25/11/96

Canberra Bulletin of Public Administration

PO Box 3147

BMDC ACT 2617

Privatisation - the financial implications: review

John Quiggin

Centre for Economic Policy Research,

Australian National University

and

Department of Economics

James Cook University

TOWNSVILLE, QLD 4811

Communications to John Quiggin at

(Internet) jquiggin@coombs.anu.edu.au

FAX + 61 77 814149

Phone + 61 77 81 5387

+ 61 77 251269

Privatisation - the financial implications: review

Mnay different justifications have been offered for privatisation, but the most consistent theme is the claim that privatisation will improve public finances. However, this claim has rarely been presented in a coherent fashion or subject to critical scrutiny. It is with anticipation therefore, that one opens a volume entitled Privatisation: The Financial Implications. The book begins well. Peter Forsyth dismisses the notion that the improvement in the measured budget deficit associated with privatisation represents a genuine reduction in the budget deficit. With this fallacy disposed of, the way is clear for an assessment of whether privatisation actually improves the government's fiscal position. Unfortunately, the issue is not touched again until the penultimate page of the book when Richard Shallcrass raises the question 'Does financial analysis of the impact of these privatisations on debt financing justify the loss of value to the Crown's balance sheet? In other words, are the net interest payments avoided larger than the net dividends foregone?'. Except that it is appropriate to consider total profits foregone (that is, to count profits retained in the enterprise as well as dividends) this is an admirably succinct statement of the basic problem a book of this kind should have addressed. Shallcrass continues 'Comprehensive analysis has yet to furnish an answer'. This statement can only be interpreted as saying that the necessary analysis had not been undertaken when the book was written, rather than that a comprehensive analysis had been commenced with indecisive results.

In fact, empirical analysis of this question reveals results that are too clear-cut to admit any doubt. At least in the English-speaking countries, privatisation has never yielded savings in public debt interest sufficient to offset the loss of profits of government business enterprises (Quiggin 1995). As is observed by Domberger (1995), this fact does not constitute an open-and-shut case against privatisation. However, it surely represents the appropriate starting point for any study of the financial implications of privatisation. From this starting point it would be necessary to assess whether the loss in public sector income associated with privatisation is justified by the associated reduction in public sector exposure to risk. Unfortunately, none of the contributions to this book even begin to assess this issue.

Of th contributions sandwiched between Forsyth and Shallcrass, two are primarily technical. The contributions by Grant and King (on auction theory) and by Lee and Martini (on investment appraisal) cover topics that are relevant to privatisation (in that privatisation involves both investment decisions and the sale of assets) but none of their content is specific to the issue of privatisation.

The remaining papers deal with the mechanics of privatisation, usually taking an uncirtical approach. The tone is set by Ewan Waterman, who quotes a study of twelve privatisations finding that 'consumers benefited, or were no worse off, in nine of the twelve cases' (p29). This claim is logically consistent with the possibility that 'consumers suffered, or were no better off, in nine of the twelve cases'. The reader has no way of knowing what the studies actually said, but the bias in presentation is indicative.

Michael Lawriwsky and Charles Kiefel offer what purports to be a strategic planning model for privatisation. The authors observe that opponents of privatisation will bring economic arguments to bear such as the claim that 'privatisation will result in the loss of dividend payments to the people of Victoria.' However, they apparently judge that, in a strategic planning context, it is not necessary to respond to these arguments. Certainly they do not even consider the possibility that such arguments might be valid.

John Curtis discusses offering mechanisms in privatisation, focusing almost exclusively on the case of public flotation. The information presented in the article is useful, but there is no mention of critical issues like the almost universal tendency to underpricing in privatisations using the publci float approach. (The editors observe the intriguing fact that private sector flotations in the US also appear to display underpricing, though this is not on the scale observed, for example in United Kingdom privatisations).

Balfour discusses the privatisation of the Commonwealth Bank. As might be expected from a senior official of the bank in question, the approach is fairly uncritical. It is noteworthy that the only benefit of privatisation is the hypothetical one of capital market discipline. Given the fact that the Commonwealth, like the major private banks, is regarded by the Reserve Bank as 'too big to fail', one might suggest that the likelihood of market discipline being imposed on the Commonwealth Bank in any direct fashion is quite remote.

The article by Stephen Morris on privatisation in a Federal system is one of the best in the book. It deals with the problems associated with Federal-State taxation and borrowing arrangements and shows how these arrangements distort the incentives facing State governments. On the one hand the exemption of State government business enterprises from company taxes stacks the deck against privatisation. On the other hand, the restrictions in aggregate public sector borrowing encourage resort to pseudo-private arrangements that circumvent the guidelines. The result as Morris observes, is a 'proliferation of BOT {Build, Operate and Transfer] schemes which may not merely fail to deliver efficiency benefits, but may make matters worse'.

Peter Greig examines the politically loaded issue of privatisation and Victoria's credit rating. He suggests that a sale of $16 billion worth of debt, combined with efficiency improvements would raise Victoria's credit rating from AA to AAA, implying a saving of 0.3 percentage points in the interest rate payable on state debt (abotu $50 million a year on the remaining debt). Although Greig does not mention it, the obvious implication is one of using a whale to catch a minnow. Even a 3 per cent commission on the privatisation would wipe out a decade's worth of the interest savings associated with a AAA rating.

Alan Tregilgas addresses the issue of risk, but does not discuss the large literature indicating that private sector risk premiums are much higher than would be expected from a perfect capital market. His conclusion (p133) that 'only when credit risk is a prue reflection of underlying operating conditions and financial risks, and is unaffected by ownership or regulatory support, will the cost of capital more closely reflect the udnerlying economic conditions' would be more convincing if it could be shown that private sector capital markets in fact do a good job of reflecitng underlying economic conditions.

Finally, David Johnson discusses the issue of rent-seeking in government business enterprises, but does not find any real evidence to suppor the rent-seeking hypothesis.

What is striking about this volume is the fact that the proposition that privatisation is financially beneficial to governments is taken as given by most of the contributors, despite the absence of any evidence to support it. It is perhaps relevant to observe that many decisions to nationalise private industries were undertaken in the past on the basis of similarly inadequate evidence. Although the fashionable ideologies have changed, the dominance of ideology over rational analysis has remained constant.

Despite its failure to address the basic issues, the volume does collect a number of useful contributions to the literature on privatisation and provides a starting point for debate on the fiscal benefits and costs of this fashionable policy.

Davis, Kevin and Harper, Ian (eds) (1993), Privatisation: The financial implications, Allen and Unwin, Sydney.

ppx111 + 174 No RRP

References

Quiggin, J. (1995), 'Does privatisation pay ?', Australian Economic Review 95(2), 23-42.

Domberger, S. (1995), 'What does privatisation achieve-A comment on Quiggin ?', Australian Economic Review 95(2), 43-7.