Date created: 28 November 1996

Last modified: 18 November 1997

Maintained by: John Quiggin

John Quiggin

Sinking feeling over floats

The Canberra Times ,

July 10, 1995

The issue of privatisation has been hotly debated among academic economists recently. There is general agreement that the practice of using asset sales to reduce the measured budget deficit is completely fraudulent. Rather, it is appropriate to compare the loss of government business enterprise profits arising from privatisation with the interest savings that arise when the proceeds of privatisation are used to repay debt. It comes as a surprise to many to learn that the profits foregone are almost invariably greater, on average, than the interest saved. The debate is between those (including myself and Bob Walker of the University of NSW) who take this result at face value and conclude that privatisation is, in general, an unsound policy and those (including Simon Domberger of the Australian Graduate School of Management) who argue that reductions in public sector risk offset the loss of average income.

The debate is clouded by the fact that, particularly in Britain, privatisation has often been accompanied by politically motivated underpricing of shares. In the most extreme cases, such as that of British Telecom, share purchasers made profits of 86 per cent on the first day of trading and enterprises were sold for prices equivalent to two or three years' profits. In a recent exchange in the Australian Economic Review, Domberger and I agreed that gross politically motivated underpricing of this kind was a thing of the past and that future privatisations would not be as severely damaging to the interests of taxpayers as those in Britain had been.

Judging by the terms of the recent Qantas prospectus, it appears that we were both wrong. The terms of the Qantas float incorporate the worst features of British political privatisations, and introduce a new one, the 'loyalty bonus'.

First of all, the price has been set a rate which is low in relation to recent profits and very low in relation to projected future profits. The issue is estimated to yield a return of 12.5 per cent, without taking account of capital gains. If the government believes its own prospectus, it should certainly not be selling.

The price has been set low because the political costs of an undersubscribed issue, which can be represented as a 'failed' or 'botched' privatisation, are far greater than those of an oversubscribed issue with the shares immediately trading above their issue price. From the taxpayers point of view, this is the reverse of the truth. It is far worse to sell a valuable asset for less than its true worth than it is to ask a high price and end up not selling. In the second case, you are simply back where you started, but in the first case the loss is irretrievable.

Within the general context of underpricing, individual investors are offered a one-way bet. They cannot pay more than the market price determined by the institutional tenders, but they may well pay less. The obvious question for taxpayers is why their assets should be sold at a low price when other bidders are ready and willing to pay more. If, as seems likely, the issue is oversubscribed, the discount for individual investors could end up costing the taxpayers as much as $30 million.

Although its financial impact is probably smaller, the loyalty bonus is the most objectionable of all of the features of the Qantas float. The loyalty bonus has rightly been attacked by fund managers Prudential Assurance Co. for discriminating against large investors, or more precisely against the shareholders and policyholders of companies that participate in the institutional section of the float. Although it might seem equitable to give 'small shareholders' a better deal, this notion collapses on closer examination. There is no reason to suppose that the ultimate shareholders in, say, Prudential Assurance are any better off than the individual investors who participate in the public float.

More importantly, the loyalty bonus is giving away public money for no justifiable reason. Assuming that one-third of the shares go to individual investors who hold on to their shares and receive the loyalty bonus, the total outlay will be around $20 million dollars. This would be enough to fund ....., and is comparable to the amount outlaid in the famous 'sports rorts'. The emotive claim that the objective is to prevent 'profiteering' is in itself an admission that the shares are already underpriced. The appropriate remedy is to ask a higher price rather than to offer an even larger profit to anyone willing to wait twelve months to cash in.

What is striking about the loyalty bonus is the lack of any obvious party political motivation. The Thatcher government's desire to create petty capitalists could be justified as good old-fashioned pork-barrelling. Every recipient of underpriced British Telecom shares was a potential Conservative voter. But with the Australian conservative parties even more strongly supportive of privatisation than the government, it is unlikely that loyal Qantas shareholders will automatically become loyal Labor voters.

The absence of a party political motive does not imply that the decision to hand over public money to Qantas shareholders is not political. The entire policy establishment including the leadership of both political parties and the 'official family' (Treasury, Finance, the Reserve Bank, Industry Commission etc.) is dominated by advocates of privatisation and more generally of cutting back all aspects of the public sector. These policies are increasingly unpopular with the electorate as a whole and a failed privatisation would be damaging to the entire policy program. The loyalty bonus is an easy way of buying popular support for privatisation and 'micro-economic reform'.

No doubt it is too late to do anything about the Qantas float. But the giveaway of public assets must not be allowed to continue. Devices like loyalty bonuses and discounts for individuals should be banned. Any future privatisation should be preceded by a comprehensive cost-benefit analysis demonstrating that the financial gains to taxpayers more than offset the loss of government business enterprise profits.

John Quiggin is Professor of Economics at James Cook University and author of Great Expectations: Microeconomic reform and Australia, published by Allen & Unwin.

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