Selling the family jewels to “save” the Budget

ScreenHunter_61 Oct. 23 07.25

By Leith van Onselen

There are a few articles out today endorsing selling Australia’s public assets in order to fund new infrastructure investment.

The AFR seems to be leading the cheerleading, with Tony Shepherd arguing that public assets are generally better-off in private hands, and that the proceeds of such sales can be leveraged into new nation-building projects:

Experience has shown that the private sector can improve service delivery and deliver quality infrastructure more cost effectively, provided standards are set and contracted…

By our estimate, the task to deliver on infrastructure needs across the economy over the next decade could amount to more than $760 billion in real private and public investment, or about 4 per cent of GDP annually…

Infrastructure Australia has identified over $100 billion worth of equity in commercial infrastructure assets that governments can recycle. Governments should be speeding up privatisation of appropriate public assets, and hypothecating the proceeds into dedicated federal, state and territory infrastructure. We should be seeing a virtuous circle where government funds are used to get good projects started and, once the asset is mature, it is then sold to the private sector.

Recycling capital by selling mature, publicly owned infrastructure assets to the private sector would allow governments to reinvest the proceeds in new green field projects. Of course, care must be taken in any privatisation to protect the community interest in terms of cost, quality of service and expansion as demand grows.

From a purely financial perspective, selling-off public assets does not necessarily benefit taxpayers – at least in the longer-term. While the Government receives funds up-front, it loses the ongoing cash flow (dividend stream) from the assets – in effect substituting a future income stream for a smaller lump-sum. Whether such asset sales are, therefore, beneficial depends on whether the upfront funds received by the Government outweighs the expected net present value of future dividends. If not, then the sale is likely to be detrimental to long-term budget finances.

The issue then turns to whether privatisation is beneficial from an efficiency or equity perspective. Again, the issue is not clear-cut. Many would argue that market structure and the degree of competition in the marketplace is far more important in determining whether a particular business is run efficiently, rather than the ownership structure (i.e. government-owned or private).

In general, there is a stronger case to keep natural monopolies, such as essential utilities, in public hands in order to prevent a private player from price-gouging and/or to to stop inefficient duplication of the infrastructure. The government can also better ensure access to poorer members of the community, thereby improving social outcomes.

On the other hand, there is generally a better case to privatise government-owned assets (businesses) that compete directly with private players, since the degree of market power is lower, consumers have choice, and the opportunities to price gouge are minimised. Medibank Private, which is high on the list of potential privatisations, seems to fit this mold.

In short, the issues around whether privatisation is good from a financial, efficiency, and equity perspective are complex, and a case-by-case approach is required, rather than perceiving one form of ownership as necessarily good or bad.

As an aside, the whole issue of Australia’s infrastructure deficit does also raise doubts over Australia’s high immigration program, which is placing greater strain on the pre-existing stock of infrastructure and risks lowering productivity as the economy pushes against capacity constraints.

Given the dubious economic arguments in favour of high immigration, and the increased infrastructure requirements such immigration demands, surely any debate over funding infrastructure should also be a debate over population policy?

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Unconventional Economist
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  1. “… with Tony Shepherd arguing that public assets are generally better-off in private hands”

    love it!

    Are we going to give the Privatisation horse another flog? It’s seems like it was only just a few years ago when it was all the rage. Fashion cycles are running so much more quickly now it seems.

    Nothing wrong with a government making some profit from it’s investments.

    “Experience has shown that the private sector can improve service delivery”
    Anyone using Optus?

    • Yes, it would be good if statements such as “Experience has shown that the private sector can improve service delivery” were backed by evidence rather than baldly asserted.

    • “…Anyone used Optus?” Or Telstra? Or Qantas? Or perhaps the experience of SA Water which had its operations privatised in a much vaunted political statement by a former SA Government, and which has quietly been brought back into the public fold because of some, er, problems.

      There were also a number of state insurance bodies and banks that were privatised. Is there any ‘evidence’ of increases in service standards and decreases in fees?

      That does not mean that from time to time privatisation should not be carried out. However, experience does not show that it is a good idea in many cases – witness the cases above.

  2. I refer readers to “Morris’s Laws of Privatisation”.


    7. As a rule of thumb, government is the cheapest source of finance even after adjusting for business and default risks. In equity and in debt, market capitalisation and issue size respectively have “liquidity” effects, with the largest capitalisation firms and largest issuers of debt able raise finance more cheaply than smaller firms and issuers, or those with idiosyncratic risks, even after adjusting for those risks.

    8. As a rule of thumb, people tend to underestimate the value of control and flexibility, often ignoring them altogether. Transferring control to another entity – or forgoing the flexibility to deal with revenues or assets in the future – represents a real loss. This is especially true in integrated businesses or networks where transferring control of one part may effectively mean transferring control of all.

    9. As a rule of thumb, privatisation of an irreducible monopoly improves internal efficiency at the expense of allocative efficiency. Attempting to restore allocative efficiency through regulation tends to reduce internal efficiency again.

    10. As a rule of thumb, privatised monopolies seek to capture regulators and governments to improve the terms of their regulation. In dealing with regulators and governments, private monopolists have the advantage of information asymmetry and incumbency.

    11. As a rule of thumb, tax farmers seek to renegotiate the terms of their farm. The advantage of incumbency allows them to present governments with a “take-it-or-leave” proposal.

    12. As a rule of thumb, where an industry is capital intensive and – whether it be publicly owned or privately owned – the investment decisions are ultimately made by the government (as in most infrastructure businesses, and many businesses in which externalities and network effects are significant) finance costs are of overriding importance. In the absence of identifiable real efficiencies there is little to be gained by privatisation.

    13. As a rule of thumb, purely financial transactions and tax farming arrangements (selling forward revenue) incur liquidity inefficiencies with no offsetting real efficiencies and there is little to be gained by privatisation.

    14. As a rule of thumb, in the absence of identifiable real efficiencies it is preferable to retain an irreducible monopoly in the public sector and contract out its individual functions, and it is preferable to retain revenue streams within the public sector and finance them with the most liquid government debt.

    15. As a rule of thumb, under a system of purely elective government, the proceeds of privatisation (including both cash and repayment of existing public debt) will be squandered by politicians trying to buy votes. The squandering may occur under the government or party responsible for the privatisation or it may occur under a subsequent government or party.

    16. As a rule of thumb, an “independent” financial adviser, economic adviser, or probity auditor will always find a way to justify a proposal which is highly desired by the politicians or government officials who appointed him or her.

    • Good post. Shepard’s comments are disingenuous regarding the so called efficiency of privatised companies and the benefits as you allude to.

      The fiasco in the UK regarding power generation or lack off is of interest. The privatised companies will not take the risk to build new generating capacity unless they get massive guarantees from the government and then they will use expensive debt from the banks.

  3. Goodness Leith you need to get out more, take a flight up to Sydney and prepare to enjoy the delights of their private airport, its modern, no thats the wrong word, efficient? well not really, cheap?..that’d be a laugh…ummm there must be something good I can say about it… no on second thoughts there not its private and its pathetic. A complete embarrassment, I’m always our Chinese Re buyers dont get back on the plane and just leave.

    There are good societal reasons why certain critical infrastructure belongs in the public sphere all this PPP BS serves only one master and that is not the Australian people or their best interests.

  4. Productivity Commission offers some reasonable evidence of the virtue of privatised electricity networks -

    see chpts 6-7

    • This is a typical Productivity Commissiom report which is required to reach a pre-determined conclusion.

      “Only a few studies have examined the privatisation of network businesses alone — and these have consistently shown improvements in performance. However, our preliminary reading of the remaining literature on privatisation is that it mostly does not control for other coincident events, which confuse estimates of the impacts of privatisation of network businesses with other changes. In many instances, privatisation was associated with broader liberalisation of the electricity sector, particularly changes in regulatory arrangements and vertical separation of generation and retailing from network provision.”

      “As an example, in the United Kingdom, Crouch (2006) concluded:

      This system has worked well since privatisation. Costs have fallen significantly, distribution charges to domestic customers have reduced by 50% in real terms and companies have broadly delivered the requirements that have been placed on them to the benefit of consumers, including improvements in the quality and security of supply. However, much of this gain would have reflected the joint implementation of CPI-x regulation and privatisation.

      Despite this resounding qualification, the Commission came to an unequivocal conclusion that:

      “State and territory governments should privatise their government-owned network businesses.”

      The report places an overwhelming empahasis on the internal efficiency of privatised networks. Internal efficiency may be expected to improve under private ownership (especially when there is poor regulation of allocative inefficiencies). Moreover, it is likely to be manifest in the period immediately following privatisation – the period considered by the Commission – as private owners seek to cut costs.

      Allocative efficiency concerns play out over a longer term as capital expenditure is required to expand the network.

      The Commission does refer to capital cost per kilometre of line length, but does not consider ways in which that might be addressed (turnkey contracting out of construction, build-finance-transfer, and/or franchised maintenance contracts) other than through privatisation of the entire entity.

      The range of options is deliberately constrained to avoid the possibility of arriving at a conclusion contrary to that which they are expected to reach. This is a very common tactic in such reports.

      There was no consideration of the long run reliability of the United States electricity system.

      The report simply assumes that regulation will work perfectly in the long run to prevent any deterioration of allocative efficiency:

      “However, regardless of ownership, all network businesses in Australia are subject to the National Electricity Rules, which constrain the exercise of market power.”

      Regulatory and political capture (which defines Australian economic activity) is simply assumed to be non-existent.

      It is one of the ironies of those who hold that (or who have been told to conclude that) the state is incapable of performing any tasks properly, that they hold the state to be capable of perfectly regulating private monopolists in the long run!!