The mixed ownership model:
radical sell off or half-baked privatisation?
Sinclair Davidson
Privatisation
• Privatisation can be defined as the transfer of ownership rights in State
Owned Enterprise to the private sector.
– Note: not necessarily control rights.
– Privatisation is also associated with changes in:
– Market participation (liberalisation).
– Regulation (deregulation).
• First modern privatisation: Volkswagen 1961 (?)
– Australia sold its half share of the Commonwealth Oil Refinery to the
Anglo-Iranian Oil Company in 1952.
• Latest trend: British Petroleum 1977.
– But the sale of State property is not new.
– Much of the early privatisation trend was “denationalisation”.
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How Mrs Thatcher saw it
• First, we had to put the balances of the industries we wanted to sell in good
order.
• Second, I saw it as part of my purpose to have a policy which extended
ownership of capital more widely.
• Third, those companies which could not be floated on the stock market were
sold to companies who were willing to buy them at the best possible price.
• Fourth, some industries were so thoroughly outdated that they would have
cost too much money to modernize.
– Margaret Thatcher: Rebuilding an Enterprise Society Through Privatisation
Reason Foundation Annual Privatization Report 2006
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20 year history of privatisation
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New Zealand has been an active participant
• 34 Privatisations in 80s and 90s.
• None in noughties.
– Tranz Rail renationalised.
– Air New Zealand renationalised.
– Airline has survived but at huge cost
– Has Air New Zealand covered cost of capital?
• New Zealand government tended to privatise by means of trade sale
– Sale of asset to single buyer or consortium.
– Share market listings have been rare.
– Share market listing has advantage of sharing benefits going forward
but has potential for greater Principal-Agent problems.
– Trend in Europe is away from IPO model to the trade sale model.
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Previous New Zealand policy
• No attempt to favour bidders or establish a shareholder democracy. Sold
assets for the highest possible price.
• Reluctance to privatise firms not in contestable markets. Competition reform
preceded privatisation.
– Donald Brash 1996: 37
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Current New Zealand policy
• New Zealand government will partially privatise assets with following
objectives:
– freeing up capital for the Government to invest in other public assets,
without having to borrow to do so
– improving the pool of investments available to New Zealand investors and
deepening capital markets
– allowing the mixed ownership companies to access capital and grow
without depending entirely on the Government
– allowing for external oversight, which places sharper discipline and more
transparency on a company’s performance, increasing the incentive for
improved performance.
– Source: Budget Policy Statement 2012
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SOEs, efficiency, and financial development
• Jeffrey Wurgler, 2000, Financial markets and the allocation of capital, Journal
of Financial Economics, 58: 187 – 214.
– Financial markets improve the allocation of capital.
– Across 65 countries, those with developed financial sectors increase
investment more in their growing industries, and decrease investment
more in their declining industries, than those with undeveloped financial
sectors.
– The efficiency of capital allocation is:
– negatively correlated with the extent of state ownership in the economy,
– positively correlated with the amount of firm-specific information in
domestic stock returns, and
– positively correlated with the legal protection of minority investors.
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SOEs, efficiency and financial development
• where I is gross fixed capital formation, V is value added, i indexes
manufacturing industry, c indexes country, and t indexes year.
• New Zealand data: 1963 – 1990.
• Estimated ηc = 0.896 (ranked 3rd after Germany and Hong Kong).
• Excellent result but financial market development?
– not so good.
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SOEs, efficiency and financial development
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Why is privatisation so controversial?
• Privatisation interacts with Bryan Caplan’s voter biases:
– anti-market bias; a tendency to underestimate the economic benefits of the
market mechanism.
– anti-foreign bias; a tendency to underestimate the economic benefits of
interaction with foreigners.
– Make work bias; a tendency to underestimate the economic benefits of
conserving labour.
– pessimistic bias; a tendency to overestimate the severity of economic
problems and underestimate the performance of the economy.
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Why is privatisation so controversial?
• To use Thomas Sowell’s terminology – there is a conflict of visions.
– “people’s romance”.
• Privatisation goes to the very core of political debate:
– What is the role and function of the State?
– What is the role of the State in civil society?
– What is the role of the State in the economy?
• For those who believe the State should have a minimal role, privatisation is
(somewhat) uncontroversial.
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Why is privatisation so controversial?
• Privatisation is a jump from the YY or NY quadrant to the YN quadrant.
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Am I being unfair to professional economists?
• No – see Ronald Coase writing in 1960.
– Most economists seem to be unaware of all this. When they are prevented
from sleeping at night by the roar of jet planes overhead (publicly
authorized and perhaps publicly operated), are unable to think (or rest) in
the day because of the noise and vibration from passing trains (publicly
authorized and perhaps publicly operated), find it difficult to breathe
because of the odour from a local sewage farm (publicly authorized and
perhaps publicly operated) and are unable to escape because their
driveways are blocked by a road obstruction (without any doubt, publicly
devised), their nerves frayed and mental balance disturbed, they proceed
to declaim about the disadvantages of private enterprise and the need for
Government regulation.
• Economists, and policy-makers generally, have tended to over-estimate the
advantages which come from governmental intervention.
• James Buchanan makes similar points.
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Why is privatisation so controversial?
• Hayek has defined intellectuals as being rationalist.
– “That is all very well in practice, but it could never work in theory.”
• Why shouldn’t government ownership work just as well as private ownership?
– If not better?
• This takes us back to the Socialist Calculation Debate.
– The calculation debate centred on two questions.
– The “replication” hypothesis:
– is it possible for a socialist society, with common ownership of the
means of production, to use planning to replicate the performance of
a capitalist society, with private ownership of these means of
production?
– The “improvement” hypothesis:
– is it possible to do “better” than replication?
– Until the late 1980s economists widely accepted that answer to both
questions could be “yes”.
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Why is privatisation so controversial?
• Theoretical arguments for SOEs.
– Market Failure.
– Natural monopoly.
– Externality (not applicable here?)
– Asymmetric information.
– Sappington and Stiglitz fundamental theorem of privatisation:
when the market will do just as well as a benevolent government.
– Beware the fallacies of nirvana economics.
– The grass is greener on the other side.
– There can be a free lunch.
– People could be different.
– If governments were benevolent, social-welfare maximisers there
would be no need to privatise.
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Why is privatisation so controversial?
– Equity risk premium anomaly.
– New Zealand estimates: 3% - 7% (best guess 5.6%).
– Lally and Marsden 2002.
– New Zealand estimates: 5.5% - 7.4%.
– Lally and Marsden 2004.
– “If the equity premium is the result of imperfections in the private capital
market, there is a prima facie case to suggest that the appropriate rate
of discount for public-sector investments is that which would be
generated by a perfect capital market, rather than the observed rate
incorporating the anomalous equity premium.”
– Grant and Quiggin (2003: 2).
– “If there is no efficiency loss associated with public ownership, the
expected marginal return to public investment … dominates the
expected marginal return to private equity. … an expansion of public
investment is desirable”.
– Grant and Quiggin (2003: 14, emphasis added).
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Why is privatisation so controversial?
– Pursuit of Social Objectives.
– Model employer.
– Promote employment of minorities, women, etc.
– Promote economic activity in remote areas.
– Overcome Principal-Agent problems.
– Shareholders have diverse interests and lack incentives to monitor.
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Digression on Adam Smith
• What Adam Smith had to say about the Principal-Agent problem
– The directors of such companies, however, being the managers rather of
other people’s money than of their own, it cannot well be expected that
they should watch over it with the same anxious vigilance with which the
partners in a private copartnery frequently watch over their own. Like the
stewards of a rich man, they are apt to consider attention to small matters
as not for their master’s honour, and very easily give themselves a
dispensation from having it. Negligence and profusion, therefore, must
always prevail, more or less, in the management of the affairs of such a
company.
– Why would we expect this issue to be resolved in a bureaucracy as
opposed to a market?
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Why is privatisation so controversial?
• Theoretical arguments against SOEs.
– Pursuit of Social Objectives.
– Redistribution tends to lead to inefficiencies.
– Picking winners.
– Inadequate monitoring.
– Soft budget constraints.
– Weak incentives.
– Mises argues that entrepreneurs only make the decisions they do
because they are profit seeking and self-interested.
– Bureaucratic functions work well for routine management tasks but not
in dynamic economic environments.
• All up theoretical arguments appear indeterminate.
• It is the empirical record that is decisive.
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Why is privatisation so controversial?
• “… private ownership must be considered superior to state ownership in all
but the most narrowly defined fields or under very special circumstances.”
Megginson 2005: 52
• So we can accept that private firms are likely to dominate public firms in
terms of performance.
– But what about the privatisation process itself?
– We have to believe that government is incapable of realising value when
running a firm but is capable of realising value when selling that same firm.
– Does this really matter?
• “Almost all studies that examine post-privatization changes in output,
efficiency, profitability, capital investment spending, and leverage document
significant increases in the first four and significant declines in leverage.”
Megginson 2005: 152
• Is that good enough for everyone?
– No – detractors point to selection bias as explaining that sort of result.
• Weight of evidence: Privatisation works (on average, over time).
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Why is privatisation so controversial?
• In addition to:
– Voter biases.
– Conflict of vision.
– There is a promoters problem.
– The risk that corporate issuers sell bad securities to the public.
– This is always a risk that buyers face.
• These three issues inter-relate to each other in privatisation.
• Some privatised firms fail.
– Bad faith?
– Poor process?
– Poor business model?
– Poor economic model?
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What should government do?
• “After the public institutions and public works necessary for the defence of the
society, and for the administration of justice, …, the other works and
institutions of this kind are chiefly those for facilitating the commerce of the
society, and those for promoting the instruction of the people.”
– Adam Smith 1776: 964
• Facilitating the commerce of society could include SOEs, but …
“…those public institutions and those public works, which, though they may
be in the highest degree advantageous to a great society, are, however, of
such a nature that the profit could never repay the expense to any individual
or small number of individuals, and which it therefore cannot be expected
that any individual or small number of individuals should erect or maintain.”
– Adam Smith 1776: 963
– Example? – Sewers.
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What should government do?
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What should government do?
• What is the cost of public funds?
– Seems to be very controversial in the literature.
– Is the cost of public funds less than the cost of private funds?
– Market anomalies?
– Taxation?
– Ethical issues?
• There is a divide between welfare economists and financial economists as to
the appropriate methodology to even approach this issue.
• If we think that the required rate of return is a function of the risk of any
project, then the public cost of capital must be equal to the private cost of
capital for that project.
– What about deadweight costs of taxation?
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What should government do?
• Andrei Shleifer and others
• Trade-off:
– Disorder refers to the risk to
individuals and their property of
private expropriation in such
forms as banditry, murder, theft,
violation of agreements, torts, or
monopoly pricing.
– Dictatorship refers to the risk to
individuals and their property of
expropriation by the state and its
agents in such forms as murder,
taxation, or violation of property.
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What should government do?
• LLS (2002) look at government
ownership of banks.
• DMNS (2003) look at government
ownership of media.
• Development Hypothesis
– Alexander Gerschenkron – Bank
finance is important in
economies with under-developed
financial systems.
• Public interest theory
– Information is a public good.
– State media ownership can
expose the public to less biased,
more complete, and more
accurate information than it could
obtain with private ownership.
• Political Hypothesis.
– Government controls banks to
capture private benefits of
control and to direct those
benefits to supporters and
friends.
• In a sample of 92 economies LLS
find that the evidence tends to
support the Political Hypothesis.
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• Political Hypothesis.
– Government-owned media outlet
would distort and manipulate
information to entrench the
incumbent politicians.
• In a sample of 97 economies DMNS
find that the evidence tends to
support the public choice theory.
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What should government do?
• Rahn Curve (or Armey Curve)
• Developed by Richard Rahn in 1988.
– Originally had economic growth on
vertical axis.
– Once governments provide essential
goods and services “economic growth
rates will inevitably decline as the
naturally expanding government adopts
new spending programs with revenues
absconded from over taxed income
producing factors owned by private
citizens”.
• Richard ‘Dick’ Armey in 1995.
– “[W]e need government to keep the
peace, prevent anarchy, run the national
parks, and maybe do the odd job here
and there. To this extent government
bears some resemblance to its
constitutional description as promoter of
the general welfare and securer of the
blessings of liberty.”
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Goals of privatisation
• Raise revenue for the State.
• Promote economic efficiency.
• Reduce government intervention in the economy.
• Promote wider share ownership.
• Introduce more competition into the economy.
• Subject SOEs to market discipline.
Megginson (2005: 14)
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Touting Privatisation
• Increased Efficiency.
– SOEs inefficient and the private sector can do better.
– Government can spend proceeds more effectively in other areas.
– Government could accelerate spending plans.
– Government could invest in other ventures.
• Public Finance.
– The proceeds could reduce the budget deficit.
– The proceeds could reduce the government debt.
– The proceeds could reduce the interest charges on government debt.
– The proceeds could assist to maintain (or improve) the government debt
rating.
• Sundry.
– Government shouldn’t be involved in risky business.
– Price will fall in future.
– Other government’s have privatised already.
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Popular views of privatisation
• Privatisation is said to have:
– produced massive wealth transfers
within the community.
– conferred privileges on insiders.
– extended share ownership.
– reduced government costs in some
areas.
– led to the loss of services to the
community.
– led to loss of jobs in government.
– led to spurious claims of savings to
taxpayers.
– risked the marginalisation of rural
communities.
– seen government-owned state based
monopolies dismantled.
– created powerful private monopolies.
– contributed to environmental
damage.
– eroded public sector accountability.
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Popular views of privatisation
• What is going on here? What is the problem?
The truth is that capitalism has not only multiplied population figures but at
the same time improved the people’s standard of living in an unprecedented
way. Neither economic thinking nor historical experience suggest that any
other social system could be as beneficial to the masses as capitalism. The
results speak for themselves. The market economy needs no apologists
and propagandists. It can apply to itself the words of Sir Christopher
Wren’s epitaph in St. Paul’s: Si monumentum requiris, circumspice.
Ludwig von Mises, 1949, Human Action, pg. 854.
• If you seek his monument, look around.
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How to privatise?
Trade Sales.
IPO (share issue privatisation).
• Advantages.
– Speed.
• Advantages.
– Revenue.
– Revenue (?).
– Increased FDI.
– Promotes stock market development.
– Transparent.
• Disadvantages.
– Do not promote stock market
development.
– Reduce liquidity.
– Non-transparent.
– Possibility of corruption.
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• Disadvantages.
– Costly and slow.
– Does not promote FDI.
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How to privatise?
• Choice between trade sale and IPO.
– Market considerations.
– IPO is more likely:
– the less developed capital markets are.
– the greater the level of income equality.
– Firm-specific considerations.
– IPO is more likely:
– for larger SOEs.
– for more profitable SOEs.
– Political considerations.
– Trade sales more likely in those economies with strong property right
protections.
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Why do government’s privatise?
• Privatisation is associated with:
– high levels of public debt.
– fiscal imbalances lead to privatisation.
– A well-functioning domestic stock market.
– “hot” IPO markets can be used to time floats.
– right-wing political parties.
– diffusing the benefits of capitalism.
• Money and ideology.
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Assessment
• Increased efficiency.
– Hard to see any downside here.
– Some privatised firms may not survive over time.
– “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)”.
– Roger Kerr February 25, 2011.
– “In my view, the main issue is transferring the business from public to
private ownership to reap the efficiency gains”.
– Roger Kerr April 14, 2011.
– In this view what matters is that the ownership transfer occurs. How it
occurs and what happens to the proceeds is of lesser importance.
– Should privatisation occur via voucher schemes?
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Assessment
• Privatising to pay off public debt?
– “This case is valid but it is a secondary argument”.
– Roger Kerr February 25, 2011.
– Most western economies have public spending problems.
– Massive increases in debt and deficit.
– Sale of public assets validates past expenditure.
– Problem is that public assets are finite while capacity for debt and deficit is
infinite.
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Privatising to pay off public debt?
• Australian Financial Review June 4, 2013 (pg. 10)
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Privatising to pay off public debt?
• Selling public assets to pay for irresponsible spending sprees may get
economies out of debt and deficit holes now, but without a fiscal constitution
that restrains future debt and deficit the underlying problem remains.
• Using privatisation proceeds to validate past consumption is a case of eating
seed capital.
• Privatising to pay off the national equivalent of “wine, women, and song”
doesn’t address the spending problem.
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Fiscal constitution
• Informal fiscal constitution – a widely-shared and broadly-measurable
consensus about how collective goods and services are to be spent.
– Buchanan and Wagner call this the “old time fiscal religion”.
– “Frugality, not profligacy, was the cardinal virtue, and this norm assumed
practical shape in the widely shared principle that public budgets should
be in balance, if not in surplus, and that deficits were to be tolerated only in
extraordinary circumstances.”
• That informal consensus has broken down.
– Not everywhere – Australian voters still believe in the old-time religion.
– New Zealand?
• Majority rule is not a sufficient constraint on excessive expenditure, taxation,
and borrowing.
• Need for explicit constraints.
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Conclusions
• Mixed ownership model is a pathway to full-privatisation.
• Privatisation “works” – by itself.
• Privatisation works better when embedded in a reform program.
• Past privatisation wave was associated with liberalisation and deregulation.
– Very radical at the time
• A coming privatisation wave?
– What is the reform agenda?
• Proposal
– Link privatisation with need for on-going fiscal reform.
– How to restrain Leviathan?
• New Zealand’s privatisation is not radical enough.
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Select Bibliography
• Bernardo Bortolotti, Marcella Fantini, Domenico Siniscalco, 2003,
Privatisation around the world: evidence from panel data, Journal of Public
Economics 88: 305 – 332.
• James Buchanan and Richard Wagner, 1977, Democracy in Deficit: The
Political Legacy of Lord Keynes, Liberty Fund.
• William Megginson, 2005, The financial economics of privatization, Oxford
University Press.
• William Megginson, Robert Nash, Jeffry Netter and Annette Poulsen, 2004,
The Choice of Private versus Public Capital Markets: Evidence from
Privatizations, The Journal of Finance, 59(6): 2835 – 2870.
• Bob Walker and Betty Walker, 2000, Privatisation: Selloff of sell out?, ABC
Books.
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