state ownership is optimal until proved otherwise.

So what of the argument that “governments have no right to sell, to the wealthy few, assets that belong to all taxpayers”? This is another myth. Taxpayers don’t “own” any of these state assets. The Crown, administered by democratically elected governments, has given itself monopoly power over numerous aspects of our lives – from the legal system under which we must all operate to the “ownership” of large swathes of the New Zealand landmass.

Over generations, however, millions of New Zealanders’ (and some foreigners’!) tax payments have helped to fund many commercially and socially profitable activities. These include building up assets such as schools, hospitals and valuable commercial enterprises such as the SOEs. (Most of our taxes of course went to pay for things we’ve already consumed – such as teachers’ and nurses’ salaries and welfare payments.)

So if the Government now wants to sell some of those SOE assets for cash it is merely transforming one type of state asset for another – the millions of dollars it will receive. The real issue here is what it then does with the cash. The two main options are: (1) invest them in another type of asset – such as building more schools and hospitals; or (2) spend the cash on things we currently need, such as teachers and social welfare benefits.

The first option is trading one asset for another. The Government essentially gives up an asset that paid it an annual dividend (potentially keeping taxes lower than they otherwise would have been). It replaces it with an asset that it hopes will give an annual social return – better educated children or whatever.

The second option – spending the cash from share sales immediately on public servants, welfare payments or lower taxes – does involve fewer state assets in total. But it represents the kinds of decisions we all (governments included) make every day – namely how much of our income to invest for the future, and how much to spend now.

The point about if the Government wants to sell some assets for cash it is merely transforming one type of state asset for another – the millions of dollars it will receive, in worth keeping in mind. As Gemmell says, what is really important is what the government does with the money.


13 Responses to “Gemmell on state assets sales”

  • You wrote “As Gemmell says, what is really important is what the government does with the money.”.

    I disagree. The important thing is that the Government’s lost income from selling the asset is more than the interest it would pay if it were to borrow the money instead. Therefore, regardless of what it does with the money, it would be better off borrowing the money than selling the asset.

  • Interesting (and ultimately conflicted) philosophical split in the third-to-last paragraph too. Apparently, a “school” (presumably referring to the buildings) and education in general are an investment, but “teachers” are not.

    Mmmmmm. I see a Chicago-styled slip showing….

  • Brent: Given a competitive sale the amount of money the government gets for the asset will equal the present value of the discounted income stream that it would have received if it kept the asset. So the amount of money the government gets via ownership or sale should be the same.

    Ashton: To a school a teacher is not an investment, they are a cost. They are a factor of production as far as the school is concerned.

  • Paul, I have difficulty understanding your reply. You wrote : “Given a competitive sale the amount of money the government gets for the asset will equal the present value of the discounted income stream that it would have received if it kept the asset.” This seems to me that you are saying that provided the sale is “competitive” the forgone income should equal the interest should it borrow the money. If so, then it cannot be better off, and risks an “uncompetitive” sale whereby it is worse off. So why do it ?

    You also wrote : “So the amount of money the government gets via ownership or sale should be the same.” This is not true. Ownership gives an input stream. Sale gives a lump sum. Unless that lump sum is invested to provide at least the same return (which is not what is being proposed), then it will be worse off.

  • Brent: First of all the price of a sale isn’t a big factor in why you privatise. The logic behind the sate of state assets is about efficiency not the price. As Anbarci and Karaaslan point out in their paper “An Efficient Privatization Mechanism”:

    “In this paper, we consider the privatization of State-Owned Enterprises (SOEs) that are legal monopolies but not natural monopolies; their markets can be opened to competition once privatization takes place and other competitors can emerge and compete successfully against them in a few years. But until that happens, these privatized SOEs can have a significant level of market power. The currently used “Revenue Maximization (RM)” privatization scheme maximizes the government revenue from privatization but does not provide sufficient incentives for the privatized SOE either to charge a price lower than the monopoly price or to improve production efficiency until competition arises. We propose a new scheme to privatize such SOEs. We term this new scheme the “Welfare Maximization (WM)” scheme. The WM scheme practically yields no revenue to the government from the privatization of any such SOE; however, it induces the privatized SOE to charge a competitive price in the absence of any regulation. It also turns out that the WM scheme provides greater incentives for post-privatization process invention (i.e., for post-privatization cost reduction) than RM scheme”.

    This is a very specific situation but it helps make the point that just worrying about the price received for an asset is not a good idea. In the above example welfare is maximised (and isn’t welfare what we should be concerned with?) while revenue is basically zero.

    The point I wish to argue here is that there is problem with thinking about privatisation in terms of the money raised. The reasons for privatisation can hold even if you get nothing from the privatisation programme. Talking about maximising the return from privatisation misses the whole point of privatisation which is to improve the efficient and productivity of the economy. If we just worry about how much we will get for the sale of assets then we should sell all of the state assets with the firms being monopolists. But that’s unlikely to do much for efficiency and welfare.

    Secondly I’m not sure were borrowing comes into this at all. Borrowing for what? The argues for privatisation do not depend on borrowing. See here and here.

    “Ownership gives an input stream. Sale gives a lump sum”

    Yes and the lump sum will equal the present value of the discounted income stream that it would have received if it kept the asset. So the amount of money the government gets via ownership or sale should be the same.

    “Unless that lump sum is invested to provide at least the same return ”

    Which is why Gemmell wrote “The real issue here is what it [the government] then does with the cash.” All a sale does is convert one asset into another asset.

    But, getting back to the point I made a the beginning, the point to note is that the advantage of privatisation is that it will depoliticise the firm. The aim is to have the greatest possible “distance” between the government and the firm. Government interference in the running of a firm is impossible to eliminate completely but a good privatisation plan will result in a situation where any government interference is as obvious and politically costly as possible. The empirical evidence, see the second link above, tells us that privately owned firm are generally more efficient than SOEs.

    For successful privatisation it is more important to get the regulatory environment right so that competition can breakout in the industry than it is to maximise the price for which the asset is sold. Basically I’m arguing we should have lexicographic preferences, with price low on the list. Worrying about whether or not the ‘family silver’ was sold too cheaply misses the point, the price received can only be see as too high or low relative to the market structure the firm finds itself it. Just arguing that a higher price could be obtained with a different market structure is only useful if the new market structure improves welfare.

    So let there be a debate about privatisation in terms of efficiency not price.

  • “Ashton: To a school a teacher is not an investment, they are a cost. They are a factor of production as far as the school is concerned.”

    Rubbish. Add fertilser to a paddock and production increases. Add a better teacher to a child and their education is improved.

    Investment. QED.

  • I missed the other one. Nowhere have I ever seen employees on a company balance sheet as an asset.

    Now tell me that labour is merely a “cost” of production. I get pissed by economists who allocate no value to a person.

    I am seeing this right now in how Callaghan Innovation is about to “value” the people and “output” of the ex IRL.

  • Labour is a “cost” of production in the sense that you have to pay for it to get the outputs. And better quality labour costs more (usually).

    A company can’t state the value of its labour – what goes on a balance sheet is what a company owns.

  • Confusing accounting with economics here.

    Yes a single teacher is a unit of cost. I have no doubt they are not shown on a balance sheet anywhere, but that doesn’t mean they are not an economic asset – teachers in the collective sense are an asset that is available to the education system.

    So perhaps they should be shown on the balance sheet in exactly the same way many businesses have there professionals showing as an asset – commonly in legal firms, advertising and other highly creative environments.

    In practise, the economic value of the accounting asset “School Building” is substantially reduced if there is no corresponding asset “Teacher”.

    Same with the asset class “Hospital” without the asset class “Doctors”

    Granted, you still have a property asset, but that puts you into a different business model. You are now a property investor.

    The education workforce then should be viewed as an asset. There is plenty of nice talk around about this thinking in the two big spend portfolios – health and education. The reality, it seems, is somewhat different.

  • In reviewing your article and responses, there is a point missing in the discussion. When a state asset is run and managed by the state, the overhead is diminished considerably. In today’s economic atmosphere of corporations taking over state services, which is what you are speaking of here, once the corporation takes over, then the overhead increases exponentially, with the top members receiving enormous sums at the expense of the common worker’s wages, and further the consumer. Cost of living increases due to the rise in costs passed on to the consumer.

    So, even if your government receives a fair price for the state asset, the control of that asset is lost, and the government no longer has the asset nor the income it produced. The government is then left with more expenses than it now afford complicated by the fact that those workers are now going to be earning less and paying more for those services they were receiving. This creates a domino effect on all workers due to the fact that other corporations can now piggy-back and cry to reduce their paid wages, while increasing their payments at the top level. The government is now receiving less income from taxes, while being left with only payments going out for non-saleable services, forcing the government to then borrow more, interest rates increase to make the sales for taxes. As more interest is paid (sucked) into the banking systems, less cash is available circulating to the common person.

    Ultimately, the state is left with only expenses and interest payments, the common person is expected to live on less, and pay more for cost of goods and services.

    • 1. Zero evidence that the state reduces overhead costs. Reasonable argument that x-inefficiency in state provision raises costs considerably. See Andrei Shleifer’s roundup in State vs Private Ownership, Journal of Economic Perspectives, 1998.
      2. Even if private ownership increased costs in the way you’re saying, so long as there’s competition to be the one who gets to own the former SOE, those rents are bid away when the asset goes to auction and the government is compensated today for the later flow of profits that goes to the company.
      3. I’m reasonably sure you’re wrong about wage effects. But even if you’re right, remember that we have progressive taxation here, so the effects on taxes collected are the opposite of what you’re claiming. Imagine the SOE had 100 workers each paid 50k. It’s privatized and drops the wages of 90 workers to 40k, giving the remaining 10 workers a 90k pay increase to $140k. Their total PAYE bill goes WAY WAY UP, not down. Don’t believe me? IRD has an income tax calculator. http://www.ird.govt.nz/calculators/tool-name/tools-t/calculator-tax-rate.html Go use it. Each person on 50k submits $8,020 in total tax – a 16% average tax rate. So the egalitarian SOE has workers paying $802,000 in tax. The evil anti-egalitarian private company has 90 workers on $40k paying $6020 in tax each (541,800) and 10 workers on 140k each paying $37,120 in tax ($371,200) for a total tax bill of $913,000. Maybe you can reverse things if you assume that the ones getting the wage cuts have lots of kids so WFF skews things.
      4. While power prices went up subsequent to electricity market liberalisation, that’s rather more an effect of supply constraints and increased demand than of excess profit taking. We do have competitive generation markets, and some of those competitors are still SOEs.

  • Paul Walker asked “Secondly I’m not sure w[h]ere borrowing comes into this at all”. The Government’s main argument for selling the asset is that it needs the money.

    Paul Walker wrote “The empirical evidence, see the second link above, tells us that privately owned firm are generally more efficient than SOEs.”.

    I do not think the privatisation of AirNZ, BNZ, and NZRail improved New Zealand at all. In the case of NZRail for example, a privately run NZRail has no need to consider external benefits such as reduced pollution, less highway damages, or increased tourism, whereas the Government can run the business at reduced efficiency, and the country as a whole will be better off. Sure the company will look less efficient, but it is maximising the benefit to the country that is the key.

  • Brent, coming back to your original post, you stated “The important thing is that the Government’s lost income from selling the asset is more than the interest it would pay if it were to borrow the money instead”.

    My response is that this is not the important point at issue. The interest yield that the government has to pay on its (our) debt is not a fixed thing – the yield on NZ debt goes up and down as interest yields on other government’s borrowings go up and down, and, importantly, the interest yield varies with the perceived financial stability of the country.

    If the government sells some assets to avoid having to borrow, the country’s debt to GDP ratio will be unchanged. If the government keeps the assets and instead borrows the funds, the country’s debt to GDP ratio will get worse and will start to look even more like that of Greece or Portugal. That increase in debt ratio will tend to shift overseas lender perceptions of NZ in an adverse way and create a real risk that the relativity between NZ government bond yields and other country bond yields will change, not necessarily in our favour.

    If NZ government borrowing interest yields rise, this will impact not only on the funds borrowed for the specific projects intended, but for all NZ Government debt – remember that every year the government has to borrow billions of dollars just to roll over existing debt that is expiring, as well as to cover this year’s budget deficit. Moreover, higher government interest costs will mean that local body borrowing interest costs will rise, and so will all consumer interest costs – because in any country the government (having the ability to compulsorily tax people) is the lowest risk borrower and pays the lowest interest costs. If the government’s interest costs go up, so do everyone else’s.

    Unfortunately either Bill English doesn’t understand this, or, more likely, thinks the public won’t understand it.

Site Meter